UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended July 31, 2015

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 of organization)
(I.R.S. Employer Identification No.)
    
800 Gessner, Suite 375, Houston, TX
 77024
(Address of Principal Executive Offices)
 (Zip Code)

(713) 970-1590
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:

Common Stock, Par Value $0.001
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Act. Yes ☐ No ☒

Indicate by check mark whether the registrant (1) 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 ☒  No ☐

Indicate by checkmark 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒  No ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

Indicate by checkmark 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.

Large accelerated filer ☐
Accelerated filer ☐
Non-accelerated filer ☐ (do not check if a smaller reporting company)
Smaller reporting company ☒

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant computed by reference to the price at which the registrant’s common equity was last sold, as of January 31, 2015 the last day of the registrant’s most recently completed second fiscal quarter) was approximately $2,981,282.

The registrant had 24,258,742 shares of common stock outstanding as of November 10, 2015.
 



FORWARD LOOKING STATEMENTS

This annual report contains forward-looking statements that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may”, “should”, “expect”, “plan”, “intend”, “anticipate”, “believe”, “estimate”, “predict”, “potential” or “continue”, the negative of such terms or other comparable terminology. In evaluating these statements, you should consider various factors, including the assumptions, risks and uncertainties outlined in this annual report under “Risk Factors”. These factors or any of them may cause our actual results to differ materially from any forward-looking statement made in this annual report. Forward-looking statements in this annual report include, among others, statements regarding:

our capital needs;
business plans; and
expectations.

While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect our current judgment regarding future events, our actual results will likely vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested herein. Some of the risks and assumptions include, but are not limited to:

our need for additional financing;
our exploration activities may not result in commercially exploitable quantities of oil and gas on our properties;
the risks inherent in the exploration for oil and gas such as weather, accidents, equipment failures and governmental restrictions;
our limited operating history;
our history of operating losses;
the potential for environmental damage;
the competitive environment in which we operate;
the level of government regulation, including environmental regulation;
changes in governmental regulation and administrative practices;
our dependence on key personnel;
conflicts of interest of our directors and officers;
our ability to fully implement our business plan;
our ability to effectively manage our growth; and
other regulatory, legislative and judicial developments.

We advise the reader that these cautionary remarks expressly qualify in their entirety all forward-looking statements attributable to us or persons acting on our behalf. Important factors that you should also consider, include, but are not limited to, the factors discussed under “Risk Factors” in this annual report.

The forward-looking statements in this annual report are made as of the date of this annual report and we do not intend or undertake to update any of the forward-looking statements to conform these statements to actual results, except as required by applicable law, including the securities laws of the United States.

Certain abbreviations and oil and gas industry terms used throughout this Annual Report are described and defined in greater detail under “Glossary of Oil and Natural Gas Terms” beginning on page 13, and readers are encouraged to review that section.

AVAILABLE INFORMATION
 
Hydrocarb Energy Corp. files annual, quarterly and current reports, proxy statements, and other information with the Securities and Exchange Commission (the “SEC”). You may read and copy documents referred to in this Annual Report on Form 10-K that have been filed with the SEC at the SEC’s Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. You can also obtain copies of our SEC filings by going to the SEC’s website at http://www.sec.gov.

REFERENCES

As used in this annual report: (i) the terms “we”, “us”, “our”, “HEC”, “Hydrocarb” and the “Company” mean Hydrocarb Energy Corp.; (ii) “SEC” refers to the Securities and Exchange Commission; (iii) “Securities Act” refers to the United States Securities Act of 1933, as amended; (iv) “Exchange Act” refers to the United States Securities Exchange Act of 1934, as amended; and (v) all dollar amounts refer to United States dollars unless otherwise indicated.
 
ii

TABLE OF CONTENTS

PART I
     
ITEM 1.
1
     
ITEM 1A.
20
     
ITEM 1B.
42
     
ITEM 2.
42
     
ITEM 3.
43
     
ITEM 4.
43
     
PART II
     
ITEM 5.
44
     
ITEM 6.
50
     
ITEM 7.
50
     
ITEM 7A.
60
     
ITEM 8.
60
     
ITEM 9.
116
     
ITEM 9A.
116
     
ITEM 9B.
116
     
PART III
     
ITEM 10.
119
     
ITEM 11.
124
     
ITEM 12.
129
     
ITEM 13.
131
     
ITEM 14.
140
     
PART IV
     
ITEM 15.
142
 
ITEM 1.
BUSINESS
 
Corporate History and Organization

We are Hydrocarb Energy Corp., incorporated in the state of Nevada. We have 1,000,000,000 shares of common stock and 100,000,000 shares of preferred stock authorized.  While working towards plans and expectations of being listed on a major stock exchange, we currently trade on the OTCQB Market under the stock symbol “HECC”.

We were incorporated under the laws of the State of Nevada on April 12, 2005 under the name “Carlin Gold Corporation”. On July 19, 2005, we changed our name to “Nevada Gold Corp.” On October 18, 2005, we changed our name to “Gulf States Energy, Inc.” and increased our authorized capital from 100,000,000 shares of common stock to 500,000,000 shares of common stock, par value $0.001 per share. On September 5, 2006, we changed our name to “Strategic American Oil Corporation”. On April 4, 2012 we completed a one for twenty-five (1:25) reverse stock split and as a result our authorized capital decreased from 500,000,000 shares of common stock to 20,000,000 shares of common stock. Also, effective April 4, 2012, we changed our name to “Duma Energy Corp.” Effective May 16, 2012, we increased our authorized capital from 20,000,000 shares to 500,000,000 shares of common stock. Effective November 29, 2013, we increased the number of our authorized shares of common stock from 500,000,000 to 1,000,000,000 shares. Effective February 18, 2014, we changed our name from Duma Energy Corp. to Hydrocarb Energy Corp. Effective on May 8, 2014, we affected a one for three (1:3) reverse split of our authorized common stock and a corresponding one for three (1:3) reverse split of our outstanding common stock setting our authorized shares of common stock to 333,333,333 shares. Effective September 28, 2015, the Company filed a Certificate of Amendment to its Articles of Incorporation with the Secretary of State of Nevada, to (1) affect an amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of the Company’s common stock to 1,000,000,000 shares; (2) affect an amendment to the Company’s Articles of Incorporation to authorize 100,000,000 shares of “blank check” preferred stock (the “Blank Check Preferred Amendment”); (3) designate 10,000 shares of Series A 7% Convertible Voting Preferred Stock (the “Series A Amendment”); and (4) designate 35,000 shares of Series B Convertible Preferred Stock (the “Series B Amendment”), each of which amendments were approved by the stockholders of the Company at the Annual Meeting of Shareholders of the Company held on September 28, 2015.  Previously effective on September 21, 2015, the Company filed a Certificate of Correction with the Secretary of State of Nevada, which cancelled and rescinded in its entirety, the previously filed Series A 7% Convertible Voting Preferred Stock designation filed by the Board of Directors without stockholder approval on December 2, 2013.

Pursuant to the Blank Check Preferred Amendment, up to 100,000,000 shares of preferred stock of the Company may be issued from time to time in one or more series, each of which will have such distinctive designation or title as may be determined by the Board of Directors of the Company prior to the issuance of any shares thereof. Preferred stock will have such voting powers, full or limited, or no voting powers, and such preferences and relative, participating, optional or other special rights and such qualifications, limitations or restrictions thereof, as shall be stated in such resolution or resolutions providing for the issue of such class or series of preferred stock as may be adopted from time to time by the Board of Directors prior to the issuance of any shares thereof.

We own 100% of the issued and outstanding share capital of (i) Penasco Petroleum Inc., a Nevada corporation, (ii) Galveston Bay Energy, LLC, a Texas limited liability company, (iii) SPE Navigation I, LLC, a Nevada limited liability company, (iv) Namibia Exploration, Inc., a Nevada corporation, (v) Hydrocarb Corporation, a Nevada corporation, (vi) Hydrocarb Texas Corporation, a Texas corporation, and (vii) Hydrocarb Namibia Energy (Pty) Limited, a company chartered in the Republic of Namibia. In addition, we own 95% of the issued and outstanding share capital of Otaiba Hydrocarb LLC, a United Arab Emirates limited liability corporation.

Our principal offices are located at 800 Gessner, Suite 375, Houston, Texas, 77024. Our telephone number is (713) 970-1590 and our fax number is (713) 970-1591. We maintain a website at http://www.hydrocarb.com. Information on our web site is not part of this filing, and we do not desire to incorporate by reference such information herein.
 
General

Our corporate mission statement is:
 
To attempt to realize extraordinary shareholder value as a frontier exploration and production company that continually enhances its domestic reserves and production while internationally achieving new world class petroleum discoveries.

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. As of July 31, 2015, we maintain developed acreage offshore in Texas. As of July 31, 2015, we were producing oil and gas from our working interest in Galveston Bay, Texas. During September 2012, we acquired, through the acquisition of Namibia Exploration Inc., a 39% non-operated working interest in a concession located onshore in Namibia, Africa. During December 2013, with our acquisition of Hydrocarb Corporation, we acquired a 51% working interest in this onshore Namibia, Africa concession and now own a 90% working interest (100% cost responsibility) in this concession.

As part of our ongoing business strategy, we continue to review and evaluate acquisition opportunities in the continental United States and internationally.

Exploration and Production Activities

Our oil and gas interests as of July 31, 2015 were as follows:

Producing properties

Galveston Bay, Texas

Through our subsidiary, Galveston Bay Energy, LLC (“GBE”), we hold majority interests (approximately 93% working interest) and operate four fields in the shallow waters of Galveston Bay which is Southeast of Houston, Texas. Currently, we are producing the four fields that were acquired with GBE. The fields were shut-in in September 2008 due to a direct hit from Hurricane Ike. The then-owner went into bankruptcy and the properties were purchased out of bankruptcy by a private seller who performed reconstruction work on the fields and later sold them to us.

The Welder Lease (Barge Canal), Texas

We previously owned a 100% working interest (72.5% net revenue interest) in approximately 81 acres of an oil and gas lease (the “Welder Lease”) located in Calhoun County, Texas. One of the wells is an oil well requiring gas lift to produce and the other well is a naturally flowing gas well. A third well is utilized for salt water disposal. These wells were sold as of March 31, 2014.

Palacios Prospect, Texas

In September 2011, we purchased a non-operated working interest in mineral leases covering 460 acres onshore in Duval County, Texas. Our working interest in the lease area is 6.70732% to the casing point of the first well drilled and 5.5% after the casing point of the first well and for subsequent operations in the lease area. Our net revenue interest in the prospect is 4.125%. In April 2012, the operator successfully completed the Palacios #1 well, which produces primarily natural gas. This well was sold in September of 2013.

Illinois

In January 2011, we entered into a farmout agreement covering our 10% working interest in multiple leases in or near Markham City, Illinois. Core Minerals Management II, LLC (“Core”) operates the properties in accordance with this farmout agreement. After payout of the property ($1,350,000 or 29,000 barrels of oil, whichever comes first) provided that we hold less than 25% working interest in the property at payout, our working interest will be adjusted to 25%. During fiscal 2012, the operator drilled wells in the contract area and commenced a pilot waterflood project to re-pressurize the reservoir and enhance recovery of oil from the area. The wells in the project area produce oil. These wells were sold in September of 2013.
 
In September 2013, we conveyed our interest in the Illinois and Palacios properties to Carter E & P, LLC, a company owned by our former Vice President of Operations, as described in greater detail below under “Part II - Item 13. Certain Relationships and Related Transactions and Director Independence.”

Unproved property – Namibia

Through our subsidiaries, Namibia Exploration, Inc. (“NEI”) and Hydrocarb Namibia Energy (Pty) Limited (“Hydrocarb Namibia”) we hold the rights to a 90% working interest (100% cost responsibility) in an onshore petroleum concession (the “Concession”), located in the Republic of Namibia, measuring approximately 5.3 million acres and covered by Petroleum Exploration License No. 0038 as issued by the Republic of Namibia Ministry of Mines and Energy. We hold our working interest in the Concession in partnership with the National Petroleum Corporation of Namibia Ltd. (“NPC Namibia”).

The concession specifies the following minimum cost responsibilities on an 8/8ths basis:

1) Initial Exploration Period that originally was set to expire on September 30, 2015, has been extended to allow us to complete the required initial exploration work until August 3, 2016:  This requires that we perform a hydrocarbon potential study, gather and review existing technical data including reprocessing of seismic lines, and acquire and process 750 kilometers of new 2-D 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 3-D 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.

As of July 31, 2015, approximately $2.3 million has been expended towards the initial exploration period work described in (1) above.

Going forward, we plan to continue our exploration work with a 2-D seismic program. We plan to continue working towards entering the first renewal exploration period (see (2) above). With our first exploration extension as provided for in our Petroleum Agreement, we would work to begin drilling exploration wells that have the potential to yield a major discovery, funding permitting. Because of the uncertainties still surrounding this field, we have not yet developed estimated well costs. This will be done once we begin work in the first renewal exploration period.
 
Unproved property – Texas
 
We are working on a program to obtain seismic data for our Galveston Bay properties. Once the data is analyzed, we intend to begin a drilling program to increase our domestic production, funding permitting.
 
Oil and Gas Reserves

The following tables illustrate and provide a summary of our oil and gas reserves as of our fiscal years ended July 31, 2015 and 2014, as estimated by third party reservoir engineers.

Summary of Oil and Gas Reserves as of July 31, 2015
 
Reserves Category
 
Oil (Mbls)
   
Natural
Gas
(MMcf)
   
Equivalent
(MMcfe)
 
PROVED (United States only):
           
Developed
   
846.3
     
9,823.6
     
14,901.4
 
Undeveloped
   
1,171.3
     
8,340.0
     
15,367.2
 
Total Proved
   
2,017.6
     
18,163.6
     
30,268.6
 

Summary of Oil and Gas Reserves as of July 31, 2014

Reserves Category
 
Oil (Mbls)
   
Natural
Gas
(MMcf)
   
Equivalent
(MMcfe)
 
PROVED (United States only):
           
Developed
   
413.3
     
5,783.2
     
8,262.9
 
Undeveloped
   
608.5
     
6,248.2
     
9,899.1
 
Total Proved
   
1021.8
     
12,031.4
     
18,162.0
 
 
Our estimates of proved reserves, located in Texas, USA, disclosed in this Form 10-K, at July 31, 2015 and 2014 were prepared by Ralph E. Davis Associates, Inc. (“RED”), our independent consulting petroleum engineers. The technical persons responsible for preparing the reserve estimates are independent petroleum engineers and geoscientists that meet the requirements regarding qualifications, independence, objectivity, and confidentiality set forth in the Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information promulgated by the Society of Petroleum Engineers.

The reserves in this report have been estimated using deterministic methods. For wells classified as proved developed where sufficient production history existed, reserves were based on individual well performance evaluation and production decline curve extrapolation techniques. Although the SEC’s reserves rules allow probable and possible reserves to be disclosed separately, we have elected not to disclose probable and possible reserves in this report.

In Texas, the Company’s proved undeveloped reserves are located on acreage held by production. Total acreage on these leases is 18,376, of this number, 1,040 acres are currently proved, developed, producing acres, and 17,336 acres are considered undeveloped. The Company has reported proved undeveloped reserves as a result of existing wells which require major expenditures to develop the reserves.

Internal Controls Over Reserves Estimates

Our policies regarding internal controls over the recording of reserves estimates require reserves to be in compliance with the SEC definitions and guidance and prepared in accordance with generally accepted petroleum engineering principles. Our internal controls over reserve estimates also include the following:
 
 
Utilization of an independent consulting petroleum engineer for the preparation of reserves estimates for 100% of our reserves; and

Involvement of personnel with appropriate background and experience to oversee the reserves estimate process and provide the requested data to the independent petroleum engineer.

Our Vice President, Craig Alexander, is the technical person primarily responsible for overseeing the preparation of our reserves estimates. Mr. Alexander has a Bachelor of Science degree in Petroleum Engineering and over 24 years of industry experience with positions of increasing responsibility in production and completion engineering and operations management. Mr. Alexander reports directly to our Chief Executive Officer.

Technologies Used in Reserves Estimation

The SEC allows the use of techniques that have been proved effective by actual production from projects in the same reservoir or an analogous reservoir or by other evidence using reliable technology that establishes reasonable certainty in connection with the establishment of reserves. Reliable technology is a grouping of one or more technologies (including computational methods) that has been field tested and has been demonstrated to provide reasonably certain results with consistency and repeatability in the formation being evaluated or in an analogous formation.

We used a combination of production and pressure performance, wireline wellbore measurements, simulation studies, offset analogies, seismic data and interpretation, wireline formation tests, geophysical logs and core data to calculate our reserves estimates.

RED used the definitions for proved reserves set forth in Regulation S-X Rule 4-10(a) and subsequent SEC staff interpretations and guidance. In the conduct of the reserve study, RED did not independently verify the accuracy and completeness of information and data furnished by us with respect to ownership interests, oil and gas production, well test data, historical costs of operation and development, product prices, or any agreements relating to current and future operations of the fields and sales of production. However, if in the course of the reserve study something came to the attention of RED which brought into question the validity or sufficiency of any such information or data, RED did not rely on such information or data until it had satisfactorily resolved its questions relating thereto or had independently verified such information or data. RED did not perform a personal field inspection of our properties.
 
Changes in Proved Undeveloped Reserves

As of July 31, 2015, we reported 15,367.5 MMcfe of proved undeveloped reserves, which represents an increase of 5,468.5 MMcfe from July 31, 2014. The following table shows of the changes in total proved undeveloped reserves for 2015:

Beginning of year
   
9,899.3
 
Revision of previous estimate
   
5,468.5
 
End of year
   
15,367.8
 

Before our acquisition of GBE during the year ended July 31, 2011, we had no proved undeveloped reserves. Accordingly, we have no proved undeveloped reserves that have been undeveloped for five years since their original disclosure as proved undeveloped reserves.

During the year ended July 31, 2015, the Company has concentrated on infrastructure, identifying potential workover and recompletions, and obtaining financing to complete this work. The increase in proved undeveloped reserves was a result of an increase in certain previously estimated oil reserves in the Galveston Bay, Texas property. When we acquired Galveston Bay Energy LLC in 2011, the Company had over 100 well-bores that had been shut in and scheduled for potential plugging and abandonment. Since the date of the acquisition, our technical staff undertook a review of the old well logs and other technical data to identify additional undeveloped oil reserves in these leases. All increases in proved undeveloped reserves are due to the re-evaluation of previously available technical data associated with such review. We have not obtained new technical data. We believe that the new interpretations and reevaluations better reflect the underlying technical data. For the year ended July 31, 2015, this increase related primarily to revaluations associated with the Red Fish Reef Field.

Production and Price History

The tables below sets forth the net quantities of oil and gas production, net of royalties, attributable to us in the years ended July 31, 2015, 2014 and 2013. For the purposes of this table, the following terms have the following meanings: (i) “Bbl” means one stock tank barrel or 42 U.S. gallons liquid volume; (ii) “Mcf” means one thousand cubic feet; (iii) “Mcfe” means one thousand cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of oil; and (iv) “MMcf” means one million cubic feet.
 
Property
 
2015
   
2014
   
2013
 
                    
Oil (Bbls):
            
              
Galveston Bay, Texas
   
55,604
     
40,536
     
57,796
 
The Welder Lease (Barge Canal), Calhoun Co. Texas
   
-
     
1,900
     
3,488
 
Markham City, Cook Co., Illinois
   
-
     
-
     
151
 
Chapman Ranch II Prospect, Nueces, Co., Texas
   
-
     
-
     
36
 
Karnes Co., Texas
   
-
     
-
     
4
 
Total Oil
   
55,604
     
42,436
     
61,475
 

Gas (Mcf)
       
         
Galveston Bay, Texas
   
152,981
     
110,286
     
75,164
 
The Welder Lease (Barge Canal), Calhoun Co. Texas
   
-
     
63,135
     
100,116
 
Palacios Prospect, Duval Co., Texas
   
-
     
148
     
1,113
 
Karnes Co., Texas
   
-
     
-
     
323
 
Total Gas
   
152,981
     
173,569
     
176,716
 
 
Total (Mcfe)
           
             
Galveston Bay, Texas
   
486,607
     
353,502
     
421,940
 
The Welder Lease (Barge Canal), Calhoun Co. Texas
   
-
     
74,535
     
121,044
 
Palacios Prospect, Duval Co., Texas
   
-
     
148
     
1,113
 
Markham City, Cook Co., Illinois
   
-
     
-
     
906
 
Chapman Ranch II Prospect, Nueces Co., Texas
   
-
     
-
     
216
 
Karnes Co., Texas
   
-
     
-
     
347
 
Total Mcfe
   
486,607
     
428,185
     
545,566
 
                         
Average Prices:
                       
                         
Oil (per Bbl)
 
$
62.34
   
$
102.87
   
$
105.63
 
Gas (per Mcf)
 
$
3.12
   
$
4.03
   
$
3.40
 
Total (per Mcfe)
 
$
8.10
   
$
11.83
   
$
12.99
 
                         
Average Costs (per Mcfe):
                       
                         
Lease operating expense (per Mcfe) (1)
 
$
9.79
   
$
11.47
   
$
8.28
 

(1) Taxes, transportation and production-related administrative expenditures are included in lease operating expenses.

Net production includes only production that is owned by us, whether directly or beneficially, and produced to our interest, less royalties and production due to others. Production of natural gas includes only marketable production of gas on an “as sold” basis. Production of natural gas includes only dry, residue and wet gas, depending on whether liquids have been extracted before we passed title, and does not include flared gas, injected gas and gas consumed in operations. Recovered gas, lift gas and reproduced gas are not included until sold.

Drilling and Other Exploratory Development Activities

The following tables set forth information regarding (i) the number of net productive and dry exploratory wells drilled and (ii) the number of net productive and dry development wells drilled during the years indicated, expressed separately for oil and gas. For the purposes of this subsection:

1) A dry well is an exploratory, development, or extension well that proves to be incapable of producing either oil or gas in sufficient quantities to justify completion as an oil or gas well.
2) A productive well is an exploratory, development, or extension well that is not a dry well.
3) Completion refers to installation of permanent equipment for production of oil or gas, or, in the case of a dry well, to reporting to the appropriate authority that the well has been abandoned.
4) The number of wells drilled refers to the number of wells completed at any time during the fiscal year, regardless of when drilling was initiated. A net well or acre is deemed to exist when the sum of fractional ownership working interests in gross wells or acres equals one.

For the purposes of this subsection (i) one or more completions in the same bore hole have been counted as one well, and (ii) a well with one or multiple completions at least one of which is an oil completion has been classified as an oil well. We do not have any wells with multiple completions.
 
Number of Wells Drilled During Year Ended July 31, 2015
 
   
Net
Productive
Exploratory
Wells
    Net Dry
Exploratory
Wells
    Net
Productive
Development
Wells
   
Net Dry
Development
Wells
    Net
Productive
Exploratory
Wells
    Net Dry
Exploratory
Wells
    Net Productive
Development
Wells
     
Net Dry
Development
Wells
 
Illinois
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Texas
   
-
     
-
     
4
     
-
     
-
     
-
     
-
     
-
 
Total
   
-
     
-
     
4
     
-
     
-
     
-
     
-
     
-
 
 
Number of Wells Drilled During Year Ended July 31, 2014
 
   
Net
Productive
Exploratory
Wells
   
Net Dry
Exploratory
Wells
   
Net Productive
Development
Wells
   
Net Dry
Development
Wells
   
Net
Productive
Exploratory
Wells
   
Net Dry
Exploratory
Wells
   
Net Productive
Development
Wells
   
Net Dry
Development
Wells
 
                                 
Illinois
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Texas
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 

Number of Wells Drilled During Year Ended July 31, 2013
 
 
Net
Productive
Exploratory
Wells
    Net Dry
Exploratory
Wells
    Net
Productive
Development
Wells
    Net Dry
Development
Wells
    Net
Productive
Exploratory
Wells
    Net Dry
Exploratory
Wells
    Net Productive
Development
Wells
      
Net Dry
Development
Wells
 
                                                 
Illinois
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Texas
   
-
     
1
     
-
     
0.25
     
-
     
-
     
-
     
-
 
Total
   
-
     
1
     
-
     
0.25
     
-
     
-
     
-
     
-
 
 
Delivery Commitments

None.

Productive Wells

The following table sets forth information regarding the total gross and net productive wells as of July 31, 2015, expressed separately for oil and gas. All of our productive oil and gas wells were located in Texas. For the purposes of this subsection: (i) one or more completions in the same bore hole have been counted as one well, and (ii) a well with one or multiple completions at least one of which is an oil completion has been classified as an oil well. We do not have any wells with multiple completions.

Number of Operating Wells

   
Oil
Gross
   
Net
   
Gas
Gross
   
Net
 
Texas
   
21.00
     
19.81
     
10.00
     
8.98
 
 
A productive well is an exploratory well, development well, producing well or well capable of production, but does not include a dry well. A dry well, or a dry hole, is an exploratory or a development well found to be incapable of producing either oil or gas in sufficient quantities to justify completion as an oil or gas well.
 
A gross well is a well in which a working interest is owned, and a net well is the result obtained when the sum of fractional ownership working interests in gross wells equals one. The number of gross wells is the total number of wells in which a working interest is owned, and the number of net wells is the sum of the fractional working interests owned in gross wells expressed as whole numbers and fractions thereof. The “completion” of a well means the installation of permanent equipment for the production of oil or gas, or, in the case of a dry hole, to the reporting of abandonment to the appropriate agency.

Acreage

The following table sets forth information regarding our gross and net developed and undeveloped oil and natural gas acreage under lease as of July 31, 2015.

   
Gross (1)
   
Net
 
Developed Acreage
       
Texas, USA
   
1,200
     
1,187
 
Undeveloped Acreage
               
Texas, USA
   
17,176
     
16,987
 
Namibia, Africa
   
5,300,000
     
4,770,000
 
Total
   
5,318,376
     
4,788,174
 
 
(1) The gross acreage cited includes leasehold acreage to be earned under the farm-out agreements.
 
In September 2012, we acquired a 39% working interest in a concession in Namibia, Africa. With our acquisition of Hydrocarb Corporation, a Nevada corporation (“HCN”) in December 2013, we acquired an additional 51% working interest and we now own a working interest of 90% of this concession. As of September 2, 2015, we have reassigned all of our working interest to be held by our subsidiary, Hydrocarb Namibia Energy (PTY) Limited. This property is a 5.3 million-acre concession in northern Namibia in Africa.

In Texas, the Company’s proved undeveloped reserves are located on acreage held by production. Total acreage on these leases is 18,376, of this number, 1,200 acres are currently proved, developed, producing acres, and 17,176 acres are considered undeveloped. The Company has reported proved undeveloped reserves as a result of existing wells which require major expenditures to develop the reserves.

A developed acre is an acre spaced or assignable to productive wells, a gross acre is an acre in which a working interest is owned, and a net acre is the result that is obtained when the sum of fractional ownership working interests in gross acres equals one. The number of net acres is the sum of the fractional working interests owned in gross acres expressed as whole numbers and fractions thereof.

Undeveloped acreage is considered to be those lease acres on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil or natural gas, regardless of whether or not such acreage contains proved reserves. As is customary in the oil and gas industry, we can retain our interest in undeveloped acreage by drilling activity that establishes commercial production sufficient to maintain the lease or by payment of delay rentals during the remaining primary term of the lease. The oil and natural gas leases in which we have an interest are for varying primary terms. Most of our developed lease acreage is beyond the primary term and is held so long as oil or natural gas is produced in commercial quantities or operations are commenced to restore production as our lease terms expire when the Company ceases drilling activity.
 
Most of our developed lease acreage is held by production and is beyond the primary lease term. As such, the Company’s leases related to the Texas properties are held so long as oil or natural gas is produced in commercial quantities or operations are commenced to restore production with our lease terms expiring only when the Company ceases drilling activity.

The lease terms related to the Company’s working interest in the Namibia concession have an “Initial Exploration Period,” which has been extended to August 3, 2016, with a minimum expenditure requirement of $4,505,000. Subsequent to the Initial Exploration Period the Company has a “First Renewal Exploration Period” of two years from end of the Initial Exploration Period. During the First Renewal Period the Company must relinquish 25% of the exploration license area and has a minimum expenditure of $17,350,000. Subsequent to the First Renewal Period the Company has a “Second Renewal (Production License) Exploration Period” of 25 years and has a minimum expenditure of $300,000.

Plan of Operations

Our Plan of Operations is described in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operation.

Government Regulation

General

The availability of a ready market for oil and gas production depends upon numerous factors beyond our control. These factors include local, state, federal and international regulation of oil and gas production and transportation, as well as regulations governing environmental quality and pollution control, state limits on allowable rates of production by a well or proration unit, the amount of oil and gas available for sale, the availability of adequate pipeline and other transportation and processing facilities, and the marketing of competitive fuels. State and federal regulations are generally intended to prevent waste of oil and gas, protect rights to produce oil and gas between owners in a common reservoir, and control contamination of the environment.

Applicable legislation is under constant review for amendment or expansion. These efforts frequently result in an increase in the regulatory burden on companies in our industry and as a consequence an increase in the cost of doing business and decrease in profitability. Numerous federal and state departments and agencies issue rules and regulations imposing additional burdens on the oil and gas industry that are often costly to comply with and carry substantial penalties for non-compliance. Our production operations may be affected by changing tax and other laws relating to the petroleum industry, constantly changing administrative regulations and possible interruptions or termination by government authorities.

The transportation and certain sales of natural gas in interstate commerce are heavily regulated by agencies of the federal government and are affected by the availability, terms and cost of transportation. The price and terms of access to pipeline transportation are subject to extensive federal and state regulation. The Federal Energy Regulatory Commission (FERC) is continually proposing and implementing new rules and regulations affecting the natural gas industry, most notably interstate natural gas transmission companies that remain subject to the FERC’s jurisdiction. The stated purpose of many of these regulatory changes is to promote competition among the various sectors of the natural gas industry. Some recent FERC proposals may, however, adversely affect the availability and reliability of interruptible transportation service on interstate pipelines.
 
State regulatory authorities have established rules and regulations requiring permits for drilling operations, drilling bonds and reports concerning operations. Many states have statutes and regulations governing various environmental and conservation matters, including the establishment of maximum rates of production from oil and gas wells, and restricting production to the market demand for oil and gas. Such statutes and regulations may limit the rate at which oil and gas could otherwise be produced. Most states impose a production or severance tax with respect to the production and sale of crude oil, natural gas and natural gas liquids within their respective jurisdictions. State production taxes are generally applied as a percentage of production or sales.

Oil and gas rights may be held by individuals and corporations, and, in certain circumstances, by governments having jurisdiction over the area in which such rights are located. As a general rule, parties holding such rights grant licenses or leases to third parties, such as us, to facilitate the exploration and development of these rights. The terms of the licenses and leases are generally established to require timely development. Notwithstanding the ownership of oil and gas rights, the government of the jurisdiction in which the rights are located generally retains authority over the manner of development of those rights.

U.S. Federal and State Taxation

The federal, state and local governments in the areas in which we operate impose taxes on the oil and natural gas products we sell and, for many of our wells, sales and use taxes on significant portions of our drilling and operating costs. In the past, there has been a significant amount of discussion by legislators and presidential administrations concerning a variety of energy tax proposals. President Obama has recently proposed sweeping changes in federal laws on the income taxation of small oil and natural gas exploration and production companies such as us. President Obama has proposed to eliminate allowing small U.S. oil and natural gas companies to deduct intangible U.S. drilling costs as incurred and percentage depletion. Many states have raised state taxes on energy sources, and additional increases may occur. Changes to tax laws could adversely affect our business and our financial results.

Environmental

General. Our activities are subject to local, state and federal laws and regulations governing environmental quality and pollution control in the United States. The exploration, drilling and production from wells, natural gas facilities, including the operation and construction of pipelines, plants and other facilities for transporting, processing, treating or storing natural gas and other products, are subject to stringent environmental laws and regulations by state and federal authorities, including the Environmental Protection Agency (“EPA”). These laws and regulations may require the acquisition of a permit by operators before drilling commences, prohibit drilling activities on certain lands lying within wilderness areas, wetlands and other ecologically sensitive and protected areas, and impose substantial remedial liabilities for pollution resulting from drilling operations. Such regulation can increase our cost of planning, designing, installing and operating such facilities.

Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, the imposition of significant investigatory or remedial obligations, and the imposition of injunctive relief that limits or prohibits our operations. Moreover, some environmental laws provide for joint and several strict liability for remediation of releases of hazardous substances, rendering a person liable for environmental damage without regard to negligence or fault on the part of such person. In addition, we may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances, such as oil and gas related products.

Changes in environmental laws and regulations occur frequently, and any changes that result in more stringent and costly waste handling, storage, transport, disposal or cleanup requirements could materially adversely affect our operations and financial position, as well as those of the oil and gas industry in general. While we believe that we are in substantial compliance with current environmental laws and regulations and have not experienced any material adverse effect from such compliance, there is no assurance that this trend will continue in the future.

Waste Disposal. We currently lease, and intend in the future to own or lease, additional properties that have been used for production of oil and gas for many years. Although we and our operators utilize operating and disposal practices that are standard in the industry, previous owners or lessees may have disposed of or released hydrocarbons or other wastes on or under the properties that we currently own or lease or properties that we may in the future own or lease. In addition, many of these properties have been operated in the past by third parties over whom we had no control as to such entities’ treatment of hydrocarbons or other wastes or the manner in which such substances may have been disposed of or released. State and federal laws applicable to oil and gas wastes and properties may require us to remediate property, including ground water, containing or impacted by previously disposed wastes (including wastes disposed of or released by prior owners or operators) or to perform remedial plugging operations to prevent future or mitigate existing contamination.
 
We may generate wastes, including hazardous wastes, that are subject to the federal Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes. The EPA has limited the disposal options for certain wastes that are designated as hazardous under RCRA. Furthermore, it is possible that certain wastes generated by our oil and gas projects that are currently exempt from treatment as hazardous wastes may in the future be designated as hazardous wastes, and therefore be subject to more rigorous and costly operating and disposal requirements.

CERCLA. The federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), also known as the “Superfund” law, generally imposes joint and several liability for costs of investigation and remediation and for natural resource damages, without regard to fault or the legality of the original conduct, on certain classes of persons with respect to the release into the environment of substances designated under CERCLA as hazardous substances. These classes of persons or so-called potentially responsible parties include the current and certain past owners and operators of a facility where there is or has been a release or threat of release of a hazardous substance and persons who disposed of or arranged for the disposal of the hazardous substances found at such a facility. CERCLA also authorizes the EPA and, in some cases, third parties to take action in response to threats to the public health or the environment and to seek to recover from the potentially responsible parties the costs of such action. Although CERCLA generally exempts petroleum from the definition of hazardous substances, we may have generated and may generate wastes that fall within CERCLA’s definition of hazardous substances. We may in the future be an owner of facilities on which hazardous substances have been released by previous owners or operators of our properties that are named as potentially responsible parties related to their ownership or operation of such property.

Air Emissions. Our projects are subject to local, state and federal regulations for the control of emissions of air pollution. Major sources of air pollutants are subject to more stringent, federally imposed permitting requirements, including additional permits. Producing wells, gas plants and electric generating facilities generate volatile organic compounds and nitrogen oxides. Some of our producing wells may be in counties that are designated as non-attainment for ozone and may be subject to restrictive emission limitations and permitting requirements. If the ozone problems in the applicable states are not resolved by the deadlines imposed by the federal Clean Air Act, or on schedule to meet the standards, even more restrictive requirements may be imposed, including financial penalties based upon the quantity of ozone producing emissions. If we fail to comply strictly with air pollution regulations or permits, we may be subject to monetary fines and be required to correct any identified deficiencies. Alternatively, regulatory agencies could require us to forego construction, modification or operation of certain air emission sources.

Clean Water Act. The Clean Water Act imposes restrictions and strict controls regarding the discharge of wastes, including produced waters and other oil and natural gas wastes, into waters of the United States, a term broadly defined. Permits must be obtained to discharge pollutants into federal waters. The Clean Water Act provides for civil, criminal and administrative penalties for unauthorized discharges of oil, hazardous substances and other pollutants. It imposes substantial potential liability for the costs of removal or remediation associated with discharges of oil or hazardous substances. State laws governing discharges to water also provide varying civil, criminal and administrative penalties and impose liabilities in the case of a discharge of petroleum or its derivatives, or other hazardous substances, into state waters. In addition, the EPA has promulgated regulations that may require us to obtain permits to discharge storm water runoff, including discharges associated with construction activities. In the event of an unauthorized discharge of wastes, we may be liable for penalties and costs.

Oil Pollution Act. The Oil Pollution Act of 1990 (“OPA”), which amends and augments oil spill provisions of the Clean Water Act, and similar legislation enacted in Texas, Louisiana and other coastal states, impose certain duties and liabilities on certain “responsible parties” related to the prevention of oil spills and damages resulting from such spills in United States waters and adjoining shorelines. A liable “responsible party” includes the owner or operator of a facility or vessel that is a source of an oil discharge or poses the substantial threat of discharge, or the lessee or permittee of the area in which a facility covered by OPA is located. OPA assigns joint and several liability, without regard to fault, to each liable party for oil removal costs, remediation of environmental damage and a variety of public and private damages. OPA also imposes ongoing requirements on a responsible party, including proof of financial responsibility to cover at least some costs of a potential spill. Few defenses exist to the liability imposed by OPA. In the event of an oil discharge, or substantial threat of discharge from our properties, vessels and pipelines, we may be liable for costs and damages. 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. For the years ended July 31, 2015 and July 31, 2014, $150,000 has been recognized and is included in the balance sheet caption “Accounts payable and accrued expenses.”
 
Other than as noted above, we believe that we are in substantial compliance with current environmental laws and regulations in each of the jurisdictions in which we operate and there are no other significant liabilities or uncertainties. Although we have not experienced any material adverse effect from such compliance, there is no assurance that this trend will continue in the future.

Insurance

Our oil and gas properties are subject to hazards inherent in the oil and gas industry, such as accidents, blowouts, explosions, implosions, fires and oil spills. These conditions can cause:

· Damage to or destruction of property, equipment and the environment;
· Personal injury or loss of life; and
· Suspension of operations.

We maintain insurance coverage that we believe to be customary in the industry against these types of hazards. However, we may not be able to maintain adequate insurance in the future at rates we consider reasonable. In addition, our insurance is subject to coverage limits and some policies exclude coverage for damages resulting from environmental contamination. The occurrence of a significant event or adverse claim in excess of the insurance coverage that we maintain or that is not covered by insurance could have a material adverse effect on our financial condition and results of operations.

Competition

The oil and natural gas industry is intensely competitive in all phases, including the exploration for new production and the acquisition of equipment and labor necessary to conduct drilling activities. The competition comes from numerous major oil companies as well as numerous other independent operators. There is also competition between the oil and natural gas industry and other industries in supplying the energy and fuel requirements of industrial, commercial and individual consumers. We are a minor participant in the industry and compete in the oil and natural gas industry with many other companies having far greater financial, technical and other resources.

We compete and will continue to compete with major and independent oil and natural gas companies for exploration opportunities, acreage and property acquisitions. We also compete for drilling rig contracts and other equipment and labor required to drill, operate and develop our properties. Most of our competitors have substantially greater financial resources, staffs, facilities and other resources than we have. In addition, larger competitors may be able to absorb the burden of any changes in federal, state and local laws and regulations more easily than we can, which would adversely affect our competitive position. These competitors may be able to pay more for drilling rigs or exploratory prospects and productive oil and natural gas properties and may be able to define, evaluate, bid for and purchase a greater number of properties and prospects than we can. Our competitors may also be able to afford to purchase and operate their own drilling rigs.

Our ability to drill and explore for oil and natural gas and to acquire properties will depend upon our ability to conduct operations, to evaluate and select suitable properties and to consummate transactions in this highly competitive environment. Many of our competitors have a longer history of operations than we have, and most of them have also demonstrated the ability to operate through industry cycles.
 
Competitive conditions may be substantially affected by various forms of energy legislation and/or regulation considered from time to time by the government of the United States and other countries, as well as factors that we cannot control, including international political conditions, overall levels of supply and demand for oil and gas, and the markets for synthetic fuels and alternative energy sources. Intense competition occurs with respect to marketing, particularly of natural gas.
 
Employees

We currently have 12 full-time employees and no part-time employees.

Subsidiaries

We own 100% of the issued and outstanding share capital of (i) Penasco Petroleum Inc., a Nevada corporation, (ii) Galveston Bay Energy, LLC, a Texas limited liability company (“GBE”), (iii) SPE Navigation I, LLC, a Nevada limited liability company, (iv) Namibia Exploration, Inc., a Nevada corporation (“NEI”), (v) Hydrocarb Corporation, a Nevada corporation (“HCN”), (vi) Hydrocarb Texas Corporation, a Texas corporation, and (vii) Hydrocarb Namibia Energy (Pty) Limited, a company chartered in the Republic of Namibia (“Hydrocarb Namibia”). In addition, we own 95% of the issued and outstanding share capital of Otaiba Hydrocarb LLC, a UAE limited liability corporation.

Glossary of Oil and Natural Gas Terms

The following are abbreviations and definitions of certain terms commonly used in the oil and gas industry and in this report:

AFE or Authorization for Expenditures. A document that lays out proposed expenses for a particular project and authorizes an individual or group to spend a certain amount of money for that project.

After-payout interest or back-in interest. Form of carried interest in which the latter converts to a regular working interest after payout, that is, after the carrying parties have recouped their costs, the carried party converts to a regular fractional working interest, paying its share of costs and receiving its share of revenues.

Assignment. The sale, transfer or conveyance of all or a fraction of ownership interest or rights owned in real estate or other such property. The term is commonly used in the oil and gas business to convey working interest, leases, royalty, overriding royalty interests and net profit interests.

Bcf. One billion cubic feet of natural gas.

BBbl. One billion barrels of crude oil or other liquid hydrocarbons.

Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil or other liquid hydrocarbons.

Blowout. When well pressure exceeds the ability of the wellhead valves to control it. Oil and gas “blow wild” at the surface.

Blowout preventers. High pressure wellhead valves, designed to shut off the uncontrolled flow of hydrocarbons.

Boe. Barrels of oil equivalent in which six Mcf of natural gas equals one Bbl of oil. This ratio does not assume price equivalency and, given price differentials, the price for a barrel of oil equivalent for natural gas may differ significantly from the price for a barrel of oil.

Boepd. Barrels of oil equivalent per day.

Bopd. Barrels of oil per day.
 
Borehole. A completed well.

Btu or British thermal Unit. The quantity of heat required to raise the temperature of one pound of water by one degree Fahrenheit.

Carried Interest. A fractional working interest in an oil and gas lease that comes about through an arrangement between co-owners of a working interest.

Casing. Pipe cemented in the well to seal off formation fluids or keep the hole from caving in.
 
Casing point. The depth in a well in which casing is set.

CAPEX. Capital expenditures.

Completion. The operations required to establish production of oil or natural gas from a wellbore, usually involving perforations, stimulation and/or installation of permanent equipment in the well or, in the case of a dry hole, the reporting of abandonment to the appropriate agency.

Condensate. Liquid hydrocarbons associated with the production of a primarily natural gas reserve.

Conventional resources. Natural gas or oil that is produced by a well drilled into a geologic formation in which the reservoir and fluid characteristics permit the natural gas or oil to readily flow to the wellbore.

Developed acreage. The number of acres that are allocated or assignable to productive wells.

Development costs. Costs incurred to obtain access to proved reserves and to provide facilities for extracting, treating, gathering and storing the oil and natural gas. More specifically, development costs, including depreciation and applicable operating costs of support equipment and facilities and other costs of development activities, are costs incurred to:

(i)            Gain access to and prepare well locations for drilling, including surveying well locations for the purpose of determining specific development drilling sites, clearing ground, draining, road building, and relocating public roads, gas lines, and power lines, to the extent necessary in developing the proved reserves;

(ii)          Drill and equip development wells, development-type stratigraphic test wells, and service wells, including the costs of platforms and of well equipment such as casing, tubing, pumping equipment, and the wellhead assembly;

(iii)         Acquire, construct, and install production facilities such as lease flow lines, separators, treaters, heaters, manifolds, measuring devices, and production storage tanks, natural gas cycling and processing plants, and central utility and waste disposal systems; and

(iv)        Provide improved recovery systems.

Development well. A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive.

Downhole. Refers to equipment or operations that take place down inside a borehole.

Downstream. All operations taking place after crude oil is produced, such as transportation, refining and
marketing.
 
Dry well. An exploratory, development or extension well that proves to be incapable of producing either natural gas or oil in sufficient quantities to justify completion as a natural gas or oil well.
 
Estimated ultimate recovery or EUR. Estimated ultimate recovery is the sum of reserves remaining as of a given date and cumulative production as of that date.

Exploratory well. A well drilled to find and produce oil or natural gas reserves not classified as proved, to find a new reservoir in a field previously found to be productive of oil or natural gas in another reservoir or to extend a known reservoir.

Farmin or farmout. An agreement under which the owner of a working interest in an oil or natural gas lease assigns the working interest or a portion of the working interest to another party who desires to drill on the leased acreage. Generally, the assignee is required to drill one or more wells in order to earn its interest in the acreage. The assignor usually retains a royalty or reversionary interest in the lease. The interest received by an assignee is a “farmin” while the interest transferred by the assignor is a “farmout.”

FERC. Federal Energy Regulatory Commission.

Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition.
 
Fracture stimulation or Frac. A process whereby fluids mixed with proppants are injected into a wellbore under pressure in order to fracture, or crack open, reservoir rock, thereby allowing oil and/or natural gas trapped in the reservoir rock to travel through the fractures and into the well for production.

Gas. Natural gas.
 
Gas lift. A method used to artificially lift fluid from wells without sufficient reservoir pressure. High pressure gas is injected down the well which aerates the fluid to reduce its density.
 
Gross acres or gross wells. The total acres or wells in which a working interest is owned.

Gross working interest. The working interest in a given property plus the proportionate share of any royalty interest, including overriding royalty interest, associated with the working interest.

Held by production. An oil and natural gas property under lease in which the lease continues to be in force after the primary term of the lease in accordance with its terms as a result of production from the property.

Horizontal drilling or well. A drilling operation in which a portion of the well is drilled horizontally within a productive or potentially productive formation. This operation typically yields a horizontal well that has the ability to produce higher volumes than a vertical well drilled in the same formation. A horizontal well is designed to replace multiple vertical wells, resulting in lower capital expenditures for draining like acreage and limiting surface disruption.

Infill drilling. The addition of wells in a field that decreases average well spacing, i.e., wells drilled to fill in between established producing wells on a lease.

Injection Well. Well used to inject fluids (usually water) into a subsurface formation by pressure.

Joint Operating Agreement or JOA. A detailed written agreement between the Working Interest Owners of a property which specifies the terms according to which that property will be developed.

Joint Venture. A large-scale project in which two or more parties (usually oil companies) cooperate. One
supplies funds and the other actually carries out the project. Each participant retains control over his share, including liability and the right to sell.
 
LOE or Lease operating expenses. The costs of maintaining and operating property and equipment on a producing oil and gas lease.

Mbbl. One thousand barrels of oil or other liquid hydrocarbons.

Mcf. One thousand cubic feet of gas.
 
MMcf. One million cubic feet of gas.

Mcfe. One thousand cubic feet of gas equivalent in which six Mcf of natural gas equals one Bbl of oil.

MMcfe. One million cubic feet of gas equivalent in which six Mcf of natural gas equals one Bbl of oil.

Mcfgpd. Thousands of cubic feet of natural gas per day.

Midstream or Middle Distillates. Refinery products in the middle of the distillation range of crude oil, including kerosene, kerosene-based jet fuel, home heating, range oil, stove oil and diesel fuel.

MMcf. One million cubic feet of natural gas.

MMBtu. One million British thermal units.

Net acres or net wells. The sum of the fractional working interest owned in gross acres or wells.

Net revenue interest. The interest that defines the percentage of revenue that an owner of a well receives from the sale of oil, natural gas and/or natural gas liquids that are produced from the well.

NGLs, natural gas liquids or liquids. Marketable liquid products including ethane, propane, butane and pentane resulting from the further processing of liquefiable hydrocarbons separated from raw natural gas by a natural gas processing facility.

NYMEX. New York Mercantile Exchange.
 
Oil. Crude oil, condensate and natural gas liquids.

On The Pump. A phrase used in reference to a well that no longer flows from natural reservoir energy but is produced by means of a pump.

Operator. The individual or company responsible for the exploration and/or exploitation and/or production of an oil or gas well or lease.

Operating costs. The sum of lease operating costs, production taxes, general and accounting expenses, and oil and gas depreciation, depletion, and amortization.

Operating interest. An interest in natural gas and oil that is burdened with the cost of development and operation of the property.

Overpressure. An expression which has been used commonly to refer to high pressure found in some formations; super-normal pressure or surpressure. Technically, it should be said that overpressure is that amount of pore pressure which is in excess of normal pore pressure in overpressured formations.

Overriding royalty interest. A fractional, undivided interest or right to production or revenues, free of costs, of a lessee with respect to an oil or natural gas well, that overrides a working interest.

Pay Zones. The term to describe the reservoir that is producing oil and gas within a given wellbore. Pay
Zones (or oil reservoirs) can vary in thickness from one foot to several hundred feet.
Permeability. A reference to the ability of oil and/or natural gas to flow through a reservoir.

Petrophysical analysis. The interpretation of well log measurements, obtained from a string of electronic tools inserted into the borehole, and from core measurements, in which rock samples are retrieved from the subsurface, then combining these measurements with other relevant geological and geophysical information to describe the reservoir rock properties.
 
Play. A set of known or postulated oil and/or natural gas accumulations sharing similar geologic, geographic and temporal properties, such as source rock, migration pathways, timing, trapping mechanism and hydrocarbon type.

Plugging and abandonment. Refers to the sealing off of fluids in the strata penetrated by a well so that the fluids from one stratum will not escape into another or to the surface. Regulations of all states require plugging of abandoned wells.

Possible reserves. Additional reserves that are less certain to be recognized than probable reserves.

Probable reserves. Additional reserves that are less certain to be recognized than proved reserves but which, in sum with proved reserves, are as likely as not to be recovered.

Producing well, production well or productive well. A well that is found to be capable of producing hydrocarbons in sufficient quantities such that proceeds from the sale of the well’s production exceed production-related expenses and taxes.

Properties. Natural gas and oil wells, production and related equipment and facilities and natural gas, oil or other mineral fee, leasehold and related interests.

Prospect. A specific geographic area which, based on supporting geological, geophysical or other data and also preliminary economic analysis using reasonably anticipated prices and costs, is considered to have potential for the discovery of commercial hydrocarbons.

Proppant. Sized particles mixed with fracturing fluid to hold fractures open after a hydraulic fracturing treatment. In addition to naturally occurring sand grains, man-made or specially engineered proppants, such as resin-coated sand or high-strength ceramic materials like sintered bauxite, may also be used. Proppant materials are carefully sorted for size and sphericity to provide an efficient conduit for production of fluid from the reservoir to the wellbore.

Proved developed reserves. Proved reserves that can be expected to be recovered through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well, or through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well.

Proved reserves. Those quantities of oil and gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible—from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations—prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. The project to extract the hydrocarbons must have commenced or the operator must be reasonably certain that it will commence the project within a reasonable time. The area of the reservoir considered as proved includes (i) the area identified by drilling and limited by fluid contacts, if any, and (ii) adjacent undrilled portions of the reservoir that can, with reasonable certainty, be judged to be continuous with it and to contain economically producible oil or gas on the basis of available geoscience and engineering data. In the absence of data on fluid contacts, proved quantities in a reservoir are limited by the lowest known hydrocarbons, as seen in a well penetration unless geoscience, engineering, or performance data and reliable technology establishes a lower contact with reasonable certainty. Where direct observation from well penetrations has defined a highest known oil elevation and the potential exists for an associated natural gas cap, proved oil reserves may be assigned in the structurally higher portions of the reservoir only if geoscience, engineering or performance data and reliable technology establish the higher contact with reasonable certainty. Reserves which can be produced economically through application of improved recovery techniques (including, but not limited to, fluid injection) are included in the proved classification when: (i) successful testing by a pilot project in an area of the reservoir with properties no more favorable than in the reservoir as a whole, the operation of an installed program in the reservoir or an analogous reservoir, or other evidence using reliable technology establishes the reasonable certainty of the engineering analysis on which the project or program was based; and (ii) the project has been approved for development by all necessary parties and entities, including governmental entities. Developed natural gas, oil and NGL reserves are reserves of any category that can be expected to be recovered (x) through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well; and (y) through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well.
 
PV-10. When used with respect to natural gas and oil reserves, PV-10 means the estimated future gross revenue to be generated from the production of proved reserves, net of estimated production and future development costs, using prices and costs in effect as of the date of the report or estimate, without giving effect to non-property related expenses such as general and administrative expenses, debt service and future income tax expense or to depreciation, depletion and amortization, discounted using an annual discount rate of 10%. Also referred to as “present value.” After-tax PV-10 is also referred to as “standardized measure” and is net of future income tax expense.

Recompletion. The completion for production of an existing wellbore in another formation from that in which the well has been previously completed.

Repeatability. The potential ability to drill multiple wells within a prospect or trend.

Reserves. Reserves are estimated remaining quantities of oil and gas and related substances anticipated to be economically producible, as of a given date, by application of development projects to known accumulations. In addition, there must exist, or there must be a reasonable expectation that there will exist, the legal right to produce or a revenue interest in the production, installed means of delivering oil and gas or related substances to market, and all permits and financing required to implement the project.

Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil and/or natural gas that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs.

Royalty or Royalty Interest. An interest in an oil and gas lease that gives the owner of the interest the right to receive a portion of the production from the leased acreage (or of the proceeds of the sale thereof), but generally does not require the owner to pay any portion of the costs of drilling or operating the wells on the leased acreage. Royalties may be either landowner’s royalties, which are reserved by the owner of the leased acreage at the time the lease is granted, or overriding royalties, which are usually reserved by an owner of the leasehold in connection with a transfer to a subsequent owner.

Service Well. A well drilled in a known oil or Natural Gas field to inject liquids that enhance recovery or dispose of salt water.

Shut-In or SI. To stop a producing oil and gas well from producing.
 
Spot market price. The price for a one-time open market transaction for immediate delivery of a specific quantity of product at a specific location where the commodity is purchased “on the spot” at current market rates.

Spud or Spudded. Begin drilling a well.

Spud Date. Date that drilling begins.

Structural Trap. An underground fold or break (or both) which creates an impervious trap where oil and gas can accumulate.  Oil will migrate underground through rock until it is “trapped”.

3-D Seismic. Advanced technology method of detecting accumulations of hydrocarbons identified through a three-dimensional image of the earth’s subsurface created through the interpretation and measurement of the intensity and timing of sound waves transmitted into the earth as they reflect back to the surface. 3-D seismic surveys allow for a more detailed understanding of the subsurface than do 2-D seismic surveys and contribute significantly to field appraisal, exploitation and production.
 
Total Depth. The maximum depth of a borehole.
 
Trend. A region of oil and/or natural gas production, the geographic limits of which have not been fully defined, having geological characteristics that have been ascertained through supporting geological, geophysical or other data to contain the potential for oil and/or natural gas reserves in a particular formation or series of formations.

2-D Seismic. The method by which a cross-section of the earth’s subsurface is created through the interpretation of reflecting seismic data collected along a single source profile.

Unconventional resource play. A set of known or postulated oil and or natural gas resources or reserves warranting further exploration which are extracted from (a) low-permeability sandstone and shale formations and (b) coalbed methane. These plays require the application of advanced technology to extract the oil and natural gas resources.

Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and natural gas, regardless of whether such acreage contains proved reserves. Undeveloped acreage is usually considered to be all acreage that is not allocated or assignable to productive wells.

Unproved and unevaluated properties. Refers to properties where no drilling or other actions have been undertaken that permit such property to be classified as proved.

Upstream. Activities concerned with finding petroleum and producing it compared to downstream which are all the operations that take place after production.
 
Vertical well. A hole drilled vertically into the earth from which oil, natural gas or water flows is pumped.

Volumetric reserve analysis. A technique used to estimate the amount of recoverable oil and natural gas. It involves calculating the volume of reservoir rock and adjusting that volume for the rock porosity, hydrocarbon saturation, formation volume factor and recovery factor.

Wellbore. The hole made by a well.

Wellhead. A device on the surface used to hold the tubing in the well. The wellhead is the originating point of the producing well at the top of the ground.
 
Well spacing. The regulation of the number and location of wells over an oil or natural gas reservoir, as a conservation measure. Well spacing is normally accomplished by order of the regulatory conservation commission in the applicable jurisdiction. The order may be statewide in its application (subject to change for local conditions) or it may be entered for each field after its discovery. In the operational context, “well spacing” refers to the area attributable between producing wells within the scope of what is permitted under a regulatory order.

Working interest. An interest in an oil and gas lease that gives the owner of the interest the right to drill for and produce oil and gas on the leased acreage and requires the owner to pay a share of the costs of drilling and production operations.

Workovers.  Operations on a producing well to restore or increase production.

Zone. A specific interval of rock strata containing one or more reservoirs. Used interchangeably with “formation”.
 
ITEM 1A.
RISK FACTORS

An investment in our common stock involves a number of very significant risks. You should carefully consider the following risks and uncertainties in addition to other information in this annual report in evaluating our company and its business before purchasing shares of our common stock. Our business, operating results and financial condition could be seriously harmed due to any of the following risks. The risks described below may not be all of the risks facing our company. Additional risks not presently known to us or that we currently consider immaterial may also impair our business operations. You could lose all or part of your investment due to any of these risks.

Risks Related to Our Company

Because we have only recently commenced business operations, we face a high risk of business failure.

We were incorporated on April 12, 2005 and originally planned to explore for gold and other minerals, but we soon shifted our focus to oil and gas exploration. Revenues were limited until our acquisition of GBE in 2011 and to date, we have not achieved profitability. Potential investors should be aware of the difficulties normally encountered by companies in the early stages of their life cycle and the high rate of failure of such enterprises. These potential problems include, but are not limited to, unanticipated problems relating to costs and expenses that may exceed current estimates. We have no actual company history upon which to base any assumption as to the likelihood that our business will prove successful, and it is possible, although not anticipated, that we may never achieve profitable operations.

We will need additional capital to complete future acquisitions, repay outstanding liabilities, conduct our operations and fund our business and our ability to obtain the necessary funding is uncertain.

We will need to raise additional funding to complete future potential acquisitions, repay outstanding liabilities and will need to raise additional funds through public or private debt or equity financing or other various means to fund our operations, acquire assets and complete exploration and drilling operations. In such a case, adequate funds may not be available when needed or may not be available on favorable terms. Such required funding includes, but is not limited to amounts required to complete our minimum cost responsibilities for our exploration program in Namibia, which will total approximately $22 million in aggregate, of which we have only expended $2.3 million as of July 31, 2015. If we need to raise additional funds in the future, by issuing equity securities, dilution to existing stockholders will result, and such securities may have rights, preferences and privileges senior to those of our common stock. If funding is insufficient at any time in the future and we are unable to generate sufficient revenue from new business arrangements, to repay our outstanding liabilities, complete planned acquisitions or operations, our results of operations and the value of our securities could be adversely affected.

We have substantial indebtedness which could adversely affect our financial flexibility and our competitive position.

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 lenders party thereto (the “Lenders”). Pursuant to the Credit Agreement, the Lenders loaned us $4 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%. 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). 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 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.
 
This agreement was subsequently amended on February 17, 2015, and again on June 10, 2015. Additional  details will be found on page 54, under Liquidity and Capital Resources.
 
While the Shadowtree Credit Agreement represents our most significant borrowing, it is not the only borrowing we have done during the year ended July 31, 2015, and subsequently. The Company sold various convertible notes and promissory notes, the terms and conditions of which are described in greater detail in the footnotes to the Company's consolidated financial statements for the consolidated financial statements for the years ended July 31, 2015 and 2014.
 
Our substantial indebtedness could have important consequences and significant effects on our business. For example, it could:

increase our vulnerability to adverse changes in general economic, industry and competitive conditions;
require us to dedicate a substantial portion of our cash flow from operations to make payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes;
limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
restrict us from taking advantage of business opportunities;
make it more difficult to satisfy our financial obligations;
place us at a competitive disadvantage compared to our competitors that have less debt obligations; and
limit our ability to borrow additional funds for working capital, capital expenditures, acquisitions, debt service requirements, execution of our business strategy or other general corporate purposes on satisfactory terms or at all.

We may need to raise additional funding in the future to repay or refinance the Notes and our accounts payable, and as such may need to seek additional debt or equity financing. Such additional financing may not be available on favorable terms, if at all. If debt financing is available and obtained, our interest expense may increase and we may be subject to the risk of default, depending on the terms of such financing. If equity financing is available and obtained it may result in our shareholders experiencing significant dilution. If such financing is unavailable, we may be forced to curtail our operations, which may cause the value of our securities to decline in value and/or become worthless.

The repayment of our Credit Agreement is secured by a security interest in all of our assets.

The repayment of the Notes represented pursuant to the Credit Facility 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. If we default in the repayment of the Notes or the Credit Agreement and/or any of the terms and conditions thereof, the Lenders may enforce their security interest over our assets which secure the repayment of such debt, and we could be forced to curtail or abandon our current business plans and operations. If that were to happen, any investment in the Company could become worthless.
 
The report of our independent registered public accounting firm expresses substantial doubt about the Company's ability to continue as a going concern.

Our auditors, MaloneBailey, LLP, have indicated in their report on the Company’s financial statements for the fiscal year ended July 31, 2015, that conditions exist that raise substantial doubt about our ability to continue as a going concern due to the fact that the Company has not generated any significant revenues from ongoing operations and incurred net losses since inception. A “going concern” opinion could impair our ability to finance our operations through the sale of equity, incurring debt, or other financing alternatives. Our ability to continue as a going concern will depend upon the availability and terms of future funding, our ability to grow our operations and integrate newly acquired assets and operations, our ability to acquire additional assets and operations, and our ability to improve operating margins and regain profitability.  If we are unable to achieve these goals, our business would be jeopardized and the Company may not be able to continue. If we ceased operations, it is likely that all of our investors would lose their investment.

We may not be able to effectively manage the demands required of a new business in our industry, such that we may be unable to successfully implement our business plan or achieve profitability.

We have earned limited revenues until recently (the past three years) and we have never achieved annual profitability. We may not be able to effectively execute our business plan or manage any growth, if any, of our business. Future development and operating results will depend on many factors, including access to adequate capital, the demand for oil and gas, price competition, and whether we can control costs. Many of these factors are beyond our control. In addition, our future prospects must be considered in light of the risks, expenses and difficulties frequently encountered in establishing a new business in the oil and gas industry, which is characterized by intense competition, rapid technological change, highly litigious competitors and significant regulation. If we are unable to address these matters, or any of them, then we may not be able to successfully implement our business plan or achieve profitability.

Because we have earned limited revenues from operations, most of our capital requirements have been met through financing and we may not be able to continue to find financing to meet our operating requirements.

We may need to obtain additional financing in order to pursue our business plan. As of July 31, 2015, we had cash and cash equivalents of $229,512 and a working capital deficit of $17,108,658. As such, unless our cash flow from operations is sufficient, we will need additional financing to pursue the exploration and development of our properties and pay for corporate overhead. We may not be able to obtain such financing at all or in amounts that would be sufficient for us to meet our current and expected working capital needs. Furthermore, in the event that our plans change or our assumptions change or prove inaccurate, we could be required to seek additional financing in greater amounts than is currently anticipated. Any inability to obtain additional financing when needed would have a material adverse effect on us, including possibly requiring us to significantly curtail or possibly cease our operations. In addition, any future equity financing may involve substantial dilution to our existing stockholders.

Because we have a history of losses and anticipate continued losses unless and until we are able to generate sufficient revenues to support our operations, we may lack the financial stability required to continue operations.

Since inception we have suffered recurring losses. We have funded our operations largely through the issuance of common stock in order to meet our strategic objectives. Our current level of oil and gas production is not sufficient to completely fund our exploration and development budget, such that we anticipate that we may need additional financing in order to pursue our plan of operations. We anticipate that our losses will continue until such time, if ever, as we are able to generate sufficient revenues to support our operations.

Costs of drilling, completing and operating wells is uncertain, and we may not achieve sufficient production to cover such costs.

The cost of drilling, completing and operating wells is often uncertain. We may not be able to achieve commercial production of oil and gas to pay such costs. Drilling operations on our properties or on properties we may acquire in the future may be curtailed, delayed or cancelled as a result of numerous factors, including title problems, weather conditions, compliance with governmental requirements and shortages or delays in the delivery of equipment. Furthermore, completion of a well does not assure a profit or a recovery of drilling, completion and operating costs. As a result, our business, results of operations and financial condition may be materially adversely affected.
 
Actual production, revenues and expenditures with respect to reserves will likely vary from estimates, which could have a material adverse effect on our business, results of operations and financial condition.

There are numerous uncertainties inherent in estimating oil and natural gas reserves and their estimated values, including many factors beyond the control of the producer. Reservoir engineering is a subjective process of estimating underground accumulations of oil and natural gas that cannot be measured in an exact manner. Estimates of economically recoverable oil and natural gas reserves and of future net cash flows necessarily depend upon a number of variable factors and assumptions, such as historical production from the area compared with production from other producing areas, the assumed effects of regulations by governmental agencies and assumptions concerning future oil and natural gas prices, future operating costs, severance and excise taxes, development costs and work-over and remedial costs, all of which may in fact vary considerably from actual results. For these reasons, estimates of the economically recoverable quantities of oil and natural gas attributable to any particular group of properties, classifications of such reserves based on risk of recovery, and estimates of the future net cash flows expected therefrom prepared by different engineers or by the same engineers but at different times may vary substantially, and such reserve estimates may be subject to downward or upward adjustment based upon such factors. Actual production, revenues and expenditures with respect to reserves will likely vary from estimates, when and if made, and such variances may be material, which could have a material adverse effect on our business, results of operations and financial condition.

Our future oil and natural gas production is highly dependent upon our ability to find or acquire reserves.

In general, the volume of production from oil and natural gas properties declines as reserves are depleted, with the rate of decline depending on reservoir characteristics. Except to the extent we conduct successful exploration and development activities or acquire properties containing proved reserves, or both, our proved reserves, if any, will decline as reserves are produced. Our future oil and natural gas production is, therefore, highly dependent upon our level of success in finding or acquiring reserves in the future. The business of exploring for, developing or acquiring reserves is capital intensive. To the extent cash flow from operations is reduced and external sources of capital become limited or unavailable, our ability to make the necessary capital investment to maintain or expand our asset base of oil and natural gas reserves would be impaired. The failure of an operator of our wells to adequately perform operations, or such operator’s breach of the applicable agreements, could adversely impact us. In addition, we may not obtain additional proved reserves or be able to drill productive wells at acceptable costs, in which case our business would fail.

Oil and gas resources may contain certain hazards which may, in turn, create certain liabilities or prevent the resources from being commercially viable.

Our properties may contain hazards such as unusual or unexpected formations and other conditions. Our projects may become subject to liability for pollution, fire, explosion, blowouts, cratering and oil spills, against which we cannot insure or against which we may decide to not insure. Such events could result in substantial damage to oil and gas wells, producing facilities and other property and/or result in personal injury. Costs or liabilities related to those events would have a material adverse effect on our business, results of operations, financial condition and cash flows.

Our success is dependent on the prices of oil and natural gas. Low oil or natural gas prices and the substantial volatility in these prices may adversely affect our business, financial condition and results of operations and our ability to meet our capital expenditure requirements and financial obligations.

The prices we receive for our oil and natural gas heavily influence our revenue, profitability, cash flow available for capital expenditures, access to capital and future rate of growth. Oil and natural gas are commodities and, therefore, their prices are subject to wide fluctuations in response to relatively minor changes in supply and demand. Historically, the prices for oil and natural gas have been volatile and will likely continue to be volatile in the future. The prices we receive for our production, and the levels of our production, depend on numerous factors. These factors include the following:
 
the domestic and foreign supply of oil and natural gas;
the domestic and foreign demand for oil and natural gas;
the prices and availability of competitors’ supplies of oil and natural gas;
the actions of the Organization of Petroleum Exporting Countries, or OPEC, and state-controlled oil companies relating to oil price and production controls;
the price and quantity of foreign imports of oil and natural gas;
the impact of U.S. dollar exchange rates on oil and natural gas prices;
domestic and foreign governmental regulations and taxes;
speculative trading of oil and natural gas futures contracts;
localized supply and demand fundamentals, including the availability, proximity and capacity of gathering and transportation systems for natural gas;
the availability of refining capacity;
the prices and availability of alternative fuel sources;
weather conditions and natural disasters;
political conditions in or affecting oil and natural gas producing regions, including the Middle East and South America;
the continued threat of terrorism and the impact of military action and civil unrest;
public pressure on, and legislative and regulatory interest within, federal, state and local governments to stop, significantly limit or regulate hydraulic fracturing activities;
the level of global oil and natural gas inventories and exploration and production activity;
authorization of exports from the Unites States of liquefied natural gas;
the impact of energy conservation efforts;
technological advances affecting energy consumption; and
overall worldwide economic conditions.

Declines in oil or natural gas prices would not only reduce our revenue, but could reduce the amount of oil and natural gas that we can produce economically. Should natural gas or oil prices decrease from current levels and remain there for an extended period of time, we may elect in the future to delay some of our exploration and development plans for our prospects, or to cease exploration or development activities on certain prospects due to the anticipated unfavorable economics from such activities, and, as a result, we may have to make substantial downward adjustments to our estimated proved reserves, each of which would have a material adverse effect on our business, financial condition and results of operations.

Our exploration, development and exploitation projects require substantial capital expenditures that may exceed cash on hand, cash flows from operations and potential borrowings, and we may be unable to obtain needed capital on satisfactory terms, which could adversely affect our future growth.

Our exploration and development activities are capital intensive. We make and expect to continue to make substantial capital expenditures in our business for the development, exploitation, production and acquisition of oil and natural gas reserves. Our cash on hand, our operating cash flows and future potential borrowings may not be adequate to fund our future acquisitions or future capital expenditure requirements. The rate of our future growth may be dependent, at least in part, on our ability to access capital at rates and on terms we determine to be acceptable.

Our cash flows from operations and access to capital are subject to a number of variables, including:

our estimated proved oil and natural gas reserves;
the amount of oil and natural gas we produce from existing wells;
the prices at which we sell our production;
the costs of developing and producing our oil and natural gas reserves;
our ability to acquire, locate and produce new reserves;
the ability and willingness of banks to lend to us; and
our ability to access the equity and debt capital markets.
 
In addition, future events, such as terrorist attacks, wars or combat peace-keeping missions, financial market disruptions, general economic recessions, oil and natural gas industry recessions, large company bankruptcies, accounting scandals, overstated reserves estimates by major public oil companies and disruptions in the financial and capital markets have caused financial institutions, credit rating agencies and the public to more closely review the financial statements, capital structures and earnings of public companies, including energy companies. Such events have constrained the capital available to the energy industry in the past, and such events or similar events could adversely affect our access to funding for our operations in the future.

If our revenues decrease as a result of lower oil and natural gas prices, operating difficulties, declines in reserves or for any other reason, we may have limited ability to obtain the capital necessary to sustain our operations at current levels, further develop and exploit our current properties or invest in additional exploration opportunities. Alternatively, a significant improvement in oil and natural gas prices or other factors could result in an increase in our capital expenditures and we may be required to alter or increase our capitalization substantially through the issuance of debt or equity securities, the sale of production payments, the sale or farm out of interests in our assets, the borrowing of funds or otherwise to meet any increase in capital needs. If we are unable to raise additional capital from available sources at acceptable terms, our business, financial condition and results of operations could be adversely affected. Further, future debt financings may require that a portion of our cash flows provided by operating activities be used for the payment of principal and interest on our debt, thereby reducing our ability to use cash flows to fund working capital, capital expenditures and acquisitions. Debt financing may involve covenants that restrict our business activities. If we succeed in selling additional equity securities to raise funds, at such time the ownership percentage of our existing stockholders would be diluted, and new investors may demand rights, preferences or privileges senior to those of existing stockholders. If we choose to farm-out interests in our prospects, we may lose operating control over such prospects.

Our oil and natural gas reserves are estimated and may not reflect the actual volumes of oil and natural gas we will receive, and significant inaccuracies in these reserve estimates or underlying assumptions will materially affect the quantities and present value of our reserves.

The process of estimating accumulations of oil and natural gas is complex and is not exact, due to numerous inherent uncertainties. The process relies on interpretations of available geological, geophysical, engineering and production data. The extent, quality and reliability of this technical data can vary. The process also requires certain economic assumptions related to, among other things, oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. The accuracy of a reserves estimate is a function of:

the quality and quantity of available data;
the interpretation of that data;
the judgment of the persons preparing the estimate; and
the accuracy of the assumptions.

The accuracy of any estimates of proved reserves generally increases with the length of the production history. Due to the limited production history of our properties, the estimates of future production associated with these properties may be subject to greater variance to actual production than would be the case with properties having a longer production history. As our wells produce over time and more data is available, the estimated proved reserves will be re-determined on at least an annual basis and may be adjusted to reflect new information based upon our actual production history, results of exploration and development, prevailing oil and natural gas prices and other factors.

Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas most likely will vary from our estimates. It is possible that future production declines in our wells may be greater than we have estimated. Any significant variance to our estimates could materially affect the quantities and present value of our reserves.
 
We may have accidents, equipment failures or mechanical problems while drilling or completing wells or in production activities, which could adversely affect our business.

While we are drilling and completing wells or involved in production activities, we may have accidents or experience equipment failures or mechanical problems in a well that cause us to be unable to drill and complete the well or to continue to produce the well according to our plans. We may also damage a potentially hydrocarbon-bearing formation during drilling and completion operations. Such incidents may result in a reduction of our production and reserves from the well or in abandonment of the well.

Our operations are subject to operational hazards and unforeseen interruptions for which we may not be adequately insured.

There are numerous operational hazards inherent in oil and natural gas exploration, development, production and gathering, including:

unusual or unexpected geologic formations;
natural disasters;
adverse weather conditions;
unanticipated pressures;
loss of drilling fluid circulation;
blowouts where oil or natural gas flows uncontrolled at a wellhead;
cratering or collapse of the formation;
pipe or cement leaks, failures or casing collapses;
fires or explosions;
releases of hazardous substances or other waste materials that cause environmental damage;
pressures or irregularities in formations; and
equipment failures or accidents.

In addition, there is an inherent risk of incurring significant environmental costs and liabilities in the performance of our operations, some of which may be material, due to our handling of petroleum hydrocarbons and wastes, our emissions to air and water, the underground injection or other disposal of our wastes, the use of hydraulic fracturing fluids and historical industry operations and waste disposal practices.

Any of these or other similar occurrences could result in the disruption or impairment of our operations, substantial repair costs, personal injury or loss of human life, significant damage to property, environmental pollution and substantial revenue losses. The location of our wells, gathering systems, pipelines and other facilities near populated areas, including residential areas, commercial business centers and industrial sites, could significantly increase the level of damages resulting from these risks. Insurance against all operational risks is not available to us. We are not fully insured against all risks, including development and completion risks that are generally not recoverable from third parties or insurance. In addition, pollution and environmental risks generally are not fully insurable.  Losses could occur for uninsurable or uninsured risks or in amounts in excess of existing insurance coverage. Moreover, insurance may not be available in the future at commercially reasonable prices or on commercially reasonable terms. Changes in the insurance markets due to various factors may make it more difficult for us to obtain certain types of coverage in the future. As a result, we may not be able to obtain the levels or types of insurance we would otherwise have obtained prior to these market changes, and the insurance coverage we do obtain may not cover certain hazards or all potential losses that are currently covered, and may be subject to large deductibles. Losses and liabilities from uninsured and underinsured events and delay in the payment of insurance proceeds could have a material adverse effect on our business, financial condition and results of operations.
 
The unavailability or high cost of drilling rigs, completion equipment and services, supplies and personnel, including hydraulic fracturing equipment and personnel, could adversely affect our ability to establish and execute exploration and development plans within budget and on a timely basis, which could have a material adverse effect on our business, financial condition and results of operations.
 
Shortages or the high cost of drilling rigs, completion equipment and services, supplies or personnel could delay or adversely affect our operations. When drilling activity in the United States and elsewhere increases, associated costs typically also increase, including those costs related to drilling rigs, equipment, supplies and personnel and the services and products of other vendors to the industry. These costs may increase, and necessary equipment and services may become unavailable to us at economical prices. Should this increase in costs occur, we may delay drilling activities, which may limit our ability to establish and replace reserves, or we may incur these higher costs, which may negatively affect our business, financial condition and results of operations.

The marketability of our production is dependent upon oil and natural gas gathering and transportation facilities owned and operated by third parties, and the unavailability of satisfactory oil and natural gas transportation arrangements would have a material adverse effect on our revenue.

The unavailability of satisfactory oil and natural gas transportation arrangements may hinder our access to oil and natural gas markets or delay production from our wells. The availability of a ready market for our oil and natural gas production depends on a number of factors, including the demand for, and supply of, oil and natural gas and the proximity of reserves to pipelines and terminal facilities. Our ability to market our production depends in substantial part on the availability and capacity of gathering systems, pipelines and processing facilities owned and operated by third parties. Our failure to obtain these services on acceptable terms could materially harm our business. We may be required to shut-in wells for lack of a market or because of inadequacy or unavailability of pipeline or gathering system capacity. If that were to occur, we would be unable to realize revenue from those wells until production arrangements were made to deliver our production to market. Furthermore, if we were required to shut-in wells we might also be obligated to pay shut-in royalties to certain mineral interest owners in order to maintain our leases. We do not expect to purchase firm transportation capacity on third-party facilities. Therefore, we expect the transportation of our production to be generally interruptible in nature and lower in priority to those having firm transportation arrangements.

The disruption of third-party facilities due to maintenance and/or weather could negatively impact our ability to market and deliver our products. The third parties control when or if such facilities are restored and what prices will be charged. Federal and state regulation of oil and natural gas production and transportation, tax and energy policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines and general economic conditions could adversely affect our ability to produce, gather and transport oil and natural gas.

We may have difficulty managing growth in our business, which could have a material adverse effect on our business, financial condition and results of operations and our ability to execute our business plan in a timely fashion.

Because of our small size, growth in accordance with our business plan, if achieved, will place a significant strain on our financial, technical, operational and management resources. Assuming we are successful in expanding our activities, including our planned increase in oil exploration, development and production, and increase the number of projects we are evaluating or in which we participate, there will be additional demands on our financial, technical and management resources. The failure to continue to upgrade our technical, administrative, operating and financial control systems or the occurrence of unexpected expansion difficulties, including the inability to recruit and retain experienced managers, geoscientists, petroleum engineers and landmen could have a material adverse effect on our business, financial condition and results of operations and our ability to execute our business plan in a timely fashion.

Financial difficulties encountered by our oil and natural gas purchasers, third-party operators or other third parties could decrease our cash flow from operations and adversely affect the exploration and development of our prospects and assets.

We will derive substantially all of our revenues from the sale of our oil and natural gas to unaffiliated third-party purchasers, independent marketing companies and mid-stream companies. Any delays in payments from our purchasers caused by financial problems encountered by them will have an immediate negative effect on our results of operations.
 
Liquidity and cash flow problems encountered by our working interest co-owners or the third-party operators of our non-operated properties may prevent or delay the drilling of a well or the development of a project. Our working interest co-owners may be unwilling or unable to pay their share of the costs of projects as they become due. In the case of a farm-out party, we would have to find a new farm-out party or obtain alternative funding in order to complete the exploration and development of the prospects subject to a farm-out agreement. In the case of a working interest owner, we could be required to pay the working interest owner’s share of the project costs. We may not be able to obtain the capital necessary to fund either of these contingencies or find a new farm-out party.

The calculated present value of future net revenues from our proved reserves will not necessarily be the same as the current market value of our estimated oil and natural gas reserves.

You should not assume that the present value of future net cash flows as included in our public filings is the current market value of our estimated proved oil and natural gas reserves. We generally base the estimated discounted future net cash flows from proved reserves on current costs held constant over time without escalation and on commodity prices using an unweighted arithmetic average of first-day-of-the-month index prices, appropriately adjusted, for the 12-month period immediately preceding the date of the estimate. Actual future prices and costs may be materially higher or lower than the prices and costs used for these estimates and will be affected by factors such as:

actual prices we receive for oil and natural gas;
actual cost and timing of development and production expenditures;
the amount and timing of actual production; and
changes in governmental regulations or taxation.

In addition, the 10% discount factor that is required to be used to calculate discounted future net revenues for reporting purposes under GAAP is not necessarily the most appropriate discount factor based on the cost of capital in effect from time to time and risks associated with our business and the oil and natural gas industry in general.

We may incur additional indebtedness which could reduce our financial flexibility, increase interest expense and adversely impact our operations and our unit costs.

In the future, we may incur significant amounts of additional indebtedness in order to make acquisitions or to develop our properties. Our level of indebtedness could affect our operations in several ways, including the following:

a significant portion of our cash flows could be used to service our indebtedness;
a high level of debt would increase our vulnerability to general adverse economic and industry conditions;
any covenants contained in the agreements governing our outstanding indebtedness could limit our ability to borrow additional funds, dispose of assets, pay dividends and make certain investments;
a high level of debt may place us at a competitive disadvantage compared to our competitors that are less leveraged and, therefore, may be able to take advantage of opportunities that our indebtedness may prevent us from pursuing; and
debt covenants to which we may agree may affect our flexibility in planning for, and reacting to, changes in the economy and in our industry.

A high level of indebtedness increases the risk that we may default on our debt obligations. We may not be able to generate sufficient cash flows to pay the principal or interest on our debt, and future working capital, borrowings or equity financing may not be available to pay or refinance such debt. If we do not have sufficient funds and are otherwise unable to arrange financing, we may have to sell significant assets or have a portion of our assets foreclosed upon which could have a material adverse effect on our business, financial condition and results of operations.
 
Competition in the oil and natural gas industry is intense, making it difficult for us to acquire properties, market oil and natural gas and secure trained personnel.

Our ability to acquire additional prospects and to find and develop reserves in the future will depend on our ability to evaluate and select suitable properties and to consummate transactions in a highly competitive environment for acquiring properties, marketing oil and natural gas and securing trained personnel. Also, there is substantial competition for capital available for investment in the oil and natural gas industry. Many of our competitors possess and employ financial, technical and personnel resources substantially greater than ours. Those companies may be able to pay more for productive oil and natural gas properties and exploratory prospects and to evaluate, bid for and purchase a greater number of properties and prospects than our financial or personnel resources permit. In addition, other companies may be able to offer better compensation packages to attract and retain qualified personnel than we are able to offer. The cost to attract and retain qualified personnel has increased in recent years due to competition and may increase substantially in the future. We may not be able to compete successfully in the future in acquiring prospective reserves, developing reserves, marketing hydrocarbons, attracting and retaining quality personnel and raising additional capital, which could have a material adverse effect on our business, financial condition and results of operations.

Our competitors may use superior technology and data resources that we may be unable to afford or that would require a costly investment by us in order to compete with them more effectively.

Our industry is subject to rapid and significant advancements in technology, including the introduction of new products and services using new technologies and databases. As our competitors use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. In addition, many of our competitors will have greater financial, technical and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. We cannot be certain that we will be able to implement technologies on a timely basis or at a cost that is acceptable to us. One or more of the technologies that we will use or that we may implement in the future may become obsolete, and we may be adversely affected.

If we do not hedge our exposure to reductions in oil and natural gas prices, we may be subject to significant reductions in prices. Alternatively, we may use oil and natural gas price hedging contracts, which involve credit risk and may limit future revenues from price increases and result in significant fluctuations in our profitability.

In the event that we choose not to hedge our exposure to reductions in oil and natural gas prices by purchasing futures and by using other hedging strategies, we may be subject to significant reduction in prices which could have a material negative impact on our profitability. Alternatively, we may elect to use hedging transactions with respect to a portion of our oil and natural gas production to achieve more predictable cash flow and to reduce our exposure to price fluctuations. While the use of hedging transactions limits the downside risk of price declines, their use also may limit future revenues from price increases. Hedging transactions also involve the risk that the counterparty may be unable to satisfy its obligations.
 
Environmental and overall public scrutiny focused on the oil and gas industry is increasing. The current trend is to increase regulations of our operations in the industry. We are subject to federal, state, and local government regulation and liability, including complex environmental laws, which could require significant expenditures and/or adversely affect the cost, manner or feasibility of doing business.

Our exploration, development, production and marketing operations are regulated extensively at the federal, state, and local levels. Environmental and other governmental laws and regulations have increased our costs to plan, design, drill, install, operate and abandon natural gas and crude oil wells. Similar to other companies in our industry, we incur substantial operating and capital costs to comply with such laws and regulations. These compliance costs may put us at a competitive disadvantage compared to larger companies in the industry which can spread such additional costs over a greater number of wells and larger operating staff. Failure to comply with these laws and regulations may result in the suspension or termination of our operations and subject us to administrative, civil and criminal penalties. Moreover, public interest in environmental protection has increased in recent years—particularly with respect to hydraulic fracturing—and environmental organizations have opposed, with some success, certain drilling projects.

Matters subject to regulation include discharge permits, drilling bonds, reports concerning operations, the spacing of wells, unitization and pooling of properties, taxation or environmental matters and health and safety criteria addressing worker protection. Under these laws and regulations, we may be required to make large expenditures that could materially adversely affect our business, financial condition and results of operations. These expenditures could include payments for:

personal injuries;
property damage;
containment and cleanup of oil and other spills;
the management and disposal of hazardous materials;
remediation and clean-up costs; and
other environmental damages.

We do not believe that full insurance coverage for all potential damages is available at a reasonable cost. Failure to comply with these laws and regulations also may result in the suspension or termination of our operations and subject us to administrative, civil and criminal penalties, injunctive relief and/or the imposition of investigatory or other remedial obligations. Laws, rules and regulations protecting the environment have changed frequently and the changes often include increasingly stringent requirements. These laws, rules and regulations may impose liability on us for environmental damage and disposal of hazardous materials even if we were not negligent or at fault. We may also be found to be liable for the conduct of others or for acts that complied with applicable laws, rules or regulations at the time we performed those acts. These laws, rules and regulations are interpreted and enforced by numerous federal and state agencies. In addition, private parties, including the owners of properties upon which our wells are drilled or the owners of properties adjacent to or in close proximity to those properties, may also pursue legal actions against us based on alleged non-compliance with certain of these laws, rules and regulations.

Additionally, the natural gas and crude oil regulatory environment could change in ways that might substantially increase our financial and managerial costs to comply with the requirements of these laws and regulations and, consequently, adversely affect our profitability.

The BP crude oil spill in the Gulf of Mexico and generally heightened industry scrutiny has resulted and may result in new state and federal safety and environmental laws, regulations, guidelines and enforcement interpretations. The EPA has recently focused on citizen concerns about the risk of water contamination and public health problems from drilling and hydraulic fracturing activities, and conducted public meetings around the country on this issue which have been well publicized and well attended. This renewed focus could lead to additional federal, state and local laws and regulations affecting our drilling, fracturing and other operations.

Other potential laws and regulations affecting us include new or increased severance taxes proposed in several states. This could adversely affect the existing operations in these states and the economic viability of future drilling. Additional laws, regulations or other changes could significantly reduce our future growth, increase our costs of operations and reduce our cash flows, in addition to undermining the demand for the natural gas and crude oil we produce.
 
We are subject to federal, state and local taxes, and may become subject to new taxes or have eliminated or reduced certain federal income tax deductions currently available with respect to oil and natural gas exploration and production activities as a result of future legislation, which could adversely affect our business, financial condition and results of operations.

The federal, state and local governments in the areas in which we operate impose taxes on the oil and natural gas products we sell and, for many of our wells, sales and use taxes on significant portions of our drilling and operating costs. In the past, there has been a significant amount of discussion by legislators and presidential administrations concerning a variety of energy tax proposals. Many states have raised state taxes on energy sources, and additional increases may occur. Changes to tax laws that are applicable to us could adversely affect our business and our financial results.

Periodically, legislation is introduced to eliminate certain key U.S. federal income tax preferences currently available to oil and natural gas exploration and production companies. Such possible changes include, but are not limited to, (a) the repeal of the percentage depletion allowance for oil and natural gas properties, (b) the elimination of current deductions for intangible drilling and development costs, (c) the elimination of the deduction for certain United States production activities, and (d) the increase in the amortization period for geological and geophysical costs paid or incurred in connection with the exploration for, or development of, oil or natural gas within the United States. It is unclear whether any such changes will actually be enacted or, if enacted, how soon any such changes could become effective. The passage of any legislation as a result of the budget proposals or any other similar change in U.S. federal income tax law could affect certain tax deductions that are currently available with respect to oil and natural gas exploration and production activities and could negatively impact our business, financial condition and results of operations.

The derivatives legislation adopted by Congress, and implementation of that legislation by federal agencies, could have an adverse impact on our ability to hedge risks associated with our business.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, which we refer to as the Dodd-Frank Act, which, among other things, sets forth the new framework for regulating certain derivative products including the commodity hedges of the type that we may elect to use, but many aspects of this law are subject to further rulemaking and will take effect over several years. As a result, it is difficult to anticipate the overall impact of the Dodd-Frank Act on our ability or willingness to enter into and maintain such commodity hedges and the terms of such hedges. There is a possibility that the Dodd-Frank Act could have a substantial and adverse impact on our ability to enter into and maintain these commodity hedges. In particular, the Dodd-Frank Act could result in the implementation of position limits and additional regulatory requirements on derivative arrangements, which could include new margin, reporting and clearing requirements. In addition, this legislation could have a substantial impact on our counterparties and may increase the cost of our derivative arrangements, if any, in the future.

If these types of commodity hedges become unavailable or uneconomic, our commodity price risk could increase, which would increase the volatility of revenues and may decrease the amount of credit available to us. Any limitations or changes in our use of derivative arrangements could also materially affect our future ability to conduct acquisitions.
 
Legislation or regulations restricting emissions of “greenhouse gases” could result in increased operating costs and reduced demand for the natural gas, natural gas liquids and oil we produce while the physical effects of climate change could disrupt our production and cause us to incur significant costs in preparing for or responding to those effects.
 
On December 15, 2009, the EPA published its final findings that emissions of carbon dioxide, methane and other “greenhouse gases” present an endangerment to public health and welfare because emissions of such gases are, according to the EPA, contributing to the warming of the earth’s atmosphere and other climatic changes. These findings allow the EPA to adopt and implement regulations that would restrict emissions of greenhouse gases under existing provisions of the federal Clean Air Act. Accordingly, the EPA has adopted regulations that would require a reduction in emissions of greenhouse gases from motor vehicles and permitting and presumably requiring a reduction in greenhouse gas emissions from certain stationary sources. In addition, on October 30, 2009, the EPA published a final rule requiring the reporting of greenhouse gas emissions from specified large greenhouse gas emission sources in the United States beginning in 2011 for emissions occurring in 2010. On November 30, 2010, the EPA released a final rule that expands its rule on reporting of greenhouse gas emissions to include owners and operators of petroleum and natural gas systems. The adoption and implementation of any regulations imposing reporting obligations on, or limiting emissions of greenhouse gases from, our equipment and operations could require us to incur costs to reduce emissions of greenhouse gases associated with our operations. Further, various states have adopted legislation that seeks to control or reduce emissions of greenhouse gases from a wide range of sources. Any such legislation could adversely affect demand for the natural gas, oil and liquids that we produce.

Some scientists have concluded that increasing concentrations of greenhouse gases in the Earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, floods and other climatic events. If any such effects were to occur, they could have an adverse effect on our exploration and production operations. Significant physical effects of climate change could also have an indirect effect on our financing and operations by disrupting the transportation or process-related services provided by midstream companies, service companies or suppliers with whom we have a business relationship. We may not be able to recover through insurance some or any of the damages, losses, or costs that may result from potential physical effects of climate change.

Restrictions on drilling activities intended to protect certain species of wildlife may adversely affect our ability to conduct drilling activities in some of the areas where we operate.

Oil and natural gas operations in our operating areas can be adversely affected by seasonal or permanent restrictions on drilling activities designed to protect various wildlife. Seasonal restrictions may limit our ability to operate in protected areas and can intensify competition for drilling rigs, oilfield equipment, services, supplies and qualified personnel, which may lead to periodic shortages when drilling is allowed. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. Permanent restrictions imposed to protect endangered species could prohibit drilling in certain areas or require the implementation of expensive mitigation measures.

As a result of a settlement approved by the U.S. District Court for the District of Columbia on September 9, 2011, the U.S. Fish and Wildlife Service is required to consider listing more than 250 species as endangered under the Endangered Species Act. The law prohibits the harming of endangered or threatened species, provides for habitat protection, and imposes stringent penalties for noncompliance. The final designation of previously unprotected species in areas where we operate as threatened or endangered could cause us to incur increased costs arising from species protection measures or could result in limitations, delays, or prohibitions on our exploration and production activities that could have an adverse impact on our ability to develop and produce our reserves.

We face risks associated with our operations in Namibia.

We are subject to various risks associated with doing business in Namibia and relating to Namibia’s economic and political environment. As is typical of an emerging market, Namibia does not possess a well-developed business, legal and regulatory infrastructure that would generally exist in a more mature free market economy.  We could also face currency risks associated with operations in Namibia. Additionally, our successful operation of particular facilities or projects may be disrupted by civil unrest, acts of sabotage or terrorism, and other local security concerns. Such concerns may require us to incur greater costs for security or to shut down operations for a period of time. Our planned operations in Namibia will also be subject to Namibia specific laws and regulations relating to areas of labor, tax, import and export requirements, anti-corruption, foreign exchange controls and cash repatriation restrictions, environmental, health, and safety, which will be different than U.S. laws and may force us to expend additional resources complying with such laws and regulations. Our failure to manage the risks associated with doing business in Namibia could have a material adverse effect upon our results of operations.
 
As a result of our intensely competitive industry, we may not gain enough market share to be profitable.

We compete in the sale of oil and natural gas on the basis of price and on the ability to deliver products. The oil and natural gas industry is intensely competitive in all phases, including the exploration for new production and the acquisition of equipment and labor necessary to conduct drilling activities. The competition comes from numerous major oil companies as well as numerous other independent operators in the United States and elsewhere. Because we are pursuing potentially large markets, our competitors include major, multinational oil and gas companies. There is also competition between the oil and natural gas industry and other industries in supplying the energy and fuel requirements of industrial, commercial and individual consumers. We are a minor participant in the industry and compete in the oil and natural gas industry with many other companies having far greater financial, technical and other resources. If we are unable to compete successfully, we may never be able to sell enough product at a price sufficient to permit us to generate profits.

The oil and natural gas market is heavily regulated, and existing or subsequently enacted laws or regulations could limit our production, increase compliance costs or otherwise adversely impact our operations or revenues.

We are subject to various federal, state and local laws and regulations. These laws and regulations govern safety, exploration, development, taxation and environmental matters that are related to the oil and natural gas industry. To conserve oil and natural gas supplies, regulatory agencies may impose price controls and may limit our production. Certain laws and regulations require drilling permits, govern the spacing of wells and the prevention of waste and limit the total number of wells drilled or the total allowable production from successful wells. Other laws and regulations govern the handling, storage, transportation and disposal of oil and natural gas and any by-products produced in oil and natural gas operations. These laws and regulations could materially adversely impact our operations and our revenues.

Laws and regulations that affect us may change from time to time in response to economic or political conditions. Thus, we must also consider the impact of future laws and regulations that may be passed in the jurisdictions where we operate. We anticipate that future laws and regulations related to the oil and natural gas industry will become increasingly stringent and cause us to incur substantial compliance costs.

The nature of our operations exposes us to environmental liabilities.

Our operations create the risk of environmental liabilities. We may incur liability to governments or to third parties for any unlawful discharge of oil, gas or other pollutants into the air, soil or water. We could potentially discharge oil or natural gas into the environment in any of the following ways:

from a well or drilling equipment at a drill site;
from a leak in storage tanks, pipelines or other gathering and transportation facilities;
from damage to oil or natural gas wells resulting from accidents during normal operations; or
from blowouts, cratering or explosions.

Environmental discharges may move through the soil to water supplies or adjoining properties, giving rise to additional liabilities. Some laws and regulations could impose liability for failure to obtain the proper permits for, to control the use of, or to notify the proper authorities of a hazardous discharge. Such liability could have a material adverse effect on our financial condition and our results of operations and could possibly cause our operations to be suspended or terminated on such property.

We may also be liable for any environmental hazards created either by the previous owners of properties that we purchase or lease or by acquired companies prior to the date we acquire them. Such liability would affect the costs of our acquisition of those properties. In connection with any of these environmental violations, we may also be charged with remedial costs. Pollution and similar environmental risks generally are not fully insurable.
 
Our success depends, to a large extent, on our ability to retain our key employees, and the loss of any of our key personnel could disrupt our business operations.

Investors in our common stock must rely upon the ability, expertise, judgment and discretion of our management and the success of our technical team in identifying, evaluating and developing prospects and reserves. Our performance and success are dependent to a large extent on the efforts and continued employment of our management and technical personnel, including our Chairman and Chief Executive Officer, Kent P. Watts, and our President Charles F. Dommer. We do not believe that they could be quickly replaced with personnel of equal experience and capabilities, and their successors may not be as effective. If any of our other key personnel resign or become unable to continue in their present roles and if they are not adequately replaced, our business operations could be adversely affected. We do not currently maintain any insurance against the loss of any of these individuals.

We have an active Board of Directors that meets several times throughout the year and is intimately involved in our business and the determination of our operational strategies. Our Board of Directors works closely with management to identify potential prospects, funding sources, acquisitions and areas for further development. One of our directors has been involved with us since the inception of Hydrocarb Corporation, our wholly-owned subsidiary, and all of our directors have a deep understanding of our operations and culture. If any of our directors resign or become unable to continue in their present role, it may be difficult to find replacements with the same knowledge and experience and as a result, our operations may be adversely affected.

Our Chief Executive Officer and Chairman and his relatives exercise voting control over the Company.

Kent P. Watts, the Company’s Chief Executive Officer and Chairman beneficially owns approximately 21% of our voting stock; Christopher Watts, the nephew of Kent P. Watts, beneficially owns approximately 28% of our voting stock; and Michael Watts, the brother of Kent P. Watts, and the father of Christopher Watts, beneficially owns approximately 7% of our voting stock. As such, Kent P. Watts and his relatives beneficially own in aggregate approximately 55% of our voting stock.  As a result, Kent P. Watts and his relatives will exercise control in determining the outcome of all corporate transactions or other matters, including the election of directors, mergers, consolidations, the sale of all or substantially all of our assets, and also the power to prevent or cause a change in control. The interests of Mr. Watts and his relatives may differ from the interests of the other stockholders and thus result in corporate decisions that are adverse to other shareholders.

Our directors may experience conflicts of interest which may detrimentally affect our profitability.

Certain directors and officers may be engaged in, or may in the future be engaged in, other business activities on their own behalf and on behalf of other companies and, as a result of these and other activities, such directors and officers may become subject to conflicts of interest, which could have a material adverse effect on our business. As of the date of the report, the Company is not aware of any conflicts of interest any of our directors have with the Company.

We incur significant costs as a result of operating as a fully reporting company and our management is required to devote substantial time to compliance initiatives.

We incur significant legal, accounting and other expenses in connection with our status as a fully reporting public company. Specifically, we are required to prepare and file annual, quarterly and current reports, proxy statements and other information with the SEC. Additionally, our officers and directors and significant shareholders are required to file Form 3, 4 and 5’s and Schedule 13-D/g’s with the SEC disclosing their ownership of the Company and changes in such ownership. Furthermore, the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and rules subsequently implemented by the SEC have imposed various new requirements on public companies, including requiring changes in corporate governance practices. As a result, our management and other personnel are required to devote a substantial amount of time and resources to the preparation of required filings with the SEC and SEC compliance initiatives. Moreover, these filing obligations, rules and regulations increase our legal and financial compliance costs and quarterly expenses and make some activities more time-consuming and costly than they would be if we were a private company. In addition, the Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure of controls and procedures. Our testing has previously revealed deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. The costs and expenses of compliance with SEC rules and our filing obligations with the SEC, or our identification of deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, could materially adversely affect our results of operations or cause the market price of our stock to decline in value.
 
Our operations are substantially dependent on the availability of water. Restrictions on our ability to obtain water may have an adverse effect on our financial condition, results of operations and cash flows.

Water is an essential component of deep shale oil and natural gas production during both the drilling and hydraulic fracturing, or fracking processes. Our operations could be adversely impacted if we are unable to locate sufficient amounts of water, or dispose of or recycle water used in our exploration and production operations. Currently, the quantity of water required in certain completion operations, such as hydraulic fracturing, and changing regulations governing usage may lead to water constraints and supply concerns (particularly in some parts of the country). Certain western states have recently experienced a drought. As a result, future availability of water from certain sources used in the past may be limited. Moreover, the imposition of new environmental initiatives and conditions could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of waste, including, but not limited to, produced water, drilling fluids and other wastes associated with the exploration, development or production of oil and natural gas. The federal Clean Water Act, or CWA and analogous state laws impose restrictions and strict controls regarding the discharge of pollutants, including produced waters and other oil and natural gas waste, into navigable waters or other regulated federal and state waters. Permits or other approvals must be obtained to discharge pollutants to regulated waters and to conduct construction activities in such waters and wetlands. Uncertainty regarding regulatory jurisdiction over wetlands and other regulated waters has, and will continue to, complicate and increase the cost of obtaining such permits or other approvals. The CWA and analogous state laws provide for civil, criminal and administrative penalties for any unauthorized discharges of pollutants and unauthorized discharges of reportable quantities of oil and other hazardous substances. Many state discharge regulations, and the Federal National Pollutant Discharge Elimination System General permits issued by the EPA, prohibit the discharge of produced water and sand, drilling fluids, drill cuttings and certain other substances related to the oil and natural gas industry into coastal waters. While generally exempt under federal programs, many state agencies have also adopted regulations requiring certain oil and natural gas exploration and production facilities to obtain permits for storm water discharges. In October 2011, the EPA announced its intention to develop federal pretreatment standards for wastewater discharges associated with hydraulic fracturing activities. If adopted, the pretreatment rules will require coalbed methane and shale gas operations to pretreat wastewater before transferring it to treatment facilities. Some states have banned the treatment of fracturing wastewater at publicly owned treatment facilities. There has been recent nationwide concern over earthquakes associated with Class II underground injection control wells, a predominant storage method for crude oil and gas wastewater. It is likely that new rules and regulations will be developed to address these concerns, possibly eliminating access to Class II wells in certain locations, and increasing the cost of disposal in others. Finally, the EPA study noted above has focused and will continue to focus on various stages of water use in hydraulic fracturing operations. It is possible that, following the conclusion of the EPA’s study, the agency will move to more strictly regulate the use of water in hydraulic fracturing operations. While we cannot predict the impact that these changes may have on our business at this time, they may be material to our business, financial condition, and operations. Compliance with environmental regulations and permit requirements governing the withdrawal, storage and use of surface water or groundwater necessary for hydraulic fracturing of wells or the disposal or recycling of water will increase our operating costs and may cause delays, interruptions or termination of our operations, the extent of which cannot be predicted. In addition, our inability to meet our water supply needs to conduct our completion operations may impact our business, and any such future laws and regulations could negatively affect our financial condition, results of operations and cash flows.
 
Our competitors may use superior technology and data resources that we may be unable to afford or that would require a costly investment by us in order to compete with them more effectively.

Our industry is subject to rapid and significant advancements in technology, including the introduction of new products and services using new technologies and databases. As our competitors use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. In addition, many of our competitors will have greater financial, technical and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. We cannot be certain that we will be able to implement technologies on a timely basis or at a cost that is acceptable to us. One or more of the technologies that we will use or that we may implement in the future may become obsolete, and we may be adversely affected.

An increase in the differential between the NYMEX or other benchmark prices of oil and natural gas and the wellhead price we receive for our production could adversely affect our business, financial condition and results of operations.

The prices that we will receive for our oil and natural gas production sometimes may reflect a discount to the relevant benchmark prices, such as NYMEX, that are used for calculating hedge positions. The difference between the benchmark price and the prices we receive is called a differential. Increases in the differential between the benchmark prices for oil and natural gas and the wellhead price we receive could adversely affect our business, financial condition and results of operations. We do not have, and may not have in the future, any derivative contracts covering the amount of the basis differentials we experience in respect of our production. As such, we will be exposed to any increase in such differentials.

Our identified drilling locations are scheduled over several years, making them susceptible to uncertainties that could materially alter the occurrence or timing of their drilling.

Our management team has identified and scheduled drilling locations in our operating areas over a multi-year period. Our ability to drill and develop these locations depends on a number of factors, including the availability of equipment and capital, approval by regulators, seasonal conditions, oil and natural gas prices, assessment of risks, costs and drilling results. The final determination on whether to drill any of these locations will be dependent upon the factors described elsewhere in this filing, as well as, to some degree, the results of our drilling activities with respect to our established drilling locations. Because of these uncertainties, we do not know if the drilling locations we have identified will be drilled within our expected timeframe or at all or if we will be able to economically produce hydrocarbons from these or any other potential drilling locations. Our actual drilling activities may be materially different from our current expectations, which could adversely affect our business, financial condition and results of operations.

We may incur losses or costs as a result of title deficiencies in the properties in which we invest.

If an examination of the title history of a property that we have purchased reveals an oil and natural gas lease has been purchased in error from a person who is not the owner of the property, our interest would be worthless. In such an instance, the amount paid for such oil and natural gas lease as well as any royalties paid pursuant to the terms of the lease prior to the discovery of the title defect would be lost.

Prior to the drilling of an oil and natural gas well, it is the normal practice in the oil and natural gas industry for the person or company acting as the operator of the well to obtain a preliminary title review of the spacing unit within which the proposed oil and natural gas well is to be drilled to ensure there are no obvious deficiencies in title to the well. Frequently, as a result of such examinations, certain curative work must be done to correct deficiencies in the marketability of the title, and such curative work entails expense. Our failure to cure any title defects may adversely impact our ability in the future to increase production and reserves. In the future, we may suffer a monetary loss from title defects or title failure. Additionally, unproved and unevaluated acreage has greater risk of title defects than developed acreage. If there are any title defects or defects in assignment of leasehold rights in properties in which we hold an interest, we will suffer a financial loss which could adversely affect our business, financial condition and results of operations.
 
We may purchase oil and natural gas properties with liabilities or risks that we did not know about or that we did not assess correctly, and, as a result, we could be subject to liabilities that could adversely affect our results of operations.

Before acquiring oil and natural gas properties, we estimate the reserves, future oil and natural gas prices, operating costs, potential environmental liabilities and other factors relating to the properties. However, our review involves many assumptions and estimates, and their accuracy is inherently uncertain. As a result, we may not discover all existing or potential problems associated with the properties we buy. We may not become sufficiently familiar with the properties to assess fully their deficiencies and capabilities. We do not generally perform inspections on every well or property, and we may not be able to observe mechanical and environmental problems even when we conduct an inspection. The seller may not be willing or financially able to give us contractual protection against any identified problems, and we may decide to assume environmental and other liabilities in connection with properties we acquire. If we acquire properties with risks or liabilities we did not know about or that we did not assess correctly, our business, financial condition and results of operations could be adversely affected as we settle claims and incur cleanup costs related to these liabilities.

Unless we replace our oil and natural gas reserves, our reserves and production will decline, which would adversely affect our business, financial condition and results of operations.

The rate of production from our oil and natural gas properties will decline as our reserves are depleted. Our future oil and natural gas reserves and production and, therefore, our income and cash flow, are highly dependent on our success in (a) efficiently developing and exploiting our current reserves on properties owned by us or by other persons or entities and (b) economically finding or acquiring additional oil and natural gas producing properties. In the future, we may have difficulty acquiring new properties. During periods of low oil and/or natural gas prices, it will become more difficult to raise the capital necessary to finance expansion activities. If we are unable to replace our production, our reserves will decrease, and our business, financial condition and results of operations would be adversely affected.

The threat and impact of terrorist attacks, cyber-attacks or similar hostilities may adversely impact our operations.

We cannot assess the extent of either the threat or the potential impact of future terrorist attacks on the energy industry in general, and on us in particular, either in the short-term or in the long-term. Uncertainty surrounding such hostilities may affect our operations in unpredictable ways, including the possibility that infrastructure facilities, including pipelines and gathering systems, production facilities, processing plants and refineries, could be targets of, or indirect casualties of, an act of terror, a cyber-attack or electronic security breach, or an act of war.

Declining general economic, business or industry conditions may have a material adverse effect on our results of operations, liquidity and financial condition.

Concerns over global economic conditions, energy costs, geopolitical issues, inflation, the availability and cost of credit, the United States mortgage market and a declining real estate market in the United States have contributed to increased economic uncertainty and diminished expectations for the global economy. These factors, combined with volatile prices of oil and natural gas, declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown and a recession. Concerns about global economic growth have had a significant adverse impact on global financial markets and commodity prices. If the economic climate in the United States or abroad continues to deteriorate, demand for petroleum products could diminish, which could impact the price at which we can sell our oil, natural gas and natural gas liquids, affect the ability of our vendors, suppliers and customers to continue operations and ultimately adversely impact our results of operations, liquidity and financial condition.
 
Risks Related to Our Common Stock

We currently have an illiquid and volatile market for our common stock, and the market for our common stock is and may remain illiquid and volatile in the future.
 
We currently have a highly sporadic, illiquid and volatile market for our common stock, which market is anticipated to remain sporadic, illiquid and volatile in the future. Factors that could affect our stock price or result in fluctuations in the market price or trading volume of our common stock include:

our actual or anticipated operating and financial performance and drilling locations, including reserve estimates;
quarterly variations in the rate of growth of our financial indicators, such as net income/loss per share, net income/loss and cash flows, or those of companies that are perceived to be similar to us;
changes in revenue, cash flows or earnings/loss estimates or publication of reports by equity research analysts;
speculation in the press or investment community;
public reaction to our press releases, announcements and filings with the SEC;
sales of our common stock by us or other shareholders, or the perception that such sales may occur;
the limited amount of our freely tradable common stock available in the public marketplace;
general financial market conditions and oil and natural gas industry market conditions, including fluctuations in commodity prices;
the realization of any of the risk factors presented in this Annual Report;
the recruitment or departure of key personnel;
commencement of, or involvement in, litigation;
the prices of oil and natural gas;
the success of our exploration and development operations, and the marketing of any oil and natural gas we produce;
changes in market valuations of companies similar to ours; and
domestic and international economic, legal and regulatory factors unrelated to our performance.

Our stock price may be impacted by factors that are unrelated or disproportionate to our operating performance. The stock markets in general have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock. Additionally, general economic, political and market conditions, such as recessions, interest rates or international currency fluctuations may adversely affect the market price of our common stock. Due to the limited volume of our shares which trade, we believe that our stock prices (bid, ask and closing prices) may not be related to our actual value, and not reflect the actual value of our common stock. Shareholders and potential investors in our common stock should exercise caution before making an investment in us.

Additionally, as a result of the illiquidity of our common stock, investors may not be interested in owning our common stock because of the inability to acquire or sell a substantial block of our common stock at one time. Such illiquidity could have an adverse effect on the market price of our common stock. In addition, a shareholder may not be able to borrow funds using our common stock as collateral because lenders may be unwilling to accept the pledge of securities having such a limited market. An active trading market for our common stock may not develop or, if one develops, may not be sustained.

We do not presently intend to pay any cash dividends on or repurchase any shares of our common stock.

We do not presently intend to pay any cash dividends on our common stock or to repurchase any shares of our common stock. Any payment of future dividends will be at the discretion of the Board of Directors and will depend on, among other things, our earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions applying to the payment of dividends and other considerations that our Board of Directors deems relevant. Cash dividend payments in the future may only be made out of legally available funds and, if we experience substantial losses, such funds may not be available. Accordingly, you may have to sell some or all of your common stock in order to generate cash flow from your investment, and there is no guarantee that the price of our common stock that will prevail in the market will ever exceed the price paid by you.
 
Because we are a small company, the requirements of being a public company, including compliance with the reporting requirements of the Exchange Act and the requirements of the Sarbanes-Oxley Act and the Dodd-Frank Act, may strain our resources, increase our costs and distract management, and we may be unable to comply with these requirements in a timely or cost-effective manner.

As a public reporting company, we must comply with the federal securities laws, rules and regulations, including certain corporate governance provisions of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and the Dodd-Frank Act, related rules and regulations of the SEC, with which a private company is not required to comply. Complying with these laws, rules and regulations will occupy a significant amount of time of our Board of Directors and management and will significantly increase our costs and expenses, which we cannot estimate accurately at this time. Among other things, we must:

establish and maintain a system of internal control over financial reporting in compliance with the requirements of Section 404 of the Sarbanes-Oxley Act and the related rules and regulations of the SEC and the Public Company Accounting Oversight Board;
prepare and distribute periodic public reports in compliance with our obligations under the federal securities laws;
maintain various internal compliance and disclosure policies, such as those relating to disclosure controls and procedures and insider trading in our common stock;
involve and retain to a greater degree outside counsel and accountants in the above activities;
maintain a comprehensive internal audit function; and
maintain an investor relations function.

In addition, being a public company subject to these rules and regulations may require us to accept less director and officer liability insurance coverage than we desire or to incur substantial costs to obtain coverage. These factors could also make it more difficult for us to attract and retain qualified members of our Board of Directors, particularly to serve on our audit committee, and qualified executive officers.

We currently have an outstanding Secured Convertible Promissory Note in the amount of $1,730,000, which is convertible into our common stock upon the occurrence of an event of default thereunder and approximately $350,000 outstanding under other notes which are convertible into our common stock in the event we do not repay such notes six months from their issuance date.

On October 19, 2015, and effective October 16, 2015, we sold a Secured Convertible Promissory Note (the “Typenex Note”) to Typenex Co-Investment, LLC (“Typenex”) in the amount of $1,730,000. The Typenex Note is due on April 19, 2016 and no interest accrues on the Typenex Note unless an event of default occurs thereunder. The amounts owed under the Typenex Note were secured by a Stock 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 two million one hundred thousand (2,100,000) shares of our common stock held by CW Navigation as security for our obligations under the Typenex Note and related documents. The Typenex Note provides for customary events of default such as failing to timely make payments under the Typenex Note when due, and including our failure to maintain a reserve of shares in connection with the conversion of the Typenex Note equal to at least three times the number of shares of common stock that could be issuable thereunder at any time (initially 3 million shares), failing to repay all of our currently outstanding variable rate convertible securities within thirty days of the date of the note, failing to repay our senior creditor by the maturity date of the Typenex Note or alternatively, failing to receive the senior lender’s consent to repay the Typenex Note at maturity in cash, and in the event the value of the securities pledged pursuant to the Pledge Agreement (as discussed above) falls below a required value after November 1, 2015, subject where applicable to our ability to cure certain defaults. At any time following an uncured event of default, Typenex has the right to convert any or all of the outstanding principal amount of the note into our common stock. The conversion price of the Typenex Note is 80% of the five lowest closing bid prices of our common stock on the 20 trading days prior to any conversion, provided that if the average of such closing bid prices is below $0.75 per share, the conversion rate is decreased by 5% (to 75%), and provided further that the conversion rate is decreased by an additional 5% if we are not DWAC eligible at any time or DTC eligible at any time (for up to an aggregate of an additional 10% decrease in the conversion rate). Finally, in the event certain defaults (defined as major defaults under the note) occur, the conversion rate may be decreased by up to an additional 15% (an additional 5% decrease in the conversion rate per the occurrence of the first three major defaults). Typenex also has the right upon the occurrence of an event of default to require us to repay in full the amount owed under the note by providing us written notice. Additionally, upon the occurrence of certain events of default as described in the Typenex Note, we are required to repay Typenex liquidated damages in addition to the amount owed under the Typenex Note. At no time may the Typenex 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.
 
Additionally, it is an event of default under the note in the event we fail to repay all of our outstanding variable securities within 30 days of the date of the note (the “Variable Security Payment Date”) or in the event we have any outstanding variable securities after such Variable Security Payment Date.
 
On November 9, 2015, we sold each of Adar Bays, LLC (“Adar”) and Union Capital, LLC (“Union”), identical 8% Short Term Cash Redeemable Notes (collectively, the “Initial Notes”) in the amount of $208,000 ($416,000 in aggregate). The Initial Notes accrue interest at the rate of 8% per annum and have a two year term. We are required to pre-pay the Initial Notes 180 days after the issuance date (the “Pre-Payment Date”), provided that if we fail to prepay such notes in full on the Pre-Payment Date (or before), the holders thereof have the right to convert the principal and accrued interest owed under such Initial Notes into our common stock at a 40% discount (increasing to 50% if we receive a DTC “Chill” on our common stock or upon the occurrence of certain events of default) to the lowest trading price of our common stock during the 15 trading days prior to conversion. At no time may the Initial Notes be converted into shares of our common stock if such conversion would result in the applicable holder and its affiliates owning an aggregate of in excess of 9.9% of the then outstanding shares of our common stock.

On November 9, 2015, we sold JSJ Investments Inc. (“JSJ”) an 8% Short Term Cash Redeemable Note (the “JSJ Note”) in the principal amount of $350,000. The JSJ Note accrues interest at the rate of 8% per annum and is payable on demand by JSJ at any time after November 9, 2016. We may prepay the JSJ note, together with accrued and unpaid interest, at any time prior to the 180th day after the issuance date (the “JSJ Pre-Payment Date”). If we fail to prepay the JSJ Note prior to the JSJ Pre-Payment Date, JSJ has the right to convert the principal and accrued interest owed under such note into our common stock at a 40% discount to the lowest trading price of our common stock during the 15 trading days prior to conversion. At no time may the JSJ Note be converted into shares of our common stock if such conversion would result in JSJ and its affiliates owning an aggregate of in excess of 4.9% (which may be increased to 9.99% with written notice from JSJ, provided such increase will not take effect for at least 61 days) of the then outstanding shares of our common stock.
 
If an event of default occurs under the Typenex Note and Typenex converts such note into common stock or the other notes described above are converted into common stock, the conversion thereof will likely cause the value of our common stock, to decline in value.  Additionally, if sequential conversions of the convertible note and sales of such converted shares take place, the price of our common stock may decline, and as a result, the holders 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 note 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. Upon the occurrence of an event of default, the Typenex Note will be convertible into shares of our common stock and upon our failure to timely repay the other notes, such notes will be convertible into 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 holder 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. The issuance of common stock upon conversion of the notes will result in immediate and substantial dilution to the interests of other stockholders since the holders may ultimately receive and sell the full amount of shares issuable in connection with the conversion of such notes. If an event of default were to occur under the Typenex Note we could face significant penalties and liquidated damages, and the conversion of such note or the other notes and sale of shares by the note holders could cause the value our common stock to decline in value or become worthless.

Our Board of Directors can authorize the issuance of additional shares of preferred stock, which could diminish the rights of holders of our common stock and make a change of control of our company more difficult even if it might benefit our shareholders.

Our Board of Directors is authorized to issue 100,000,000 shares of preferred stock in one or more series and to fix the voting powers, preferences and other rights and limitations of the preferred stock. To date we have designated Series A and Series B preferred stock, described in greater detail below under “Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” – “Description of Capital Stock”. Additional shares of preferred stock may be issued by our Board of Directors without shareholder approval, with voting powers and such preferences and relative, participating, optional or other special rights and powers as determined by our Board of Directors, which may be greater than the shares of common stock and preferred stock currently outstanding. As a result, shares of preferred stock may be issued by our Board of Directors which cause the holders to have majority voting power over our shares, provide the holders of the preferred stock the right to convert the shares of preferred stock they hold into shares of our common stock, which may cause substantial dilution to our then common stock shareholders and/or have other rights and preferences greater than those of our common stock and preferred stock shareholders including having a preference over our common stock with respect to dividends or distributions on liquidation or dissolution.

Investors should keep in mind that the Board of Directors has the authority to issue additional shares of common stock and preferred stock, which could cause substantial dilution to our existing shareholders. Additionally, the dilutive effect of any preferred stock which we may issue may be exacerbated given the fact that such preferred stock may have voting rights and/or other rights or preferences which could provide the preferred shareholders with substantial voting control over us subsequent to the date of this filing and/or give those holders the power to prevent or cause a change in control, even if that change in control might benefit our shareholders. As a result, the issuance of shares of common stock and/or preferred stock may cause the value of our securities to decrease.
 
Securities analysts may not cover, or continue to cover, our common stock and this may have a negative impact on our common stock’s market price.

The trading market for our common stock will depend, in part, on the research and reports that securities or industry analysts publish about us or our business. We do not have any control over independent analysts. We may not be able to obtain additional research coverage by independent securities and industry analysts. If no independent securities or industry analysts cover us, the trading price for our common stock could be negatively impacted. If one or more of the analysts cover us and such analysts downgrade our common stock, change their opinion of our shares or publish inaccurate or unfavorable research about our business, our stock price could decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our common stock could decrease and we could lose visibility in the financial markets, which could cause our stock price and trading volume to decline.

Our ability to uplist our common stock to the NYSE MKT or the NASDAQ Capital Market is subject to us meeting applicable listing criteria.

The NYSE MKT and NASDAQ Capital Market, as well as other exchanges, require companies desiring to list their common stock on such exchanges and markets to meet certain listing criteria including total number of stockholders; minimum stock price, total value of public float, and in some cases total shareholders’ equity and market capitalization.  Our failure to meet such applicable listing criteria could prevent us from listing our common stock on such ‘higher’ exchanges or markets. In the event we are unable to uplist our common stock, our common stock will continue to trade on the OTCQB market, which is generally considered less liquid and more volatile than then ‘higher’ exchanges and markets.  Furthermore, the trading in our common stock will likely continue to be subject to the penny stock rules, described in greater detail below under “Trading of our stock may become restricted by the SEC’s penny stock regulations and FINRA’s sales practice requirements, which may limit a stockholder’s ability to buy and sell our stock.” Our failure to uplist our common stock could make it more difficult for you to trade our common stock shares, could prevent our common stock trading on a frequent and liquid basis and could result in the value of our common stock being less than it would be if we were able to uplist.

Shareholders may be diluted significantly through our efforts to obtain financing and satisfy obligations through the issuance of securities.

Wherever possible, our Board of Directors will attempt to use non-cash consideration to satisfy obligations. In many instances, we believe that the non-cash consideration will consist of shares of our common stock, preferred stock or warrants to purchase shares of our common stock. Our Board of Directors has authority, without action or vote of the shareholders, to issue all or part of the authorized but unissued shares of common stock, preferred stock or warrants to purchase such shares of common stock. In addition, we may attempt to raise capital by selling shares of our common stock, possibly at a discount to market in the future. These actions will result in dilution of the ownership interests of existing shareholders and may further dilute common stock book value, and that dilution may be material. Such issuances may also serve to enhance existing management’s ability to maintain control of us, because the shares may be issued to parties or entities committed to supporting existing management.

A decline in the price of our common stock could affect our ability to raise further working capital and adversely impact our operations.

A decline in the price of our common stock could result in a reduction in the liquidity of our common stock and a reduction in our ability to raise additional capital for our operations. Because our operations to date have been largely financed through the sale of equity securities, a decline in the price of our common stock could have an adverse effect upon our liquidity and our continued operations. A reduction in our ability to raise equity capital in the future could have a material adverse effect upon our business plan and operations, including our ability to continue our current operations.
 
Trading of our stock may become restricted by the SEC’s penny stock regulations and FINRA’s sales practice requirements, which may limit a stockholder’s ability to buy and sell our stock.

Our common stock will be subject to the “Penny Stock” Rules of the SEC, which will make transactions in our common stock cumbersome and may reduce the value of an investment in our common stock.

Our common stock is quoted on the OTCQB Market, which is generally considered to be a less efficient market than markets such as NASDAQ or the national exchanges. Further, our securities will be subject to the “penny stock rules” adopted pursuant to Section 15(g) of the Exchange Act. The penny stock rules apply generally to companies whose common stock trades at less than $5.00 per share, subject to certain limited exemptions. Such rules require, among other things, that brokers who trade “penny stock” to persons other than “established customers” complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning trading in the security, including a risk disclosure document and quote information under certain circumstances. Many brokers have decided not to trade “penny stock” because of the requirements of the “penny stock rules” and, as a result, the number of broker-dealers willing to act as market makers in such securities is limited. In the event that we remain subject to the “penny stock rules” for any significant period, there may develop an adverse impact on the market, if any, for our securities. Because our securities are subject to the “penny stock rules”, investors will find it more difficult to dispose of our securities. Further, it is more difficult: (i) to obtain accurate quotations, (ii) to obtain coverage for significant news events because major wire services, such as the Dow Jones News Service, generally do not publish press releases about such companies, and (iii) to obtain needed capital.

In addition to the “penny stock” rules promulgated by the SEC, FINRA has adopted rules that require a broker-dealer to have reasonable grounds for believing that an investment is suitable for a customer when recommending the investment to that customer. Prior to recommending speculative low-priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative low priced securities will not be suitable for at least some customers. FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.

ITEM 1B.
UNRESOLVED STAFF COMMENTS

None.

ITEM 2.
PROPERTIES

The Company’s oil and gas properties are described in greater detail above under “Item 1. Business”.

Office Lease

In March 2011, we executed a lease for office space in Houston, Texas. The lease term was three years and we had an option to extend the lease for an additional three years. Our scheduled rent was $6,406 per month plus common area maintenance cost for the first year, $6,673 plus common area maintenance cost for the second year, and $6,940 per month plus common area maintenance cost for the third year. We did not elect to extend this lease when it expired in March of 2014. During 2013 we rented office space at 545 N. Upper Broadway, Suite 900, Corpus Christi, Texas, 78401 for $3,200 per month. In September 2013, we terminated our lease for office space in Corpus Christi, Texas.

In February 2014, we agreed to sublease 4,915 square feet of office space from Greenshale Energy, LLC located at 800 Gessner Rd., Houston, Texas 77024. The lease has a term through December 31, 2017. Monthly rent of $10,650 is due under the lease from March 1, 2014 through December 31, 2014; $10,854 is due under the lease from January 1, 2015 through December 31, 2015; $11,059 is due under the lease from January 1, 2016 through December 31, 2016; and $11,264 is due under the lease from January 1, 2017 through December 31, 2017.
 
Rent expense during the years ended July 31, 2015 and 2014 was $175,893 and $186,464, respectively. See Note 13 – Commitments and Contingencies in the attached financial statements for details regarding our commitments related to our future obligations.

ITEM 3.
LEGAL PROCEEDINGS

Although we may, from time to time, be involved in litigation and claims arising out of our operations in the normal course of business, we are not currently a party to any material legal proceeding.

Previously, we were subject to Civ. Action No. 4:15-cv-00727, Hydrocarb Energy Corp., et al. v. Vincent Pasquale Scaturro; In the United States District Court for the Southern District of Texas Houston Division. Hydrocarb Energy Corp. was Plaintiff in this action, and had 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. Specifically, in November 2014, Pasquale V. Scaturro, the Company’s former Chief Executive Officer and Kent P. Watts, the Company’s current Chief Executive Officer and Chairman, entered into a stock purchase agreement, which was amended in December 2014, at which time certain of the adult children of Mr. Watts became party to the agreement.  Pursuant to the agreement, Mr. Watts and his children agreed to sell Mr. Scaturro the outstanding capital stock of a company which they owned which is located in Namibia which owns real estate, in consideration for 475,000 shares of common stock held by Mr. Scaturro (deliverable in tranches between December 2014 and April 2015, of which an aggregate of 75,000 had been delivered as of the date of the lawsuit below) to be transferred to Mr. Watts’ children and a promissory note in the amount of $475,000 payable to Mr. Watts.  Additionally, Mr. Scaturro also entered into a lock-up agreement, whereby he agreed to sell a maximum of 500 shares of the Company’s common stock which he holds or may hold in the future, per day, until the listing by the Company on a national exchange or NASDAQ, and thereafter to sell 5% of the ten day moving volume weighted average of shares per day, during the 24 months following the date of the December agreement. Subsequently, Kent P. Watts assigned his rights under the lock-up agreement to the Company and the lawsuit was filed by the Company seeking damages for Mr. Scaturro’s breach of contract.  In July 2015, the parties entered into a settlement agreement whereby Mr. Scaturro agreed to transfer an aggregate of 2,237,500 shares of our common stock to Kent P. Watts, (of which 300,000 shares will be transferred to Mr. Watts’ legal counsel as part of a contingent settlement of amounts owed to such legal counsel) and an aggregate of 162,500 shares of our common stock to two children of Mr. Watts; Mr. Scaturro retained 307,058 shares (the “Remaining Shares”), all interests held by Mr. Watts’ children in the Namibia company were transferred to Mr. Scaturro, and the consulting agreement which was previously in place between the Company and Mr. Scaturro was terminated.  The parties also agreed to dismiss the lawsuit and cross and counter claims with prejudice and release each other from outstanding claims and causes of actions.  Finally, Mr. Scaturro agreed to sell no more than 500 of the Remaining Shares per day until December 18, 2016. Subsequently the parties dismissed the lawsuit with prejudice as of July 20, 2015.

The General Land Office of the State of Texas (“GLO”) has asserted claims against the Company under various Miscellaneous Easements.  The GLO claims that the Company is obligated to either renew the various Miscellaneous Easements by paying a renewal fee to the GLO, or to remove any pipeline laid in the various Miscellaneous Easements.  The GLO has asserted its claims, and the company has disclaimed any obligations under the various Miscellaneous Easements.  On August 29, 2014, the Company filed a lawsuit in state district court in Chambers County, Texas asking the court to reform an assignment and assumption agreement in the property records of Chambers County.  The Company has been in discussions with the GLO in an attempt to resolve the dispute.  At this time, there is no estimate of loss with respect to this lawsuit.

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 July 31, 2015, $150,000 has been recognized and is included in the balance sheet under the caption “Accounts payable and accrued expenses.”

ITEM 4.
MINE SAFETY DISCLOSURES

Not applicable.
 
PART II

ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market Information

Shares of our common stock became quoted on the OTC Bulletin Board under the symbol “SGCA” on August 14, 2008. On May 17, 2012, in connection with our name change, our trading symbol changed to “DUMA”. On February 18, 2014, in connection with our name change, our trading symbol again changed to “HECC”.  Currently our common stock is quoted on the OTCQB Market maintained by OTC Markets (the “OTCQB”) under the trading symbol “HECC”.

The following tables set forth the high and low sales price for one share of our common stock, as quoted on the OTCBB, prior to its closure in late 2014, and thereafter on the OTCQB. These over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, markdown or commission and may not represent actual transactions. The prices below are adjusted for the 1:3 reverse stock split on May 8, 2014. We do not have any securities that are currently traded on any other exchange or quotation system.

Quarter Ended
 
High
   
Low
 
         
July 31, 2015
 
$
1.62
   
$
0.90
 
April 30, 2015
 
$
1.46
   
$
0.40
 
January 31, 2015
 
$
3.25
   
$
0.40
 
October 31, 2014
 
$
5.37
   
$
2.87
 
                 
July 31, 2014
 
$
6.00
   
$
3.45
 
April 30, 2014
 
$
8.85
   
$
4.56
 
January 31, 2014
 
$
8.10
   
$
5.43
 
October 31, 2013
 
$
6.75
   
$
5.43
 

Holders

As of October 31, 2015, we had 125 shareholders of record.

Dividend Policy

No dividends have been declared or paid on our common stock. We have incurred recurring losses and do not currently intend to pay any cash dividends in the foreseeable future.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table sets forth information as of July 31, 2015:

Equity Compensation Plan Information

       
Number of Securities to be Issued Upon Exercise of Outstanding Options, warrants and Rights
   
Weighted Average Exercise Price of Outstanding Options, Warrants and Rights
   
Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans (excluding securities reflected in column (a))
 
     
(a)
   
(b)
   
(c)
 
               
(a) 
Equity compensation plans approved by security holders
   
N/A
 
   
N/A
 
   
N/A
 
(b) 
Equity compensation plans not approved by security holders
                       
1.  2013 Stock Incentive Plan    
198,334
   
$
7.14
     
267,744
 
  2.  Compensation Warrants    
978,299
   
$
7.50
     
N/A
 
Total   1,176,633         267,744  
 
(1) Does not include the 2015 Stock Incentive Plan which was approved by the Board of Directors on August 17, 2015 and approved by the stockholders on September 28, 2015, as described below.
2009 Stock Incentive Plan

On May 21, 2009, our Board of Directors authorized and approved the adoption of the 2009 Restated Stock Incentive Plan (the “2009 Plan”), which absorbed and replaced the 2007 Stock Incentive Plan. The purpose of the 2009 Plan is to enhance our long-term stockholder value by offering opportunities to our directors, officers, employees and eligible consultants to acquire and maintain stock ownership in order to give these persons the opportunity to participate in our growth and success, and to encourage them to remain in our service.

The 2009 Plan is to be administered by our Board of Directors or a committee appointed by and consisting of two or more members of the Board of Directors, which shall determine, among other things, (i) the persons to be granted awards under the 2009 Plan; (ii) the number of shares or amount of other awards to be granted; and (iii) the terms and conditions of the awards granted. The Company may issue restricted shares, options, stock appreciation rights, deferred stock rights, dividend equivalent rights, among others, under the 2009 Plan. An aggregate of 133,334 of our shares could be issued pursuant to the grant of awards under the 2009 Plan, which was replaced by the 2013 Plan described below.
 
An award may not be exercised after the termination date of the award and may be exercised following the termination of an eligible participant’s continuous service only to the extent provided by the administrator under the 2009 Plan. If the administrator under the 2009 Plan permits a participant to exercise an award following the termination of continuous service for a specified period, the award terminates to the extent not exercised on the last day of the specified period or the last day of the original term of the award, whichever occurs first. In the event an eligible participant’s service has been terminated for “cause”, he or she shall immediately forfeit all rights to any of the awards outstanding.

2010 Stock Incentive Plan

During August 2010, the Board of Directors authorized and approved the adoption of the 2010 Stock Incentive Plan (the “2010 Plan”). An aggregate of 66,667 shares of our common stock may be issued under the plan. The purpose of the 2010 Plan is to enhance our long-term stockholder value by offering opportunities to our directors, officers, employees and eligible consultants to acquire and maintain stock ownership in order to give these persons the opportunity to participate in our growth and success, and to encourage them to remain in our service.

The 2010 Plan is to be administered by our Board of Directors or a committee appointed by and consisting of two or more members of the Board of Directors, which shall determine, among other things, (i) the persons to be granted awards under the 2010 Plan; (ii) the number of shares or amount of other awards to be granted; and (iii) the terms and conditions of the awards granted. The Company may issue restricted shares, options, stock appreciation rights, deferred stock rights, dividend equivalent rights, among others, under the 2010 Plan. An aggregate of 66,667 of our shares could be issued pursuant to the grant of awards under the 2010 Plan, which was replaced by the 2013 Plan described below.
 
An award may not be exercised after the termination date of the award and may be exercised following the termination of an eligible participant’s continuous service only to the extent provided by the administrator under the 2010 Plan. If the administrator under the 2010 Plan permits a participant to exercise an award following the termination of continuous service for a specified period, the award terminates to the extent not exercised on the last day of the specified period or the last day of the original term of the award, whichever occurs first. In the event an eligible participant’s service has been terminated for “cause”, he or she shall immediately forfeit all rights to any of the awards outstanding.
 
2011 Stock Incentive Plan

During April 2011, the Board of Directors authorized and approved the adoption of the 2011 Stock Incentive Plan (the “2011 Plan”). An aggregate of 333,333 shares of our common stock could be issued under the plan, which was replaced by the 2013 Plan described below.

The purpose of the 2011 Plan is to enhance our long-term stockholder value by offering opportunities to our directors, officers, employees and eligible consultants to acquire and maintain stock ownership in order to give these persons the opportunity to participate in our growth and success, and to encourage them to remain in our service.

The 2011 Plan is to be administered by our Board of Directors or a committee appointed by and consisting of two or more members of the Board of Directors, which shall determine, among other things, (i) the persons to be granted awards under the 2011 Plan; (ii) the number of shares or amount of other awards to be granted; and (iii) the terms and conditions of the awards granted. The Company may issue restricted shares, options, stock appreciation rights, deferred stock rights, dividend equivalent rights, among others, under the 2011 Plan.

An award may not be exercised after the termination date of the award and may be exercised following the termination of an eligible participant’s continuous service only to the extent provided by the administrator under the 2011 Plan. If the administrator under the 2011 Plan permits a participant to exercise an award following the termination of continuous service for a specified period, the award terminates to the extent not exercised on the last day of the specified period or the last day of the original term of the award, whichever occurs first. In the event an eligible participant’s service has been terminated for “cause”, he or she shall immediately forfeit all rights to any of the awards outstanding.

2013 Stock Incentive Plan

During February 2013, the Board of Directors authorized and approved the adoption of the 2013 Stock Incentive Plan (the “2013 Plan”). This plan superseded all of the Company’s other previous plans, as described above. An aggregate of 883,333 shares of common stock may be issued under the plan.

The Plan is administered by the Board of Directors, which has substantial discretion to determine persons, amounts, time, price, exercise terms, and restrictions of the grants, if any.

An award may not be exercised after the termination date of the award and may be exercised following the termination of an eligible participant’s continuous service only to the extent provided by the administrator under the 2013 Plan. If the administrator under the 2013 Plan permits a participant to exercise an award following the termination of continuous service for a specified period, the award terminates to the extent not exercised on the last day of the specified period or the last day of the original term of the award, whichever occurs first. In the event an eligible participant’s service has been terminated for “cause”, he or she shall immediately forfeit all rights to any of the awards outstanding.
 
During the year ended July 31, 2015, we granted options to purchase 25,000 shares of our common stock under the 2013 Plan. During the year ended July 31, 2015, no options to purchase shares of our common stock expired unexercised. As of July 31, 2015, a total of 267,744 shares were available to be issued under the 2013 Plan.
 
Compensation Warrants
 
During the year ended July 31, 2015, we granted warrants to purchase 311,632 shares of our common stock. The balance of 666,667 compensation warrants were issued primarily in 2011, at the time of the purchase of the Galveston Bay subsidiary. As of the date of this filing, warrants to purchase 978,299 shares remain outstanding.
 
2015 Stock Incentive Plan

The Company’s 2015 Stock Incentive Plan (the “2015 Plan”) was approved by the Board of Directors on August 17, 2015 and approved by the stockholders on September 28, 2015.

Subject to adjustment in connection with the payment of a stock dividend, a stock split or subdivision or combination of the shares of common stock, or a reorganization or reclassification of the Company’s common stock, the maximum aggregate number of shares of common stock which may be issued pursuant to awards under the 2015 Plan is one million shares.

The 2015 Plan provides an opportunity for any employee, officer, director or consultant of the Company, except for instances where services are in connection with the offer or sale of securities in a capital-raising transaction, or they directly or indirectly promote or maintain a market for the Company’s securities, subject to any other limitations provided by federal or state securities laws and the terms of the 2015 Plan, to receive (i) incentive stock options (to eligible employees only); (ii) nonqualified stock options; (iii) restricted stock; (iv) stock awards; (v) shares in performance of services; or (vi) any combination of the foregoing. In making such determinations, the Board may take into account the nature of the services rendered by such person, his or her present and potential contribution to the Company’s success, and such other factors as the Board of Directors in its discretion deems relevant.

The 2015 Plan is administered by either (a) the Compensation Committee of the Company (if designated by the Board of Directors); or (b) the entire Board of Directors of the Company, as determined from time to time by the Board of Directors (the “Administrator”). The Administrator has the exclusive right to interpret and construe the 2015 Plan, to select the eligible persons who will receive an award, and to act in all matters pertaining to the grant of an award and the determination and interpretation of the provisions of the related award agreement, including, without limitation, the determination of the number of shares subject to stock options and the option period(s) and option price(s) thereof, the number of shares of restricted stock or shares subject to stock awards or performance shares subject to an award, the vesting periods (if any) and the form, terms, conditions and duration of each award, and any amendment thereof consistent with the provisions of the 2015 Plan.

Employees, non-employee directors, and consultants of the Company and its subsidiaries are eligible to participate in the 2015 Plan. Incentive stock options may be granted under the 2015 Plan only to employees of our company and its affiliates. Employees, directors and consultants of our company and its affiliates are eligible to receive all other types of awards under the 2015 Plan. The grant of any incentive stock options under the 2015 Plan is subject to the approval of the 2015 Plan by our stockholders within 12 months of the approval of the 2015 Plan by our Board of Directors.

To date, no awards have been granted under the 2015 Plan.

Recent Sales of Unregistered Securities

Other than listed below, we have previously disclosed in our Quarterly Reports on Form 10-Q and/or Current Reports on Form 8-K all unregistered equity securities that we issued during our fiscal year ended July 31, 2015.

On June 28, 2015, after a lengthy negotiation, we entered into a Financial Services Agreement with Geoserve Marketing LLC (“Geoserve”) a company controlled by Michael Watts, the father-in-law of Jeremy Driver, our former Chief Executive Officer and director, and brother to our current Chief Executive Officer, Kent P. Watts, pursuant to which Geoserve agreed to provide investor relations and related services to us for a period of three years in consideration for an aggregate of 850,000 shares of restricted common stock.  The agreement can be terminated by either party with 60 days’ notice after the expiration of six months, provided that the 850,000 shares are deemed earned upon Geoserve’s entry into the agreement.  We were previously party to a consulting agreement with Geoserve in 2011 which had expired as of our entry into the June 2015 agreement.
 
In connection with the September 28, 2015, designation of our Series B Convertible Preferred Stock, all outstanding Convertible Promissory Notes sold in connection with our offering of “Units”, each consisting of (a) 25,000 shares of the Company’s restricted common stock; and (b) Convertible Promissory Notes with a face amount of $100,000, automatically converted into shares of Series B Convertible Preferred Stock as described below.  The Convertible Notes were convertible into common stock of the Company at any time at the holder’s option at a conversion price of $4 per share, and were automatically convertible into shares of Series B Convertible Preferred Stock of the Company upon designation of such Series B Convertible Preferred Stock with the Secretary of State of Nevada which occurred on September 28, 2015.  In connection with such automatic conversion, a total of $3 million in Convertible Notes held by our Chief Executive Officer and Chairman, Kent P. Watts, and a total of $50,000 in Convertible Notes held by David L. Gillespie automatically converted into an aggregate of 3,050 shares of our Series B Convertible Preferred Stock (with Mr. Watts receiving 3,000 shares and Mr. Gillespie receiving 50 shares). We claim an exemption from registration provided by Section 3(a)(9) of the Securities Act, as the security was exchanged by us with our existing security holder in a transaction where no commission or other remuneration was paid or given directly or indirectly for soliciting such exchange.
 
From August to September 2015, the Company sold $1,740,832 in Convertible Subordinated Promissory Notes (including $83,333 in notes sold to Clint Summers who was a director of the Company from September 7, 2015 until his untimely death shortly thereafter; $32,500 in notes sold to Brian Kenny, who is the nephew of the Company’s Chief Executive Officer and Chairman; $100,000 to the Company’s director, S. Chris Herndon; $516,667 to entities owned or controlled by Kent P. Watts, the Company’s Chief Executive Officer and Chairman). The notes are due two years from their issuance date, accrue interest which is payable quarterly in arrears, at either a cash interest rate (equal to the WTI Rate described below) or a stock interest rate (12% per annum)(at the option of each holder at the beginning of each quarter), provided no principal or interest can be paid in cash until all amounts owed by the Company to its senior lender is paid in full.  In the event the stock interest rate is chosen by the holder, restricted shares of common stock equal to the total accrued dividend divided by the average of the closing sales prices of the Company’s common stock for the applicable quarter are required to be issued in satisfaction of amounts owed on a quarterly basis.  In the event the cash interest rate is chosen, interest accrues until converted into common stock (as discussed below) or until the Company is able to pay such accrued interest in cash pursuant to the terms of the note.  The “WTI Rate” equals an annualized percentage interest rate equal to the average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”). 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%). Notwithstanding the above, in the event that the average quarterly closing spot price is $40 or less, the WTI Rate for the applicable following quarter is 0%.  All principal and accrued interest on the notes are convertible into common stock at a conversion price of $0.75 per share at any time. Additionally, the Company may force the conversion of the notes into common stock in the event the trading price of the Company’s common stock is equal to at least $5.00 per share for at least 20 out of any 30 consecutive trading days.  Any shares of common stock issuable upon conversion of the notes are subject to a lock-up whereby no shares of common stock can be sold until January 1, 2016, and no more than 2,500 shares of common stock can be sold per day thereafter until the Company’s common stock is listed on the NASDAQ or NYSE market or the trading volume of the Company’s common stock is in excess of 100,000 shares per day. The notes have standard and customary events of default.
In September 2015, the Company issued 1,000,000 shares of restricted common stock to Snap or Tap Productions, LLC in consideration for agreeing to provide two years of public relations and investor awareness services to the Company.
We believe that the issuances described above were exempt from registration pursuant to (a) Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”); or (b) Rule 506 of the Securities Act, and the regulations promulgated thereunder.  With respect to the transactions described above, no general solicitation was made either by us or by any person acting on our behalf. The transactions were all privately negotiated, and none involved any kind of public solicitation. No underwriters or agents were involved in the foregoing grants 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. All recipients confirmed their status as “accredited investors”.
 
As described below under “Item 9B. Other Information”, in November 2015, we sold $416,000 in Initial Notes and $416,000 in Second Notes; and the JSJ Note, all of which notes are convertible into our common stock pursuant to the applicable terms of such notes. We believe that the sale of the notes were exempt from registration pursuant to (a) Section 4(a)(2) of the Securities Act; or (b) Rule 506 of the Securities Act, and the regulations promulgated thereunder. With respect to the transactions described above, no general solicitation was made either by us or by any person acting on our behalf. The transactions were all privately negotiated, and none involved any kind of public solicitation. 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. All recipients were “accredited investors”.
 
Description of Capital Stock

Common Stock

Holders of our common stock: (i) are entitled to share ratably in all of our assets available for distribution upon liquidation, dissolution or winding up of our affairs; (ii) do not have preemptive, subscription or conversion rights, nor are there any redemption or sinking fund provisions applicable thereto; and (iii) are entitled to one vote per share on all matters on which stockholders may vote at all stockholder meetings. Each shareholder is entitled to receive the dividends as may be declared by our directors out of funds legally available for dividends. Our directors are not obligated to declare a dividend. Any future dividends will be subject to the discretion of our directors and will depend upon, among other things, future earnings, the operating and financial condition of our Company, our capital requirements, general business conditions and other pertinent factors.

The presence of the persons entitled to vote at least one-third (1/3) of the outstanding shares of voting stock entitled to vote on a matter before the stockholders constitutes a quorum.

The affirmative vote of a majority of the shares present in person or represented by proxy at the meeting and entitled to vote on the matter and represented at a meeting at which a quorum is present constitute an act of the stockholders, except for the election of directors, who are appointed by a plurality of the shares entitled to vote at a meeting at which a quorum is present.

Preferred Stock

Effective September 28, 2015, the Company filed a Certificate of Amendment to its Articles of Incorporation with the Secretary of State of Nevada, to (1) affect an amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of the Company’s common stock to 1,000,000,000 shares; (2) affect an amendment to the Company’s Articles of Incorporation to authorize 100,000,000 shares of “blank check” preferred stock (the “Blank Check Preferred Amendment”); (3) designate 10,000 shares of Series A 7% Convertible Voting Preferred Stock (the “Series A Amendment”); and (4) designate 35,000 shares of Series B Convertible Preferred Stock (the “Series B Amendment”), each of which amendments were approved by the stockholders of the Company at the annual meeting of stockholders held on September 28, 2015.  Previously effective on September 21, 2015, the Company filed a Certificate of Correction with the Secretary of State of Nevada, which cancelled and rescinded in its entirety, the previously filed Series A 7% Convertible Voting Preferred Stock designation filed by the Board of Directors without stockholder approval on December 2, 2013.

Pursuant to the Blank Check Preferred Amendment, up to 100,000,000 shares of preferred stock of the Company may be issued from time to time in one or more series, each of which will have such distinctive designation or title as may be determined by the Board of Directors of the Company prior to the issuance of any shares thereof. Preferred stock will have such voting powers, full or limited, or no voting powers, and such preferences and relative, participating, optional or other special rights and such qualifications, limitations or restrictions thereof, as shall be stated in such resolution or resolutions providing for the issue of such class or series of preferred stock as may be adopted from time to time by the Board of Directors prior to the issuance of any shares thereof.

Series A Preferred Stock

Pursuant to the Series A Amendment, the Company designated 10,000 shares of Series A 7% Convertible Voting Preferred Stock, which has a stated value of $400 per share, pays dividends at 7% per annum, is convertible into the Company’s common stock (together with accrued and unpaid dividends), at a 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 stockholders 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). As described in greater detail in the Company’s Definitive Schedule 14A Proxy Statement filed with the SEC on August 18, 2015, the (“Proxy”), the approval of the Series A Amendment was only to ratify the effect of certain prior transactions, and the Company has no outstanding Series A Preferred Stock and no current plans to issue Series A Preferred Stock at this time.
 
Series B Preferred Stock

Pursuant to the Series B Amendment, the Company designated 35,000 shares of Series B Convertible Preferred Stock. 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 average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”) multiplied by the face value (provided that the interest rate for the first quarter after issuance is 7% per annum). Until the end of the third calendar quarter following the initial issuance date (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 to Shadow Tree Capital Management, LLC, and other lenders under the Company’s senior credit facility, as well as any future debt used to refinance, repay or supplement the senior credit facility, 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.
 
ITEM 6.
SELECTED FINANCIAL DATA

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.

ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition, changes in financial condition, plan of operations and results of operations should be read in conjunction with (i) our audited consolidated financial statements as at July 31, 2015 and 2014; and (ii) the section entitled “Business”, each included in this annual report. The discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including, but not limited to, those set forth under “Risk Factors” and elsewhere in this annual report.

Executive Summary

The following table shows the comparison for the last two years in certain key areas. Our focus, managerially, is on building revenue and cash flow. Our acquisition strategy will be driven by these same two criteria. We believe that shareholder returns and value will be most enhanced, at least in the short term, by focusing on increasing both revenue and cash flow.

   
2015
   
2014
 
         
Revenue
 
$
3,941,541
   
$
5,065,096
 
Cash provided by (used in) operations
 
$
3,088,113
 
$
(456,658
)
Total assets
 
$
31,134,501
   
$
25,732,155
 
Net loss attributable to the Company
 
$
(12,628,018
)
 
$
(6,549,322
)
Total stockholders' (deficit) equity
 
$
(1,088,622
)
 
$
9,924,116
 

Recent Highlights:
 
Completed first phase of multi-well development program in Galveston Bay.
Made additional infrastructure improvements to assure limited downtime over winter months.
Completed negotiations for continued operations of Red Fish Reef Field.
Began significant capital and equity raise program.
Negotiated drilling contract as operator of new well.

Near Term Focus and Plans:

Continue multi-well development program in Galveston Bay, Texas to enhance production, cash flow and reserves.
Seek new partner to assist in financing new 2-D seismic acquisition program in Namibia.
Add new independent directors that can enhance our growth opportunities and expand the Company’s influence.
Up-list to either NASDAQ or NYSE MKT stock markets to maximize liquidity and access to capital, contingent on meeting uplisting criteria.
 
Plan of Operations

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 2-D seismic data over the concession. This will include seeking a new partner that will, at least partially, carry us through the seismic acquisition program. 3-D 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 (“UAE.”) 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 Company 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.

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.
 

Results of Operations

The following table sets out our consolidated losses for the periods indicated:

   
Years Ended
July 31,
   
Increase /
   
Percentage
 
   
2015
   
2014
   
(Decrease)
   
Change
 
                 
Revenues
 
$
3,941,541
   
$
5,065,096
   
$
(1,123,555
)
   
(22
)%
                                 
Operating expenses
                               
Lease operating expense
   
4,762,854
     
4,913,313
     
(150,459
)
   
(3
)%
Depreciation, depletion, and amortization
   
945,207
     
910,837
     
34,370
     
4
%
Accretion
   
993,579
     
1,043,928
     
(50,349
)
   
(5
)%
Consulting fees - related party
   
1,037,000
     
6,754
     
1,030,246
     
15,254
%
General and administrative expense     4,985,879       4,585,450       400,429       9 %
Total operating expenses
   
12,724,519
     
11,460,282
     
1,264,237
     
11
%
Loss from operations
   
(8,782,978
)
   
(6,395,186
)
   
(2,387,792
)
   
37
%
                                 
Consulting and other income (expense)
   
(194,827
)
   
23,134
     
(217,961
)
   
(942
)%
Interest expense, net
   
(2,401,236
)
   
(132,955
)
   
(2,268,281
)
   
(1,706
)%
Loss on derivative warrant liability
   
(1,214,806
)
   
-
     
(1,214,806
)
   
(100
)%
Loss on disposal of assets
   
(625
)    
(23,990
)
    23,365      
97
%
Foreign currency transaction (loss)
   
(34,851
)
   
(21,253
)
   
(13,598
)
   
(64
)%
Net loss before income taxes
   
(12,629,323
)
   
(6,550,250
)
   
(6,079,093
)
   
(93
)%
                                 
Income tax provision
   
-
     
(4,599
)
   
4,599
     
100
%
Net loss
   
(12,629,323
)
   
(6,554,849
)
   
(6,074,474
)
   
(93
)%
                                 
Less: Net loss attributable to non-controlling interests
   
(1,305
)
   
(5,527
)
   
4,222
     
76
%
Net loss
   
(12,628,018
)
   
(6,549,322
)
   
(6,078,696
)
   
(93
)%
 
We recorded a net loss attributable to Hydrocarb Energy Corp. after dividends of $12,628,018, or $(0.60) per basic and diluted common share, during the fiscal year ended July 31, 2015, as compared to $6,549,322, or $(0.43) per basic and diluted common share, during the fiscal year ended July 31, 2014.

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

  Revenues decreased from $5,065,096 in the prior year to $3,941,541 in the current year, a decrease of $1,123,555 or 22%. Of the total revenue decrease $1,878,361 was due to lower oil and gas prices in 2015 compared to 2014, offset by an increase in revenue due to higher volume of $756,723.  Oil pricing decreased by 65% in 2015 to an average of $62.34 per barrel, while gas prices decreased by 29% to $3.12 per Mcf, as a result of market pricing.
  Lease operating expenses decreased from $4,913,313 in the prior year to $4,762,854 in the current year, a decrease of $150,459 or 3%. This decrease was primarily due to lower production taxes as a result of lower revenues in the current year.
Accretion expense decreased from $1,043,928 in the prior year to $993,207, a decrease of $50,349 in the current year as a result of ARO costs adjustments.
Depreciation, depletion, and amortization increased from $910,837 in the prior year to $945,207 in the current year, an increase of $34,370. This increase was due to higher production in the current year versus the same period of last year.
Consulting fees – related party in 2014 pertained to warrants granted as compensation to a company for investor relations and public relations services. This company is a related party, as it is controlled by Michael Watts, the father-in-law of our former CEO, Jeremy Driver, and brother of our current CEO. The warrant grant occurred in April 2011 and consisted of immediately vesting warrants and warrants that vest in accordance with a market condition. The warrants that vested immediately were valued using the Black-Sholes option pricing method and the expense was recognized on the vesting date. The warrants with a market condition were valued using a lattice model and the expense was amortized over the service period, which was completed during the first quarter of fiscal year 2014.
General and administrative expenses increased from $4,585,450 in the prior year to $4,985,879 in the current year, an increase of $355,025 or 9%. This increase was the result of higher professional fees in the prior year offset by lower compensation expense as a result of staff reduction in the current year.
Consulting and other income primarily represents income earned for geological consulting services and asset acquisition consulting. This item decreased from $171,697 in the prior year to $23,134 in the current year. The decrease was due to the completion of the consulting project at HCN.
Change in the fair value of the derivative resulted in a loss of $1,214,806 during the year ended July 31, 2015.
Interest expense increased from $132,955 in the prior year to $2,401,236 in the current year as a result of additional borrowing in the current year.
 
Liquidity and Capital Resources

The following table sets forth our cash and working capital as follows:

    2015     2014  
             
Cash and cash equivalents
 
$
229,512
   
$
144,258
 
Restricted cash
 
$
12,488,755
   
$
6,877,944
 
Working capital (deficit)
 
$
(17,108,658
)
 
$
(3,566,332
)

Shadow Tree 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 lenders party thereto (the “Lenders”). Pursuant to the Credit Agreement, the Lenders loaned us $4 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 had 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 could only be used for the Oil and Gas Activities.  No Additional Loan was made under the terms of the Credit Agreement prior to the date of the Restated Credit Agreement (as described below).

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 (“HCN”) 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 HCN 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 did not accrue any interest for the first nine months after their issuance date (August 15, 2014), provided thereafter they were to 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”) was less than $900,000; or (b) 14% per annum, where the Trailing Three Month Revenues were equal to or greater than $900,000, payable monthly in arrears through the maturity date of such Notes, August 15, 2016.

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”) were outstanding on the 12 month anniversary of the Effective Date; (c) 32,500 restricted shares in the event any amount was 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 was outstanding under the Loan Documents on the 21 month anniversary of the Effective Date. The shares were 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.

Effective June 10, 2015, we entered into an Amended and Restated Credit Agreement (the “Restated Credit Agreement”) with 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, which was previously amended on February 17, 2015.
 
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 (which amount was not repaid in full), 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 Credit Agreement; waived, effective as of the date of the Restated Credit Agreement all previous 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.

In connection with the amendments to the original Credit Agreement discussed above, we also entered into a First Amendment to Stock Grant Agreement and additional promissory notes evidencing the additional loan described above in the aggregate amount of $475,632 with the Lenders (the “Additional Notes”).

The Restated Credit Agreement contains customary representations, warranties, covenants and requirements for the Company to indemnify the Lenders, Agent and their affiliates. The Restated 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 Restated Credit Agreement.

The Restated 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 Restated Credit Agreement as any transfer of 25% or more of the voting stock of such entity.

Our plan of operations over the next twelve months is dependent, at least in part, upon one or more of the following occurring:

Raising capital through the sale of equity or debt;
Raising capital through the sale of working interests in our producing properties;
Borrowing money from lenders to perform the work;
Freeing up previously restricted cash (State bonding requirement) as shut-in wells are brought back into production and/or as wells are plugged; and
Performing work one project at a time (capital permitting) and using the increased cash flow to fund the next projects.
 
Our plan of operations over the next twelve months will 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 12 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. We recognize that the United States economy and others have suffered through a period of uncertainty during which the capital markets have been highly volatile, and that there is no certainty that these markets will stabilize or improve. If the price of oil drops to levels seen in previous years, we recognize that it will adversely affect our cash flow from operations and our ability to raise additional capital. 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

During the year ended July 31, 2015 and subsequently, the Company sold various convertible notes and promissory notes, the terms and conditions of which are described in greater detail in the footnotes to the Company’s consolidated financial statements for the years ended July 31, 2015 and 2014, which are included herein under “Item 8. Financial Statement and Supplemental Data”, under Note 7 – Notes Payable and Note 16 – Subsequent Events.
 
Net Cash Provided by (Used in) Operating Activities

For the year ended July 31, 2015, net cash used in operating activities was $3,088,113 compared to net cash used in operating activities of $456,658 for the year ended July 31, 2014. The primary items contributing to net cash used in operating activities for the year ended July 31, 2015, were the net loss of $12 million and the $1.8 million change in asset retirement obligation, offset by $1.2 million of amortization of debt discount, $1.5 million of share based compensation, $1.2 million of loss on debt settlement and $1.2 million of change in derivative liabilities.

Net Cash Used in Investing Activities

For the year ended July 31, 2015, we used cash of $2,298,522 in investing activities compared to using cash in investing activities of $554,678 for the year ended July 31, 2014. The use of cash in 2015 consisted primarily of purchase of oil and, gas properties totaling $2,412,651, offset by the use of restricted cash of $113,217. Cash used in investing activities during fiscal 2014 consisted primarily of investment in oil and gas assets totaling $1,052,679 and the purchase of property and equipment of $169,794, offset by the proceeds from the sale of oil and gas properties of $625,000.

Net Cash Provided by Financing Activities

Financing activities during the year ended July 31, 2015 provided cash of $5,471,889 compared to $800,765 provided in the prior year. The primary provider of cash in the current year was the net proceeds from borrowings. In the prior year the primary factor was the net proceeds from borrowings from related parties and proceeds from collections on receivable from a stock sale.

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 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, the fair value of our warrant derivative liability, and accounting for stock-based compensation.

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.

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 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 unit 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 proved 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. During the years ended July 31, 2015 and 2014, the ceiling exceeded the net book value of the property and it was not necessary to record an impairment charge.
 
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 Obligation

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 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 update our assessment accordingly. Additional retirement obligations increase the liability associated with new oil and natural gas wells and gathering systems as these obligations are incurred.

Fair Value

Accounting standards regarding fair value of financial instruments define fair value, establish a three-level hierarchy which prioritizes and defines the types of inputs used to measure fair value, and establish disclosure requirements for assets and liabilities presented at fair value on the consolidated balance sheets.

Fair value is the amount that would be received from the sale of an asset or paid for the transfer of a liability in an orderly transaction between market participants. A liability is quantified at the price it would take to transfer the liability to a new obligor, not at the amount that would be paid to settle the liability with the creditor.

The three-level hierarchy is as follows:

Level 1 inputs consist of unadjusted quoted prices for identical instruments in active markets.
Level 2 inputs consist of quoted prices for similar instruments.
Level 3 valuations are derived from inputs which are significant and unobservable and have the lowest priority.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. We have determined that certain warrants outstanding during the period covered by these financial statements qualify as derivative financial instruments under the provisions of FASB ASC Topic No. 815-40, “Derivatives and Hedging – Contracts in an Entity’s Own Stock.” These warrant agreements include provisions designed to protect holders from a decline in the stock price (‘down-round’ provision) by reducing the exercise price in the event we issue equity shares at a price lower than the exercise price of the warrants. As a result of this down-round provision, the exercise price of these warrants could be modified based upon 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 and consequently, these warrants must be treated as a liability and recorded at fair value at each reporting date.

The fair value of these warrants was determined using a lattice model with any change in fair value during the period recorded in earnings as “Gain (loss) on derivative warrant liability.”

Significant inputs used to calculate the fair value of the warrants include expected volatility, risk-free interest rate and management’s assumptions regarding the likelihood of a future repricing of these warrants pursuant to the down-round provision.
 
The following table sets forth the changes in the fair value measurement of our Level 3 derivative warrant liability as follows:

As of July 31,
 
2015
   
2014
 
         
Beginning of period
 
$
-
   
$
-
 
Initial fair value of derivative liability
   
792,329
     
-
 
Unrealized loss on changes in fair value of derivative liability
   
2,144,712
     
-
 
Fair value of derivative liabilities on repayment of debt     (935,907 )    
-
 
End of period
 
$
2,001,134
   
$
-
 

The unrealized loss on changes in fair value was recorded as increase in the derivative liability and as an unrealized loss on the change in fair value of the liability in our statement of operations.

As additional consideration for the loan evidenced by the Typenex Convertible Note, we granted Typenex a five year warrant (the “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 had an initial exercise price of $2.25 per share, and were initially exercisable for 38,889 shares of common stock.
 
During the year ended July 31, 2011, we entered into a consulting agreement with Geoserve Marketing, LLC (“Geoserve”). Under the terms of the agreement, the Company granted warrants to purchase 400,000 shares of common stock that have a market condition. If the Company’s 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 the Company’s 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”).
 
As of each of these expiration dates, the fair value of the warrant was determined for a final mark to market adjustment and the outstanding warrant derivative liability was reclassified to additional paid-in capital, as the warrants were no longer derivatives.

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.

See Note 1 of our Consolidated Financial Statements for our year ended July 31, 2015 for a summary of other significant accounting policies.
 
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. See Note 13 of our Consolidated Financial Statements for a description of our multi-year commitments.

ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are a “smaller reporting company” as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.

ITEM 8.
FINANCIAL STATEMENT AND SUPPLEMENTAL DATA
 
HYDROCARB ENERGY CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS

Report of Independent Registered Public Accounting Firm
62
   
Consolidated Balance Sheets as of July 31, 2015 and 2014
63
   
Consolidated Statements of Operations for the years ended July 31, 2015 and 2014
64
   
Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the years ended July 31, 2015 and 2014
65
   
Consolidated Statements of Cash Flows for the years ended July 31, 2015 and 2014
66
   
Notes to Consolidated Financial Statements
 68
 
Report of Independent Registered Public Accounting Firm

The Board of Directors
Hydrocarb Energy Corp.
Houston, Texas

We have audited the accompanying consolidated balance sheets of Hydrocarb Energy Corp. and its subsidiaries (collectively, the “Company”) as of July 31, 2015 and 2014 and the related consolidated statements of operations and comprehensive loss, cash flows and changes in stockholders’ equity for each of the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatements. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hydrocarb Energy Corp. and its subsidiaries as of July 31, 2015 and 2014, and the results of their operations and their cash flows for each of the year then ended in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 15 to the financial statements, the Company has suffered recurring losses from operations, which raises substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters are described in Note 15. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ MaloneBailey, LLP
www.malone-bailey.com
Houston, Texas
November 13, 2015
 
HYDROCARB ENERGY CORP.
CONSOLIDATED BALANCE SHEETS

   
July 31, 2015
   
July 31, 2014
 
ASSETS
       
Current assets:
       
Cash and cash equivalents
 
$
229,512
   
$
144,258
 
Oil and gas revenues receivable
   
219,676
     
372,120
 
Accounts receivable - related party
   
-
     
58,014
 
Other current assets
   
526,056
     
446,320
 
Other receivables, net
   
101,334
     
38,455
 
Total current assets
   
1,076,578
     
1,059,167
 
                 
Oil and gas properties, accounted for using the full cost method of accounting Evaluated property, net of accumulated depletion of $4,381,912 and $3,491,420, respectively; and accumulated impairment of $373,335 and $373,335, respectively
   
14,823,669
     
15,288,370
 
Unevaluated property
   
2,260,912
     
2,119,769
 
Restricted cash     12,488,755       6,877,944  
Other assets
   
373,877
     
219,942
 
Property and equipment, net of accumulated depreciation of $190,971 and $135,590, respectively
   
110,710
     
166,963
 
TOTAL ASSETS
 
$
31,134,501
   
$
25,732,155
 
                 
LIABILITIES AND EQUITY (DEFICIT)
               
Current liabilities:
               
Accounts payable and accrued expenses
 
$
3,732,664
   
$
2,795,675
 
Short term notes payable, net of discount $655,927 and $0     4,719,284       334,688  
Convertible short term related party note, net of discount $191,385 and $0     1,365,899       -  
Convertible short term related party note, net of discount of $7,262 and $0
   
342,738
     
-
 
Asset retirement obligation – short term
   
25,000
     
1,133,690
 
Derivative Liability
   
2,001,134
     
-
 
Advances
   
5,919,932
     
195,904
 
Due to related parties
   
78,585
     
165,542
 
Total current liabilities
   
18,185,236
     
4,625,499
 
                 
Convertible notes payable, net of discount $81,782 and $0
   
374,053
     
-
 
Convertible notes payable - related party, net of discount $734,024 and $0
   
2,265,976
     
-
 
Notes payable - related party     600,000       600,000  
Asset retirement obligation – long term
   
10,797,858
     
10,582,540
 
Total liabilities
   
32,223,123
     
15,808,039
 
                 
Stockholders' Equity (Deficit):
               
Common stock: $001 par value; 1,000,000,000 shares authorized; 23,001,589 and 21,081,602 shares issued and outstanding as of July 31, 2015 and 2014, respectively
   
23,002
     
21,082
 
Receivable for common stock
   
(413,898
)
   
(2,184,879
)
Additional paid-in capital
   
82,072,483
     
82,228,799
 
Accumulated deficit
   
(82,734,369
)
   
(70,106,351
)
Total stockholders' (deficit) equity
   
(1,052,782
)
   
9,958,651
 
Non-controlling interests
   
(35,840
)
   
(34,535
)
Total equity (deficit)
   
(1,088,622
)
   
9,924,116
 
TOTAL LIABILITIES AND EQUITY (DEFICIT)
 
$
31,134,501
   
$
25,732,155
 

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

HYDROCARB ENERGY CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS

   
Years Ended July 31,
 
   
2015
   
2014
 
         
Revenues
 
$
3,941,541
   
$
5,065,096
 
Operating expenses
               
Lease operating expense
   
4,762,854
     
4,913,313
 
Depreciation, depletion, and amortization
   
945,207
     
910,837
 
Accretion
   
993,579
     
1,043,928
 
Consulting fees - related party
   
1,037,000
     
6,754
 
General and administrative expense
   
4,985,879
     
4,585,450
 
Total operating expenses
   
12,724,519
     
11,460,282
 
                 
Loss from operations
   
(8,782,978
)
   
(6,395,186
)
                 
Consulting and other income (expense)
   
(194,827
)
   
23,134
 
Interest expense, net
   
(2,401,236
)
   
(132,955
)
Loss on derivatives
   
(1,214,806
)
   
-
 
Loss on disposal of assets
    (625    
(23,990
)
Foreign currency transaction (loss)
   
(34,851
)
   
(21,253
)
                 
Net loss before income taxes
   
(12,629,323
)
   
(6,550,250
)
Income tax provision
   
-
     
(4,599
)
                 
Net loss
   
(12,629,323
)
   
(6,554,849
)
                 
Less: Net loss attributable to non-controlling interests
   
(1,305
)
   
(5,527
)
Net loss attributable to Hydrocarb Energy Corp.
   
(12,628,018
)
   
(6,549,322
)
                 
Basic and diluted loss per common share:
 
$
(0.60
)
 
$
(0.43
)
                 
Weighted average shares outstanding (basic and diluted)
   
21,184,600
     
15,150,782
 

The accompanying notes are an integral part of these consolidated financial statements.
 
HYDROCARB ENERGY CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)
 
   
Preferred Stock
   
Common Stock
   
Additional
Paid-in
   
Treasury
   
Non
Controlling
   
Stock
Subscription
   
Accumulated
   
Total
Equity
 
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Stock
   
Interest
   
Receivable
   
Deficit
   
(Deficit)
 
Balance, July 31, 2013
   
4,225
   
$
1,690,000
     
4,427,071
   
$
4,427
   
$
75,137,401
   
$
(822,250
)
 
$
(29,008
)  
$
-
   
$
(63,522,775
)
 
$
12,457,795
 
HCN issuance of common stock
                   
8,396,667
     
8,397
     
22,674
                                     
31,071
 
Issuance of HCN preferred stock to settle debt and accounts payable
   
3,963
     
1,585,200
                                                             
1,585,200
 
Dividend on HCN preferred stock                                                                     (34,254 )     (34,254 )
HCN preferred stock Cancellation
   
(8,188
)
   
(3,275,200
)
                   
3,275,200
                                     
-
 
Stock issued to employees and directors
                   
167,904
     
168
     
813,659
                                     
813,827
 
Common stock  issued to settle debt
                   
619,960
     
620
     
3,588,947
     
(3,589,567
)
                           
-
 
HCN sale of HEC stock for receivable
                                   
(1,551,938
)
   
4,411,817
             
(2,859,879
)
           
-
 
Amortization of fair value of stock options
                                   
943,572
                                     
943,572
 
Warrants granted to related party                                     6,754                                       6,754  
HEC Common stock issued to satisfy contingently-issued rights from NEI Acquisition
                   
7,470,000
     
7,470
     
(7,470
)
                                   
-
 
Collections on Stock Subscription Receivable
                                                           
675,000
             
675,000
 
Net loss attributable to HEC
                                                                   
(6,549,322
)
   
(6,549,322
)
Net loss attributable to noncontrolling interest
                                                   
(5,527
)
                   
(5,527
)
Restated Balance, July 31, 2014
   
-
     
-
     
21,081,602
     
21,082
     
82,228,799
     
-
     
(34,535
)
   
(2,184,879
)
   
(70,106,351
)
   
9,924,116
 
Preferred Stock Exchange for unit offering with related party
                   
750,000
     
750
     
(2,058,730
)                                    
(2,057,980
)
Unit Offering
                   
12,500
     
12
     
12,488
                                     
12,500
 
Stock for services
                   
200,000
     
200
     
388,500
                                     
388,700
 
Stock for services with related party                     850,000       850       1,036,150                                       1,037,000  
Stock issued with debt
                   
92,500
     
93
     
280,392
                                     
280,485
 
Amortization of fair value of stock options
                                   
112,500
                                     
112,500
 
Correction of Stock issued for Directors
                   
(790
)
   
(1
)
   
(2,725
)
                                   
(2,726
)
Share cancellation
                   
(22,931
)
   
(23
)
   
23
                                     
-
 
Stock issued for Director Compensation
                   
16,674
     
17
     
27,649
                                     
27,666
 
Shares issued for Settlement
                   
22,034
     
22
     
64,978
                                     
65,000
 
Tainting of derivative warrants
                                   
(17,541
)
                                   
(17,541
)
Non-controlling interest
                                                   
(1,305
)
                   
(1,305
)
Cash received on stock subscription receivable
                                                           
531,000
             
531,000
 
Settlement on stock subscription receivable
                                                           
1,239,981
             
1,239,981
 
Net Loss
                                                                   
(12,628,018
)
   
(12,628,018
)
Balance at July 31, 2015
                 
$
23,001,589
   
$
23,002
   
$
82,072,483
   
$
-
   
$
(35,840
)
 
$
(413,898
)
 
$
(82,734,369
)
 
$
(1,088,622
)
 
The accompanying notes are an integral part of these consolidated financial statements.
 
HYDROCARB ENERGY CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Years Ended July 31,
 
         
   
2015
   
2014
 
CASH FLOWS FROM OPERATING ACTIVITIES
       
Net loss
 
$
(12,629,323
)
 
$
(6,554,849
)
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation, depletion and amortization
   
945,207
     
910,837
 
Accretion
   
993,579
     
1,043,928
 
Amortization of debt discount
   
1,236,638
     
-
 
Loss on disposal of assets
   
625
     
23,990
 
Change in allowance for doubtful accounts
   
-
     
11,948
 
Warrants granted to related party
   
-
     
6,754
 
Share based compensation
   
1,563,140
     
1,757,399
 
Loss on settlement shares
   
65,000
     
-
 
Loss on one-time interest fee     40,000       -  
Loss on early payment penalty     69,643       -  
Amortization on debt issuance cost
   
285,036
     
-
 
Settlement of dividend with related party
   
327,879
     
-
 
Loss on debt settlement of stock subscription receivable
   
1,239,981
     
-
 
Change in derivative liabilities
   
1,214,806
     
-
 
                 
Changes in operating assets and liabilities:
               
Accounts receivable
   
48,281
     
353,571
 
Other receivables
   
41,285
 
   
262,594
 
Accounts receivable - related party
   
58,014
     
143,270
 
Other assets
   
171,613
     
263,510
 
Accounts payable and accrued expenses
   
1,368,424
     
184,900
 
Accounts payable related party
   
(86,957
   
1,244,054
 
Advances
   
-
     
15,100
 
Settlement of asset retirement obligation
   
(40,984
)
   
(123,664
)
NET CASH (USED IN) OPERATIONS
   
(3,088,113
)
   
(456,658
)
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchases of oil and gas properties
   
(2,412,651
)
   
(1,052,679
)
Purchases of property and equipment
   
-
     
(169,794
)
Proceeds from sale of oil and gas properties
   
912
     
625,000
 
Change in restricted cash
   
113,217
     
42,795
 
CASH USED IN INVESTING ACTIVITIES
   
(2,298,522
)
   
(554,678
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Payments on notes payable
   
(527,828
)
   
(471,052
)
Proceeds from note payable to related party
   
316,917
     
600,000
 
Proceeds from collections on receivable for stock sale
   
531,000
     
675,000
 
Proceeds from Subscription Unit
   
50,000
     
-
 
Proceeds from borrowings
   
5,101,800
     
-
 
Proceeds from HCN issuance of common stock
   
-
     
31,071
 
Dividend on HCN preferred stock
   
-
     
(34,254
)
CASH PROVIDED BY FINANCING ACTIVITIES
   
5,471,889
     
800,765
 
                 
NET CHANGE IN CASH AND CASH EQUIVALENTS
   
85,254
     
(210,571
)
                 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
   
144,258
     
354,829
 
                 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
229,512
   
$
144,258
 
 
SUPPLEMENTAL CASH FLOW INFORMATION
       
Cash paid during the period for:
       
Income taxes
 
$
-
   
$
10,000
 
Interest
 
$
267,457
   
$
21,497
 
                 
NONCASH INVESTING AND FINANCING ACTIVITIES
               
Asset retirement obligation sold
 
$
-
   
$
33,195
 
Asset retirement obligations revisions
 
$
(1,845,967
)
 
$
(104,237
)
Restricted Cash
 
$
5,724,028
   
$
-
 
Note payable for prepaid insurance
 
$
309,212
   
$
403,104
 
Discount from derivatives
 
$
768,787
   
$
-
 
Tainted warrant liability
 
$
17,541
   
$
-
 
Settlement of HCN debt with HCN preferred stock
 
$
-
   
$
1,585,200
 
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
 
Unit Offering to Related Party
 
$
(2,057,980
)  
$
-
 
Value of shares issued to lenders as part of debt financing
 
$
280,485
   
$
-
 
Note payable for legal fees   $ 442,784     $ -  
Debt issue cost paid directly by lender   $ 335,538     $ -  
Original issue discount on notes payable   $ 749,146     $ -  

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

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

Description of business and basis of presentation

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 were incorporated under the laws of the State of Nevada on April 12, 2005 under the name “Carlin Gold Corporation”. On July 19, 2005, we changed our name to “Nevada Gold Corp.” On October 18, 2005, we changed our name to “Gulf States Energy, Inc.” and increased our authorized capital from 100,000,000 shares of common stock to 500,000,000 shares of common stock, par value $0.001 per share. On September 5, 2006, we changed our name to “Strategic American Oil Corporation”.

On April 4, 2012, we completed a one new share for twenty-five old share (1:25) reverse stock split and as a result our authorized capital decreased from 500,000,000 shares of common stock to 20,000,000 shares of common stock. Also, effective April 4, 2012, we changed our name to “Duma Energy Corp.” Effective May 16, 2012, we increased our authorized capital from 20,000,000 shares to 500,000,000 shares of common stock. Effective November 29, 2013, the Company increased the number of its authorized shares of common stock from 500,000,000 to 1,000,000,000 shares of common stock.  Effective February 18, 2014, we changed our name from Duma Energy Corp. to Hydrocarb Energy Corp. Effective May 8, 2014, we effected a 1:3 reverse split of our authorized common stock and a corresponding 1:3 reverse split of our outstanding common stock. All share and per share amounts for all periods in this report have been retroactively restated to reflect the reverse split.

Effective September 28, 2015, the Company filed a Certificate of Amendment to its Articles of Incorporation with the Secretary of State of Nevada, to (1) affect an amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of the Company’s common stock to 1,000,000,000 shares; (2) affect an amendment to the Company’s Articles of Incorporation to authorize 100,000,000 shares of “blank check” preferred stock (the “Blank Check Preferred Amendment”); (3) designate 10,000 shares of Series A 7% Convertible Voting Preferred Stock (the “Series A Amendment”); and (4) designate 35,000 shares of Series B Convertible Preferred Stock (the “Series B Amendment”), each of which amendments were approved by the stockholders of the Company at the Annual Meeting of Shareholders of the Company held on September 28, 2015.  Previously, effective on September 21, 2015, the Company filed a Certificate of Correction with the Secretary of State of Nevada, which cancelled and rescinded in its entirety, the previously filed Series A 7% Convertible Voting Preferred Stock designation filed by the Board of Directors without stockholder approval on December 2, 2013.

Our common stock is quoted under the symbol “HECC” on the OTCQB Market.

We own 100% of the issued and outstanding share capital of (i) Penasco Petroleum Inc., a Nevada corporation, (ii) Galveston Bay Energy, LLC, a Texas limited liability company, (iii) SPE Navigation I, LLC, a Nevada limited liability company, (iv) Namibia Exploration, Inc., a Nevada corporation, (v) Hydrocarb Corporation, a Nevada corporation, (vi) Hydrocarb Texas Corporation, a Texas corporation, and (vii) Hydrocarb Namibia Energy (Pty) Limited, a company chartered in the Republic of Namibia. In addition, we own 95% of the issued and outstanding share capital of Otaiba Hydrocarb LLC, a UAE limited liability corporation.

As of July 31, 2015, we maintain developed and undeveloped acreage offshore in Texas. As of July 31, 2015, we were producing oil and gas from our working interest in four offshore fields in Galveston Bay, Texas. During September 2012, we acquired, through the acquisition of Namibia Exploration Inc., a 39% non-operated working interest in a concession located onshore in Namibia, Africa. During December 2013, with our acquisition of Hydrocarb Corporation, we acquired a 51% working interest in this onshore Namibia, Africa concession and now own a 90% working interest (100% cost responsibility) in the Namibia, Africa concession.
 
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 United Arab Emirates (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 the Company 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.

Use of estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, if any, at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the respective reporting periods. We base our estimates and judgments on historical experience and on various other assumptions and information that we believe to be reasonable under the circumstances. Estimates and assumptions about future events and their effects cannot be perceived with certainty and, accordingly, these estimates may change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes.

Significant areas requiring management’s estimates and assumptions include the determination of the fair value of transactions involving stock-based compensation and financial instruments, estimates of the costs and timing of asset retirement obligations, and oil and natural gas proved reserve quantities. Oil and natural gas proved reserve quantities form the basis for the calculation of amortization of oil and natural gas properties and for asset impairment tests. Management emphasizes that reserve estimates are inherently imprecise and that estimates of more recent reserve discoveries are more imprecise than those for properties with long production histories.

Actual results may differ from the estimates and assumptions used in the preparation of our consolidated financial statements.
 
Cash and cash equivalents

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

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

Restricted cash

Restricted cash consists of two components. The first is certificates of deposit that have been posted as collateral for letters of credit supporting bonds guaranteeing remediation of our oil and gas properties in Texas and escrow funds deposited directly with regulatory authorities. As of July 31, 2015 and 2014, restricted cash totaled $6,771,781 and $6,877,944, respectively. The second component represents pass through funds for which the Company is the operator of a to-be drilled well. As of July 31, 2015 and 2014, this component totaled $5,716, 974 and $0, respectively. 
 
Receivables and allowance for doubtful accounts

Oil and gas revenues receivable are recorded at the invoiced amount and do not bear any interest. We regularly review collectability and establish or adjust an allowance for uncollectible amounts as necessary using the specific identification method. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Management has determined that a reserve for uncollectible amounts was not required in the periods presented.

Accounts receivable – related party includes the oil and gas revenue receivable from our Barge Canal properties, which, up until September 1, 2013, were operated by a company owned by one of our former officers who was also a director, and joint interest billings receivable from two working interest partners who are related to our former Chief Financial Officer, the former Chief Executive Officer and the current Chief Executive Officer. This balance also includes an oil and gas receivable from Lifestream, LLC, a company owned by the brother of our current CEO.

Other receivables consist of joint interest billings due to us from participants holding a working interest in oil and gas properties that we operate.

We regularly review collectability and establish or adjust an allowance for uncollectible amounts as necessary using the specific identification method. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. As of July 31, 2015 and 2014, we have reserved $78,242 and $70,742 respectively, for potentially uncollectable other receivables.

Available for sale securities

We invest in marketable equity securities which are classified as available for sale. The first in first out method is used to determine the cost basis of our equity securities sold. Available-for-sale securities are marked to market based on the fair values of the securities determined in accordance with ASC Section 820 (Fair Value Measurement), with the unrealized gains and losses, net of tax, reported as a component of accumulated other comprehensive income (loss). The Company does not own any marketable securities as of July 31, 2015 and July 31, 2014.

Other current assets

Other current assets consist primarily of prepaid insurance, prepaid interest expense, prepayments made towards properties not operated by us, and accrued interest on our deposits.
 
Concentrations

Our operations are concentrated in Texas and the majority of our operations are conducted offshore in Galveston Bay. We operate in the oil and gas exploration and production industry. If the oil and natural gas exploration and production industry as a whole were adversely affected, for example by weather, supply shortages, or other factors, we would also experience adverse effects. Because our properties are offshore, we are also vulnerable to adverse weather.

For the year ended July 31, 2015, 88% of our revenue was attributable to one purchaser. At July 31, 2015, this same purchaser accounted for 74% of our accounts receivable. For the year ended July 31, 2014, 83% of our revenue was attributable to one purchaser. At July 31, 2014, this same purchaser accounted for 88% of our accounts receivable.

We place cash with high quality financial institutions and at times may exceed the federally insured limits. We have not experienced a loss in such accounts nor do we expect any related losses in the near term.

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 unit 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.

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.

Impairment

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 proved 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. As of July 31, 2015 and July 31, 2014, the net book value of oil and gas properties did not exceed the ceiling amount and thus, no impairment of the properties was required.
 
Asset retirement obligation

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 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 update our assessment accordingly. Additional retirement obligations increase the liability associated with new oil and natural gas wells and gathering systems as these obligations are incurred.

Other assets

Other assets at July 31, 2015 and 2014 consisted primarily of prepaid land use fees, which are payments that cover multiple years (typically ten years) rental for easements and surface leases. These are paid as they come due on an ongoing basis and amortized over the rental period. In addition, other assets also include a domain name for $30,267, which is an intangible asset with an indefinite life due to the fact that it is renewable annually for nominal cost. We evaluate intangible assets with an indefinite life for possible impairment at least annually by comparing the fair value of the asset with its carrying value. In addition, other assets also consisted of debt issuance cost which associated with legal fees and financing expenses for issuing new promissory notes. Debt issuance costs are amortized over the life of the notes.

Property and equipment, other than oil and gas

Property and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the related asset, generally three to five years. Fully depreciated assets are retained in property and accumulated depreciation accounts until they are removed from service. We perform ongoing evaluations of the estimated useful lives of the property and equipment for depreciation purposes. Maintenance and repairs are expensed as incurred.

Impairment of long-lived assets

We periodically review our long-lived assets, other than oil and gas property, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. We recognize an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value. We recorded no impairment on our non-oil and gas long-lived assets during the years ended July 31, 2015 and 2014, respectively.

Advances

Advances consist of prepayments received from working interest partners pertaining to their share of the costs of drilling oil and gas wells. Partners are billed in advance for the estimated cost to drill a well and as the work proceeds, the prepayment is applied against their share of the actual drilling cost. As of July 31, 2015 and 2014, advances totaled $5,919,932 and $195,904, respectively. The amount as of July 31, 2015, includes $5,716,974 for a to-be drilled well that the Company is the Operator only. The Company owns no working interest in this well.
 
Revenue recognition

We recognize revenue when persuasive evidence of an arrangement exists, services have been rendered, the sales price is fixed or determinable, and collectability is reasonably assured. We follow the “sales method” of accounting for oil and natural gas revenue, so we recognize revenue on all natural gas or crude oil sold to purchasers, regardless of whether the sales are proportionate to our ownership in the property. Actual sales of gas are based on sales, net of the associated volume charges for processing fees and for costs associated with delivery, transportation, marketing, and royalties in accordance with industry standards. Operating costs and taxes are recognized in the same period in which revenue is earned. Severance and ad valorem taxes are reflected as a component of lease operating expense.
 
Income taxes

We account for income taxes using the asset and liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Fair value

Accounting standards regarding fair value of financial instruments define fair value, establish a three-level hierarchy which prioritizes and defines the types of inputs used to measure fair value, and establish disclosure requirements for assets and liabilities presented at fair value on the consolidated balance sheets.

Fair value is the amount that would be received from the sale of an asset or paid for the transfer of a liability in an orderly transaction between market participants. A liability is quantified at the price it would take to transfer the liability to a new obligor, not at the amount that would be paid to settle the liability with the creditor.

The three-level hierarchy is as follows:

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 in their entirety based on the lowest level of input that is significant to the fair value measurement. We have determined that certain warrants and convertible notes outstanding during the period covered by these financial statements qualify as derivative financial instruments under the provisions of FASB ASC Topic No. 815-40, “Derivatives and Hedging – Contracts in an Entity’s Own Stock.” (See Note 8 – Fair Value).

The fair value of these instruments was determined using a lattice model with any change in fair value during the period recorded in earnings as “Loss on derivatives.”

Significant inputs used to calculate the fair value of the warrants include expected volatility, risk-free interest rate and management’s assumptions regarding the likelihood of a future repricing of these warrants pursuant to the down-round provision.

We had derivative liability of $2,001,134 and $0 that was accounted for at fair value on a recurring basis as of July 31, 2015 and July 31, 2014. The carrying amounts reported in the balance sheet for cash, accounts receivable, accounts receivable – related party, accounts payable and accrued expenses, and notes payable approximate their fair market value based on the short-term maturity of these instruments.
 
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 vesting date, which is presumed to be the date 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.

Stock Split

On May 8, 2014, we affected a 1-for-3 reverse stock split. All share and per share amounts have been retroactively restated to reflect the reverse split. This presentation is consistent with the guidance in ASC 260-10-55-12, Earnings Per Share, which requires retroactive restatement of earnings per share if a capital structure change due to a stock dividend, stock split or reverse split occurs after the date of the latest balance sheet, but before the release of the financial statements or the effective date of the registration statement, whichever is later.

Earnings per share

We compute basic earnings per share using the weighted average number of shares of common stock outstanding during each period. Diluted earnings per share includes the dilutive effects of common stock equivalents on an “as if converted” basis. For the years ended July 31, 2015 and 2014, potential dilutive securities had an anti-dilutive effect and were not included in the calculation of diluted net loss per common share.

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. See Note 13 - Commitments and Contingencies for more information on legal proceedings.

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.
 
Accumulated Other Comprehensive Income (Loss), net of tax

We follow the provisions of ASC 220, “Comprehensive Income”, which establishes standards for reporting comprehensive income. In addition to net loss, comprehensive loss includes all changes to equity during a period, except those resulting from investments and distributions to the owners of the Company.

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 a 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

On December 9, 2013 (the “Acquisition Date”), we acquired HCN (the “HCN Acquisition”) pursuant to a Share Exchange Agreement (the “HCN Exchange Agreement”) dated November 27, 2013.  The purchase price was 8,396,667 shares of the Company’s common stock to HCN’s stockholders in exchange (which included Kent P. Watts, our Chief Executive Officer and Chairman) for 100% of the outstanding equity interest in HCN and 8,188 shares of the Company’s Series A Preferred Stock to Kent P. Watts, the Company’s Chief Executive Officer and Chairman, a holder of convertible preferred stock in HCN in exchange of 100% of the holder’s preferred stock in HCN. The preferred stock issued had a value of $3,275,200 (8,188 shares at par value of $400).

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

In anticipation of the HCN acquisition, the Company issued 619,960 shares of its common stock to HCN as full payment for the Company’s indebtedness to HCN in the amount of $3,589,567. A condition to the Agreement closing was that HCN would sell the 619,960 shares before closing of the acquisition, which it did (see Note 10 – 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 the Company’s Chairman of the Board and entities related to him and his family. Since HCN and the Company 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 twelve months ended July 31, 2015 and 2014 and assets and liabilities of HCN as of July 31, 2015 and 2014 are included in these financial statements as if the transaction had occurred at the beginning of the periods. 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 the Company.

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, the Company owned 39% working-interest right in this concession. With the HCN acquisition, we now own a 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 August 2016): 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 2-D 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 3-D 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 Company’s 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 which were waived in connection with the issuance.

In connection with certain due diligence subsequently undertaken by the Company, it came 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 was 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.
 
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.

On June 10, 2015, with the approval of the Board of Directors of the Company (i.e., Mr. Watts personally, and Mr. Herndon, our then directors), Mr. Watts exchanged all rights he had to 8,188 shares of Series A 7% Convertible Voting Preferred Stock (which were required to have a face value of $3,275,200) pursuant to the terms of the HCN Exchange Agreement, 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 Exchange Agreement, totaling, $327,879, into 32 “Units”, each consisting of (a) 25,000 shares of the Company’s restricted common stock; and (b) Convertible Promissory Notes with a face amount of $100,000.  As such, 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 Convertible Note was convertible into common stock of the Company at any time at Mr. Watt’s option at a conversion price of $4 per share, and was automatically convertible into shares of Series B Convertible Preferred Stock of the Company upon designation of such Series B Convertible Preferred Stock with the Secretary of State of Nevada which occurred on September 28, 2015. The Convertible Note accrued interest (prior to its automatic conversion into Series B Preferred Stock), quarterly in arrears, which accrued interest is added to the principal balance of the Convertible Note. The interest rate of the Convertible Note was equal to the average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”), provided that in the event that the average quarterly closing spot price is $40 or less, the WTI Rate for the applicable following quarter is 0%. Any amounts not paid under the Convertible Note when due accrue interest at the rate of 12% per annum until paid in full.
 
On July 21, 2015, Mr. Watts and the Company agreed in principle to reduce the number of total Units due to Mr. Watts to 30 units. On September 21, 2015, Mr. Watts and the Company entered into a First Amendment to Exchange Agreement, which amended the Exchange Agreement dated June 10, 2015. The First Amendment formally reduced the total Units due to Mr. Watts to 30 units, and as such, Mr. Watts received Convertible Promissory Notes with a principal amount of $3 million and 750,000 shares of common stock in connection with the exchange originally contemplated by the Exchange Agreement, valued at $614,141 , which was recorded as a debt discount.

Additionally, at the Company’s Annual Meeting of Stockholders held on September 28, 2015, the Company’s stockholders ratified the designation of the Company’s Series A Preferred and on the same date, the Company designated Series A Preferred Stock with the Secretary of State of Nevada, provided that the approval of the Series A Preferred Stock was only to ratify the effect of certain prior transactions, and the Company has no outstanding Series A Preferred Stock and no current plans to issue Series A Preferred Stock at this time.
 
During the year, the Company discovered an error relating to Preferred Stock. In accordance with the SEC Staff Accounting Bulletin No. 108 ("SAB 108"), the Company evaluated this error and determined that the error was immaterial to the prior reporting period affected. Therefore, as permitted by SAB l08, the Company corrected the prior year in the current year filing, previously reported results for the fiscal year ended July 31, 2014.
 
The following table shows the impact of the error to the Consolidated Balance Sheet and the Consolidated Statement of Operations and Comprehensive Loss:
 
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
For the year ended 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
   
(34,254
)
   
34,254
     
-
 
Deemed dividend on preferred stock
   
(150,548
)
   
150,548
     
-
 
Accretion dividend-Beneficial Cash Feature on preferred stock
   
(949,808
)
   
949,808
     
-
 
Net loss attributable to Hydrocarb Energy Corp. after dividends
 
$
(7,683,932
)
 
$
1,134,610
   
$
(6,549,322
)
 
Note 3 – Oil and Gas Properties

Oil and natural gas properties consisted of the following:

For the year ended July 31,
 
2015
   
2014
 
         
Evaluated Properties
       
Costs subject to depletion
 
$
19,578,916
   
$
19,153,125
 
Accumulated impairment
   
(373,335
)
   
(373,335
)
Accumulated depletion
   
(4,381,912
)
   
(3,491,420
)
Total evaluated properties
   
14,823,669
     
15,288,370
 
                 
Unevaluated properties
   
2,260,912
     
2,119,769
 
Net oil and gas properties
 
$
17,084,581
   
$
17,408,139
 

Evaluated properties

Effective September 1, 2013, we conveyed our interest in the Dix, Melody, Curlee, Palacios and Illinois properties to Carter E&P LLC in conjunction with our termination of Steven Carter as Vice President of Operations for $0 cash proceeds and the assumption of the abandonment liabilities of $4,381. In accordance with full cost rules, we recognized no gain or loss on the sale.
 
Effective March 25, 2014, we conveyed our interest in the Barge Canal Welder properties to Winright Oil Company LLC. We received net proceeds of $625,000 for this conveyance. In accordance with full cost rules, we recognized no gain or loss on the sale.
 
Additions to evaluated oil and gas properties during the year ended July 31, 2015 and during the year ended July 31, 2014 consisted mainly of exploration costs, geological and geophysical costs of $2,271,509 and $34,029, respectively.

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 $141,143 during the year ended July 31, 2015 consisted primarily of:

Approximately $141,143 of leasehold costs, specifically payment of the annual concession fee to the Government of Namibia. As of July 31, 2015, approximately $2.3 million has been expended towards the initial exploration period.
 
For the year ended July 31, 2014 we have incurred total costs of $994,964 including NEI's cost basis incurred upon acquisition of the property, which was $562,048.
 
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 July 31, 2015 and July 31, 2014, the net book value of oil and gas properties did not exceed the ceiling amount and thus, no impairment of the properties was required. Changes in production rates, levels of reserves, future development costs, and other factors will determine our actual ceiling test calculation and impairment analyses in future periods.

Note 5 – Asset Retirement Obligation

The following is a reconciliation of our asset retirement obligation (ARO) liability as of July 31, 2015 and 2014, respectively.

   
2015
   
2014
 
Reconciliation of asset retirement obligation balance:
       
Liability for asset retirement obligation, beginning of period
 
$
11,716,230
   
$
10,933,398
 
Asset retirement obligations sold
   
-
     
(33,195
)
Accretion
   
993,579
     
1,043,928
 
Revisions in estimated cash flows
   
(1,845,967
)
   
(104,237
)
Costs incurred
   
(40,984
)
   
(123,664
)
Liability for asset retirement obligation, end of period
 
$
10,822,858
   
$
11,716,230
 
                 
Current portion of asset retirement obligation
 
$
25,000
   
$
1,133,690
 
Noncurrent portion of asset retirement obligation
   
10,797,858
     
10,582,540
 
Total liability for asset retirement obligation
 
$
10,822,858
   
$
11,716,230
 

Estimated Timing of asset retirement obligation payments:

Fiscal Year
 
Pipelines
   
Easements
   
Wellbores
   
Facilities
   
Total
 
2016
 
$
-
   
$
-
   
$
25,000
   
$
-
   
$
25,000
 
2017
   
291,951
     
11,923
     
1,643,516
     
-
     
1,947,390
 
2018
   
59,148
     
67,153
     
589,306
     
628,874
     
1,344,481
 
2019
   
56,548
     
11,507
     
586,373
     
-
     
654,428
 
2020
   
-
     
48,931
     
52,786
     
149,040
     
250,757
 
2021 to 2025
   
1,097,520
     
159,885
     
2,396,106
     
571,250
     
4,224,761
 
2026 to 2030
   
218,805
     
112,757
     
1,109,154
     
-
     
1,440,716
 
2031 to 2035
   
43,170
     
115,475
     
132,673
     
602,140
     
893,458
 
Thereafter
   
-
     
41,867
     
-
     
-
     
41,867
 
                                         
Total
 
$
1,767,142
   
$
569,498
   
$
6,534,914
   
$
1,951,304
   
$
10,822,858
 
 
The above dismantlement, restoration or abandonment obligations relate to the Company's following properties: (1) a combined total of 44 pipelines located in Chambers County, Texas and Galveston County, Texas (2) a combined total of 119 surface or right of way easements located in Chambers County, Texas and Galveston County, Texas (3) a combined total of 144 wellbores located in Chambers County, Texas and Galveston County, Texas and (4) a combined total of 9 facilities located in Chambers County, Texas and Galveston County, Texas.

The Company's ARO reflects the estimated present value of the amount of dismantlement, removal, site reclamation and similar activities associated with the Company's oil and gas properties. Inherent in the fair value calculation of the ARO are numerous assumptions and judgments including the ultimate settlement amounts, inflation factors, credit adjusted discount rates, timing of settlement, and changes in the legal, regulatory, environmental and political environments. To the extent future revisions to these assumptions impact the fair value of the existing ARO liability, a corresponding adjustment is made to the oil and gas property balance.

As of July 31, 2015, the Company does not have any active dismantlement, restoration or abandonment activities in progress or underway. During the year ended July 31, 2015, the Company plugged 2 wells reducing its wellbore retirement obligations from those previously reported for the year ended July 31, 2014. The Company historically conducts all such remediation activities during the winter or spring periods, which have yet to be determined as of the date of this filing.

Note 6 – Related Party Notes Payable

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 July 31, 2015. As part of the financing agreement with Shadow Tree Capital Management, LLC (as discussed below), this note has been subordinated, and no payments will be made until the Shadow Tree debt has been repaid.

Related Party Exchange Agreement

On June 10, 2015, with the approval of the Board of Directors of the Company (i.e., Mr. Watts personally, and Mr. Herndon, our then directors), Mr. Watts exchanged all rights he had to 8,188 shares of Series A 7% Convertible Voting Preferred Stock (which were required to have a face value of $3,275,200) pursuant to the terms of the HCN Exchange Agreement, 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 Exchange Agreement, totaling, $327,879, into 32 “Units”, each consisting of (a) 25,000 shares of the Company’s restricted common stock; and (b) Convertible Promissory Notes with a face amount of $100,000.  As such, 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 Convertible Note was convertible into common stock of the Company at any time at Mr. Watt’s option at a conversion price of $4 per share, and was automatically convertible into shares of Series B Convertible Preferred Stock of the Company upon designation of such Series B Convertible Preferred Stock with the Secretary of State of Nevada which occurred on September 28, 2015. The Convertible Note accrued interest (prior to its automatic conversion into Series B Preferred Stock), quarterly in arrears, which accrued interest is added to the principal balance of the Convertible Note. The interest rate of the Convertible Note was equal to the average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”), provided that in the event that the average quarterly closing spot price is $40 or less, the WTI Rate for the applicable following quarter is 0%. Any amounts not paid under the Convertible Note when due accrue interest at the rate of 12% per annum until paid in full.
 
On September 14, 2015, Kent P. Watts, the Chief Executive Officer and Chairman of the Company subscribed for $350,000 in Convertible Subordinated Promissory Notes and on September 17, 2015 he subscribed for an additional $166,667 in Convertible Promissory Notes (collectively, the “Watts Notes”).  The Watts Notes are due two years from their issuance date, accrue interest which is payable quarterly in arrears, at either a cash interest rate (equal to the WTI Rate described below) or a stock interest rate (12% per annum)(at the option of the holder at the beginning of each quarter), provided no principal or interest on the Watts Notes can be paid in cash until all amounts owed by the Company to its senior lender are paid in full.  In the event the stock interest rate is chosen by Mr. Watts, restricted shares of common stock equal to the total accrued dividend divided by the average of the closing sales prices of the Company’s common stock for the applicable quarter are required to be issued in satisfaction of amounts owed on a quarterly basis.  In the event the cash interest rate is chosen, interest accrues until converted into common stock (as discussed below) or until the Company is able to pay such accrued interest in cash pursuant to the terms of the Watts Notes.  The “WTI Rate” equals an annualized percentage interest rate equal to the average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”). 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%). Notwithstanding the above, in the event that the average quarterly closing spot price is $40 or less, the WTI Rate for the applicable following quarter is 0%.  All principal and accrued interest on the Watts Notes is convertible into common stock at a conversion price of $0.75 per share at any time. Additionally, the Company may force the conversion of the Watts Notes into common stock in the event the trading price of the Company’s common stock is equal to at least $5.00 per share for at least 20 out of any 30 consecutive trading days.  Any shares of common stock issuable upon conversion of the Watts Notes are subject to a lock-up whereby no shares of common stock can be sold until January 1, 2016, and no more than 2,500 shares of common stock can be sold per day thereafter until the Company’s common stock is listed on the NASDAQ or NYSE market or the trading volume of the Company’s common stock is in excess of 100,000 shares per day. The Watts Notes have standard and customary events of default. The payment of the Watts Notes are 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”).
 
On July 21, 2015, Mr. Watts and the Company agreed in principle to reduce the number of total Units due to Mr. Watts to 30 units. On September 21, 2015, Mr. Watts and the Company entered into a First Amendment to Exchange Agreement, which amended the Exchange Agreement dated June 10, 2015. The First Amendment formally reduced the total Units due to Mr. Watts to 30 units, and as such, Mr. Watts received Convertible Promissory Notes with a principal amount of $3 million and 750,000 shares of common stock in connection with the exchange originally contemplated by the Exchange Agreement, valued at $614,141, which was recorded as a debt discount.
 
The net note payable balance of $2,385,859 has been removed from additional paid‐in‐capital for the exchange.
 
As of July 31, 2015, the Company has recognized $97,490 of amortization expense of the note discount, with a net payable balance of $2,265,976 and unamortized debt discount of $734,024. We are amortizing these discounts over the term of the note using the effective interest method.
 
Effective on September 28, 2015, with the Company’s designation of its Series B Convertible Preferred Stock, the Convertible Promissory Notes received by Mr. Watts in connection with the Exchange Agreement automatically converted into 3,000 shares of Series B Convertible Preferred Stock.

Duma Holding Convertible Promissory Note- Related Party
 
On July 16, 2015, pursuant to a Note Subscription Agreement, we sold a $350,000 Convertible Secured Promissory Note (with a $7,000 original issuance discount) to Duma Holdings, LLC (“Duma Holding” and the “Duma Holdings Note”). The Duma Holdings Note (along with any unpaid interest thereon) is convertible at any time, provided the note is converted in full, into (a) 1.75 units (“Units”), each consisting of 25,000 shares of common stock of the Company and $100,000 in face amount of Convertible Subordinated Promissory Notes in the form currently offered by the Company in its ongoing private offering of Units as previously disclosed in the Current Report on Form 8-K filed by the Company with the Securities and Exchange Commission on June 19, 2015 (which allow the holder thereof the right to convert such notes into common stock at a conversion price of $4 per share, and convert into shares of our to-be designated and approved Series B Convertible Preferred Stock upon designation thereof by the Company, subject to approval of such Series B Convertible Preferred Stock by stockholders at the annual meeting); and (b) 350,000 shares of common stock (393,750 shares of common stock in aggregate when combined with the shares which form part of the Units). The Duma Holdings Note is due and payable by us on November 30, 2015. The Duma Holdings Note accrues interest at the rate of 15% per annum, payable beginning on October 31, 2015, and quarterly thereafter through maturity. The Duma Holdings Note can only be repaid with the prior written approval of Duma Holdings.  The Duma Holdings Note contains usual and customary events of default, representations and warranties.  The payment of the principal and accrued interest due under the Duma Holdings Note is personally guaranteed by Kent P. Watts, our Chief Executive Officer and Michael Watts, his brother, pursuant to separate guaranty agreements (the “Guarantee Agreements”), and secured by a first priority security interest on certain real estate owned by Kent P. Watts pursuant to a Deed of Trust, Assignment of Rents and Security Agreement.
 
As of July 31, 2015, the net payable balance is $342,738. During the year ended July 31, 2015, $892 of amortization of debt discount was expensed.
 
Note 7 – Notes Payable and Convertible Notes

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 lenders party thereto (the “Lenders”).  Pursuant to the Credit Agreement, the Lenders loaned us $4 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 had 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 could only be used for the Oil and Gas Activities.  No Additional Loan was made under the terms of the Credit Agreement prior to the date of the Restated Credit Agreement (as described below).

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 (“HCN”) 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 HCN 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 Company has no independent assets or operations, the guarantees are full and unconditional, and joint and several, and any subsidiaries of the company other than the subsidiary guarantors are minor.

The Notes did not accrue any interest for the first nine months after their issuance date (August 15, 2014), provided thereafter they were to 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”) was less than $900,000; or (b) 14% per annum, where the Trailing Three Month Revenues were equal to or greater than $900,000, payable monthly in arrears through the maturity date of such Notes, August 15, 2016.

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”) were outstanding on the 12 month anniversary of the Effective Date; (c) 32,500 restricted shares in the event any amount was 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 was outstanding under the Loan Documents on the 21 month anniversary of the Effective Date.  The shares were 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.
 
Effective June 10, 2015, we entered into an Amended and Restated Credit Agreement (the “Restated Credit Agreement”) with 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, which was previously amended on February 17, 2015. As part of this agreement, we received an additional loan.
 
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 (which amount was not repaid in full), 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 Credit Agreement; waived, effective as of the date of the Restated Credit Agreement all previous 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.
 
We have evaluated this amendment and determined it did not qualify for extinguishment accounting. In connection with the amendments to the original Credit Agreement discussed above, we also entered into a First Amendment to Stock Grant Agreement and additional promissory notes evidencing the additional loan described above in the aggregate amount of $475,632 with the Lenders (the “Additional Notes”).

The Restated Credit Agreement, contains customary representations, warranties, covenants and requirements for the Company to indemnify the Lenders, Agent and their affiliates.  The Restated 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 Restated Credit Agreement.

The Restated 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 Restated Credit Agreement as any transfer of 25% or more of the voting stock of such entity.

For the term loan, the Company has recognized $724,290 of amortization expense of the original issuance discount, with a net payable balance of $4,212,903 and unamortized original issuance discount of $583,606 as of July 31, 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. During the year ended July 31, 2015, we recognized $193,007 of amortization expense and have $90,448 in unamortized debt issuance cost as of July 31, 2015.
 
For the additional loan, the Company has recognized $10,539 of amortization expense of the original issuance discount, with a net payable balance of $403,311 and unamortized original issuance discount of $82,860 as of July 31, 2015. In addition, we have recognized $23,782 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. During the year ended July 31, 2015, we recognized $7,011 of amortization expense and have $16,771 in unamortized debt issuance cost as of July 31, 2015.

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 $0 and $5,530 as of July 31, 2015 and July 31, 2014, respectively.

In February 2015, we financed our commercial insurance program using a note payable for $414,384. Under the note, we are obligated to make eight payments of $52,586 per month, which include principal and interest, beginning in March 2015. As of July 31, 2015, the note payable balance was approximately $103,071.
 
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 July 31, 2014, the note payable balance was $179,158.

In June 2013, the outstanding balance on our line of credit of $300,000 with a commercial bank was replaced by a term loan that matures on June 22, 2015. As of July 31, 2014, the balance outstanding related to this note was $150,000. In August 2014, the Company paid off the outstanding balance of $150,000 plus accrued interest and fees, in connection with entering into the Credit Agreement with Shadow Tree Capital Management.
 
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.
 
As of July 31, 2015, we have repaid the note and all accrued interest. As of July 31, 2015, the Company has recognized the full discount of $80,433 into amortization expense of the note discount.

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 July 31, 2015, we have repaid the note and all accrued interest. As of July 31, 2015, the Company has recognized the full discount of $105,000 into amortization expense of the note discount.

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. These shares have been returned to the Company as of October 28, 2015, and cancelled.

As of July 31, 2015, the net payable balance was $335,619. As of July 31, 2015, the Company has recognized $11,619 of amortization expense of the note discount, with a net payable balance of $335,619 and unamortized debt discount of $14,381. We are amortizing these discounts over the term of the note using effective interest method.

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 July 31, 2015, we have repaid the note and all accrued interest. As of July 31, 2015, the Company has recognized the full discount of $110,825 into amortization expense of the note discount.
 
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.

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 July 31, 2015, the net payable balance was $207,835.  The Typenex Convertible Note was forgiven by Typenex in connection with our sale of the Typenex Note (described below under Note 16 – Subsequent Events – “Typenex Co-Investment, LLC Convertible Note”) to Typenex. As of July 31, 2015, the Company has recognized $61,480 of amortization expense of the note discount, with a net payable balance of $207,835 and unamortized debt discount of $142,165. We are amortizing these discounts over the term of the note using effective interest method.

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.

As of July 31, 2015, the net payable balance was $408,149. As of July 31, 2015, the Company has recognized $3,149 of amortization expense of the note discount, with a net payable balance of $408,149 and unamortized debt discount of $6,351. We are amortizing these discounts over the term of the note using effective interest method.
 
JMJ Convertible Promissory Note

On July 28, 2015, the Company sold JMJ Financial (“JMJ”) a Convertible Promissory Note in the principal amount of up to $1,000,000 (the “JMJ Convertible Note”). The initial amount received in connection with the sale of the JMJ Convertible Note was $300,000, and the JMJ Convertible Note currently has a face amount of $373,333, as all amounts borrowed under the note include a 10% original issue discount. Moving forward, JMJ may loan us additional funds (up to $900,000 in aggregate) at our request, provided that JMJ has the right in its sole discretion to approve any future request for additional funding. Each advance under the JMJ Convertible Note is due two years from the date of such advance, with the $373,333 initially owed under the note due on July 28, 2017.

The JMJ Convertible Note (including principal and accrued interest and where applicable other fees) is convertible into our common stock, beginning 180 days after the date the note was sold (January 24, 2016), at the lesser of $1.23 per share or 60% of the lowest trading price of our common stock in the 25 trading days prior to the date of any conversion, provided that if we are not DWAC eligible at the time of any conversion an additional 10% discount applies, and in the event our common stock is not DTC eligible at the time of any conversion, an additional 5% discount applies. The JMJ Convertible Note provides that unless we and JMJ agree in writing, JMJ is not eligible to convert any amount of the note into common stock which would result in JMJ owning more than 4.99% of our common stock.

JMJ agreed to subordinate all amounts owed to it under the JMJ Convertible Note to the amounts we owe to our senior lender.

A one-time interest charge of 12% was applied to the principal amount of the note, which remains payable regardless of the repayment (or conversion) date of the note.

As of July 31, 2015, the net payable balance was $341,200. As of July 31, 2015, the Company has recognized $1,200 of amortization expense of the note discount, with a net payable balance of $341,200 and unamortized debt discount of $32,133. We are amortizing these discounts over the term of the note using effective interest method.

Christian Smith & Jewell Convertible Note

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.

For the term loan, the Company has recognized $29,422 of amortization expense of the note discount, with a net payable balance of $414,296, including the unamortized original issuance discount as of July 31, 2015. We are amortizing these discounts over the term of the note.

David L. Gillespie Unit Note

Effective on July 15, 2015, the Company sold David Gillespie, 0.5 Unit for an aggregate purchase price of $50,000, with each Unit 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”). The Note was convertible into common stock of the Company at any time at Mr. Gillespie’s option at a conversion price of $4 per share, and was automatically convertible into shares of Series B Convertible Preferred Stock of the Company upon designation of such Series B Convertible Preferred Stock with the Secretary of State of Nevada which occurred on September 28, 2015. The Note accrued interest (prior to its automatic conversion into Series B Preferred Stock), quarterly in arrears, which accrued interest is added to the principal balance of the Note. The interest rate of the Note was equal to the average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”), provided that in the event that the average quarterly closing spot price is $40 or less, the WTI Rate for the applicable following quarter is 0%. Any amounts not paid under the Note when due accrue interest at the rate of 12% per annum until paid in full.
 
As of July 31, 2015, the Company has recognized $166 of amortization expense of the note discount, with a net payable balance of $32,718 and unamortized debt discount of $17,282. We are amortizing these discounts over the term of the note using effective interest method.

Brian Kenny Convertible Promissory Note

Effective on July 28, 2015, the Company owed Brian Kenny, the aggregate principal amount of $32,500, which accrued interest at 12% per annum. The maturity date of this convertible note is July 31, 2017. At any time prior to the earlier of the payment in full by the Company and the conversion in full, the outstanding amount of this convertible note can be converted into restricted shares of common stock of the Company at the conversion price of $0.75 per share. The outstanding amount of this convertible note will be converted automatically on the condition that the closing sales price of the Company’s common stock is equal to at least the trading price for a period of at least twenty (20) days out of any consecutive thirty (30) trading days.

For the term loan, the Company has recognized $133 of amortization expense of the debt discount, with a net payable balance of $133 and unamortized debt discount of $32,367 as of July 31, 2015.

Note 8 – Fair Value

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:
 
Note 9 – Derivative Liabilities
 
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 July 31, 2015:
 
July 31, 2015

Description
 
(Level 1)
   
(Level 2)
   
(Level 3)
   
Total Carrying
Value
 
Convertible Notes
  $      
$
-
   
$
1,213,235
   
$
1,213,235
 
Typenex Co-Warrants
 
$
-
   
$
-
   
$
252,854
   
$
252,854
 
Tainted Conversion Notes (Note 7)
                 
$
526,323
     
526,323
 
Tainted Warrants (Note 7)
  $      
$
-
   
$
8,722
   
$
8,722
 
Total
 
$
-
   
$
-
   
$
2,001,134
   
$
2,001,134
 
 
Embedded Derivative Instruments

The Company determined that the following convertible notes (collectively “Convertible Notes”) issued during the year ended July 31, 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 to 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
* Duma Holdings Convertible Note

Tainted Convertible Notes

For the year ended July 31, 2015, newly issued convertible notes were considered tainted derivative instruments due to the issuances of various convertibles notes issued. Those convertible notes contain a variable conversion price and therefore, we cannot conclude that we will have sufficient authorized unissued shares to settle all the warrants and convertible notes. Accordingly, the Company recorded a derivative liability for the aggregate fair value of the tainted convertible notes. (Refer to Note 7 for further information regarding the convertible notes):

Tainted Kent P. Watts Convertible Note
Tainted Christian Smith & Jewell Law Note
Tainted David L. Gillespie Convertible Note
Tainted Brian Kenny Convertible Note

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

   
Initial
   
July 31, 2015
 
Common stock issuable
   
1,815,358
     
2,317,057
 
Market value of common stock on measurement date (1)
 
$
0.91 – 1.24
   
$
1.25
 
Adjusted exercise price
 
$
0.52 – 4.00
   
$
0.28-$4.00
 
Risk free interest rate (2)
   
0.06% - 0.25
%
   
0.06%-1.00
%
Instrument lives in years
   
0.17 – 1.00
     
0.17 – 0.43
 
Expected volatility (3)
   
91%-137
%
   
90%-119
%
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 0.17 and 3 - 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 year ended July 31, 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
July 31,
2015
 
LG Capital
 
$
-
   
$
80,433
   
$
270,947
   
$
(351,380
)
 
$
-
 
Adar Bays, LLC
   
-
     
109,170
     
242,210
     
(351,380
)
   
-
 
JSJ Investments, Inc.
   
-
     
110,825
     
122,322
     
(233,147
)
   
-
 
Typenex Co-Investment
   
-
     
66,720
     
1,145,968
     
-
     
1,212,688
 
Duma Holdings
   
-
     
1,154
     
(607
)
   
-
     
546
 
Embedded Convertible Note-Subtotal
 
$
-
   
$
368,302
   
$
1,780,841
   
$
(935,907
)
 
$
1,213,235
 
Tainted Kent P. Watts
 
$
-
   
$
217,373
   
$
102,587
   
$
-
   
$
319,960
 
Tainted Christian Smith & Jewell
   
-
     
57,910
     
109,167
     
-
     
167,077
 
Tainted David L. Gillespie
   
-
     
4,948
     
8
     
-
     
4,956
 
Tainted Brian Kenny
   
-
     
34,330
     
-
     
-
     
34,330
 
Tainted Note - Subtotal
 
$
-
   
$
314,561
   
$
211,762
   
$
-
   
$
526,323
 
Note Derivatives - Total
 
$
-
   
$
682,863
   
$
1,992,602
   
$
(935,907
)
 
$
1,739,558
 

Warrants

As additional consideration for the loan evidenced by the Typenex Convertible Note, we granted Typenex a five year warrant (the “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 initially exercisable for 38,889 shares of common 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

During the year ended July 31, 2011, we entered into a consulting agreement with Geoserve Marketing, LLC (“Geoserve”). Under the terms of the agreement, the Company granted warrants to purchase 400,000 shares of common stock that have a market condition. If the Company’s 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 the Company’s 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”).

On February 17, 2015, the Warrant B and Warrant C that were previously issued to Geoserve were considered tainted derivative instruments due to the issuances of various convertibles notes during the three months 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 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 year ended July 31, 2015 was as follows:

   
Balance at July 31, 2014
   
Initial Valuation
   
Increase (Decrease) in Fair Value of Derivative Liabilities
   
Balance at July 31, 2015
 
Tainted Warrant-Geoserve (Note 7)
   
-
     
17,541
     
(8,819
)
   
8,722
 
Typenex Co-Warrants
 
$
-
   
$
91,925
   
$
160,929
   
$
252,854
 
   
$
-
   
$
109,466
   
$
152,110
   
$
261,576
 

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

   
Initial
   
July 31, 2015
 
Common stock issuable
   
705,556
     
979,167
 
Market value of common stock on measurement date (1)
 
$
0.92-1.07
   
$
1.25
 
Adjusted exercise price
 
$
2.25-7.50
   
$
0.28-7.50
 
Risk free interest rate (3)
   
0.25-1.57
%
   
0.14-1.41
%
Instrument lives in years
   
1.00-5.00
     
0.55-4.60
 
Expected volatility
   
112
%
   
112-118
%
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) Upon the issuance of the Vis Vires convertible note on March 31, 2015, it was assumed that the anti-dilution 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 between 0.14 and 5 - year Treasury Bill as of the respective offering or measurement date.

(4) 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 $768,787 was 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. A day one loss of $6,000 was recorded as a loss on derivatives.

On April 24, 2015, the Company repaid the principal 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.

On July 31, 2015, the Company repaid the principal amount of the JSJ Investment convertible notes, resulting in a change of $259,742. The change was recorded as a loss from derivatives and the related unamortized discount was expensed immediately.

As of July 31, 2015, the aggregated balance of derivative liability was $2,001,134 and the unamortized discount was $391,918. During the year ended July 31, 2015 $376,869 of the derivative discount has been amortized to interest expense.

Note 10 – Capital Stock

Stock Split

Our capitalization at July 31, 2015 was 1,000,000,000 authorized common shares with a par value of $0.001 per share.

Common Stock Issuances

On June 10, 2015, with the approval of the Board of Directors of the Company (i.e., Mr. Watts personally, and Mr. Herndon, our then directors), Mr. Watts exchanged all rights he had to 8,188 shares of Series A 7% Convertible Voting Preferred Stock (which were required to have a face value of $3,275,200) pursuant to the terms of the HCN Exchange Agreement, 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 Exchange Agreement, totaling, $327,879, into 32 “Units”, each consisting of (a) 25,000 shares of the Company’s restricted common stock; and (b) Convertible Promissory Notes with a face amount of $100,000.  As such, 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.  See also Note 6 – “Related Party Notes Payable”.

During July 2015, the Company entered into a subscription agreement with Mr. David L. Gillespie for the subscription to purchase ½ of one Unit as described in greater detail above. As such, Mr. Gillespie was issued 12,500 shares of common stock of the Company and a Convertible Subordinated Promissory Note with an aggregate principal amount of $50,000.

Pursuant to our Credit Agreement, as noted in Note 7 - Notes Payable, during August 2014, we issued 60,000 shares of restricted common stock to the Lenders.  And during May 2015, we issued another 32,500 shares of restricted common stock to the Lenders. The Company recorded these shares as a debt discount at a fair value of $247,653 and $32,828 respectively. 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 year ended July 31, 2014 we issued 167,904 shares of common stock, to employees and directors for services performed. In conjunction with the issuance of these shares we recognized $813,827 in compensation expense.
 
During the twelve months ended July 31, 2015, 16,674 shares of restricted common stock valued at $27,666 were issued to directors of the Company as director compensation. Additionally, during the twelve months ended July 31, 2015, 1,050,000 shares of restricted common stock were issued to certain vendors for services rendered during the period for legal and professional services. The fair value of the 1,050,000 shares issued for services is $1,425,700.  Of these shares 850,000 shares valued at $1,037,000 were issued to a related party. We issued a total of 22,034 shares to settle certain prior litigation with ERG Resources, LLC. The value of these shares was $65,000. On May 5, 2015, 22,931 shares of common stock were agreed to be mutually canceled, which shares had originally been issued for consulting services.
 
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. At July 31, 2015, we have $325,000 outstanding on this receivable.
 
On December 4, 2013 HCN sold 619,960 shares of unregistered and restricted Company common stock in return for a $1,859,879 non-interest bearing note receivable from SMDRE LLC (“SMDRE”), an entity in which Michael Watts, the brother of our Chief Executive Officer, has a minority interest.  The Company acquired this receivable upon its acquisition of HCN.  The 619,960 shares of Company common stock were previously issued by the Company to HCN to settle liabilities due by the Company related to the consulting services agreement described below in Note 7 – Notes Payable.  The receivable from the individual is due to the Company 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 comes first); or 3) 100% of any remaining balance due within 90 days of the Company being listed on a major stock exchange and at such time as the share price is above $6.00 per share.  As with the above receivable for common stock, this receivable for the sale of the Company 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.

On April 27, 2015, the Board of Directors agreed to offer SMDRE the option, for 90 days, for the SMDRE note to be paid in full for a 67% discount (i.e., the offer to be paid $619,898 immediately) (the “Pre-Payment Option”).   Between April 27, 2015 and July 9, 2015 the Company received payments on the SMDRE LLC note in the amount of $531,000.  The balance of the discounted note of $88,898 has been extended until the end of calendar year 2015. As of July 31, 2015, we have written off $1,239,981 related to the discount on this receivable.

Stock Compensation Plans

As of July 31, 2015, the Company could grant up to 267,744 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.

The fair value of each option is estimated using the Black-Scholes valuation model. Expected volatility is based solely on historical volatility because we do not have traded options. Prior to May 2009, the volatility was determined by referring to the average historical volatility of a peer group of public companies because we did not have sufficient trading history to determine our own historical volatility.  Beginning with computations after May 2009, when there was an active trading market for our stock, we have included our own historical volatility in determining the volatility used.  As of October 2013, we determined that 4.5 years of trading history was sufficient to determine historical volatility; accordingly valuations from October 2013 onwards will be performed without using a peer group.

The expected term calculation for stock options is based on the simplified method as described in the Securities and Exchange Commission Staff Accounting Bulletin number 107. We use this method because we do not have sufficient historical information on exercise patterns to develop a model for expected term. The risk-free interest rate is based on the U. S. Treasury yield in effect at the time of grant for an instrument with a maturity that is commensurate with the expected term of the stock options. The dividend yield rate of zero is based on the fact that we have never paid cash dividends on our common stock and we do not intend to pay cash dividends on our common stock.

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.
 
In February 2013, options to purchase an aggregate of 200,000 shares of common stock with an exercise price of $6.60 per share and a term of ten years were granted to our then three independent directors.  The options vest at the rate of 20% of such options each six months over the first 30 months following the grant date. The fair value of the total option award on the date of grant was $1,196,589. The fair market value of this award was estimated using the Black-Sholes option pricing model.

In August 2013, 13,333 of the 200,000 options granted to our independent directors became vested and the remainder of the previously unamortized fair value of these options, $16,184, was recognized on the vesting date. The fair value was estimated using the Black-Sholes option pricing model with an expected life of 6.5 years, a risk free interest rate of 2.01%, a dividend yield of 0%, and a volatility factor of 144.01%.

In October 2013, the board accelerated the vesting of the remaining 53,333 options so that they became fully and immediately vested.  The fair value of the options on the date of vesting of $810,738 was recognized immediately as an expense. The fair value was estimated using the Black-Sholes option pricing model with an expected life of 6.5 years, a risk free interest rate of 2.09%, a dividend yield of 0%, and a volatility factor of 117.31%.

In addition, during October 2013, the final tranche of certain options that had originally been granted to non-employees in April 2011 vested, for which we recognized $60,622 in expense.

In August 2014, options to purchase an aggregate of 25,000 shares of common stock with an exercise price of $4.50 per share and a term of five years were granted to an independent director, Chris Herndon. Compensation expense of $112,500 was recognized during the three months ended October 31, 2014.

No options have been exercised, and options to purchase 92,000 shares expired during the twelve months ended July 31, 2015.

The following table provides information about options granted to non-employees under our stock incentive plans during the years ended as follows:

As of July 31,
 
2015
 
2014
 
       
Number of options granted
   
25,000
     
-
 
Compensation expense recognized
 
$
112,500
   
$
887,544
 
Weighted average exercise price of options granted
 
$
4.50
   
$
-
 

The following table details the significant assumptions used to compute the fair market values of stock options granted or revalued during the years ended as follows:

As of July 31,
       
2015
               
2014
       
                         
Risk-free interest rate
   
-
     
-
     
1.64
%
   
-
     
-
     
-
 
Dividend yield
   
-
     
-
     
0
%
   
-
     
-
     
0
%
Volatility factor
   
-
     
-
     
443.47
%
   
-
     
-
     
-
 
Expected life (in years)
   
-
     
-
     
5.00
     
-
     
-
     
-
 

Based on the fair value of the options as of July 31, 2015, there was no unrecognized compensation costs related to non-vested share based compensation arrangements granted to non-employees.
 
Summary information regarding stock options issued and outstanding as follows:

   
Options
   
Weighted average share price
   
Aggregate intrinsic value
   
Weighted average remaining contractual life
(in years)
 
                    
Outstanding at July 31, 2013
 
$
512,000
   
$
6.81
     
-
     
7.98
 
Granted
   
-
     
-
                 
Exercised
   
-
     
-
                 
Expired or forfeited
   
(246,667
)
   
7.50
                 
Outstanding at July 31, 2014
 
$
265,333
   
$
6.81
     
-
     
7.95
 
Granted
   
25,000
     
4.50
     
-
     
5.00
 
Exercised
   
-
     
-
     
-
     
-
 
Expired or forfeited
   
(92,000
)
   
6.85
     
-
     
-
 
Outstanding at July 31, 2015
 
$
198,333
   
$
6.52
   
$
-
     
4.06
 
                                 
Exercisable at July 31, 2015
 
$
198,333
   
$
6.52
     
-
     
4.06
 

No non-vested stock options existed as of July 31, 2015.

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

   
Warrants
   
Weighted average share price
   
Aggregate intrinsic value
   
Weighted average remaining contractual
life
(in years)
 
                                 
Outstanding at year ended July 31, 2013
   
1,236,959
   
$
7.50
   
$
-
     
1.87
 
Granted
   
-
     
-
     
-
     
-
 
Exercised
   
-
     
-
     
-
     
-
 
Expired
   
(152,375
)
   
7.50
     
-
     
-
 
Outstanding at year ended July 31, 2014
   
1,084,584
     
7.50
     
-
     
1.04
 
Granted
   
311,632
     
0.28
     
302,283
     
4.60
 
Exercised
   
-
     
-
     
-
     
-
 
Expired
   
(417,917
)
   
7.50
     
-
     
-
 
Outstanding at year ended July 31, 2015
   
978,299
   
$
5.20
   
$
302,283
     
1.84
 

Warrants outstanding and exercisable as of July 31, 2015:

 
Exercise Price
   
Outstanding Number
of Shares
 
Remaining Life
 
Exercisable Number
of Shares
 
       
 
$
0.28
     
311,632
 
5 years or less
   
311,632
 
 
$
7.50
     
666,667
 
1 year or less
   
666,667
 
           
978,299
       
978,299
 
 
Warrants outstanding and exercisable as of July 31, 2014:

   
Exercise Price
   
Outstanding Number
of Shares
 
Remaining Life
 
Exercisable Number
of Shares
 
             
 
$
7.50
     
666,667
 
2 years or less
   
666,667
 
 
$
7.50
     
349,117
 
1 year or less
   
349,117
 
 
$
7.50
     
68,800
 
1 year or less
   
68,800
 
           
1,084,584
       
1,084,584
 

Note 11 – 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 of the Company through November, 2013. Additionally, Michael Watts is the brother of Kent P. Watts, who became the Company’s Chairman of the 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 the Company’s common stock. Between them, they are beneficial owners of approximately 55% of the Company’s outstanding common stock.

A company controlled by Michael Watts purchased a 5% working interest in one of our wells in Galveston Bay.  During the year ended as of July 31, 2015, the Company received approximately $58,000 from Mr. Michael Watts for this related party receivable previously outstanding for approximately the same amount as of July 31, 2014.
 
As of July 31, 2015 and July 31, 2014, this company owed us $186 and $58,014, respectively, in joint interest billings.

During 2011, we entered into a consulting contract with Geoserve Marketing, a company controlled by Michael Watts.  The contract permits us to terminate the agreement after the first year with thirty days’ notice. On June 28, 2015, the Company entered into a new agreement with Geoserve Marketing for consulting service and issued 850,000 shares of restricted common stock. We recognized expense of $1,037,000 and $6,754 from this contract as of July 31, 2015 and 2014, respectively.  As of July 31, 2015, we owe Geoserve $4,353 in expense reimbursement.

During the quarter ended October 2012, we purchased NEI for up to 8,396,667 shares of the Company’s common stock.

In February 2013, we sold a 2% working interest in a 366.85 acre tract of unevaluated property, the Dix prospect, in San Patricio County, Texas to Carter. Carter paid cash of $1,541, the proportional share of the land acquisition costs.

In August 2013, we closed our Corpus Christi office and terminated Steven Carter as our Vice President of Operations.  In conjunction with the office closure and termination, we assumed operatorship of the Barge Canal properties effective September 1, 2013.  In addition, we conveyed multiple properties located in the South Texas and Illinois area to Mr. Carter for $0 cash consideration and assumption of the associated asset retirement obligations. Although he was not a related party after September 2013, we considered the transactions with his company during his tenure as an officer of the Company as related party transactions because they were not compensation transactions or entered into in the ordinary course of business, and because he was a related party at the time they occurred.

On 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 July 31, 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:
 
   
Year ended
 
   
2015
 
2014
 
Revenues
 
$
     
$
39,274
 
Lease operating costs
 
$
     
$
23,259
 
Overhead costs incurred
 
$
     
$
4,687
 
 
In October 2013, prior to our acquisition of HCN, we settled our obligations to HCN under the HCN Consulting Agreement through the issuance of 619,960 shares of common stock of the Company. The HCN Consulting Agreement was between HCN and NEI and provided for HCN to be the primary negotiator and operator of the Namibian concession. These obligations consisted of the then-outstanding $2,400,000 Fee and $533,630 of interest and late fees associated with the Fee. Further, $25,000 of the related interest and fees was settled in cash. Prior to the Company’s acquisition of HCN, HCN sold these shares to an entity, in which Michael Watts has a minority interest, for a note receivable of $1,859,879. The Company arranged the sales of these shares in anticipation of a possible business combination, in an effort to ensure that the shares would remain as part of public float and therefore continue to be properly included in calculations for exchange-listing criteria and provide a source of funding for Company operations. It is anticipated that these shares will eventually be sold and the proceeds of their sales used to pay the receivable. As HCN is now our wholly-owned subsidiary, this receivable for the sale of the Company common stock is classified as receivable for common stock within equity. See discussion of this receivable in Note 10 – Capital Stock – 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. At July 31, 2015, we have $325,000 outstanding on this receivable.
 
On December 4, 2013 HCN sold 619,960 shares of unregistered and restricted Company common stock in return for a $1,859,879 non-interest bearing note receivable from SMDRE LLC (“SMDRE”), an entity in which Michael Watts, the brother of our Chief Executive Officer, has a minority interest.  The Company acquired this receivable upon its acquisition of HCN.  The 619,960 shares of Company common stock were previously issued by the Company to HCN to settle liabilities due by the Company related to the consulting services agreement described below in Note 7 – Notes Payable.  The receivable from the individual is due to the Company 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 comes first); or 3) 100% of any remaining balance due within 90 days of the Company being listed on a major stock exchange and at such time as the share price is above $6.00 per share.  As with the above receivable for common stock, this receivable for the sale of the Company 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.

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. 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 July 31, 2014. 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.

On April 27, 2015, the Board of Directors agreed to offer SMDRE the option, for 90 days, for the SMDRE note to be paid in full for a 67% discount (i.e., the offer to be paid $619,898 immediately) (the “Pre-Payment Option”).   Between April 27, 2015 and July 9, 2015 the Company received payments on the SMDRE LLC note in the amount of $531,000.  The balance of the discounted note of $88,898 has been extended until the end of calendar year 2015. As of July 31, 2015, we have written off $1,239,981 related to the discount on this receivable.

On April 30, 2014, Kent P. Watts advanced HCN (prior to its acquisition by the Company) 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. During the year ended as of July 31, 2015, the Company had current liabilities owed to Mr. Watts of approximately $78,585.
 
On July 16, 2015, pursuant to a Note Subscription Agreement, we sold a $350,000 Convertible Secured Promissory Note (with a $7,000 original issuance discount) to Duma Holdings, LLC ("Duma Holding" and the "Duma Holdings Note"). The Duma Holdings Note (along with any unpaid interest thereon) is convertible at any time, provided the note is converted in full, into (a) 1.75 units ("Units" ), each consisting of 25,000 shares of common stock of the Company and $100,000 in face amount of Convertible Subordinated Promissory Notes in the form currently offered by the Company in its ongoing private offering of Units as previously disclosed in the Current Report on Form 8-K filed by the Company with the Securities and Exchange Commission on June 19. 2015 (which allow the holder thereof the right to convert such notes into common stock at a conversion price of $4 per share, and convert into shares of our to-be designated and approved Series B Convertible Preferred Stock upon designation thereof by the Company, subject to approval of such Series B Convertible Preferred Stock by stockholders at the annual meeting); and (b) 350,000 shares of common stock (393,750 shares of common stock in aggregate when combined with the shares which form part of the Units). The Duma Holdings Note is due and payable by us on November 30, 2015. The Duma Holdings Note accrues interest at the rate of 15% per annum, payable beginning on October 31, 2015, and quarterly thereafter through maturity. The Duma Holdings Note can only be repaid with the prior written approval of Duma Holdings. The Duma Holdings Note contains usual and customary events of default, representations and warranties. The payment of tile principal and accrued interest due under the Duma Holdings Note is personally guaranteed by Kent P. Watts, our Chief Executive Officer and Michael Watts, his brother, pursuant to separate guaranty agreements (the "Guarantee Agreements"), and secured by a first priority security interest on certain real estate owned by Kent P. Watts pursuant to a Deed of Trust, Assignment of Rents and Security Agreement.
 
Note 12- Income Taxes

Our net loss before income taxes totaled $12,629,323 and $6,550,250 for the years ended July 31, 2015 and 2014, respectively. We recognized zero and $4,599 income tax benefit during the years ended July 31. 2015 and 2014, respectively.

The reconciliation of our income tax provision at the statutory rate to the reported income tax expense is as follows:

As of and For the Year ended July 31,
 
2015
   
2014
 
         
U.S. statutory federal rate
   
35.00
%
   
35 00
%
State income tax rate
   
0.58
%
   
0.58
%
Equity-based compensation
   
(0.32
)%
   
(5.16
)%
Loss on derivatives
   
(3.43
)%
   
-
%
Other
   
1.95
%
   
(6.64
)%
Net operating loss
   
(33.78
)%
   
(23.70
)%
Effective statutory rate
   
0.00
%
   
0.08
%

Our deferred income taxes reflect the net tax effects of operating loss, tax credit carry forwards and temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences representing net future deductible amounts become deductible. As of July 31, 2015, the Company has provided a 100% valuation allowance on its deferred tax assets.

Components of deferred tax assets as of July 31, 2015 and 2014 are as follows:

As of and For the Year ended July 31.
 
2015
   
2014
 
         
Stock based compensation
 
$
40,022
   
$
338,078
 
Property, including depreciable property
   
(3,159,840
)
   
(3,122,873
)
Asset retirement obligation
   
3,850,232
     
4,168,049
 
Net operating loss carry-forward
   
9,787,622
     
5,596,732
 
Other
   
(277,393
)
   
20,860
 
     
10,240,643
     
7,000,846
 
Valuation allowance for deferred tax assets
   
(10,240,643
)
   
(7,000,846
)
Total deferred tax assets
 
$
-
   
$
-
 

The valuation allowance is evaluated at the end of each year, considering positive and negative evidence about whether the deferred tax asset will be realized. At that time, the allowance will either be increased or reduced; reduction could result in the complete elimination of the allowance if positive evidence indicates that the value of the deferred tax assets is no longer impaired and the allowance is no longer required.

We have no positions for which it is reasonable that the total amounts of unrecognized tax benefits at July 31, 2015 will significantly increase or decrease within 12 months.

Generally, our income tax years 2011 through 2015 remain open and subject to examination by Federal tax authorities or the tax authorities in Louisiana and Texas which are the jurisdictions where we have our principal operations. No material amounts of the unrecognized income tax benefits have been identified to date that would impact our effective income tax rate.
 
As of July 31, 2015, we had approximately $27,512,641 of U.S. federal and state net operating loss carry-forward (“NOLs”) available to offset future taxable income, which begins expiring in 2027, if not utilized. Future tax benefits that may arise as a result of these losses have not been recognized in these financial statements.  The deferred tax asset generated by the loss carry-forward has been fully reserved due to the uncertainty we will be able to realize the benefit from it.

In conjunction with the merger with HCN, we believe we incurred an ownership change within the meaning of Section 382 of the Internal Revenue Code. As a result, applicable federal and state tax law places an annual limitation on the amount of NOLs that may be used. As of the filing date of this report, we have completed our Section 382 analysis in connection with the merger.

If we were to have taxable income in excess of the 382 Limitation following a Section 382 “ownership change,” we would not be able to offset tax on the excess income with the NOLs. Although any loss carryforwards not used as a result of any Section 382 Limitation would remain available to offset income in future years (again, subject to the Section 382 Limitation) until the NOLs expire, the “ownership change” could significantly defer the utilization of the loss carryforwards, accelerate payment of federal income tax and may cause some of the NOLs to expire unused.

Note 13 – Commitments and Contingencies

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.

Although we may, from time to time, be involved in litigation and claims arising out of our operations in the normal course of business, we are not currently a party to any material legal proceeding.

Previously, we were subject to Civ. Action No. 4:15-cv-00727, Hydrocarb Energy Corp., et al. v. Vincent Pasquale Scaturro; In the United States District Court for the Southern District of Texas Houston Division. Hydrocarb Energy Corp. was Plaintiff in this action, and had 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. Specifically, in November 2014, Pasquale V. Scaturro, the Company’s former Chief Executive Officer and Kent P. Watts, the Company’s current Chief Executive Officer and Chairman, entered into a stock purchase agreement, which was amended in December 2014, at which time certain of the adult children of Mr. Watts became party to the agreement.  Pursuant to the agreement, Mr. Watts and his children agreed to sell Mr. Scaturro the outstanding capital stock of a company which they owned which is located in Namibia which owns real estate, in consideration for 475,000 shares of common stock held by Mr. Scaturro (deliverable in tranches between December 2014 and April 2015, of which an aggregate of 75,000 had been delivered as of the date of the lawsuit below) to be transferred to Mr. Watts’ children and a promissory note in the amount of $475,000 payable to Mr. Watts.  Additionally, Mr. Scaturro also entered into a lock-up agreement, whereby he agreed to sell a maximum of 500 shares of the Company’s common stock which he holds or may hold in the future, per day, until the listing by the Company on a national exchange or NASDAQ, and thereafter to sell 5% of the ten day moving volume weighted average of shares per day, during the 24 months following the date of the December agreement. Subsequently, Kent P. Watts assigned his rights under the lock-up agreement to the Company and the lawsuit was filed by the Company seeking damages for Mr. Scaturro’s breach of contract.  In July 2015, the parties entered into a settlement agreement whereby Mr. Scaturro agreed to transfer an aggregate of 2,237,500 shares of our common stock to Kent P. Watts, (of which 300,000 shares will be transferred to Mr. Watts’ legal counsel as part of a contingent settlement of amounts owed to such legal counsel), and an aggregate of 162,500 shares of our common stock to two children of Mr. Watts; Mr. Scaturro retained 307,058 shares (the “Remaining Shares”), all interests held by Mr. Watts’ children in the Namibia company were transferred to Mr. Scaturro, and the consulting agreement which was previously in place between the Company and Mr. Scaturro was terminated.  The parties also agreed to dismiss the lawsuit and cross and counter claims with prejudice and release each other from outstanding claims and causes of actions.  Finally, Mr. Scaturro agreed to sell no more than 500 of the Remaining Shares per day until December 18, 2016.  The lawsuit has been settled in July 2015.
 
The General Land Office of the State of Texas (“GLO”) has asserted claims against the Company under various Miscellaneous Easements.  The GLO claims that the Company is obligated to either renew the various Miscellaneous Easements by paying a renewal fee to the GLO, or to remove any pipeline laid in the various Miscellaneous Easements.  The GLO has asserted its claims, and the company has disclaimed any obligations under the various Miscellaneous Easements.  On August 29, 2014, the Company filed a lawsuit in state district court in Chambers County, Texas asking the court to reform an assignment and assumption agreement in the property records of Chambers County.  The Company has been in discussions with the GLO in an attempt to resolve the dispute.  At this time, there is no estimate of loss with respect to this lawsuit.
 
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 July 31, 2015, $150,000 has been recognized and is included in the balance sheet under the caption “Accounts payable and accrued expenses.”

Commitments

In March 2011, we executed a lease for office space in Houston, Texas.  The lease term was three years and we had an option to extend the lease for an additional three years.  Our scheduled rent was $6,406 per month plus common area maintenance cost for the first year, $6,673 plus common area maintenance cost for the second year, and $6,940 per month plus common area maintenance cost for the third year.  We did not extend this lease, but entered into a sublease arrangement with Greenshale LLC for office space in the same building.  During September 2013, we terminated our lease for office space in Corpus Christi, Texas.
 
In February 2014, we agreed to sublease 4,915 square feet of office space from Greenshale Energy, LLC located at 800 Gessner Rd., Houston, Texas 77024.  The lease has a term through December 31, 2017.  Monthly rent of $10,650 is due under the lease from March 1, 2014 through December 31, 2014; $10,854 is due under the lease from January 1, 2015 through December 31, 2015; $11,059 is due under the lease from January 1, 2016 through December 31, 2016; and $11,264 is due under the lease from January 1, 2017 through December 31, 2017.

In April 2012, we executed a Compression and Handling Agreement (the “PHA”) with another operator. Under the terms of the PHA, oil, natural gas, and salt water from one of our fields would be disposed of through the operator’s facility. Under the agreement, we are responsible for approximately a flat fee of $1,000 per month as a gauging fee, our pro-rata share of repairs at the facility, and compression, salt water disposal, and other charges based on the volumes disposed of through the facility.
 
In April 2015, this agreement was amended, as the Company will be handling the compression and dehydration of the gas with its own equipment. The agreement calls for ground lease, services fees, and other costs. The agreement is to continue until terminated by either party. 
 
Rent expense during the years ended July 31, 2015 and 2014 was $175,993 and $186,463 respectively. See Note 7 – Notes Payable, for details regarding our commitments related to our future obligations.

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.

During the years ended July 31, 2015 and 2014, we prepaid the fees associated with the Greenbank letters of credit for the respective year’s interest upfront and amortized these fees on a straight-line basis over their respective annual periods. The following table reflects the prepaid balances as follows:

July 31,
  2015     2014  
         
Prepaid letter of credit fees
 
$
99,300
   
$
101,251
 
Amortization
   
-
     
(8,488
)
Net prepaid letter of credit fees
 
$
99,300
   
$
92,763
 
 
Note 14 – Additional Financial Statement Information

Other receivables

Other receivables consist of joint interest billings due to us from participants holding a working interest in oil and gas properties that we operate.  We regularly review collectability and establish or adjust an allowance for uncollectible amounts as necessary using the specific identification method. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. As of July 31, 2015 and 2014, we have reserved $78,242 and $70,742, respectively, for potentially uncollectable other receivables.

Other current assets

Other current assets consisted of the following:

As of July 31,
 
2015
   
2014
 
         
Prepaid letter of credit fees
 
$
99,300
   
$
92,763
 
Prepaid insurance
   
314,889
     
287,743
 
Other prepaid expenses
   
1,266
     
63,143
 
Employee advance
   
80,000
     
-
 
Prepaid expense
   
30,601
     
-
 
Accrued interest income
   
-
     
2,671
 
Other current assets
 
$
526,056
   
$
446,320
 

Property and Equipment

Property and equipment consisted of the following:

As of July 31,
   
2015
   
2014
 
           
Furniture and fixtures
5 years
 
$
24,085
   
$
24,085
 
Marine vessels
5 years
   
109,742
     
109,742
 
Vehicles
5 years
   
40,496
     
40,496
 
Computer equipment and software
2 years
   
125,271
     
126,143
 
Leasehold improvements
2 years
   
2,087
     
2,087
 
Total property and equipment
     
301,681
     
302,553
 
Less accumulated depreciation
     
(190,971
)
   
(135,590
)
Net book value
   
$
110,710
   
$
166,963
 
                   
Depreciation expense
   
$
54,716
   
$
36,894
 

Accounts payable and accrued expenses

Accounts payable and accrued expenses consisted of the following:

As of July 31,
 
2015
   
2014
 
         
Trade payables
 
$
3,321,118
   
$
2,567,324
 
Accrued payroll
   
55,328
     
43,578
 
Accrued interest and fees
   
204,585
     
37,853
 
Revenue payable
   
4,449
     
5,790
 
Local taxes and royalty payable
   
117,753
     
111,699
 
Federal and state income taxes payable
   
29,431
     
29,431
 
Total accounts payable and accrued expenses
 
$
3,732,664
   
$
2,795,675
 
 
Note 15 – 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 the Company.

Note 16 – Subsequent Events
 
Adar Bays, LLC and Union Capital, LLC Notes

On November 9, 2015, we sold each of Adar Bays, LLC (“Adar”) and Union Capital, LLC (“Union”), identical 8% Short Term Cash Redeemable Notes (collectively, the “Initial Notes”) in the amount of $208,000 ($416,000 in aggregate). The Initial Notes were issued pursuant to the terms of Securities Purchase Agreements dated as of the same date. In addition to the Initial Notes, we sold Adar and Union each another secured note in the amount of $208,000 each ($416,000 in aggregate)(the “Second Notes”). The purchase price of the Initial Notes was paid in cash at closing (November 10, 2015), and the purchase price of the Second Notes was each paid by way of the issuance of an offsetting $208,000 secured note issued to us by each of Adar and Union (the “Buyer Notes”). Pursuant to the Securities Purchase Agreements, Adar and Union each agreed not to sell short any shares of our common stock so long as each purchaser’s Initial Note or Second Note is outstanding. In connection with the sale of the Initial Notes, we paid $16,000 in legal fees ($8,000 to each investor) and paid $30,000 in due diligence fees ($15,000 per Initial Note), provided that substantially similar fees are payable in connection with the Second Notes in the event such Second Notes are paid by Adar and Union as described in greater detail below.

The Initial Notes accrue interest at the rate of 8% per annum and have a two year term. We are required to pre-pay the Initial Notes 180 days after the issuance date (the “Pre-Payment Date”), provided that if we fail to prepay such notes in full on the Pre-Payment Date (or before), the holders thereof have the right to convert the principal and accrued interest owed under such Initial Notes into our common stock at a 40% discount (increasing to 50% if we receive a DTC “Chill” on our common stock or upon the occurrence of certain events of default) to the lowest trading price of our common stock during the 15 trading days prior to conversion. Notwithstanding the foregoing, there is an initial soft floor of $0.30 per share on conversions, which means that in the event our common stock closes below $0.30 per share, then the applicable holder may not convert its notes for the 10 trading days immediately preceding the first time the price closes below $0.30 per share. However, in the event the price of our common stock closes above $0.30 per share in that 10 day period, the holder may again convert, without waiting the balance of the 10 days. Additionally, following the 10 day period, the applicable holder has a three day grace period to convert, even if the common stock closes below the next lower soft floor level (as described in the following sentence). This process is repeated with soft floors of $0.15 per share and $0.075 per share. At no time may the Initial Notes be converted into shares of our common stock if such conversion would result in the applicable holder and its affiliates owning an aggregate of in excess of 9.9% of the then outstanding shares of our common stock.

The Initial Notes may be prepaid, including in connection with any pre-payment on or prior to the Pre-Payment Date, with the following penalties: (i) if the Initial Notes are prepaid within 60 days of the issuance date, then at 115% of the face amount plus any accrued interest; (ii) if the Initial Notes are prepaid after 60 days after the issuance date but less than 121 days after the issuance date, then at 135% of the face amount plus any accrued interest and (iii) if the Initial Notes are prepaid after 120 days after the issuance date but on or before the Pre-Payment Date, then at 145% of the face amount plus any accrued interest. The Initial Notes may not be prepaid after the Pre-Payment Date, except with the approval of the applicable holders. Additionally, upon the occurrence of certain fundamental transactions involving the Company and its common stock, the Initial Notes are required to be redeemed in cash for 150% of the principal amount then outstanding, plus accrued and unpaid interest (provided upon the occurrence of such event, such Initial Notes may also be converted into common stock at the option of the holders).

The Initial Notes provide for customary events of default such as failing to timely make payments under the Initial Notes when due, and including our failure to maintain a reserve of shares in connection with the conversion of the Initial Notes equal to at least four times the number of shares of common stock that could be issuable thereunder at any time (initially 1.1 million shares per Initial Note), any judgment existing against us in excess of $250,000, our common stock being delisted from an exchange (including any OTC Markets exchange), a change in the majority of our Board of Directors, us becoming delinquent in our periodic filings with the SEC, or us losing our “bid” price for our common stock, subject where applicable to our ability to cure certain defaults. Upon the occurrence of an event of default, the holders of the Initial Notes can declare the entire amount of the Initial Notes immediately due and payable, together in the event of certain defaults, additional penalties or liquidated damages totaling between an additional 10% and 50% of the outstanding principal amount of the Initial Notes, together in some cases with make-whole payments for delivery delays and other penalties. Additionally, upon the occurrence of an event of default, the interest rate of the Initial Notes increases to 24% per annum.
 
The Second Notes accrue interest at the rate of 8% per annum, are due on November 9, 2017 and have substantially similar terms and conditions as the Initial Notes described above (except that they include additional events of default such as us having a closing bid price less than $0.50 per share and/or having an aggregate trading value of our common stock of less than $50,000 in any five consecutive trading day period), provided that there are no prepayment penalties associated with the Second Notes, and provided further that no amounts are due under the Second Note (including interest thereon) and the Second Notes are not convertible, unless or until each investor’s applicable Buyer Note is paid in full in cash. In the event we repay a holder’s Initial Note by the Pre-Payment Date, the applicable Second Note and Buyer Note are automatically cancelled.

The Buyer Notes accrue interest at the rate of 8% per annum (which until the Buyer Notes are paid in full in cash, offset amounts due under the Second Notes) and are due on July 9, 2016, unless (a) we do not meet the “current information requirements” required under Rule 144 of the Securities Act of 1933, as amended; or (b) we provide the applicable investor at least 30 days’ notice prior to the six month anniversary of the issuance date of the Buyer Note of our intention to reject the payment of the Buyer Note, in which case the applicable holder may cross cancel its payment obligations under the applicable Buyer Note as well as our payment obligations under the offsetting Second Note. The holders may only prepay the Buyer Note with our written approval.

Pursuant to a side letter entered into with each of Adar and Union, each investor agreed to grant us an option for three 30 day conversion moratorium periods, with the first period beginning on the Pre-Payment Date, and the next two beginning 30 days and 60 days, respectively, after the end of such first period. We are able to exercise the conversion moratorium period options by notifying the applicable investor no later than 10 trading days prior to the Pre-Payment Date (or thereafter, the end of the next applicable conversion moratorium period) and by paying the applicable investor(s) $20,000 prior to five trading days before the end of the then current period (with the first such payment due at least five trading days prior to the Pre-Payment Date).

Each of Adar and Union also entered into a Subordination Agreement in favor of our senior lender, Shadow Tree Capital Management, LLC, to subordinate the repayment of the Initial Notes (and if applicable, the Second Notes) to amounts owed by us to Shadow Tree.

JSJ Investments Inc. Note

On November 9, 2015, we sold JSJ Investments Inc. (“JSJ”) an 8% Short Term Cash Redeemable Note (the “JSJ Note”) in the principal amount of $350,000. The JSJ Note accrues interest at the rate of 8% per annum and is payable on demand by JSJ at any time after November 9, 2016. We may prepay the JSJ note, together with accrued and unpaid interest, at any time prior to the 180th day after the issuance date (the “JSJ Pre-Payment Date”). Along with any prepayment, we are required to pay the following pre-payment penalties in addition to the principal amount then outstanding under the JSJ Note: until the 60th day after the issuance date, a premium of 25% of the principal amount of the note, in addition to outstanding interest; from the 61st day to the 120th day after the issuance date, premium of 35% of the principal amount of the note, in addition to outstanding interest; from the 121st day to the JSJ Pre-Payment Date, a premium of 45% of the principal amount of the note, in addition to outstanding interest; and after the JSJ Pre-Payment Date, a premium of 50% of the then outstanding principal amount of the note, plus accrued interest (provided that after the JSJ Pre-Payment Date the JSJ Note can only be prepaid with the written consent of JSJ). Upon the occurrence of any event of default under the JSJ Note the amounts due thereunder accrue interest at the rate of 18% per annum. JSJ agreed not to sell short any shares of our common stock so long as the JSJ Note is outstanding.

If we fail to prepay the JSJ Note prior to the JSJ Pre-Payment Date, JSJ has the right to convert the principal and accrued interest owed under such note into our common stock at a 40% discount to the lowest trading price of our common stock during the 15 trading days prior to conversion. Notwithstanding the foregoing, there is an initial soft floor of $0.30 per share on conversions, which means that in the event our common stock closes below $0.30 per share, then the holder may not convert its note for the 10 trading days immediately preceding the first time the price closes below $0.30 per share. However, in the event the price of our common stock closes above $0.30 per share in that 10 day period, the holder may convert, without waiting the balance of the 10 days. Additionally, following the 10 day period, the holder has a three day grace period to convert, even if the common stock closes below the next lower soft floor level (as described in the following sentence). This process is repeated with soft floors of $0.15 per share and $0.075 per share. At no time may the JSJ Note be converted into shares of our common stock if such conversion would result in JSJ and its affiliates owning an aggregate of in excess of 4.9% (which may be increased to 9.99% with written notice from JSJ, provided such increase will not take effect for at least 61 days) of the then outstanding shares of our common stock.
 
We are subject to fees, penalties and in some cases liquidated damages for our failure to comply with the terms of the JSJ Note. The JSJ Note provides for customary events of default such as failing to timely make payments under the JSJ Note when due, and including our failure to maintain a reserve of shares in connection with the conversion of the JSJ Note as provided in the JSJ Note, us becoming delinquent in our periodic filings with the SEC, and if OTC Markets changes our designation to ‘No Information’ (Stop Sign), ‘Caveat Emptor’ (Skull and Crossbones), or ‘OTC’, ‘Other OTC’ or ‘Grey Market’ (Exclamation Mark Sign). Upon the occurrence of an event of default, JSJ can declare the entire amount of the JSJ Note immediately due and payable, together in the event of certain defaults, with additional penalties or liquidated damages.

Pursuant to a side letter entered into with JSJ, JSJ agreed to grant us an option for three 30 day conversion moratorium periods, with the first period beginning on the JSJ Pre-Payment Date, and the next two beginning 30 days and 60 days, respectively, after the end of such first period. We are able to exercise the options for conversion moratoriums by notifying JSJ no later than 10 trading days prior to the JSJ Pre-Payment Date (or thereafter, the end of the next applicable conversion moratorium period) and by paying the applicable investor(s) between $25,000 and $35,000 (depending on the applicable extension period) prior to five trading days before the end of the then current period (with the first such payment due at least five trading days prior to the Pre-Payment Date).

JSJ also entered into a Subordination Agreement in favor of our senior lender, Shadow Tree Capital Management, LLC, to subordinate the repayment of the JSJ Note to amounts owed by us to Shadow Tree.
 
Voting Agreements

On or around August 25, 2015, Kent P. Watts, our Chief Executive Officer and Chairman, entered into a voting agreement in favor of S. Chris Herndon, a member of the Board of Directors of the Company.  Pursuant to the voting agreement, Mr. Watts provided Mr. Herndon a voting proxy to vote all of the shares of common stock which Mr. Watts owned (approximately 4,946,955 shares as of his entry into the agreement) or which he may acquire in the future, to vote to elect or remove (as applicable) 66.6% of members of the Company’s Board of Directors on any stockholder vote (i.e., 2 out of 3 directors).  The voting agreement was to become effective, only if Mr. Watts had sold $1 million in securities in private transactions on or before September 21, 2015 and was to remain effective from such date, if ever, until the earlier of: (a) August 19, 2017; and (b) the due date of a certain convertible note which a company affiliated with Mr. Herndon (Duma Holdings, LLC) may choose to purchase from the Company in the future as described in greater detail above under Note 7 – Notes Payable - “Convertible Notes Payable” – “Duma Holding Convertible Promissory Note”.

On or around the same date, Christopher Watts, the nephew of Kent P. Watts, and the largest shareholder of the Company, entered into a voting agreement with Mr. Herndon on substantially similar terms as the voting agreement with Kent P. Watts described above.

As a result of Mr. Watts not selling $1 million in securities in private transactions on similar terms as described above before September 21, 2015, the voting agreements were never effective and have since expired; provided that the parties have recently confirmed their intention to amend the voting agreements to remove the prior condition to effectiveness regarding the required sale of $1 million in securities before September 21, 2015, and as such, we anticipate the voting agreements being amended after the date of this filing to remove such condition and to provide for Mr. Herndon to have voting powers under the voting agreements as described above, until such voting agreements are terminated as described above.  In the event the voting agreements are amended in the future, as is currently contemplated by the parties, Mr. Herndon will have the right to appoint 66.6% of the members of the Company’s Board of Directors.
 
Typenex Warrant Exercise

Effective September 8, 2015, Typenex Co-Investment, LLC (“Typenex”), exercised warrants to purchase 260,788 shares of our common stock which it held (at an exercise price of $1.17 per share. The warrants originally had (a) an exercise price of $2.25 per share, but were subsequently reduced in connection with Typenex’s anti-dilution rights to $1.17 per share and (b) provided Typenex the right to acquire 38,889 shares of common stock, but were subsequently increased to 260,788 shares of common stock in connection with Typenex’s anti-dilution rights, in a net cashless transaction. On September 18, 2015, in connection with such exercise, we issued 128,048 net shares of common stock to Typenex.
 
Kent P. Watts and S. Chris Herndon Convertible Subordinated Promissory Note Subscription

On September 14, 2015, Kent P. Watts, the Chief Executive Officer and Chairman of the Company subscribed for $350,000 in Convertible Subordinated Promissory Notes and on September 17, 2015 he subscribed for an additional $166,667 in Convertible Promissory Notes (collectively, the “Watts Notes”).  The Watts Notes are due two years from their issuance date, accrue interest which is payable quarterly in arrears, at either a cash interest rate (equal to the WTI Rate described below) or a stock interest rate (12% per annum)(at the option of the holder at the beginning of each quarter), provided no principal or interest on the Watts Notes can be paid in cash until all amounts owed by the Company to its senior lender is paid in full.  In the event the stock interest rate is chosen by Mr. Watts, restricted shares of common stock equal to the total accrued dividend divided by the average of the closing sales prices of the Company’s common stock for the applicable quarter are required to be issued in satisfaction of amounts owed on a quarterly basis.  In the event the cash interest rate is chosen, interest accrues until converted into common stock (as discussed below) or until the Company is able to pay such accrued interest in cash pursuant to the terms of the Watts Notes.  The “WTI Rate” equals an annualized percentage interest rate equal to the average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”). 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%). Notwithstanding the above, in the event that the average quarterly closing spot price is $40 or less, the WTI Rate for the applicable following quarter is 0%.  All principal and accrued interest on the Watts Notes is convertible into common stock at a conversion price of $0.75 per share at any time. Additionally, the Company may force the conversion of the Watts Notes into common stock in the event the trading price of the Company’s common stock is equal to at least $5.00 per share for at least 20 out of any 30 consecutive trading days.  Any shares of common stock issuable upon conversion of the Watts Notes are subject to a lock-up whereby no shares of common stock can be sold until January 1, 2016, and no more than 2,500 shares of common stock can be sold per day thereafter until the Company’s common stock is listed on the NASDAQ or NYSE market or the trading volume of the Company’s common stock is in excess of 100,000 shares per day. The Watts Notes have standard and customary events of default.

Previously, on August 26, 2015, Mr. S. Chris Herndon, the Company’s director purchased a Convertible Promissory Note in the amount of $100,000 with substantially similar terms as the Watts Notes (the “Herndon Note”).

First Amendment to Exchange Agreement
 
On July 21, 2015, Mr. Watts and the Company agreed in principle to reduce the number of total Units due to Mr. Watts to 30 Units. On September 21, 2015, Mr. Watts and the Company entered into a First Amendment to Exchange Agreement, which amended the Exchange Agreement dated June 10, 2015. Pursuant to the original terms of the Exchange Agreement, Mr. Watts exchanged all rights he had to 8,188 shares of Series A 7% Convertible Voting Preferred Stock, 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, into 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. 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 maturity date of June 10, 2018 (the "Watts Exchange Note") in connection with the Exchange Agreement. The First Amendment reduced the total Units due to Mr. Watts to 30 Units, and as such. Mr. Watts received Convertible Promissory Notes with a principal amount of $3 million and 750,000 shares of common stock in connection with the exchange originally contemplated by the Exchange Agreement.

Annual Meeting of Stockholders and Adoption of 2015 Stock Incentive Plan

The Annual Meeting of Shareholders of the Company was held on September 28, 2015 (the “Meeting”). At the Meeting, the stockholders of the Company approved the adoption of the Company’s 2015 Stock Incentive Plan (the “Plan”). The Plan was originally approved by the Board of Directors of the Company on August 17, 2015, subject to stockholder approval. The Plan provides an opportunity, subject to approval of our Board of Directors of individual grants and awards, for any employee, officer, director or consultant of the Company, except for instances where services are in connection with the offer or sale of securities in a capital-raising transaction, or they directly or indirectly promote or maintain a market for the Company’s securities, subject to any other limitations provided by federal or state securities laws, to receive (i) incentive stock options (to eligible employees only); (ii) nonqualified stock options; (iii) restricted stock; (iv) stock awards; (v) shares in performance of services; or (vi) any combination of the foregoing. Subject to adjustment in connection with the payment of a stock dividend, a stock split or subdivision or combination of the shares of common stock, or a reorganization or reclassification of the Company’s common stock, the maximum aggregate number of shares of common stock which may be issued pursuant to awards under the Plan is one million shares.
 
Certificate of Amendment Filing; Series A 7% Convertible Voting Preferred Stock and Series B Convertible Preferred Stock

Effective September 28, 2015, the Company filed a Certificate of Amendment to its Articles of Incorporation with the Secretary of State of Nevada, to (1) affect an amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of the Company’s common stock to 1,000,000,000 shares; (2) affect an amendment to the Company’s Articles of Incorporation to authorize 100,000,000 shares of “blank check” preferred stock (the “Blank Check Preferred Amendment”); (3) designate 10,000 shares of Series A 7% Convertible Voting Preferred Stock (the “Series A Amendment”); and (4) designate 35,000 shares of Series B Convertible Preferred Stock (the “Series B Amendment”), each of which amendments were approved by the stockholders of the Company at the Meeting.  Previously. effective on September 21, 2015, the Company filed a Certificate of Correction with the Secretary of State of Nevada, which cancelled and rescinded in its entirety, the previously filed Series A 7% Convertible Voting Preferred Stock designation filed by the Board of Directors without stockholder approval on December 2, 2013.

Pursuant to the Blank Check Preferred Amendment, up to 100,000,000 shares of preferred stock of the Company may be issued from time to time in one or more series, each of which will have such distinctive designation or title as may be determined by the Board of Directors of the Company prior to the issuance of any shares thereof. Preferred stock will have such voting powers, full or limited, or no voting powers, and such preferences and relative, participating, optional or other special rights and such qualifications, limitations or restrictions thereof, as shall be stated in such resolution or resolutions providing for the issue of such class or series of preferred stock as may be adopted from time to time by the Board of Directors prior to the issuance of any shares thereof.

Pursuant to the Series A Amendment, the Company designated 10,000 shares of Series A 7% Convertible Voting Preferred Stock, which has a stated value of $400 per share, pays dividends at 7% per annum, is convertible into the Company’s common stock (together with accrued and unpaid dividends), at a 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 stockholders 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). The approval of the Series A Amendment was only to ratify the effect of certain prior transactions, and the Company has no current plans to issue Series A Preferred Stock at this time.

Pursuant to the Series B Amendment, the Company designated 35,000 shares of Series B Convertible Preferred Stock. 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 average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”) multiplied by the face value (provided that the interest rate for the first quarter after issuance is 7% per annum). Until the end of the third calendar quarter following the initial issuance date (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 to Shadow Tree Capital Management, LLC, and other lenders under the Company’s senior credit facility, as well as any future debt used to refinance, repay or supplement the senior credit facility, 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.

Automatic Conversion of Convertible Notes Sold As Part of Units

In connection with the September 28, 2015, designation of our Series B Convertible Preferred Stock, all outstanding Convertible Promissory Notes sold in connection with our offering of “Units”, each consisting of (a) 25,000 shares of the Company’s restricted common stock; and (b) Convertible Promissory Notes with a face amount of $100,000, automatically converted into shares of Series B Convertible Preferred Stock as described below.  The Convertible Notes were convertible into common stock of the Company at any time at the holder’s option at a conversion price of $4 per share, and were automatically convertible into shares of Series B Convertible Preferred Stock of the Company upon designation of such Series B Convertible Preferred Stock with the Secretary of State of Nevada which occurred on September 28, 2015.  In connection with such automatic conversion, a total of $3 million in Convertible Notes held by our Chief Executive Officer and Chairman, Kent P. Watts, and a total of $50,000 in Convertible Notes held by David L. Gillespie automatically converted into an aggregate of 3,050 shares of our Series B Convertible Preferred Stock (with Mr. Watts receiving 3,000 shares and Mr. Gillespie receiving 50 shares).

Typenex Co-Investment, LLC Convertible Note

On October 19, 2015, and effective October 16, 2015, we sold a Secured Convertible Promissory Note (the “Typenex Note”) to Typenex Co-Investment, LLC (“Typenex”) in the amount of $1,730,000. The Typenex Note was issued pursuant to the terms of a Securities Purchase Agreement dated as of the same date. The Typenex Note included a $475,000 original issuance discount and also included $5,000 which went to pay Typenex’s legal fees in connection with the transaction. Additionally, a total of $263,011 of the purchase price of the Typenex Note was paid by way of the forgiveness by Typenex of amounts owed by us to Typenex under a Secured Convertible Promissory Note in the original principal amount of $350,000 which we sold to Typenex in March 2015 (provided the warrants granted to Typenex in connection with the prior March 2015 transaction remain outstanding). As a result, we received a total of $986,990 in cash in connection with the sale of the Typenex Note.
 
The Typenex Note is due on April 19, 2016 and no interest accrues on the Typenex Note unless an event of default occurs thereunder. The note is convertible into common stock, as discussed below, only if an event of default under the note occurs and is not cured pursuant to the terms of the note.  Following an event of default, the note accrues interest at the rate of 22% per annum (subject to applicable usury laws) until paid in full. We have the right to pre-pay the Typenex Convertible Note prior to maturity, provided that we pay $1,492,500 on or before 90 days after the date the note is issued; $1,611,250 after 90 days, but before 135 days, after the note is issued; and the full amount of the note, $1,730,000, between the date that is 135 days after the note is issued and maturity.

The amounts owed under the Typenex 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 two million one hundred thousand (2,100,000) shares of our common stock held by CW Navigation as security for our obligations under the Typenex 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 1.5 times the then balance of the note (initially $2,595,000), at any time after November 1, 2015, it constitutes a default of the Typenex Note. From the date of funding until November 1, 2015 (and at any time thereafter at the request of Typenex), CW Navigation or its affiliates can pledge additional shares to bring the required value of the shares pledged above the minimum collateral value threshold or to over-collateralize the note. Subsequent to the closing, KW Navigation has pledged an additional one million (1,000,000) collateral shares to Typenex under the Pledge Agreement to bring the required value of the shares pledged above the required minimum collateral value threshold.

The Typenex Note provides for customary events of default such as failing to timely make payments under the Typenex Note when due, and including our failure to maintain a reserve of shares in connection with the conversion of the Typenex Note equal to at least three times the number of shares of common stock that could be issuable thereunder at any time (initially 3 million shares), failing to repay all of our currently outstanding variable rate convertible securities within thirty days of the date of the note, failing to repay our senior creditor (Shadow Tree, as defined below) by the maturity date of the Typenex Note or alternatively, failing to receive Shadow Tree’s consent to repay the Typenex Note at maturity in cash, and in the event the value of the securities pledged pursuant to the Pledge Agreement (as discussed above) falls below the required value after November 1, 2015, subject where applicable to our ability to cure certain defaults. Additionally, it is an event of default under the note in the event we fail to repay all of our outstanding variable securities within 30 days of the date of the note (the “Variable Security Payment Date”) or in the event we have any outstanding variable securities after such Variable Security Payment Date.

At any time following an uncured event of default, Typenex has the right to convert any or all of the outstanding principal amount of the note into our common stock. The conversion price of the Typenex Note is 80% of the five lowest closing bid prices of our common stock on the 20 trading days prior to any conversion, provided that if the average of such closing bid prices is below $0.75 per share, the conversion rate is decreased by 5% (to 75%), and provided further that the conversion rate is decreased by an additional 5% if we are not DWAC eligible at any time or DTC eligible at any time (for up to an aggregate of an additional 10% decrease in the conversion rate). Finally, in the event certain defaults (defined as major defaults under the note) occur, the conversion rate may be decreased by up to an additional 15% (an additional 5% decrease in the conversion rate per the occurrence of the first three major defaults). Typenex also has the right upon the occurrence of an event of default to require us to repay in full the amount owed under the note by providing us written notice. Additionally, upon the occurrence of certain events of default as described in the Typenex Note, we are required to repay Typenex liquidated damages in addition to the amount owed under the Typenex Note.

At no time may the Typenex 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. Additionally, and at no time may pledged shares be received by Typenex pursuant to the terms of the Pledge Agreement, which would result in Typenex and its affiliates owning an aggregate of in excess of 9.99% of the then outstanding shares of our common stock.

We are subject to various fees and penalties under the Typenex Note for our failure to timely deliver shares due upon any conversion. The Typenex Note also includes various restrictions on our ability to enter into subsequent variable rate security transactions following the date thereof.
 
Typenex also entered into a Subordination Agreement in favor of our senior lender, Shadow Tree Capital Management, LLC (“Shadow Tree”), to subordinate the repayment of the Typenex Note to amounts owed by us to Shadow Tree.

We intend to use the proceeds raised from the sale of the Typenex Note to payoff amounts owed to under our variable rate convertible note held by KBM Worldwide, Inc. in the amount of $575,464, for the partial payment of amounts owed under our variable rate convertible note held by JMJ Financial with a balance of $373,333, and for other general corporate purposes, with the goal of having these completed by the end of November 2015.
 
Additional Subsequent Events
 
In August 2015, the Company transferred the 39% working interest in certain Namibian oil and gas concessions then held by Namibia Exploration, Inc., the Company’s wholly-owned subsidiary to Hydrocarb Namibia Energy (Pty) Limited, also the Company’s wholly-owned subsidiary, to consolidate ownership of such working interests in Hydrocarb Namibia Energy (Pty) Limited.
 
In August 2015, the Company issued 60,000 Form S-8 registered shares to James W. Christian, a partner at Christian Smith & Jewell, the Company’s legal counsel, in consideration for legal fees owed. 
 
In August 2015, the Company entered into a non-exclusive placement agent agreement with a placement agent in connection with its private offering of convertible notes.  The placement agent never sold any securities for the Company and the agreement was subsequently terminated without any consideration being paid to the placement agent.
 
From August to September 2015, the Company sold $1,740,832 in Convertible Subordinated Promissory Notes (including $83,333 in notes sold to Clint Summers who was a director of the Company from September 7, 2015 until his untimely death shortly thereafter; $32,500 in notes sold to Brian Kenny, who is the nephew of the Company’s Chief Executive Officer and Chairman; $100,000 to the Company’s director, S. Chris Herndon; and $516,667 to entities owned or controlled by Kent P. Watts, the Company’s Chief Executive Officer and Chairman). The notes are due two years from their issuance date, accrue interest which is payable quarterly in arrears, at either a cash interest rate (equal to the WTI Rate described below) or a stock interest rate (12% per annum)(at the option of each holder at the beginning of each quarter), provided no principal or interest can be paid in cash until all amounts owed by the Company to its senior lender is paid in full.  In the event the stock interest rate is chosen by the holder, restricted shares of common stock equal to the total accrued dividend divided by the average of the closing sales prices of the Company’s common stock for the applicable quarter are required to be issued in satisfaction of amounts owed on a quarterly basis.  In the event the cash interest rate is chosen, interest accrues until converted into common stock (as discussed below) or until the Company is able to pay such accrued interest in cash pursuant to the terms of the note.  The “WTI Rate” equals an annualized percentage interest rate equal to the average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”). 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%). Notwithstanding the above, in the event that the average quarterly closing spot price is $40 or less, the WTI Rate for the applicable following quarter is 0%.  All principal and accrued interest on the notes are convertible into common stock at a conversion price of $0.75 per share at any time. Additionally, the Company may force the conversion of the notes into common stock in the event the trading price of the Company’s common stock is equal to at least $5.00 per share for at least 20 out of any 30 consecutive trading days.  Any shares of common stock issuable upon conversion of the notes are subject to a lock-up whereby no shares of common stock can be sold until January 1, 2016, and no more than 2,500 shares of common stock can be sold per day thereafter until the Company’s common stock is listed on the NASDAQ or NYSE market or the trading volume of the Company’s common stock is in excess of 100,000 shares per day. The notes have standard and customary events of default.
 
In September 2015, the Company issued 1,000,000 shares of restricted common stock to Snap or Tap Productions, LLC in consideration for agreeing to provide two years of public relations and investor awareness services to the Company.  The shares are fully vested upon issuance. The fair value of the shares was $1,480,000.
            
In September 2015, GBE received an extension of a prior Term Pooling Agreement relating to 1,280 acres of land in Chambers County, Texas. As extended the Term Pooling Agreement now expires on December 3, 2017.
 
Note 17 – Supplemental Oil and Gas Information (Unaudited)

The following supplemental information regarding our oil and gas activities is presented pursuant to the disclosure requirements promulgated by the SEC and ASC 932, Extractive Activities —Oil and Gas, (ASC 932).

Users of this information should be aware that the process of estimating quantities of “proved” and “proved developed” oil and natural gas reserves is very complex, requiring significant subjective decisions in the evaluation of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors including, but not limited to, additional development activity, evolving production history and continual reassessment of the viability of production under varying economic conditions. As a result, revisions to existing reserve estimates may occur from time to time. Although every reasonable effort is made to ensure reserve estimates reported represent the most accurate assessments possible, the subjective decisions and variances in available data for various reservoirs make these estimates generally less precise than other estimates included in the financial statement disclosures.

Proved reserves represent estimated quantities of natural gas and crude oil that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under economic and operating conditions in effect when the estimates were made. Proved developed reserves are proved reserves expected to be recovered through wells and equipment in place and under operating methods used when the estimates were made. The oil price as of July 31, 2015 and 2014 is based on the 12-month un-weighted average of the first of the month prices of the NYMEX (Cushing, OK WTI) posted price which equates to $64.94 and $100.11 per barrel, respectively. The gas price as of July 31, 2015 and 2014 is based on the 12-month un-weighted average of the first of the month prices of the NYMEX (Cushing, OK WTI) spot price which equates to $3.25 and $4.10 per MMbtu, respectively. The base prices were adjusted for heating content, premiums and product differentials based on historical revenue statements. All prices are held constant in accordance with SEC guidelines. All proved reserves are located in the United States; specifically, primarily in on-shore and off-shore Texas.

The following table illustrates our estimated net proved reserves, including changes, and proved developed reserves for the periods indicated, as estimated by third party reservoir engineers. Our proved reserves are located in the United States of America, our home country.

Proved Reserves

   
Oil
(Barrels)
   
Gas
(Mcf)
   
Total
(Mcfe)
 
Balance – July 31, 2013
   
659,700
     
12,730,390
     
16,688,590
 
Revisions of previous estimates
   
422,261
     
4,477
     
2,538,043
 
Sale of reserves in place
   
(17,750
)
   
(529,937
)
   
(636,437
)
Production
   
(42,436
)
   
(173,569
)
   
(428,185
)
Balance – July 31, 2014
   
1,021,775
     
12,031,361
     
18,162,011
 
Revisions of previous estimates
   
1,051,419
     
6,285,180
     
12,593,693
 
Production
   
(55,604
)
   
(152,981
)
   
(486,605
)
Balance – July 31, 2015
   
2,017,590
     
18,163,560
     
30,269,100
 
 
During the year ended July 31, 2015, the Company increased estimated reserves reported under the line items “Revisions of previous estimates” due to an increase in certain previously estimated reserves in the Galveston Bay, Texas properties. When we acquired Galveston Bay Energy LLC in 2011, the Company had over 100 well-bores that had been shut in and scheduled for potential plugging and abandonment. Since the date of the acquisition, our technical staff undertook a review of the old well logs and other technical data associated with such review to identify additional undeveloped oil reserves in these leases. All increases in proved undeveloped reserves are due to the re-evaluation of previously available technical data associated with such review. We have not obtained new technical data. We believe that the new interpretations and reevaluations better reflect the underlying technical data. Completion of successful wells in both the Fisher Reef and Red Fish Reef Field resulted in additional behind pipe and proved underdeveloped reserves for the year ended July 31, 2015.

Proved Reserves as of July 31, 2015
 
Oil
(Barrels)
   
Gas
(Mcf)
   
Total
(Mcfe)
 
             
Proved developed producing
   
357,760
     
2,077,760
     
4,224,320
 
Proved developed non-producing
   
488,570
     
7,745,820
     
10,677,240
 
Proved undeveloped
   
1,171,260
     
8,339,980
     
15,367,540
 
Total proved reserves
   
2,017,590
     
18,163,560
     
30,269,100
 

Proved Reserves as of July 31, 2014
 
Oil
(Barrels)
   
Gas
(Mcf)
   
Total
(Mcfe)
 
             
Proved developed producing
   
200,981
     
969,940
     
2,175,826
 
Proved developed non-producing
   
212,320
     
4,813,192
     
6,087,112
 
Proved undeveloped
   
608,474
     
6,248,229
     
9,899,073
 
Total proved reserves
   
1,021,775
     
12,031,361
     
18,162,011
 

Proved developed producing and proved developed non-producing reserves increased from July 31, 2014 to July 31, 2015 as a result of changes in estimates, based on current information.  The increase in proved undeveloped reserves was a result of an increase in certain previously estimated reserves in the Galveston Bay, Texas property.

The reserves in the report have been estimated using deterministic methods. For wells classified as proved developed producing where sufficient production history existed, reserves were based on individual well performance evaluation and production decline curve extrapolation techniques. For undeveloped locations and wells that lacked sufficient production history, reserves were based on analogy to producing wells within the same area exhibiting similar geologic and reservoir characteristics, combined with volumetric methods. The volumetric estimates were based on geologic maps and rock and fluid properties derived from well logs, core data, pressure measurements, and fluid samples. Well spacing was determined from drainage patterns derived from a combination of performance-based recoveries and volumetric estimates for each area or field. Proved undeveloped locations were limited to areas of uniformly high quality reservoir properties, between existing commercial producers.

Capitalized Costs Related to Oil and Gas Activities

The following table illustrates the total amount of capitalized costs relating to oil and natural gas producing activities and the total amount of related accumulated depreciation, depletion and amortization.

For the year ended July 31,
 
2015
   
2014
 
         
Unevaluated properties
 
$
2,260,912
   
$
2,119,769
 
Evaluated properties
   
19,578,916
     
19,153,125
 
Less impairment
   
(373,335
)
   
(373,335
)
     
21,466,493
     
20,899,559
 
Less depreciation, depletion, and amortization
   
(4,381,912
)
   
(3,491,420
)
Net capitalized cost
 
$
17,084,581
   
$
17,408,139
 
 
Costs Incurred in Oil and Gas Activities

Costs incurred in property acquisition, exploration and development activities for the year ended July 31, 2015 were as follows:

   
Total
   
Namibia
   
USA
 
Property acquisition
           
Unproved
 
$
141,143
   
$
141,143
   
$
-
 
Proved
   
-
     
-
     
-
 
Exploration
   
38,762
     
-
     
38,762
 
Drilling and development costs
   
2,232,748
     
-
     
2,232,748
 
Changes in ARO
   
(139,183
)
           
(139,183
)
Cost recovery
   
(1,706,539
)
           
(1,706,539
)
Total costs incurred
 
$
566,931
   
$
141,143
   
$
425,788
 

Costs incurred in property acquisition, exploration, and development activities for the year ended July 31, 2014 were as follows:
 
   
Total
   
Namibia
   
USA
 
Property acquisition
           
Unproved
 
$
821,665
   
$
821,665
   
$
-
 
Proved
   
13
     
-
     
13
 
Exploration
   
238,112
     
173,299
     
64,813
 
Drilling and development costs
   
(6,334
)
   
-
     
(6,334
)
Changes in ARO
   
(105,015
)
   
-
     
(105,015
)
Cost recovery
   
(658,195
)
   
-
     
(658,195
)
Total costs incurred
 
$
290,246
   
$
994,964
   
$
(704,718
)

Costs Excluded

Our excluded costs as of July 31, 2015 and 2014 relate to costs incurred in the concession acquired in Namibia, Africa. The concession provides for a multi-year exploration program as described in Note 3 – Oil and Gas Properties.  The program provides that an initial well be drilled by September 2017.  Accordingly, we anticipate including the excluded costs in the amortization base within the next four to five years.  All costs that were excluded as of July 31, 2015 and 2014 were as follows, and were incurred during the respective years noted below.

Costs Excluded by Year Incurred

As of July 31,
 
2015
   
2014
 
     
Property acquisition
 
$
141,143
   
$
821,665
 
Exploration
   
-
     
173,299
 
Total
 
$
141,143
   
$
994,964
 

Changes in Costs Excluded by Country

   
Namibia
   
USA
 
         
Balance at July 31, 2013
 
$
1,124,805
   
$
-
 
Additional Cost Incurred
   
994,964
     
-
 
Balance at July 31, 2014
   
2,119,769
     
-
 
Additional Cost Incurred
   
141,143
     
-
 
Balance at July 31, 2015
 
$
2,260,912
   
$
-
 
 
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Natural Gas Reserves

The following Standardized Measure of Discounted Future Net Cash Flow information has been developed utilizing ASC 932, Extractive Activities —Oil and Gas, (ASC 932) procedures and based on estimated oil and natural gas reserve and production volumes. It can be used for some comparisons, but should not be the only method used to evaluate us or our performance. Further, the information in the following table may not represent realistic assessments of future cash flows, nor should the Standardized Measure of Discounted Future Net Cash Flow be viewed as representative of our current value.

We believe that the following factors should be taken into account when reviewing the following information:

future costs and selling prices will probably differ from those required to be used in these calculations;
due to future market conditions and governmental regulations, actual rates of production in future years may vary significantly from the rate of production assumed in the calculations;
a 10% discount rate may not be reasonable as a measure of the relative risk inherent in realizing future net oil and natural gas revenues; and
future net revenues may be subject to different rates of income taxation.

Under the Standardized Measure, the future cash inflows were estimated by applying the un-weighted 12-month average of the first day of the month cash price quotes, except for volumes subject to fixed price contracts, to the estimated future production of year-end proved reserves. Estimates of future income taxes are computed using current statutory income tax rates including consideration for estimated future statutory depletion and tax credits. The resulting net cash flows are reduced to present value amounts by applying a 10% discount factor. The reserve report, as prepared by an independent consulting petroleum engineer and incorporated by reference to Exhibit 99.1 to the Annual Report on Form 10-K to which these financial statements are included, filed for the year ended July 31, 2015, did not include all future plugging and abandonment costs. Therefore, the Company made adjustments for these costs in its computations of the Standardized Measure.  All proved reserves are located in the United States of America.

The Standardized Measure is as follows:

For the year ended July 31,
 
2015
   
2014
 
         
Future cash inflows
 
$
206,774,120
   
$
159,283,690
 
Future production costs
   
(71,055,710
)
   
(54,437,098
)
Future development costs
   
(56,321,551
)
   
(43,054,816
)
Future income tax expenses
   
(27,788,901
)
   
(21,627,122
)
     
51,607,958
     
40,164,654
 
10% annual discount for estimated timing of cash flows
   
(22,718,796
)
   
(15,807,988
)
Future net cash flows at end of year
 
$
28,889,162
   
$
24,356,666
 
 
Changes in Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Natural Gas Reserves

The following is a summary of the changes in the Standardized Measure of discounted future net cash flows for our proved oil and natural gas reserves during each of the years in the two year period ended July 31, 2015:
 
   
2015
   
2014
 
         
Standardized measure of discounted future net cash flows at beginning of year
 
$
24,356,666
   
$
6,352,793
 
Net changes in prices and production costs
   
(21,776,026
)
   
20,980,014
 
Changes in estimated future development costs
   
(7,426,468
)
   
(764,412
)
Sales of oil and gas produced, net of production costs
   
819,396
     
(151,783
)
Discoveries and extensions
   
-
     
-
 
Purchases of minerals in place
     -      
-
 
Sales of minerals in place
   
-
     
(2,228,023
)
Revisions of previous quantity estimates
   
31,608,990
     
8,885,117
 
Development costs incurred
     -      
-
 
Change in income taxes
   
(2,440,575
)
   
(9,694,393
)
Accretion of discount
   
3,747,179
     
977,353
 
Standardized measure of discounted future net cash flows at year end
 
$
28,889,162
   
$
24,356,666
 

The following schedule includes only the revenues from the production and sale of gas, oil, condensate and NGLs. The income tax expense is calculated by applying the current statutory tax rates to the revenues after deducting costs, which include depletion, depreciation and amortization allowances, after giving effect to permanent differences. The results of operations exclude general office overhead and interest expense attributable to oil and gas activities.

Results of Operations for Producing Activities

For the year ended July 31,
 
2015
   
2014
 
         
Net revenues from production
 
$
3,941,541
   
$
5,065,096
 
                 
Expenses
               
Lease operating expense
   
4,762,854
     
4,913,313
 
Accretion
   
993,579
     
1,043,928
 
Operating expenses
   
5,756,433
     
5,957,241
 
                 
Depletion and amortization
   
890,491
     
873,942
 
Total expenses
   
6,646,924
     
6,831,183
 
                 
Income before income tax
   
(2,705,383
)
   
(1,766,087
)
Income tax expense
           
-
 
Results of operations
 
$
(2,705,383
)
 
$
(1,766,087
)
                 
Depletion and amortization rate per net equivalent Mcfe
 
$
1.83
   
$
2.04
 
 
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.
CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Principal Executive Officer and Principal Financial 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 and Principal Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were not effective to ensure that information required to be disclosed in reports filed under the Exchange Act is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our Principal Executive Officer, as appropriate to allow timely decisions regarding required disclosure, due to the deficiencies in our internal control over financial reporting as described below.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act).

As of July 31, 2015, we assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established in Internal Control -Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and SEC guidance on conducting such assessments. We utilized the original (1992) COSO Framework to conduct our assessment.  Based on that evaluation, we concluded that, as of July 31, 2015, our internal controls and procedures were not effective to detect the inappropriate application of accounting principles generally accepted in the United States of America as more fully described below. This was due to deficiencies that existed at the time in which the internal control procedures were implemented that adversely affected our internal controls and that may be considered to be a material weakness.

The matters involving internal controls and procedures that our management considered to be material weaknesses under the standards of the Public Company Accounting Oversight Board were: (1) while the Company has implemented written policies and procedures for accounting and financial reporting with respect to the requirements and application of Generally Accepted Accounting Principles (GAAP) and SEC disclosure requirements, we have not conducted a formal assessment of whether the policies that have been implemented address the specific risks of misstatement; accordingly, we could not conclude whether the control activities are designed effectively nor whether they operate effectively; and (2) we do not have an effective mechanism for monitoring the system of internal controls.

Management believes that the material weaknesses set forth above did not have a material adverse effect on our financial results for the year ended July 31, 2015.

We are committed to improving our financial organization. Our control weaknesses are largely a function of not having sufficient staff.  As resources become available, we plan to augment our staff so that we can devote more effort to addressing our control deficiencies.  Additionally, as financial resources become available, we will consider engaging third party consultants to assist with control activities.

We will continue to monitor and evaluate the effectiveness of our internal controls and procedures over financial reporting on an ongoing basis and are committed to taking further action by implementing additional enhancements or improvements, or deploying additional human resources as may be deemed necessary.
 
Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during our most recent fiscal quarter that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B.
OTHER INFORMATION

As described in greater detail in the Current Report on Form 8-K filed by the Company with the Securities and Exchange Commission on November 13, 2015, on November 9, 2015, we sold Adar Bays, LLC (“Adar”) and Union Capital, LLC (“Union”), identical 8% Short Term Cash Redeemable Notes (collectively, the “Initial Notes”) in the amount of $208,000 ($416,000 in aggregate). In addition to the Initial Notes, we sold Adar and Union each another secured note in the amount of $208,000 each ($416,000 in aggregate)(the “Second Notes”). The purchase price of the Initial Notes was paid in cash at closing (November 10, 2015), and the purchase price of the Second Notes was each paid by way of the issuance of an offsetting $208,000 secured note issued to us by each of Adar and Union (the “Buyer Notes”). The Initial Notes accrue interest at the rate of 8% per annum and have a two year term. We are required to pre-pay the Initial Notes, together with applicable pre-payment penalties, 180 days after the issuance date (the “Pre-Payment Date”), provided that if we fail to prepay such notes in full on the Pre-Payment Date (or before), the holders thereof have the right to convert the principal and accrued interest owed under such Initial Notes into our common stock at a 40% discount (increasing to 50% if we receive a DTC “Chill” on our common stock or upon the occurrence of certain events of default) to the lowest trading price of our common stock during the 15 trading days prior to conversion. Notwithstanding the foregoing, there is an initial soft floor of $0.30 per share on conversions, which means that in the event our common stock closes below $0.30 per share, then the applicable holder may not convert its notes for the 10 trading days immediately preceding the first time the price closes below $0.30 per share. However, in the event the price of our common stock closes above $0.30 per share in that 10 day period, the holder may again convert, without waiting the balance of the 10 days. Additionally, following the 10 day period, the applicable holder has a three day grace period to convert, even if the common stock closes below the next lower soft floor level (as described in the following sentence). This process is repeated with soft floors of $0.15 per share and $0.075 per share (collectively, the “Conversion Floors”). At no time may the Initial Notes be converted into shares of our common stock if such conversion would result in the applicable holder and its affiliates owning an aggregate of in excess of 9.9% of the then outstanding shares of our common stock.
 
The Initial Notes provide for customary events of default such as failing to timely make payments under the Initial Notes when due, and including our failure to maintain a reserve of shares in connection with the conversion of the Initial Notes equal to at least four times the number of shares of common stock that could be issuable thereunder at any time (initially 1.1 million shares per Initial Note), any judgment existing against us in excess of $250,000, our common stock being delisted from an exchange (including any OTC Markets exchange), a change in the majority of our Board of Directors, us becoming delinquent in our periodic filings with the SEC, or us losing our “bid” price for our common stock, subject where applicable to our ability to cure certain defaults. Upon the occurrence of an event of default, the holders of the Initial Notes can declare the entire amount of the Initial Notes immediately due and payable, together in the event of certain defaults, additional penalties or liquidated damages totaling between an additional 10% and 50% of the outstanding principal amount of the Initial Notes, together in some cases with make-whole payments for delivery delays and other penalties. Additionally, upon the occurrence of an event of default, the interest rate of the Initial Notes increases to 24% per annum.

The Second Notes accrue interest at the rate of 8% per annum, are due on November 9, 2017 and have substantially similar terms and conditions as the Initial Notes described above (except that they include additional events of default such as us having a closing bid price less than $0.50 per share and/or having an aggregate trading value of our common stock of less than $50,000 in any five consecutive trading day period), provided that there are no prepayment penalties associated with the Second Notes, and provided further that no amounts are due under the Second Note (including interest thereon) and the Second Notes are not convertible, unless or until each investor’s applicable Buyer Note is paid in full in cash. In the event we repay a holder’s Initial Note by the Pre-Payment Date, the applicable Second Note and Buyer Note are automatically cancelled.

The Buyer Notes accrue interest at the rate of 8% per annum (which until the Buyer Notes are paid in full in cash, offset amounts due under the Second Notes) and are due on July 9, 2016, unless (a) we do not meet the “current information requirements” required under Rule 144 of the Securities Act; or (b) we provide the applicable investor at least 30 days’ notice prior to the six month anniversary of the issuance date of the Buyer Note of our intention to reject the payment of the Buyer Note, in which case the applicable holder may cross cancel its payment obligations under the applicable Buyer Note as well as our payment obligations under the offsetting Second Note. The holders may only prepay the Buyer Note with our written approval.

Pursuant to a side letter (the “Side Letter”) entered into with each of Adar and Union, each investor agreed to grant us an option for three 30 day conversion moratorium periods, with the first period beginning on the Pre-Payment Date, and the next two beginning 30 days and 60 days, respectively, after the end of such first period. We are able to exercise the conversion moratorium period options by notifying the applicable investor no later than 10 trading days prior to the Pre-Payment Date (or thereafter, the end of the next applicable conversion moratorium period) and by paying the applicable investor(s) $20,000 prior to five trading days before the end of the then current period (with the first such payment due at least five trading days prior to the Pre-Payment Date).

Each of Adar and Union also entered into a Subordination Agreement in favor of our senior lender, Shadow Tree Capital Management, LLC, to subordinate the repayment of the Initial Notes (and if applicable, the Second Notes) to amounts owed by us to Shadow Tree.
 
On November 12, 2015, we sold JSJ Investments Inc. (“JSJ”) an 8% Short Term Cash Redeemable Note (the “JSJ Note”) in the principal amount of $350,000. The JSJ Note accrues interest at the rate of 8% per annum and is payable on demand by JSJ at any time after November 9, 2016. We may prepay the JSJ note, together with accrued and unpaid interest, at any time prior to the 180th day after the issuance date (the “JSJ Pre-Payment Date”). Along with any prepayment, we are required to pay the following pre-payment penalties in addition to the principal amount then outstanding under the JSJ Note: until the 60th day after the issuance date, a premium of 25% of the principal amount of the note, in addition to outstanding interest; from the 61st day to the 120th day after the issuance date, premium of 35% of the principal amount of the note, in addition to outstanding interest; from the 121st day to the JSJ Pre-Payment Date, a premium of 45% of the principal amount of the note, in addition to outstanding interest; and after the JSJ Pre-Payment Date, a premium of 50% of the then outstanding principal amount of the note, plus accrued interest (provided that after the JSJ Pre-Payment Date the JSJ Note can only be prepaid with the written consent of JSJ). Upon the occurrence of any event of default under the JSJ Note the amounts due thereunder accrue interest at the rate of 18% per annum. JSJ agreed not to sell short any shares of our common stock so long as the JSJ Note is outstanding.

If we fail to prepay the JSJ Note prior to the JSJ Pre-Payment Date, JSJ has the right to convert the principal and accrued interest owed under such note into our common stock at a 40% discount to the lowest trading price of our common stock during the 15 trading days prior to conversion, subject to the Conversion Floors. At no time may the JSJ Note be converted into shares of our common stock if such conversion would result in JSJ and its affiliates owning an aggregate of in excess of 4.9% (which may be increased to 9.99% with written notice from JSJ, provided such increase will not take effect for at least 61 days) of the then outstanding shares of our common stock.

We are subject to fees, penalties and in some cases liquidated damages for our failure to comply with the terms of the JSJ Note. The JSJ Note provides for customary events of default such as failing to timely make payments under the JSJ Note when due, and including our failure to maintain a reserve of shares in connection with the conversion of the JSJ Note as provided in the JSJ Note, us becoming delinquent in our periodic filings with the SEC, and if OTC Markets changes our designation to ‘No Information’ (Stop Sign), ‘Caveat Emptor’ (Skull and Crossbones), or ‘OTC’, ‘Other OTC’ or ‘Grey Market’ (Exclamation Mark Sign). Upon the occurrence of an event of default, JSJ can declare the entire amount of the JSJ Note immediately due and payable, together in the event of certain defaults, with additional penalties or liquidated damages.

We also entered into a side letter agreement with JSJ with substantially similar terms as the Side Letter (except that payments range between $25,000 and $35,000 depending on the applicable extension period) and JSJ also entered into a Subordination Agreement in favor of our senior lender, Shadow Tree Capital Management, LLC, to subordinate the repayment of the JSJ Note to amounts owed by us to Shadow Tree.
 
PART III

ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Officers and Directors

Our directors and executive officers and their respective ages as of the date of this annual report are as follows:

Name
Age
Position with the Company
Kent P. Watts
57
Chief Executive Officer and Chairman
Charles F. Dommer
61
President and Chief Operating Officer
Christine P. Spencer
59
Chief Accounting Officer
S. Chris Herndon
55
Director

The following describes the business experience of each of our directors and executive officers, including other directorships held in reporting companies:

Kent P. Watts, Chief Executive Officer and Chairman

Mr. Watts was appointed to the Board of Directors and as Chairman on October 11, 2013. On August 8, 2014, the Board of Directors appointed Mr. Watts as Chief Executive Officer. Mr. Watts is currently and has been Chairman and Chief Executive Officer of Hydrocarb Corporation (our wholly-owned subsidiary) since November 2009. Between June 1997 and October 2009 he was the founder, Chairman, and Chief Executive Officer for Hyperdynamics Corporation (OTCQX:HDY)(“Hyperdynamics”), an exploration and production company and prior to that an information technology services company. In 2006, Mr. Watts became the Founder and Chairman of American Friends of Guinea (AFG), a non-profit organization. He remains Chairman of AFG. Prior to June 1997, Mr. Watts served as Chairman, President and Chief Executive Officer of several companies in varying fields such as information technology services and computer manufacturing.  From 1983 to 1987, Mr. Watts provided advisory and public accountancy and advisory services. He holds a BBA from the University of Houston and he is a licensed Certified Public Accountant and Real Estate Broker in the State of Texas.

Director Qualifications:

Mr. Watts has extensive business experience as a successful entrepreneur and has been active in the oil and natural gas industry since 2002.  He has been the Chairman, board member, CFO, and Chief Executive of various public companies since 1996 and as founder, Chairman, and CEO, led Hyperdynamics Corporation to be listed on the NYSE MKT in 2005.  Between 2002 and 2006, he also led Hyperdynamics to acquire one of the largest exploration blocks ever off the coast of the Republic of Guinea in western Africa.  Mr. Watts left Hyperdynamics in 2009 to start Hydrocarb Corporation and secured a 21,000 square kilometer onshore block in Namibia in 2011.  Mr. Watts plays a key role in the executive management and implementation of strategic initiatives and problem resolution at the Company.  We believe that Mr. Watts is qualified to serve as a director.

Charles F. Dommer, President and Chief Operating Officer

Charles F. Dommer was appointed President and Chief Operating Officer of the Company on October 27, 2013.  Mr. Dommer is an exploration and development executive with 35 years of managerial positions for international and domestic oil and gas exploitation, exploration and acquisitions.  Mr. Dommer has managed many major projects in the competitive arena of oil and gas exploration and development. From December 2010 until present, Mr. Dommer has served as the Vice President of Exploration and Development for Hydrocarb Corporation.  From January 2000 to December 2010, Mr. Dommer served as President of Trans Global Engineering, Inc., of Denver, Colorado, primarily directing production operations as Chief Geologist (Vice President of Exploration and Production) for Lukoil-AIK in Russia.  Mr. Dommer’s past experience includes Senior Geologist at Phillips Petroleum Company, located in Texas, and the establishment of a Geology and Reservoir Engineering Department in Siberia as Chief Geologist (Vice President of Exploration and Production) for Occidental Petroleum Joint Venture, Vanyoganneft.  Mr. Dommer has a B.S. Geology degree from Arizona State University.
 
Christine P. Spencer, Chief Accounting Officer

On June 13, 2014, Christine P. Spencer was appointed Chief Accounting Officer of the Company. Ms. Spencer has been the controller of Hydrocarb Energy Corp. since February of 2013.  Ms. Spencer’s prior work history before joining Hydrocarb Energy Corp. are as follows: from October 2010 to July 2012, she was controller of Platinum Pressure Pumping, an oilfield service company; prior to that, from November 2009 to October 2010, she served as controller of Holden Roofing Company, a residential and commercial roofing company; and from April 2008 through August 2009, Ms. Spencer was the Chief Financial Officer for David Powers Homes, a residential building contractor.  Ms. Spencer is a certified public accountant in Texas and has over 37 years of public and private accounting experience.  Ms. Spencer has a Bachelor’s of Science degree in Accountancy, with High Honors from the University of Illinois.

S. Chris Herndon, Director

Mr. Herndon has been a director of the Company since October 11, 2012.  Mr. Herndon is an experienced financial and management professional with more than 30 years of experience. Currently, Mr. Herndon serves as Partner of Cyrus Partners, an investment company focusing on the energy, healthcare, and real estate sectors. Beginning in 2002 through 2011, Mr. Herndon served as Chief Financial Officer and Partner of AppOne, a financial technology company designed to serve the auto finance industry. From 1996 to 2001, Mr. Herndon served as CEO and Partner of The Mattress Firm, growing the organization from 100 stores to 275 stores before selling the firm to Bain Capital. Mr. Herndon was also a Registered Investment Advisor with Malachi Financial Services from 1994 to 1996. From 1983 to 1994, Mr. Herndon served as Chief Financial Officer and Controller of Duer Wagner and Co., an oil and gas operator in Texas. From 1982 to 1983 he served as a Public Accountant with Price Waterhouse.

Mr. Herndon is a graduate of Texas Christian University where he earned his Bachelor of Business Administration and Accounting, after which he became a Certified Public Accountant (CPA) in 1985. He is actively involved with several charities locally and internationally.

Director Qualifications:

Mr. Herndon has extensive experience in the business world in general. He also has extensive practical knowledge of doing business in Texas and the United States. In addition, we believe Mr. Herndon demonstrates personal and professional integrity, ability, judgment, and effectiveness in serving the long-term interests of the Company’s stockholders.  As a result of the above, we believe that Mr. Herndon is qualified to serve as a director.

Director Qualifications

The Board of Directors believes that each of our directors is highly qualified to serve as a member of the Board of Directors. Each of the directors has contributed to the mix of skills, core competencies and qualifications of the Board of Directors. When evaluating candidates for election to the Board of Directors, the Board of Directors seeks candidates with certain qualities that it believes are important, including integrity, an objective perspective, good judgment, and leadership skills. Our directors are highly educated and have diverse backgrounds and talents and extensive track records of success in what we believe are highly relevant positions.

Term of Office

Our directors are appointed for a one-year term to hold office until their respective successors are duly elected and qualified. Our officers are appointed by our Board of Directors and hold office until they resign or are removed from office by the Board of Directors.

Significant Employees

Other than Craig Alexander, our Vice President, the Company has no significant employees other than our executive officers.  Mr. Alexander has been with the Company since early 2011. Before joining our Company, he was employed by Galveston Bay Energy serving as Operations Manager. Mr. Alexander has more than 21 years of oil and gas experience in production and completion engineering and operations management with Erskine Energy, Millennium Offshore Group, and Amerada Hess Corporation. He is a graduate of the University of Texas at Austin with a B.S. in Petroleum Engineering.  Mr. Alexander is considered a non-executive officer.
 
CORPORATE GOVERNANCE

The Company promotes accountability for adherence to honest and ethical conduct; endeavors to provide full, fair, accurate, timely and understandable disclosure in reports and documents that the Company files with the SEC and in other public communications made by the Company; and strives to be compliant with applicable governmental laws, rules and regulations.

Board Leadership Structure

Our Board of Directors has the responsibility for selecting the appropriate leadership structure for the Company. In making leadership structure determinations, the Board of Directors considers many factors, including the specific needs of the business and what is in the best interests of the Company’s stockholders. Our current leadership structure is comprised of a combined Chairman of the Board and Chief Executive Officer (“CEO”), Mr. Watts. The Board of Directors believes that this leadership structure is the most effective and efficient for the Company at this time.  Mr. Watts possesses detailed and in-depth knowledge of the issues, opportunities, and challenges facing the Company, and is thus best positioned to develop agendas that ensure that the Board of Directors’ time and attention are focused on the most critical matters. Combining the Chairman of the Board and CEO roles promotes decisive leadership, fosters clear accountability and enhances the Company’s ability to communicate its message and strategy clearly and consistently to our stockholders, particularly during periods of turbulent economic and industry conditions.

Risk Oversight

Effective risk oversight is an important priority of the Board of Directors. Because risks are considered in virtually every business decision, the Board of Directors discusses risk throughout the year generally or in connection with specific proposed actions. The Board of Directors’ approach to risk oversight includes understanding the critical risks in the Company’s business and strategy, evaluating the Company’s risk management processes, allocating responsibilities for risk oversight among the full Board of Directors, and fostering an appropriate culture of integrity and compliance with legal responsibilities.  The Board of Directors exercises direct oversight of strategic risks to the Company, including reviewing and assessing the Company’s processes to manage business and financial risk and financial reporting risk; reviewing the Company’s policies for risk assessment and assessing steps management has taken to control significant risks; overseeing risks relating to compensation programs and policies; recommending the slate of director nominees for election at the annual stockholder meetings; reviewing, evaluating and recommending changes to the Company’s corporate governance guidelines; and establishing the process for conducting the review of the Chief Executive Officer’s performance.  The Company is currently searching for two additional independent directors to assist with these processes and plans to form an Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee in the future when the Company has added additional independent members of the Board of Directors.

Family Relationships

None of our directors are related by blood, marriage, or adoption to any other director, executive officer, or other key employees.

Arrangements between Officers and Directors

To our knowledge, there is no arrangement or understanding between any of our officers and any other person, including directors, pursuant to which the officer was selected to serve as an officer.

Other Directorships

No directors of the Company are also directors of issuers with a class of securities registered under Section 12 of the Exchange Act (or which otherwise are required to file periodic reports under the Exchange Act).
 
Involvement in Certain Legal Proceedings

To the best of our knowledge, during the past ten years, none of our directors or executive officers were involved in any of the following: (1) any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time; (2) any conviction in a criminal proceeding or being a named subject to a pending criminal proceeding (excluding traffic violations and other minor offenses); (3) being subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities; (4) being found by a court of competent jurisdiction (in a civil action), the SEC or the Commodities Futures Trading Commission to have violated a federal or state securities or commodities law, (5) being the subject of, or a party to, any Federal or State judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated, relating to an alleged violation of (i) any Federal or State securities or commodities law or regulation; (ii) any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order; or (iii) any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or (6) being the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.

Board of Directors Meetings

The Company had 35 official meetings of the Board of Directors of the Company during the last fiscal year ending July 31, 2014 and 36 meetings during the fiscal year ended July 31, 2015.  Each director attended at least 75% of the total number of meetings of the Board. The Company has not adopted a policy requiring its directors to attend its annual meeting of stockholders. Mr. Watts attended the Company’s 2015 Annual Meeting of Stockholders; however, Mr. Herndon had a prior engagement and was unable to attend.

Committees of the Board

On February 19, 2014, the Company adopted committee charters for an Audit Committee, Nominating and Corporate Governance Committee and Compensation Committee (the “Committees”).  However, as the Company only has one independent director and only two total directors at this time, no members of the Board of Directors have been appointed to such Committees to date.  Until such time as the Company appoints members to the Committees, the Committees have no authority, and all functions of such Committees are instead performed by the full Board of Directors. Because the Committees currently have no members and no authority, the description of the charters of each of the Committees has not been included herein; however, the charters of each Committee as adopted by the Board of Directors are set forth on our corporate website (hydrocarb.com), under “About” – “Corporate Governance”.  The Company plans to file a Form 8-K at such time, if ever, as the Company appoints any members of its Board of Directors to any of the Committees and further plans to file applicable Committee Charters with the SEC at that time.

Stockholder Communications with the Board

Our stockholders and other interested parties may communicate with members of the Board of Directors by submitting such communications in writing to our non-executive Secretary, Kathi Brogdon, who, upon receipt of any communication other than one that is clearly marked “Confidential,” will note the date the communication was received, open the communication, make a copy of it for our files and promptly forward the communication to the director(s) to whom it is addressed. Upon receipt of any communication that is clearly marked “Confidential,” our Secretary will not open the communication, but will note the date the communication was received and promptly forward the communication to the director(s) to whom it is addressed. If the correspondence is not addressed to any particular board member or members, the communication will be forwarded to a board member to bring to the attention of the Board of the Directors.
 
Director Independence

The Board of Directors annually determines the independence of each director and nominee for election as a director. In assessing director independence, the Board of Directors considers, among other matters, the nature and extent of any business relationships, including transactions conducted, between the Company and each director and between the Company and any organization for which one of our directors is a director or executive officer or with which one of our directors is otherwise affiliated.

Our Board of Directors has determined that Mr. Herndon is an independent director as defined under Rule 10A-3 of the Exchange Act.

Code of Conduct

We have adopted a Code of Conduct that applies to all directors and officers. The code describes the legal, ethical and regulatory standards that must be followed by the directors and officers of the Company and sets forth high standards of business conduct applicable to each director and officer. As adopted, the Code of Conduct sets forth written standards that are designed to deter wrongdoing and to promote, among other things:

(1) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;

(2) full, fair accurate, timely and understandable disclosure in reports and documents that we file with, or submit to, the SEC and in other public communications made by us;

(3) compliance with applicable governmental laws, rules and regulations;

(4) the prompt internal reporting of violations of the code to the appropriate person or persons identified in the code; and

(5) accountability for adherence to the code.

We revised the Code of Conduct during the year ended July 31, 2013.  A copy of our Code of Conduct was filed as Exhibit 14.1 to our Annual Report on Form 10-K for the year ended July 31, 2013, filed with the Securities and Exchange Commission on November 12, 2013.

We intend to disclose any amendments to our Code of Conduct and any waivers with respect to our Code of Conduct granted to our principal executive officer, our principal financial officer, or any of our other employees performing similar functions on our website at www.hydrocarb.com, within four business days after the amendment or waiver. In such case, the disclosure regarding the amendment or waiver will remain available on our website for at least 12 months after the initial disclosure. There have been no waivers granted with respect to our Code of Conduct to any such officers or employees to date.
 
Compliance with Section 16(a) of the Exchange Act

Section 16(a) of the Exchange Act requires our directors and officers, and the persons who beneficially own more than 10% of our common stock, to file reports of ownership and changes in ownership with the SEC. Copies of all filed reports are required to be furnished to us pursuant to Rule 16a-3 promulgated under the Exchange Act. Based solely on the reports received by us and on the representations of certain of the reporting persons, we believe that these persons have complied with all applicable filing requirements during the year ended July 31, 2015, except as follows:
 
Name
 
Number of forms
filed late
 
Number of Transactions
reported late
         
Kent P. Watts
 
6
 
2
Pasquale Scaturro
 
4
 
0
S. Chris Herndon
 
5
 
0
KW Navigation Inc. (1)
 
1
 
0
CW Navigation Inc. (1)
 
1
 
0
KD Navigation Inc. (1)
 
1
 
0
Charles F. Dommer
 
1
 
0

(1) Companies owned 100% by Christopher Watts, nephew of our current CEO and Chairman.

Pursuant to SEC rules, we are not required to disclose in this annual report any failure to timely file a Section 16(a) report that has been disclosed by us in a prior proxy statement or annual report.

ITEM 11.
EXECUTIVE COMPENSATION

Summary Compensation Table

The following table sets forth information concerning the compensation of our Chief Executive Officer, Chief Accounting Officer (as well as persons with respect to whom disclosure would have been required had they been serving in such roles as of the end of the applicable fiscal years) and the two most highly compensated officers other than the Chief Executive Officer and Chief Accounting Officer (collectively, our “Named Executive Officers”) during our fiscal years ended July 31, 2015 and 2014:

Name and Principal Position
 
Year
 
Salary
   
Bonus
   
Stock
Awards (2)
   
All Other
Compensation
   
Total (1)
 
                         
Kent P. Watts (3)
 
2015
 
$
96,154
   
$
-
   
$
12,000
   
$
-
   
$
108,154
 
CEO and Chairman
 
2014
 
$
-
   
$
-
   
$
14,621
   
$
-
   
$
14,621
 
Christine P. Spencer (4)
 
2015
 
$
160,085
   
$
35,000
   
$
-
   
$
-
   
$
195,085
 
Chief Accounting Officer
 
2014
 
$
132,923
   
$
-
   
$
144,000
   
$
-
   
$
276,923
 
Craig Alexander
 
2015
 
$
200,123
   
$
45,000
   
$
-
   
$
-
   
$
245,123
 
Vice President, non-executive officer
 
2014
 
$
185,000
   
$
-
   
$
185,000
   
$
-
   
$
370,000
 
Pasquale V. Scaturro
 
2015
 
$
6,923
   
$
-
   
$
-
   
$
50,000
   
$
56,923
 
Former CEO (5)
 
2014
 
$
75,257
   
$
-
   
$
23,518
   
$
-
   
$
98,775
 
Tyler W. Moore
 
2014
 
$
20,584
   
$
-
   
$
152,369
   
$
-
   
$
172,953
 
Former CFO (6)
                                           
Charles F. Dommer
 
2015
 
$
180,200
   
$
20,000
   
$
-
   
$
-
   
$
200,200
 
President and COO (7)
 
2014
 
$
99,205
   
$
-
   
$
13,320
   
$
-
   
$
112,525
 
Jeremy G. Driver (8)
 
2014
 
$
111,724
   
$
-
   
$
-
   
$
-
   
$
111,724
 
Former President and CEO
                                           
Sarah Berel-Harrop (9)
 
2014
 
$
162,163
   
$
-
   
$
-
   
$
-
   
$
162,163
 
Former Secretary, Treasurer & CFO
                                           
Steven L. Carter (10)
 
2014
 
$
65,718
   
$
-
   
$
-
   
$
-
   
$
65,718
 
Former Vice President, Operations
                                           

(1)  Does not include perquisites and other personal benefits, or property, unless the aggregate amount of such compensation is more than $10,000.  None of our executive officers received any Option Awards, Non-Equity Incentive Plan Compensation or Nonqualified Deferred Compensation Earnings during the periods presented.

(2) Represents the fair value of the grant of shares of our common stock calculated in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718.
 
(3) Appointed as Chief Executive Officer on August 8, 2014.  Stock Award compensation for fiscal 2014 is in consideration for services to the Board of Directors.

(4) Appointed as Chief Accounting Officer on June 13, 2014.

(5) Effective November 15, 2013, Mr. Scaturro was appointed as Chief Executive Officer of the Company. Mr. Scaturro resigned as Chief Executive Officer of the Company on August 8, 2014.

(6) Mr. Moore was appointed as Chief Financial Officer of the Company effective December 2, 2013 and resigned as Chief Financial Officer effective March 31, 2014.

(7) Appointed as President and COO of the Company effective October 27, 2013.

(8) Effective on October 27, 2013, Mr. Driver resigned as President of the Company and effective on November 15, 2013, Mr. Driver resigned as Chief Executive Officer of the Company.

(9) Effective November 25, 2013, Ms. Berel-Harrop resigned as Secretary of the Company. Effective on December 2, 2013, Ms. Berel-Harrop resigned as Chief Financial Officer of the Company and was appointed as Chief Accounting Officer. On January 7, 2014, Ms. Berel-Harrop resigned as Chief Accounting Officer and Treasurer.

(10) Mr. Carter’s employment as Vice President Operations was terminated effective August 30, 2013.

Compensation of Directors

Our directors, including Mr. Watts, our executive director, and Mr. S. Chris Herndon, who is our non-executive director, receive the following compensation for their service on the Board of Directors:

$12,000 per quarter, with $4,000 payable in stock (based on the average trading price of all trading days during the applicable quarter) for each non-executive member of the Board of Directors and $8,000 per quarter, with $4,000 payable in stock (based on the average trading price of all trading days during the applicable quarter) for each executive member of the Board of Directors,

$2,000 per year for serving as a committee chair (assuming committees of the Board of Directors are formed in the future),

Meeting fees of $2,000 per meeting for any board meetings other than four quarterly regular meetings, and

Meeting fees of $1,500 per meeting for any committee meetings other than four quarterly regular meetings.

The following table provides information regarding compensation during the year ended July 31, 2015 earned by directors who are not executive officers.  The compensation of our directors who are executive officers is disclosed in the “Summary Compensation” Table above.

Name
Fees Earned or
Paid in Cash
($)
 
Option Awards
(1)
($)
 
All Other
Compensation
($)
 
Total
 
($)
 
         
S. Chris Herndon
 
$
12,000
   
$
112,500
   
$
12,000
   
$
136,300  

* The table above does not include the amount of any expense reimbursements paid to the above directors.  No directors received any Stock Awards, Option Awards, Non-Equity Incentive Plan Compensation, or Nonqualified Deferred Compensation Earnings during the period presented.  Does not include perquisites and other personal benefits, or property, unless the aggregate amount of such compensation is more than $10,000.
 
(1) Represents the fair value of the grant of certain options to purchase shares of our common stock calculated in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718.
 
Outstanding Equity Awards at Year Ended July 31, 2015

As of July 31, 2015, no Executive Officer had any outstanding equity awards outstanding.  No Executive Officers had any stock options outstanding which were exercisable or unexercisable as of July 31, 2015.  Additionally, no Named Executive Officers had any unearned securities awards outstanding as of July 31, 2015.

Employment, Consulting and Services Agreements

The following is a summary of the material terms of the employment, consulting or services agreements we have entered into with our officers and employees.

Kent P. Watts Employment Agreement

On March 9, 2015, and effective as of January 20, 2015, we entered into an executive employment agreement with Kent P. Watts to serve as our Chief Executive Officer.  The agreement, which was also approved by our senior lender, provides for the payment to Mr. Watts of a salary of $250,000 per year (increasing by $75,000 per year in the event our common stock trades on any stock exchange); a bonus of $200,000 (subject to certain requirements in the agreement) once we have raised $9.4 million in total funding between August 1, 2014 and July 31, 2015 which funds were not raised, and a bonus of 2% of the first $10 million raised in debt or equity; 1% of the next funds raised in debt or equity between $10 million and $25 million; and ½% for all funds raised above $25 million, all of which may be paid to Mr. Watts at his option in cash, shares of common stock or preferred stock.  The agreement remains in effect until July 31, 2017. Upon the occurrence of a “change of control” of the Company, as defined in the agreement, and the termination of employment by Mr. Watts or the Company in connection therewith, or in the event we terminate the agreement without cause, we are required to pay Mr. Watts his then current salary plus insurance for the lesser of one (1) year or the remaining term of the agreement.  Mr. Watts has agreed to not require us to pay him any of the amounts that he would have been due under the terms of the agreement from January 20, 2015 until the date the agreement was entered into until such time as we raise additional funds.

Charles F. Dommer Employment Agreement

Effective March 1, 2014, the Company entered into an employment agreement with Charles F. Dommer, pursuant to which Mr. Dommer agreed to serve as an employee of the Company for a term of one year.  Pursuant to the agreement, Mr. Dommer’s salary was $120,000 per year.

Effective July 19, 2014, the Company entered into a replacement employment agreement with Charles F. Dommer, pursuant to which Mr. Dommer agreed to serve as the President of the Company for a term of one year.  Pursuant to the agreement, Mr. Dommer’s salary is $240,000 per year.  Mr. Dommer was also due a bonus of $20,000 in connection with the Company closing certain financing transactions which were consummated and which bonus was paid in August 2014.  Finally, Mr. Dommer is due a bonus equal to 2% of the net cash proceeds received by the Company for any working interest purchased from the Company by any joint venture with regard to any international concessions and operated by the Company. If Mr. Dommer’s employment is terminated by the Company in connection with a Change of Control (as defined in the agreement), either involuntarily by the Company or voluntarily by Mr. Dommer within 90 days of such Change of Control, the Company is required to continue paying his salary and reimburse him for insurance payments for one year after such termination date.  Additionally, in the event the agreement is terminated by the Company for any reason other than cause or by Mr. Dommer for good reason (each as defined in the agreement), Mr. Dommer is due six months of salary as a severance payment.
 
On July 20, 2015, the Company entered into a new employment agreement with Mr. Dommer with substantially similar terms as those described above, except for providing for him to serve as the President and Chief Operating Officer of the Company until July 20, 2016, and providing for him to receive a bonus equal to 2% of the net cash proceeds received from the Company for any working interest sold by the Company to any part in regards to any U.S. or international concessions owned and operated by the Company.
 
Christine P. Spencer Employment Agreement

Effective June 12, 2015, we entered into an employment agreement with Christine P. Spencer, pursuant to which Ms. Spencer agreed to serve as the Chief Accounting Officer of the Company at a salary of $160,000 per year. The agreement has a term of one year, provided that the agreement automatically extends for additional one year periods unless either party provides the other written notice of their intent not to renew the agreement at least 60 days prior to the date of any applicable automatic extension and the agreement automatically extended for an additional year through June 2016. In the event the Company terminates the agreement without cause or Ms. Spencer terminates the agreement for good reason, Ms. Spencer is due salary and insurance benefits for a period of 12 months from the termination date. “Cause” includes a conviction for a felony, a crime involving moral turpitude or a plea of guilty or no lo contender to a charge of such crime, the theft or embezzlement, or attempted theft or embezzlement of money or property of the Company, perpetration or attempted perpetration of fraud, or participation in connection therewith, on the Company, unauthorized appropriation of any tangible or intangible material asset or property of the Company, dishonesty with respect to any matter concerning the Company, or the substantial and repeated failure to perform under the employment agreement. “Good reason” means our material breach of the agreement, any action by us which results in the material diminishment of Ms. Spencer’s job functions or responsibilities, any attempt by us to cause Ms. Spencer to relocate as a requirement of continued employment, or any reduction in salary or material reduction in benefits (unless such reduction in benefits is applicable generally to all employees).

Carter Professional Services Agreement (Terminated)

On December 20, 2006, our Board of Directors authorized and approved the execution of the “Carter Professional Services Agreement”. The initial term of the agreement was two years expiring on November 30, 2008, and the agreement was amended to increase Mr. Carter’s compensation in June 2011. Pursuant to the terms and provisions of the Carter Professional Services Agreement: (i) Steven Carter agreed to provide duties to us commensurate with his then executive position as our Vice President of Operations; (ii) we would pay to Mr. Carter a monthly fee of $14,583.33; (iii) we approved the issuance of 20,000 shares of our common stock at a price of $0.025 per share (on a post-share consolidation basis); (iv) we approved the granting of an aggregate of not less than 24,000 options to purchase shares of our common stock at $8.75 per share (amended to be $2.50 per share) for a ten year term (on a post-share consolidation basis); and (v) the Carter Professional Services Agreement may be terminated without cause by either of us by providing prior written notice of the intention to terminate at least 90 days (in the case of our Company after the initial term) or 30 days (in the case of Mr. Carter) prior to the effective date of such termination.  In August, 2013, we terminated the agreement.  In accordance with the terms of the agreement, he received the fee due under the terms of the agreement through the end of November 2013.

Jeremy G. Driver Agreement (2009)(Terminated)

Effective December 1, 2009, we entered into an executive services agreement with Mr. Driver, which was revised in June 2011 to increase his monthly fee, pursuant to which he was to perform such duties and responsibilities as set out in the agreement and as our Board of Directors from time to time reasonably determined and assigned.  In consideration for his services under the agreement, as amended, we agreed:

to pay Mr. Driver a monthly fee of $14,583.33;
to pay Mr. Driver a one-time signing bonus of $20,000;
to provide Mr. Driver with industry standard bonuses, from time to time, based, in part, on the performance of the Company and the achievement by Mr. Driver of reasonable management objectives, as determined by the Company’s Board of Directors in good faith;
to provide Mr. Driver with three weeks paid vacation;
to provide Mr. Driver with a monthly benefits stipend of $450 together with full participation, at the Company’s expense, in the Company’s current medical services and life insurance benefits programs for management and employees; and
to grant Mr. Driver incentive stock options to purchase not less than an aggregate of 100,000 common shares of the Company, at an exercise price $5.00 per share (amended to be $2.50 per share), vesting as to one-quarter of said stock options on the date of grant (that being as to 25,000) and on each day which is six months thereafter in succession for each remaining one-quarter of the optioned common shares, and all being exercisable for a period of three years from the date of grant and in accordance with the provisions of the Company’s current Stock Incentive Plan.
 
The initial term of the agreement was one year ending on December 1, 2010, and the agreement was subject to automatic renewal on a monthly basis unless either the Company or Mr. Driver provides written notice of an intention not to renew the agreement not later than 30 days prior to the end of the then-current initial term or renewal of the agreement.  In October 2013, this agreement was terminated and we entered into a new employment agreement with Mr. Driver, as described below.

 Jeremy G. Driver Agreement (2013)(Terminated)

On October 11, 2013, we entered into a new agreement with Mr. Driver, which was modified on October 27, 2013 and was effective October 1, 2013.  In consideration for his services under the agreement, as amended, we agreed to provide Mr. Driver with a monthly salary of $14,583.33, participation in company benefits programs, and four weeks paid vacation.  The agreement provided for Mr. Driver to be paid six months’ salary as severance in the event of:

termination by the Company for other than cause,
termination by Mr. Driver for “Good Reason”, which includes a diminishment of job functions or responsibilities and attempts by the Company to relocate Mr. Driver, or
termination by Mr. Driver for any reason within 90 days of a change in control of the Company.

The initial term of the agreement was one year ending on October 1, 2014, and the agreement was subject to automatic renewal for consecutive one year periods unless either the Company or Mr. Driver provided written notice of an intention not to renew the agreement not later than 60 days prior to the end of the then-current initial term or renewal of the agreement.

Effective October 11, 2013, Mr. Driver resigned as Chairman and as a member of the Board of Directors of the Company. Effective on October 27, 2013, Mr. Driver resigned as President of the Company and effective on November 15, 2013, Mr. Driver resigned as Chief Executive Officer of the Company.

Sarah Berel-Harrop Agreement (Terminated)

On October 11, 2013, we entered into an employment agreement with Ms. Berel-Harrop, which was effective October 1, 2013.  In consideration for her services under the agreement, as amended, we agreed to provide Ms. Berel-Harrop with a monthly salary of $12,500, participation in Company benefits programs, and three weeks paid vacation.  The agreement provides for Ms. Berel-Harrop to be paid six months’ salary as severance in the event of:

termination by the Company for other than cause,
termination by Ms. Berel-Harrop for “Good Reason”, which includes a diminishment of job functions or responsibilities and attempts by the Company to relocate Ms. Berel-Harrop, or
termination by Ms. Berel-Harrop for any reason within 90 days of a change in control of the Company.

The initial term of the agreement was one year ending on October 1, 2014, and the agreement was subject to automatic renewal for consecutive one year periods unless either the Company or Ms. Berel-Harrop provided written notice of an intention not to renew the agreement not later than 60 days prior to the end of the then-current initial term or renewal of the agreement.

Effective November 25, 2013, Ms. Berel-Harrop resigned as Secretary of the Company. Effective on December 2, 2013, Ms. Berel-Harrop resigned as Chief Financial Officer of the Company and was appointed as Chief Accounting Officer. On January 7, 2014, Ms. Berel-Harrop resigned as Chief Accounting Officer and Treasurer.
 
Craig Alexander Agreement

On October 11, 2013, we entered into an employment agreement with Mr. Alexander (our non-executive Vice President), which is effective October 1, 2013. In consideration for his services under the agreement, as amended, we have agreed to provide Mr. Alexander with a monthly salary of $15,417.67, participation in Company benefits programs, and three weeks paid vacation.  The agreement provides for Mr. Alexander to be paid six months’ salary as severance in the event of:

termination by the Company for other than cause,
termination by Mr. Alexander for “Good Reason”, which includes a diminishment of job functions or responsibilities and attempts by the Company to relocate Mr. Alexander, or
termination by Mr. Alexander for any reason within 90 days of a change in control of the Company.

The initial term of the agreement was one year ending on October 1, 2014, and the agreement is subject to automatic renewal for consecutive one year periods unless either the Company or Mr. Alexander provides written notice of an intention not to renew the agreement not later than 60 days prior to the end of the then-current initial term or renewal of the agreement. The agreement automatically renewed in October 2014 and 2015, and therefore will remain in effect (subject to additional renewals) through October 2016.

ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table sets forth certain information concerning the number of shares of our voting stock owned beneficially as of November 10, 2015 by: (i) each person (including any group) known to us to own more than 5% of our shares of common stock; (ii) each of our directors; (iii) each of our officers; and (iv) our officers and directors as a group. Based on 24,258,742 shares of common stock outstanding as of November 10, 2015.

Beneficial ownership is determined in accordance with the rules of the SEC and includes voting and/or investing power with respect to securities. These rules generally provide that shares of common stock subject to options, warrants or other convertible securities that are currently exercisable or convertible, or exercisable or convertible within 60 days of the applicable date, are deemed to be outstanding and to be beneficially owned by the person or group holding such options, warrants or other convertible securities for the purpose of computing the percentage ownership of such person or group, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or group.

To our knowledge, except as indicated in the footnotes to this table and pursuant to applicable community property laws, (a) the persons named in the table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them, subject to applicable community property laws; and (b) no person owns more than 5% of our common stock.  Unless otherwise indicated, the address for each of the officers or directors listed in the table below is 800 Gessner, Suite 375, Houston, Texas 77024.
 
Title of Class
 
Name and Address of Beneficial Owner (1)
 
Amount and Nature of Beneficial Owner
   
Percent of Class
 
             
Directors and Officers:
                 
             
Common Stock
 
Kent P. Watts
    5,286,833  
(2)
   
20.6
%
   
800 Gessner, Suite 375
                 
   
Houston, Texas, U.S.A. 77024
                 
                       
Common Stock
 
Christine P. Spencer
   
32,814
       
*
 
   
800 Gessner, Suite 375
                 
   
Houston, Texas, U.S.A. 77024
                 
                       
Common Stock
 
Charles F. Dommer
   
841,702
       
3.4
%
   
800 Gessner, Suite 375
                 
   
Houston, Texas, U.S.A. 77024
                 
                       
Common Stock
 
S. Chris Herndon
    724,562  
(3)
    2.9
%
   
800 Gessner, Suite 375
                 
   
Houston, Texas, U.S.A. 77024
                 
                       
   
Directors and officers together (4 persons)
    6,885,991        
26.1
%

Greater Than 5% Stockholders:
 
             
Common Stock
 
Christopher Watts
   
6,872,824
 
(4)
   
28
%
 
14019 SW Frwy #301-600
                 
 
Sugar Land, Texas, U.S.A. 77478
                 
                       
Common Stock
 
Michael Watts
   
1,617,502
 
(5)
   
6.6
%
 
14019 SW Frwy #301-600
                 
 
Sugar Land, Texas, U.S.A. 77478
                 

 
* Indicates beneficial ownership of less than 1% of the total outstanding common stock.
 
(1)  Under Rule 13-D-3 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares: (i) voting power, which includes the power to vote, or to direct the voting of shares, and/or (ii) investment power, which includes the power to dispose or direct the disposition of shares. In addition, shares are deemed to be beneficially owned by a person if the person has the right to acquire the shares within 60 days of the date as of which the information is provided.
 
(2) Includes 750,000 shares of common stock issuable upon conversion of 3 million outstanding shares of Series B Convertible Preferred Stock and 688,889 shares of common stock issuable upon the conversion of $516,667 of outstanding convertible promissory notes, which allow the holder thereof the right to convert amounts owed into common stock at the rate of $0.75 per share.  Does not include 50,000 shares of common stock which Mr. Watts has agreed to cancel pursuant to the terms of the September 21, 2015, First Amendment to Exchange Agreement, or shares of common stock issuable upon conversion of convertible notes which Mr. Watts as agreed to cancel in connection with such agreement, nor does it include 300,000 shares currently in Mr. Watts name, which are to be transferred to the law firm of Christian Smith & Jewell in connection with contingent legal fees due with the settlement of the Vincent Pasquale Scaturro litigation in July 2015, which had not been transferred as of the date of this report.
 
(3) Includes 66,667 shares of common stock issuable upon exercise of outstanding and vested options with an exercise price of $6.60 and 25,000 shares issuable upon the exercise of outstanding and vested options with an exercise price of $4.50.  Includes shares of common stock issuable upon conversion of a convertible note held by Duma Holdings, LLC, 20% of which Mr. Herndon is deemed to beneficially own, which is convertible at the option of the holder into (a) 1.75 units, each consisting of 25,000 shares of common stock of the Company and $100,000 in face amount of Convertible Subordinated Promissory Notes (which allow the holder thereof the right to convert such notes into common stock at a conversion price of $4 per share, and convert into shares of our to-be designated and approved Series B Convertible Preferred Stock upon designation thereof by the Company as described herein); and (b) 350,000 shares of common stock.  Includes shares of common stock issuable upon conversion of a $100,000 Convertible Promissory Note held by Mr. Herndon which is convertible into common stock at a conversion price of $0.75 per share at any time.

(4) Christopher Watts is the 100% owner of and deemed owner of CW Navigation, Inc. (“CW Navigation”), KD Navigation, Inc., and KW Navigation, Inc.  Because Mr. Watts has voting and dispositive control over these entities, Mr. Watts is deemed to beneficially own the shares of common stock held by each of these entities. Mr. Watts is the nephew of Kent P. Watts, our Chief Executive Officer and Chairman and the son of Michael Watts (see footnote 5 below).  Includes 2,100,000 shares of common stock of the Company pledged by CW Navigation and 1,000,000 shares of common stock pledged by KW Navigation, Inc., to Typenex Co-Investment, LLC, to secure amounts owed by the Company under a Secured Convertible Promissory Note in the amount of $1.73 million dated October 19, 2015.
 
Changes in Control

The Company is not aware of any arrangements which may at a subsequent date result in a change of control of the Company.

ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

Except as discussed below or otherwise disclosed above under “Item 11. Executive Compensation”, there have been no transactions since August 1, 2013, and there is not currently any proposed transaction, in which the Company was or is to be a participant, where the amount involved exceeds $120,000, and in which any officer, director, or any stockholder owning greater than five percent (5%) of our outstanding voting shares, nor any member of the above referenced individual’s immediate family, had or will have a direct or indirect material interest.

Carter E & P, LLC

A company controlled by one of our former officers (Steven Carter) operated our Barge Canal properties, the Curlee Prospect in Bee County, Texas and the Dix Prospect in San Patricio County, Texas.  Revenues generated from these properties were $39,274 and $643,203 for the years ended July 31, 2014 and 2013, respectively.  In addition, lease operating costs incurred from these properties were $23,259 and $224,047 for the years ended July 31, 2014 and 2013, respectively.  Mr. Carter resigned as of November 2013, Galveston Bay Energy took over the operations of the Barge Canal properties as of September 2013, and sold them in March of 2014.

As of January 31, 2015, July 31, 2014 and 2013, respectively, we had outstanding accounts receivable associated with these properties of $0, $0 and $91,967 and no accounts payable.  We have no current contact with either Mr. Carter or these properties currently.

In December 2012, we acquired a 366.85 acre tract of property (the “Dix Prospect”), in San Patricio County, Texas. As of July 31, 2013, we incurred $76,938 in acquisition and land costs. In February 2013, we sold a 75% working interest in the prospect to partners on a third for a quarter basis, under which the 75% interest holders will carry 25% of the working interest to the casing point of the initial well drilled on the prospect. In January 2013, we sold 2% of our 25% carried working interest to Carter E&P (defined below), a company owned by our former Vice President of Operations (Steven Carter) and retained a 23% working interest which is carried to the casing point of the initial well.
 
Effective September 1, 2013, we conveyed our interest in the Dix, Melody, Curlee, Palacios and Illinois properties to Carter E&P, LLC (“Carter E&P”) in conjunction with our termination of Steven Carter as Vice President of Operations for $0 in cash proceeds and the assumption of the abandonment liabilities of $4,381. In accordance with full cost rules, we recognized no gain or loss on the sale. During the year ended July 31, 2013, Carter E&P operated several properties onshore in South Texas, including our Barge Canal properties. Although he was not a related party after September 2013, we considered the transactions with his company during his tenure as an officer of the Company as related party transactions because they were not compensation transactions or entered into in the ordinary course of business, and because he was a related party at the time they occurred.
 
Kirby Caldwell Note

On September 6, 2013, HCN sold 191,667 shares of the Company’s common stock to an employee of HCN in exchange for a note receivable in the amount of $1,000,000.  This employee is nephew to Kent Watts, our CEO. The Company 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 the Company’s common stock being listed on either the NASDAQ market or NYSE stock exchange. 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 our stock being listed on a major market or stock exchange, we will receive up to $1,000,000, or the note can be paid earlier at the discretion of the other party. We collected $675,000 in cash on this note receivable through July 31, 2014.  At July 31, 2013, these shares were classified as treasury stock within equity at the cost HCN obtained them from outside entities for services performed following the consolidation of comparative periods for acquired entities under common control.  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.

Kent P. Watts Note

In November 2013, we issued a promissory note for funds received from Mr. Kent P. Watts, our Chairman and Chief Executive Officer, of $100,000.  Under the terms of the note, principal on the note was due after one year and incurred interest at 5% per annum payable on a monthly basis.  In April 2014, the Company entered into a new debt agreement whereby Mr. Watts agreed to loan the Company up to $600,000 at an interest rate of 6.25%.  The previous debt of $100,000 was rolled into this new note.  Additionally, we borrowed $200,000 from Mr. Watts during April 2014 and $300,000 from Mr. Watts in May 2014.  The total balance on the note was $600,000 as of January 31, 2015. Accrued interest is payable monthly beginning in May 2014, and beginning in August 2014 the principal is due in 36 monthly payments through July 2017, provided no payments have been made on the note to date.  The note is secured by the Company’s assets owned by Galveston Bay Energy, LLC (“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.

SMDRE Note

On December 4, 2013, Hydrocarb Corporation (“HCN”) sold 619,960 shares of restricted common stock of the Company in consideration for a $1,859,879 non-interest bearing note from SMDRE LLC (“SMDRE”), of which Michael Watts, a related party, holds a 49% interest.  We acquired this note upon our acquisition of HCN on December 9, 2013.  The 619,960 shares of our common stock were previously issued by us to HCN to settle liabilities related to a consulting services agreement which was in place between us and HCN.  The note was due upon the occurrence of any of the following conditions: (1) upon 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 occurred first); or (3) within 90 days of the date our common stock is listed on a major stock exchange and trades at a share price above $6.00 per share.

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.

On April 27, 2015, the Board of Directors agreed to offer SMDRE the option, for 90 days, for the SMDRE note to be paid in full for a 67% discount (i.e., the offer to be paid $619,898 immediately) (the “Pre-Payment Option”).
 
As part of a negotiation to help the Company raise capital with regard to its private placement of Units, and without effecting the Pre-Payment Option, the Board of Directors on June 27, 2015, along with SMDRE, approved an amendment to the SMDRE note, providing that in consideration for a simultaneous $106,000 payment by Geoserve Marketing, an affiliate of SMDRE which is controlled by Michael Watts, the father-in-law of Jeremy Driver, our former Chief Executive Officer and director, and brother to our current Chief Executive Officer, decreasing the amount owed under the note (and simultaneously decreasing the amount required to be paid in connection with the Pre-Payment Option), that the remaining amount of the note would be due 90 days after the Company receiving a listing on a major stock exchange.  Between April 27, 2015 and July 9, 2015 the Company received payments on the SMDRE LLC note in the amount of $531,000.  The balance of the discounted note of $88,898 has been extended until the end of calendar year 2015.

HCN Acquisition; Series A Preferred Stock; Unit Conversion

On December 9, 2013 (the “Acquisition Date”), we acquired HCN (the “HCN Acquisition”) pursuant to a Share Exchange Agreement (the “HCN Exchange Agreement”) dated November 27, 2013.  The purchase price was 8,396,667 shares of the Company’s common stock to HCN’s stockholders in exchange (which included Kent P. Watts, our Chief Executive Officer and Chairman) for 100% of the outstanding equity interest in HCN and 8,188 shares of the Company’s Series A Preferred Stock to Kent P. Watts, the Company’s Chief Executive Officer and Chairman, a holder of convertible preferred stock in HCN in exchange of 100% of the holder’s preferred stock in HCN. At the date of closing the 8,396,667 shares of common stock issued had a market valuation of $64,990,200 (based on market close of $7.74 on December 9, 2013) and the preferred stock issued had a value of $3,275,200 (8,188 shares at par value of $400).

In addition, the HCN Exchange Agreement provided that the Company would issue 7,470,000 shares of its common stock to the holders of certain rights to acquire Company common stock.  These rights were previously issued by the Company as contingent consideration in connection with the acquisition of NEI.  The rights had been convertible into the Company’s common stock based upon Company market capitalization milestones.  The rights were issued to entities deemed related parties to the Company.  These shares were issued on December 9, 2013.

In connection with certain due diligence undertaken by the Company in 2015, it came 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, 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 certificate of designations with the Secretary of State of Nevada. Consequently, we believe that the Series A Preferred was never validly issued or outstanding and the 2013 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.

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, Mr. Watts purportedly earned dividends of $150,548 on such securities and as of the date of the exchange by Mr. Watts of the right to receive the Series A Preferred a total of $327,879 in dividends had accrued.

On June 10, 2015, with the approval of the Board of Directors of the Company (i.e., Mr. Watts personally, and Mr. Herndon, our then directors), Mr. Watts exchanged all rights he had to 8,188 shares of Series A 7% Convertible Voting Preferred Stock (which were required to have a face value of $3,275,200) pursuant to the terms of the HCN Exchange Agreement, 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 Exchange Agreement, totaling, $327,879, into 32 “Units”, each consisting of (a) 25,000 shares of the Company’s restricted common stock; and (b) Convertible Promissory Notes with a face amount of $100,000.  As such, 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 Convertible Note was convertible into common stock of the Company at any time at Mr. Watt’s option at a conversion price of $4 per share, and was automatically convertible into shares of Series B Convertible Preferred Stock of the Company upon designation of such Series B Convertible Preferred Stock with the Secretary of State of Nevada which occurred on September 28, 2015. The Convertible Note accrued interest (prior to its automatic conversion into Series B Preferred Stock), quarterly in arrears, which accrued interest is added to the principal balance of the Convertible Note. The interest rate of the Convertible Note was equal to the average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”), provided that in the event that the average quarterly closing spot price is $40 or less, the WTI Rate for the applicable following quarter is 0%. Any amounts not paid under the Convertible Note when due accrue interest at the rate of 12% per annum until paid in full.
 
On July 21, 2015, Mr. Watts and the Company agreed in principle to reduce the number of total Units due to Mr. Watts to 30 units. On September 21, 2015, Mr. Watts and the Company entered into a First Amendment to Exchange Agreement, which amended the Exchange Agreement dated June 10, 2015. The First Amendment formally reduced the total Units due to Mr. Watts to 30 units, and as such, Mr. Watts received Convertible Promissory Notes with a principal amount of $3 million and 750,000 shares of common stock in connection with the exchange originally contemplated by the Exchange Agreement, valued at $614,141, which was recorded as a debt discount.

Pasquale V. Scaturro Transactions

Effective on August 8, 2014, Pasquale V. Scaturro resigned as the Chief Executive Officer of the Company provided that on the same date Mr. Scaturro entered into a consulting agreement with the Company and agreed to provide the Company Geological and Geophysical consulting services pertaining to the Company’s oil and gas concession in Namibia.  Pursuant to the agreement we were required to pay Mr. Scaturro $10,000 per month (for 12 months) and provide him a success fee of $250,000 upon the sale or joint venture of the Company’s Owambo Concession in Namibia. The agreement had a 180 day term, renewable thereafter in 30 day periods for an additional 180 days, provided such agreement was terminated in connection with the settlement agreement discussed below.

In November 2014, Pasquale V. Scaturro, the Company’s former Chief Executive Officer and Kent P. Watts, the Company’s current Chief Executive Officer and Chairman, entered into a stock purchase agreement, which was amended in December 2014, at which time certain of the adult children of Mr. Watts became party to the agreement.  Pursuant to the agreement, Mr. Watts and his children agreed to sell Mr. Scaturro the outstanding capital stock of a company which they owned which is located in Namibia which owns real estate, in consideration for 475,000 shares of common stock held by Mr. Scaturro (deliverable in tranches between December 2014 and April 2015, of which an aggregate of 75,000 had been delivered as of the date of the lawsuit described below) to be transferred to Mr. Watts’ children and a promissory note in the amount of $475,000 payable to Mr. Watts.  Additionally, Mr. Scaturro also entered into a lock-up agreement, whereby he agreed to sell a maximum of 500 shares of the Company’s common stock which he held or may hold in the future, per day, until the listing by the Company on a national exchange or NASDAQ, and thereafter to sell 5% of the ten day moving volume weighted average of shares per day, during the 24 months following the date of the December 2014 agreement.  Subsequently, Kent P. Watts assigned his rights under the lock-up agreement to the Company and a lawsuit was filed by the Company seeking damages for Mr. Scaturro’s breach of contract.  In July 2015, the parties entered into a settlement agreement whereby Mr. Scaturro agreed to transfer an aggregate of 2,237,500 shares of our common stock to Kent P. Watts, (of which 300,000 shares are to be transferred to Mr. Watt’s legal counsel as part of a contingent settlement of amounts owed to such legal counsel) and an aggregate of 162,500 shares of our common stock to two children of Mr. Watts; Mr. Scaturro retained 307,058 shares (the “Remaining Shares”), all interests held by Mr. Watts’ children in the Namibia company were transferred to Mr. Scaturro, and the consulting agreement which was previously in place between the Company and Mr. Scaturro was terminated.  The parties also agreed to dismiss the lawsuit and cross and counter claims with prejudice and release each other from outstanding claims and causes of actions.  Finally, Mr. Scaturro agreed to sell no more than 500 of the Remaining Shares per day until December 18, 2016.  In connection with the filing of the lawsuit, the Company agreed to pay all cash legal fees incurred by Mr. Watts in connection with the enforcement of the rights under the agreement.

Typenex Secured Convertible Promissory 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 accrued interest at the rate of 10% per annum (22% upon the occurrence of an event of default) and was due and payable in full on January 5, 2016.  The conversion price of the Typenex Convertible Note was initially $2.25 per share, provided that if our market capitalization fell below $20 million (provided further that our current market capitalization was below $20 million), the conversion price became 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 was 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 also included anti-dilution rights in the event we sold or issued any securities with a price less than the applicable conversion price, subject to certain exceptions.
 
Beginning on the date that was six months after March 5, 2015, and continuing each month thereafter until maturity, we were 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 were 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.

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 and 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.

Effective September 8, 2015, Typenex exercised warrants to purchase 260,788 shares of our common stock which it held (at an exercise price of $1.17 per share – the warrants originally had (a) an exercise price of $2.25 per share, but were subsequently reduced in connection with Typenex’s anti-dilution rights to $1.17 per share, and (b) provided Typenex the right to acquire 38,889 shares of common stock, but were subsequently increased to 260,788 shares of stock in connection with Typenex’s anti-dilution rights) in a net cashless transaction and on September 18, 2015, in connection with such exercise, we issued 128,048 net shares of common stock to Typenex.

The amounts owed under the Typenex Convertible Note were secured by a Stock 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, pledged two million one hundred thousand (2,100,000) shares of our common stock as security for our obligations under the Typenex Convertible Note and related documents. KW Navigation (an affiliate of CW Navigation) pledged an additional one million (1,000,000) collateral shares to Typenex under the Pledge Agreement to bring the required value of the shares pledged above the required minimum collateral value threshold.

Typenex also entered into a subordination agreement in favor of 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.

The Typenex Convertible Note was repaid in full in October 2015 in connection with our entry into the Typenex Note described below under “Typenex Secured Note”.
 
Convertible Promissory Note with Vis Vires Group

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.

Geoserve Marketing Agreement

On June 28, 2015, after a lengthy negotiation, we entered into a Financial Services Agreement with Geoserve Marketing LLC (“Geoserve”) a company controlled by Michael Watts, the father-in-law of Jeremy Driver, our former Chief Executive Officer and director, and brother to our current Chief Executive Officer, pursuant to which Geoserve agreed to provide investor relations and related services to us for a period of three years in consideration for an aggregate of 850,000 shares of restricted common stock.  The agreement can be terminated by either party with 60 days’ notice after the expiration of six months, provided that the 850,000 shares are deemed earned upon Geoserve’s entry into the agreement.  We were previously party to a consulting agreement with Geoserve in 2011 which had expired as of our entry into the June 2015 agreement. We recognized expense of $0 and $6,754 from the prior contract during the year ended July 31, 2015 and July 31, 2014, respectively.
 
Duma Holdings Note

On July 16, 2015, pursuant to a Note Subscription Agreement, we sold a $350,000 Convertible Secured Promissory Note (with a $7,000 original issuance discount) to Duma Holdings, LLC (“Duma Holdings” and the “Duma Holdings Note”), of which S. Chris Herndon, a member of our Board of Directors, owns a 20% interest.  The Duma Holdings Note (along with any unpaid interest thereon) is convertible at any time, provided the note is converted in full, into (a) 1.75 Units; and (b) 350,000 shares of common stock (393,750 shares of common stock in aggregate when combined with the shares which form part of the Units). The Duma Holdings Note is due and payable by us on November 30, 2015. The Duma Holdings Note accrues interest at the rate of 15% per annum, payable beginning on October 31, 2015, and quarterly thereafter through maturity.  The Duma Holdings Note can only be repaid with the prior written approval of Duma Holdings.  The Duma Holdings Note contains usual and customary events of default, representations and warranties.  The principal and accrued interest due under the Duma Holdings Note is personally guaranteed by Kent P. Watts, our Chief Executive Officer and Michael Watts, his brother, pursuant to separate guaranty agreements (the “Guarantee Agreements”), and secured by a first priority security interest on certain real estate owned by Kent P. Watts pursuant to a Deed of Trust, Assignment of Rents and Security Agreement.

Voting Agreement

On or around August 25, 2015, Mr. Watts entered into a voting agreement in favor of S. Chris Herndon, a member of the Board of Directors of the Company.  Pursuant to the voting agreement, Mr. Watts provided Mr. Herndon a voting proxy to vote all of the shares of common stock which Mr. Watts owned (approximately 4,946,955 shares as of his entry into the agreement) or which he may acquire in the future, to vote to elect or remove (as applicable) 66.6% of members of the Company’s Board of Directors on any stockholder vote (i.e., 2 out of 3 directors).  The voting agreement was to become effective, only if Mr. Watts had sold $1 million in securities in private transactions before September 21, 2015 and was to remain effective from such date, if ever, until the earlier of: (a) August 19, 2017; and (b) the due date of a certain convertible note which a company affiliated with Mr. Herndon (Duma Holdings, LLC) may choose to purchase from the Company in the future as described above under “Duma Holdings Note”.

On or around the same date, Christopher Watts, the nephew of Kent P. Watts, and the largest shareholder of the Company, entered into a voting agreement with Mr. Herndon on substantially similar terms as the voting agreement with Kent P. Watts described above.

As a result of Mr. Watts not selling $1 million in securities in private transactions on similar terms as described above before September 21, 2015, the voting agreements were never effective and have since expired; provided that the parties have recently confirmed their intention to amend the voting agreements to remove the prior condition to effectiveness regarding the required sale of $1 million in securities before September 21, 2015, and as such, we anticipate the voting agreements being amended after the date of this filing to remove such condition and to provide for Mr. Herndon to have voting powers under the voting agreements as described above, until such voting agreements are terminated as described above.  In the event the voting agreements are amended in the future, as is currently contemplated by the parties, Mr. Herndon will have the right to appoint 66.6% of the members of the Company’s Board of Directors.
 
Increase In Directors and Director Appointment

Effective September 7, 2015, the Board of Directors increased the number of members of the Company’s Board of Directors from two to three and appointed Clint Summers as a member of the Board of Directors to fill the newly created vacancy, each pursuant to the power provided to the Board of Directors by the Company’s Bylaws and the Nevada Revised Statutes. Subsequent to the date of Mr. Summers’ appointment as a member of the Board of Directors, on September 7, 2015, Mr. Summers unexpectedly passed away from natural causes.

On August 20, 2015 and August 27, 2015, Mr. Summers purchased 166,666 shares of restricted common stock (333,332 shares in aggregate) from Mr. Watts for $0.50 per share in a private transaction.

Mr. Summers was a 20% owner of Duma Holdings, which purchased a $350,000 Convertible Secured Promissory Note as described above under “Duma Holdings Note”.

On September 2, 2015, Mr. Summers purchased a Convertible Subordinated Promissory Note from the Company in the aggregate principal amount of $83,333, which has substantially similar terms as the Watts Notes, described under “Convertible Subordinated Promissory Notes” below.
 
Convertible Subordinated Promissory Notes

On September 14, 2015, Kent P. Watts, the Chief Executive Officer and Chairman of the Company, subscribed for $350,000 in Convertible Subordinated Promissory Notes and on September 17, 2015 he subscribed for an additional $166,667 in Convertible Promissory Notes (collectively, the “Watts Notes”).  The Watts Notes are due two years from their issuance date, accrue interest which is payable quarterly in arrears, at either a cash interest rate (equal to the WTI Rate described below) or a stock interest rate (12% per annum)(at the option of the holder at the beginning of each quarter), provided no principal or interest on the Watts Notes can be paid in cash until all amounts owed by the Company to its senior lender is paid in full.  In the event the stock interest rate is chosen by Mr. Watts, restricted shares of common stock equal to the total accrued dividend divided by the average of the closing sales prices of the Company’s common stock for the applicable quarter are required to be issued in satisfaction of amounts owed on a quarterly basis.  In the event the cash interest rate is chosen, interest accrues until converted into common stock (as discussed below) or until the Company is able to pay such accrued interest in cash pursuant to the terms of the Watts Notes.  The “WTI Rate” equals an annualized percentage interest rate equal to the average of the closing spot prices for West Texas Intermediate crude oil on each trading day during the immediately prior calendar quarter divided by ten, plus two (the “WTI Interest Rate”). 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%). Notwithstanding the above, in the event that the average quarterly closing spot price is $40 or less, the WTI Rate for the applicable following quarter is 0%.  All principal and accrued interest on the Watts Notes is convertible into common stock at a conversion price of $0.75 per share at any time. Additionally, the Company may force the conversion of the Watts Notes into common stock in the event the trading price of the Company’s common stock is equal to at least $5.00 per share for at least 20 out of any 30 consecutive trading days.  Any shares of common stock issuable upon conversion of the Watts Notes are subject to a lock-up whereby no shares of common stock can be sold until January 1, 2016, and no more than 2,500 shares of common stock can be sold per day thereafter until the Company’s common stock is listed on the NASDAQ or NYSE market or the trading volume of the Company’s common stock is in excess of 100,000 shares per day. The Watts Notes have standard and customary events of default.

Previously, on August 26, 2015, Mr. S. Chris Herndon, the Company’s director purchased a Convertible Promissory Note in the amount of $100,000 with substantially similar terms as the Watts Notes (the “Herndon Note”). Additionally, Brian Kenny, the nephew of Kent. P. Watts, our Chief Executive Officer and Chairman, purchased $35,000 in Convertible Promissory Notes.

Typenex Secured Note

On October 19, 2015, and effective October 16, 2015, we sold a Secured Convertible Promissory Note (the “Typenex Note”) to Typenex in the amount of $1,730,000. The Typenex Note was issued pursuant to the terms of a Securities Purchase Agreement dated as of the same date. The Typenex Note included a $475,000 original issuance discount and also included $5,000 which went to pay Typenex’s legal fees in connection with the transaction. Additionally, a total of $263,011 of the purchase price of the Typenex Note was paid by way of the forgiveness by Typenex of amounts owed by us to Typenex under the Typenex Convertible Note described above under “Typenex Secured Convertible Note”. As a result, we received a total of $986,990 in cash in connection with the sale of the Typenex Note.

The Typenex Note is due on April 19, 2016 and no interest accrues on the Typenex Note unless an event of default occurs thereunder. The note is convertible into common stock, as discussed below, only if an event of default under the note occurs and is not cured pursuant to the terms of the note.  Following an event of default, the note accrues interest at the rate of 22% per annum (subject to applicable usury laws) until paid in full. We have the right to pre-pay the Typenex Convertible Note prior to maturity, provided that we pay $1,492,500 on or before 90 days after the date the note is issued; $1,611,250 after 90 days, but before 135 days, after the note is issued; and the full amount of the note, $1,730,000, between the date that is 135 days after the note is issued and maturity.

The amounts owed under the Typenex 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 two million one hundred thousand (2,100,000) shares of our common stock held by CW Navigation as security for our obligations under the Typenex 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 1.5 times the then balance of the note (initially $2,595,000), at any time after November 1, 2015, it constitutes a default of the Typenex Note.  KW Navigation pledged an additional one million (1,000,000) collateral shares to Typenex under the Pledge Agreement to bring the required value of the shares pledged above the required minimum collateral value threshold.
 
The Typenex Note provides for customary events of default such as failing to timely make payments under the Typenex Note when due, and including our failure to maintain a reserve of shares in connection with the conversion of the Typenex Note equal to at least three times the number of shares of common stock that could be issuable thereunder at any time (initially 3 million shares), failing to repay all of our currently outstanding variable rate convertible securities within thirty days of the date of the note, failing to repay our senior creditor (Shadow Tree) by the maturity date of the Typenex Note or alternatively, failing to receive Shadow Tree’s consent to repay the Typenex Note at maturity in cash, and in the event the value of the securities pledged pursuant to the Pledge Agreement (as discussed above) falls below the required value after November 1, 2015, subject where applicable to our ability to cure certain defaults. Additionally, it is an event of default under the Note in the event we fail to repay all of our outstanding variable securities within 30 days of the date of the Note (the “Variable Security Payment Date”) or in the event we have any outstanding variable securities after such Variable Security Payment Date. 

 
At any time following an uncured event of default, Typenex has the right to convert any or all of the outstanding principal amount of the note into our common stock. The conversion price of the Typenex Note is 80% of the five lowest closing bid prices of our common stock on the 20 trading days prior to any conversion, provided that if the average of such closing bid prices is below $0.75 per share, the conversion rate is decreased by 5% (to 75%), and provided further that the conversion rate is decreased by an additional 5% if we are not DWAC eligible at any time or DTC eligible at any time (for up to an aggregate of an additional 10% decrease in the conversion rate). Finally, in the event certain defaults (defined as major defaults under the note) occur, the conversion rate may be decreased by up to an additional 15% (an additional 5% decrease in the conversion rate per the occurrence of the first three major defaults). Typenex also has the right upon the occurrence of an event of default to require us to repay in full the amount owed under the note by providing us written notice. Additionally, upon the occurrence of certain events of default as described in the Typenex Note, we are required to repay Typenex liquidated damages in addition to the amount owed under the Typenex Note.

At no time may the Typenex 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. Additionally, and at no time may pledged shares be received by Typenex pursuant to the terms of the Pledge Agreement, which would result in Typenex and its affiliates owning an aggregate of in excess of 9.99% of the then outstanding shares of our common stock.

We are subject to various fees and penalties under the Typenex Note for our failure to timely deliver shares due upon any conversion. The Typenex Note also includes various restrictions on our ability to enter into subsequent variable rate security transactions following the date thereof.

Typenex also entered into a Subordination Agreement in favor of our senior lender, Shadow Tree, to subordinate the repayment of the Typenex Note to amounts owed by us to Shadow Tree.

Other Transactions

During the six months ended January 31, 2015, the Company received approximately $58,000 from Mr. Michael Watts (the brother of our Chief Executive Officer, Kent P. Watts, the father of Christopher Watts, who is a greater than 5% shareholder of the Company due to his ownership and control of CW Navigation Inc., KD Navigation Inc., and KW Navigation Inc., significant stockholders of the Company, for a related party receivable previously outstanding for approximately the same amount as of July 31, 2014.

Accounts receivable – related party includes the oil and gas revenue receivable from our Barge Canal properties, which, up until September 1, 2013, were operated by a company owned by one of our former officers who was also a director, and joint interest billings receivable from two working interest partners who are related to our former Chief Financial Officer, the former Chief Executive Officer and the current Chief Executive Officer. This balance also includes an oil and gas receivable from Lifestream, LLC, a company owned by the brother of our current CEO.  Accounts receivable – related party was $0 and $58,014 as of July 31, 2015 and 2014, respectively.
 
A company controlled by Michael Watts purchased a 5% working interest in one of our wells in Galveston Bay.  As of July 31, 2015 and July 31, 2014, this company owed us $186 and $58,014, respectively, in joint interest billings.

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.  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 the Company) 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. During the twelve months ended as of July 31, 2015, the Company had current liabilities owed to Mr. Watts of approximately $104,162.

During the twelve months ended July 31, 2015, the Company received approximately $58,000 from Mr. Michael Watts for a related party receivable previously outstanding for approximately the same amount as of July 31, 2014.

Review and Approval of Related Party Transactions

We have not adopted formal policies and procedures for the review, approval or ratification of transactions, such as those described above, with our executive officer(s), director(s) and significant stockholders, provided that it is our policy that any future material transactions between us and members of management or their affiliates shall be on terms no less favorable than those available from unaffiliated third parties.

In addition, our Code of Conduct (described above under “Item 10. Directors, Executive Officers and Corporate Governance” - “Corporate Governance” - “Code of Conduct”), which is applicable to all of our employees, officers and directors, requires that all employees, officers and directors avoid any conflict, or the appearance of a conflict, between an individual’s personal interests and our interests.

Independent Directors

S. Chris Herndon is an independent director of our Company as provided in the listing standards of the NYSE MKT Equities Exchange (notwithstanding that our common stock is not currently listed on the NYSE MKT).

ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES

Our current independent auditor, MaloneBailey, LLP, served as our independent registered public accounting firm and audited our financial statements for the fiscal years ended July 31, 2015 and 2014. Aggregate fees for professional services rendered to us by our auditor are set forth below:

Year Ended July 31,
 
2015
   
2014
 
         
Audit Fees
 
$
117,450
   
$
167,500
 
Audit -Related Fees
   
-
     
-
 
Other
   
-
     
-
 
Tax Fees
   
10,000
     
-
 
Total
 
$
127,450
   
$
167,500
 
 
Audit Fees

Audit fees are the aggregate fees billed for professional services rendered by our independent auditors for the audit of our annual financial statements, the review of the financial statements included in each of our quarterly reports and services provided in connection with statutory and regulatory filings or engagements.

Audit Related Fees

Audit related fees are the aggregate fees billed by our independent auditors for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements and are not described in the preceding category.

Tax Fees

Tax fees are billed by our independent auditors for tax compliance, tax advice and tax planning.

All Other Fees

All other fees include fees billed by our independent auditors for products or services other than as described in the immediately preceding three categories.

Policy on Pre-Approval of Services Performed by Independent Auditors

It is the policy of our Board of Directors that all services to be provided by our independent registered public accounting firm, including audit services and permitted audit-related and non-audit services, must be pre-approved by our Board of Directors. Our Board of Directors pre-approved all services, audit and non-audit related, provided to us by our independent registered public accounting firm for 2015 and 2014.
 
PART IV
 
ITEM 15.
EXHIBITS

(a) Documents filed as part of this report.

(1) All financial statements

Index to Consolidated Financial Statements

 
Page
Report of Independent Registered Public Accounting Firm
F-2
Consolidated  Balance Sheets as of July 31, 2015 and 2014
F-3
Consolidated Statements of Operations for the years ended July 31, 2015 and 2014
F-4
Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the years ended July 31, 2015 and 2014
F-5
Consolidated  Statements of Cash Flows for the years ended July 31, 2015 and 2014
F-6
Notes to Consolidated Financial Statements
F-7

(2) Financial Statement Schedules

All financial statement schedules have been omitted, since the required information is not applicable or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements and notes thereto included in this Form 10-K.

(3) Exhibits required by Item 601 of Regulation S-K

The information required by this Section (a)(3) of Item 15 is set forth on the exhibit index that follows the Signatures page of this Form 10-K.
 
SIGNATURES

Pursuant to the requirements of Section 13 and 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

HYDROCARB ENERGY CORP.

By:
/s/ Kent P. Watts
 
 
Chief Executive Officer, Executive Chairman, and Director
 
 
(Principal Executive Officer)
 
 
Date:  November 13, 2015
 
     
By:
/s/Christine P. Spencer
 
 
Chief Accounting Officer
 
 
(Principal Financial Officer and Principal Accounting Officer)
 
 
Date: November 13, 2015
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature
 
Title
 
Date
         
/s/ Kent P. Watts
 
Chief Executive Officer, Executive Chairman, and Director
 
November 13, 2015
Kent P. Watts
 
(Principal Executive Officer)
   
         
/s/ Christine P. Spencer
 
Chief Accounting Officer
 
November 13, 2015
Christine P. Spencer
 
(Principal Financial Officer and Principal Accounting Officer)
   
         
/s/ S. Chris Herndon
 
Director
 
November 13, 2015
S. Chris Herndon
       
 
EXHIBIT INDEX

Exhibit
Number
 
Description of Exhibit
3.1 (1)
 
Articles of Incorporation and amendments thereto, dated July 19, 2005, October 18, 2005 and September 5, 2006
3.2 (2)
 
Certificate of Change filed with the Nevada Secretary of State on March 22, 2012
3.3 (2)
 
Articles of Merger filed with the Nevada Secretary of State on March 22, 2012
3.4 (3)
 
Certificate of Amendment filed with the Nevada Secretary of State on May 16, 2012
3.6 (4)
 
Amendment to Articles of Incorporation (name change and increase in authorized shares of stock to 1,000,000,000) February 4, 2014
3.7 (5)
 
Certificate of Change Pursuant to NRS 78.209 (April 14, 2014), affecting a reduction in authorized shares of common stock to 333,333,333 shares of common stock and affecting a 1:3 reverse stock split
3.8 (6)
 
Certificate of Amendment to Articles of Incorporation dated September 28, 2015 (Increase in authorized shares of common stock to 1 billion, authorization of 100 million “blank check” preferred stock shares, designation of 10,000 shares of Series A 7% Convertible Voting Preferred Stock, and designation of 35,000 shares of Series B Convertible Preferred Stock)
3.8 (7)
 
Amended and Restated By-Laws (July 20, 2014)
10.1 (8)
 
2009 Restated Stock Incentive Plan
10.2 (8)
 
Geoserve Marketing, LLC Agreement, dated February 15, 2011
10.3 (8)
 
SPE Navigation 1, LLC Agreement to acquire work interest., dated February 15, 2011
10.4 (9)
 
Purchase and Sale Agreement among CW Navigation Inc., KD Navigation Inc., and KW Navigation Inc. (as the Seller parties), SPE Navigation I, LLC and Strategic American Oil Corporation, executed September 22, 2011
10.5 (2)
 
2010 Stock Incentive Plan
10.6 (2)
 
2011 Stock Incentive Plan
10.7 (2)
 
Farm-Out Agreement with Core Minerals, January 2011, as amended March 9, 2011
10.8 (11)
 
Share Exchange Agreement dated August 7, 2012 among each of: Namibia Exploration Inc.;
Michael E. Watts; C.W. Navigation, Inc.; K.W. Navigation, Inc.; K.D. Navigation, Inc.; and
Duma Energy Corp.
10.9 (11)
 
Consulting Services Agreement between Duma Energy Corp. and Hydrocarb Corporation, dated August 7, 2012
10.10 (12)
 
Joint Operating Agreement between Hydrocarb Namibia Energy Corporation and Namibia Exploration, Inc. as fully executed on September 6, 2012
10.11 (12)
 
Assignment Agreement between the Republic of Namibia Minister of Mines and Energy, Hydrocarb Namibia Energy Corporation (Proprietary) Limited and Namibia Exploration, Inc. as fully executed on August 23, 2012.
10.12 (13)
 
2013 Stock Incentive Plan
10.13 (14)***
 
Employment Agreement between the Company and Jeremy Glenn Driver effective October 1, 2013
10.14 (14)***
 
Employment Agreement between the Company and Sarah Berel-Harrop effective October 1, 2013
10.15 (14)
 
Form of Indemnification Agreement
10.16 (13)***
 
Employment Agreement between the Company and William Craig Alexander effective October 1, 2013
10.17 (15)
 
Secured Promissory Note (Kent P. Watts) - $600,000, dated April 18, 2014
10.18 (16)
 
Stock Exchange Agreement dated November 27, 2013, by and among Duma Energy Corp., a Nevada corporation (“DUMA”), Hydrocarb Corporation, a Nevada corporation (“HCN”), the holders of 100% of the shares of common stock and preferred stock of HCN and the holders of rights to acquire DUMA common stock and Exhibits Thereto
10.19 (16)
 
December 4, 2013 Sales Agreement and Note with SMDRE, LLC
10.20 (16)
 
August 8, 2014 (effective August 4, 2014) Amendment to Note Payable Terms with SMDRE, LLC
10.21 (17)
 
Credit Agreement dated as of August 15, 2014, by and among Hydrocarb Energy Corporation, as borrower, Shadow Tree Capital Management, LLC, as agent, and the Lenders thereto
10.22 (17)
 
Stock Grant Agreement between Hydrocarb Energy Corporation and the Lenders dated August 15, 2014
 
10.23 (17)
 
Guarantee and Collateral Agreement by Hydrocarb Energy Corporation and its subsidiaries in favor of the Lenders dated August 15, 2014
10.24 (17)
 
$1,136,363 Term Loan Note dated August 15, 2014 payable to Quintium Private Opportunity Fund, LP
10.25 (17)
 
$3,409,091 Term Loan Note dated August 15, 2014 payable to Shadow Tree Funding Vehicle A-Hydrocarb LLC
10.26 (18)
 
August 2014 Consulting Agreement with Pasquale V. Scaturro
10.27 (18)
 
March and July 2014 Employment Agreement with Charles F. Dommer
10.28 (18)
 
June 2014 Employment Agreement with Christine P. Spencer
 10.29 (18)
 
Secured Promissory Note (April 18, 2014) - Kent P. Watts – ($600,000)
 10.30 (18)
 
Sales Agreement and Note (September 6, 2013) - Kirby Caldwell
10.31 (19)
 
Securities Purchase Agreement between Hydrocarb Energy Corp. and LG Capital Funding, LLC (February 17, 2015)
10.32 (19)
 
8% Convertible Redeemable Note ($105,000 – LG Capital Funding, LLC)(February 17, 2015)
10.33 (19)
 
Securities Purchase Agreement between Hydrocarb Energy Corp. and Adar Bays, LLC (February 17, 2015)
10.34 (19)
 
8% Convertible Redeemable Note ($105,000 – Adar Bays, LLC)(February 17, 2015)
10.35 (19)
 
Securities Purchase Agreement between Hydrocarb Energy Corp. and KBM Worldwide, Inc. (February 17, 2015)
10.36 (19)
 
Convertible Promissory Note ($350,000 – KBM Worldwide, Inc.)(February 17, 2015)
10.37 (19)
 
10% Convertible Promissory Note ($137,000 – JSJ Investments Inc.)(February 23, 2015)
10.38 (19)
 
Securities Purchase Agreement between Hydrocarb Energy Corp. and Typenex Co-Investment, LLC (March 5, 2015)
10.39 (19)
 
Secured Convertible Promissory Note ($350,000 – Typenex Co-Investment, LLC.)(March 5, 2015)
10.40 (19)
 
Warrant to Purchase Shares of Common Stock (March 5, 2015 - Typenex Co-Investment, LLC)
10.41 (19)
 
Stock Pledge Agreement between Typenex Co-Investment, LLC and CW Navigation, Inc. (March 5, 2015)
10.42 (20)***
 
Executive Employment Agreement with Kent P. Watts (March 9, 2015)
10.43 (21)
 
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
10.44 (21)
 
Securities Purchase Agreement dated March 31, 2015 between Hydrocarb Energy Corporation and Vis Vires Group, Inc.
10.45 (21)***
 
Exchange Agreement between Hydrocarb Energy Corporation and Kent P. Watts (June 10, 2015)
10.46 (21)***
 
Convertible Promissory Note ($3,200,000) owed to Kent P. Watts
10.47 (21)
 
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
10.48 (21)
 
First Amendment to Stock Grant Agreement between Hydrocarb Energy Corporation and the Lenders dated June 10, 2015
10.49 (21)
 
$365,724 Term Loan Note dated June 10, 2015 payable by Hydrocarb Energy Corporation to Shadow Tree Funding Vehicle A-Hydrocarb LLC
10.50 (21)
 
$118,908 Term Loan Note dated June 10, 2015 payable by Hydrocarb Energy Corporation to Quintium Private Opportunity Fund, LP
10.51 (22)***
 
Employment Agreement with Christine P. Spencer effective June 12, 2015
10.52 (22)
 
Note Subscription Agreement dated July 16, 2015 with Duma Holdings, LLC
10.53 (22)
 
$350,000 Convertible Secured Promissory Note dated July 16, 2015 issued by Hydrocarb Energy Corporation to Duma Holdings, LLC
10.54 (22)
 
Guaranty of Kent P. Watts (July 16, 2015)
10.55 (22)
 
Guaranty of Michael Watts (July 16, 2015)
10.56 (23)
 
Convertible Promissory Note dated July 28, 2015 by Hydrocarb Energy Corporation in favor of JMJ Financial in the principal amount of $1,000,000
10.57 (24)
 
Form of Convertible Subordinated Promissory Note
10.58 (24)
 
Voting Agreement (August 25, 2015) between Kent P. Watts and S. Chris Herndon
10.59 (24)
 
Voting Agreement (August 28, 2015) between Christopher Watts and S. Chris Herndon
 
10.60 (24)
 
First Amendment to Exchange Agreement between Kent P. Watts and Hydrocarb Energy Corporation (September 21, 2015)
10.61 (25)
 
Securities Purchase Agreement dated October 16, 2015 between Hydrocarb Energy Corporation and Typenex Co-Investment, LLC
10.62 (25)
 
Secured Convertible Promissory Note dated October 16, 2015 by Hydrocarb Energy Corporation in favor of Typenex Co-Investment, LLC ($1,730,000)
10.63 (25)
 
Stock Pledge Agreement dated October 16, 2015 by CW Navigation, Inc. in favor of Typenex Co-Investment, LLC
10.64 (25)
 
Subordination and Postponement Agreement dated October 16, 2015 by and among Hydrocarb Energy Corporation, Shadow Tree Capital Management LLC, and Typenex Co-Investment, LLC
10.64 (26)
 
2015 Stock Incentive Plan
10.65(27)
 
Securities Purchase Agreement dated November 9, 2015 between Hydrocarb Energy Corporation and Adar Bays, LLC
10.66(27)
 
Securities Purchase Agreement dated November 9, 2015 between Hydrocarb Energy Corporation and Union Capital, LLC
10.67(27)
 
8% Short Term Cash Redeemable Note ($208,000), Due November 9, 2017, dated November 9, 2015, issued by Hydrocarb Energy Corporation to Adar Bays, LLC
10.68(27)
 
8% Short Term Cash Redeemable Note ($208,000), Due November 9, 2017, dated November 9, 2015, issued by Hydrocarb Energy Corporation to Union Capital, LLC
10.69(27)
 
8% Short Term Cash Redeemable Secured Note ($208,000), Due November 9, 2017, dated November 9, 2015, issued by Hydrocarb Energy Corporation to Adar Bays, LLC
10.70(27)
 
8% Short Term Cash Redeemable Secured Note ($208,000), Due November 9, 2017, dated November 9, 2015, issued by Hydrocarb Energy Corporation to Union Capital, LLC
10.71(27)
 
Collateralized Secured Promissory Note dated November 9, 2015 ($208,000), issued by Adar Bays, LLC to Hydrocarb Energy Corporation
10.72(27)
 
Collateralized Secured Promissory Note dated November 9, 2015 ($208,000), issued by Union Capital, LLC to Hydrocarb Energy Corporation
10.73(27)
 
Side Letter Agreement dated November 9, 2015 between Adar Bays, LLC and Hydrocarb Energy Corporation
10.74(27)
 
Side Letter Agreement dated November 9, 2015 between Union Capital, LLC and Hydrocarb Energy Corporation
10.75(27)
 
8% Short Term Cash Redeemable Note ($350,000), dated November 9, 2015, issued by Hydrocarb Energy Corporation to JSJ Investments Inc.
10.76(27)
 
Side Letter Agreement dated November 9, 2015 between JSJ Investments Inc.and Hydrocarb Energy Corporation
10.77(27)   Financial Consulting Agreement between Hydrocarb Energy Corporation and Geoserve Marketing LLC
10.78(27)***   Employment Agreement with Charles F. Dommer (July 20, 2015)
14.1 (13)
 
Code of Conduct
 
Subsidiaries of Hydrocarb Energy Corp.
 
Consent of MaloneBailey, LLP
 
Consent of Ralph E. Davis Associates, Inc.
 
Certification of Chief Executive Officer pursuant to Securities Exchange Act of 1934 Rule 13a-14(a) or 15d-14(a)
 
Certification of Chief Accounting Officer pursuant to Securities Exchange Act of 1934 Rule 13a-14(a) or 15d-14(a)
 
Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350
99.1(25)
 
Report of Ralph E Davis Associates, Inc., dated September 11, 2015
 101.INS+
 
XBRL Instance Document
101.SCH+
 
XBRL Taxonomy Extension Schema
101.CAL+
 
XBRL Taxonomy Extension Calculation Linkbase
 101.DEF+
 
XBRL Taxonomy Extension Definition Linkbase
101.LAB+
 
XBRL Taxonomy Extension Label Linkbase
101.PRE+
 
XBRL Taxonomy Extension Presentation Linkbase

* Filed herewith.

** Furnished herewith.

*** Indicates management contract or compensatory plan or arrangement.

(1) Filed as an exhibit to our registration statement on Form S-1/A (Amendment No.1) filed with the Securities and Exchange Commission on February 8, 2008 and incorporated herein by reference (File Number 333-149070).

(2) Filed as an exhibit to our Annual Report on Form 10-K filed with the Securities and Exchange Commission on November 15, 2011 and incorporated herein by reference (File Number 000-53313).
 
(3) Filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on May 17, 2012 and incorporated herein by reference (File Number 000-53313).

(4) Filed as exhibit 3.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on February 10, 2014 and incorporated herein by reference (File Number 000-53313).
 
(5) Filed as exhibit 3.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on May 7, 2014 and incorporated herein by reference (File Number 000-53313).
 
(6) Filed as exhibit 3.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 29, 2015 and incorporated herein by reference (File Number 000-53313).
 
(7) Filed as exhibit 3.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission on July 24, 2014 and incorporated herein by reference (File Number 000-53313).
 
(8) Filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on February 22, 2011 and incorporated herein by reference (File Number 000-53313).
 
(9) Filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 22, 2011 and incorporated herein by reference (File Number 000-53313).
 
(10) Filed as an exhibit to our Annual Report on Form 10-K filed with the Securities and Exchange Commission on November 15, 2011 and incorporated herein by reference (File Number 000-53313).
 
(11) Filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on August 8, 2012 and incorporated herein by reference (File Number 000-53313).
 
(12) Filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 12, 2012 and incorporated herein by reference (File Number 000-53313).
 
(13) Filed as an exhibit to our Annual Report on Form 10-K filed with the Securities and Exchange Commission on November 12, 2013 and incorporated herein by reference (File Number 000-53313).

(14) Filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on October 16, 2013 and incorporated herein by reference (File Number 000-53313).
 
(15) Filed as exhibit 10.1 of our Current Report on Form 8-K filed with the Securities and Exchange Commission on May 2, 2014 and incorporated herein by reference (File Number 000-53313).
 
(16) Filed exhibits to our Current Report on Form 8-K/A Amendment No. 1 filed with the Securities and Exchange Commission on June 3, 2014 and incorporated herein by reference (File Number 000-53313).
 
(17) Filed as exhibits to our Current Report on Form 8-K filed with the Securities and Exchange Commission on August 21, 2014 and incorporated herein by reference (File Number 000-53313).
 
(18) Filed as exhibits to our Annual Report on Form 10-K filed with the Securities and Exchange Commission on November 13, 2014 and incorporated herein by reference (File Number 000-53313).
 
(19) Filed as exhibits to our Current Report on Form 8-K filed with the Securities and Exchange Commission on March 11, 2015 and incorporated herein by reference (File Number 000-53313).

(20) Filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on March 17, 2015 and incorporated herein by reference (File Number 000-53313).

(21) Filed as exhibits to our Current Report on Form 8-K filed with the Securities and Exchange Commission on July 19, 2015 and incorporated herein by reference (File Number 000-53313).
 
(22) Filed as exhibits to our Current Report on Form 8-K filed with the Securities and Exchange Commission on July 31, 2015 and incorporated herein by reference (File Number 000-53313).
 
(23) Filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on August 3, 2015 and incorporated herein by reference (File Number 000-53313).

(24) Filed as exhibits to our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 22, 2015 and incorporated herein by reference (File Number 000-53313).
 
(25) Filed as exhibits to our Current Report on Form 8-K filed with the Securities and Exchange Commission on October 21, 2015 and incorporated herein by reference (File Number 000-53313).

(26) Filed as exhibits to our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 29, 2015 and incorporated herein by reference (File Number 000-53313).
 
(27)
Filed as exhibits to our Current Report on Form 8-K filed with the Securities and Exchange Commission on November 13, 2015 and incorporated herein by reference (File Number 000-53313).

+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.
 
 
148




EXHIBIT 21.1

Subsidiaries

We own:
(i) Penasco Petroleum Inc., a Nevada corporation (100% owned),
(ii) Galveston Bay Energy, LLC, a Texas limited liability company (100% owned),
(iii) SPE Navigation I, LLC, a Nevada limited liability company (100% owned),
(iv) Namibia Exploration, Inc., a Nevada corporation (100% owned),
(v) Hydrocarb Corporation, a Nevada corporation (100% owned)(“HCN”),
(vi) Hydrocarb Texas Corporation, a Texas corporation (100% owned by HCN),
 
 
(vii)
Hydrocarb Namibia Energy (Pty) Limited, a company chartered in the Republic of Namibia (100% owned by HCN), and
 
(viii) Otaiba Hydrocarb LLC, a UAE limited liability corporation (95% owned by HCN).
 
 




EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in Registration Statement No. 333-197070 on Form S-8 of Hydrocarb Energy Corp. (the “Company”), of our report dated November 13, 2015, relating to the consolidated financial statements of the Company and subsidiaries appearing in the Annual Report on Form 10-K of the Company for the year ended July 31,  2015, and 2014.

/s/ MaloneBailey, LLP
www.malone-bailey.com
Houston, Texas

November 13, 2015
 
 




EXHIBIT 23.2
CONSENT OF RALPH E DAVIS ASSOCIATES, INC.

As independent oil and gas consultants, Ralph E Davis Associates, Inc., hereby consents to the references to our firm in the form and context in which they appear in the Annual Report on Form 10-K of Hydrocarb Energy Corp. (the “Company”) for the year ended July 31, 2015 (the “Annual Report”).
 
We also hereby further consent to the inclusion and use in the Annual Report of our report dated September 11, 2015, entitled “Oil, Condensate, and Natural Gas Reserves SEC Non-Escalated Analysis Hydrocarb Energy Corporation As of July 31, 2015” (the “Report”) and to the incorporation by reference of our Report as Exhibit 99.1 to the Annual Report.
 
We also consent to the incorporation by reference in Registration Statement No. 333-197070 on Form S-8 of the Company, of all references to our firm and all information from the Reports.

/s/ RALPH E DAVIS ASSOCIATES, INC.

RALPH E DAVIS ASSOCIATES, INC.

November 13, 2015
 
 




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 annual report on Form 10-K 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:
November 13, 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 annual report on Form 10-K 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:
November 13, 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 annual Report of Hydrocarb Energy Corp, on Form 10-K for the year ended July 31, 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:
November 13, 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.