NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
June
30, 2017
(UNAUDITED)
NOTE
1 - NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Texas
South Energy, Inc. (the “Company”) was incorporated pursuant to the laws of the State of Nevada on March 15, 2010.
The Company is engaged in the oil and gas business, generating or acquiring oil and gas projects, drilling and operating the wells
and producing the oil and gas reserves.
On
January 11, 2017, pursuant to the laws of the State of Texas, the Company formed Texas South Operating Company, Inc.as a wholly
owned subsidiary of the Company. Texas South Energy, Inc. and Texas South Operating Company, Inc. (collectively, the “Company”)
now file consolidated financial statements effective with the March 31, 2017 filing. The consolidated financial statements reflect
our accounts after elimination of all significant intercompany transactions and balances.
While
the Company had previously established a fiscal year end of October 31, on March 3, 2017 the Company adopted a year end of December
31. A transition 10-K was filed for the period November 2016 through December 2016 to report the change in our year end.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation
and Basis of Presentation
The
accompanying unaudited consolidated financial statements have been prepared in all material respects in accordance with United
States generally accepted accounting principles (“U.S. GAAP”) for interim financial information. Intercompany accounts
and transactions are eliminated. Pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”),
certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with
U.S. GAAP have been condensed or omitted. The accompanying unaudited consolidated financial statements have been prepared on the
same basis as the audited financial statements for the year ended October 31, 2016 and the transition report for November 1, 2016
through December 31, 2016. The exception being that the 2016 financial statements were not consolidated with Texas South Operating
Company, Inc. since the Company had not yet been organized.
Because
certain information and footnote disclosures have been condensed or omitted, these unaudited consolidated financial statements
should be read in conjunction with the audited financial statements and notes thereto as of and for the year ended October 31,
2016, which are included in the Company’s annual report for the year ended October 31, 2016 (the “2016 Annual Report”)
and the transition report for the period of November 1 through December 31, 2016. In management’s opinion, all normal and
recurring adjustments considered necessary for a fair presentation of the financial position, results of operations and cash flows
for the periods presented have been included. Management believes that the disclosures made in these unaudited consolidated financial
statements are adequate to make the information not misleading. Interim period operating results do not necessarily indicate the
results that may be expected for any other interim period or for the full fiscal year.
There
have been no changes in the Company’s significant accounting policies from those that were disclosed in the Company’s
2016 Annual Report or the transition report for the two months ended December 31, 2016.
Use
of Estimates and Assumptions
The
preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period. While management believes that such
estimates are reasonable when considered in conjunction with the financial position and results of operations taken as a whole,
actual results could differ from those estimates, and such differences may be material to the financial statements.
Basic
and Diluted Net Loss per Share
The
Company computes loss per share in accordance with ASC 260, “Earnings per Share” which requires presentation of both
basic and diluted earnings per share on the face of the statement of operations. Basic loss per share is computed by dividing
net loss available to common shareholders by the weighted average number of outstanding common shares during the period. Diluted
loss per share gives effect to all dilutive potential common shares outstanding during the period. Dilutive loss per share excludes
all potential common shares if their effect is anti-dilutive. The Company has no potential dilutive instruments and accordingly
basic loss and diluted loss per share are the same.
Recent
Accounting Pronouncements
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued its final standard on revenue from contracts with
customers. The standard, issued as Accounting Standards Update (“ASU”) No. 2014-09:
Revenue from Contracts with
Customers (Topic 606)
, outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts
with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle
of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers
in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.”
ASU 2014-09 becomes effective for reporting periods (including interim periods) beginning after December 15, 2017. Early application
is permitted for reporting periods (including interim periods) beginning after December 15, 2016. This new standard permits the
use of either the retrospective or cumulative effect transition method. Because the Company currently has such low revenues, the
new guidance is not expected to have a material impact on its financial statements and related disclosures.
In
September 2015, FASB issued an accounting standards update for “Business Combinations,” which requires that an acquirer
recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which
the adjustment amounts are determined. We adopted this new guidance prospectively in the first quarter of 2016.
Other
new pronouncements issued but not effective until after June 30, 2017 are not expected to have a material impact on the Company’s
financial position, results of operations, or cash flows.
NOTE
3 - GOING CONCERN
The
Company’s financial statements are prepared in accordance with generally accepted accounting principles applicable to a
going concern. This contemplates the realization of assets and the liquidation of liabilities in the normal course of business.
Currently, the Company does not have sufficient cash, nor does it have operations or a source of revenue sufficient to cover its
operational costs in order to allow it to continue as a going concern. The Company has accumulated losses as of June 30, 2017
of $11,307,403. The Company will be dependent upon the raising of additional capital through the sale of its existing projects
and/or the best-efforts placement of its equity and/or debt securities in order to implement its business plan. There can be no
assurance that the Company will be successful in either situation in order to continue as a going concern. These factors raise
substantial doubt regarding the Company’s ability to continue as a going concern. These financial statements do not include
any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classification of
liabilities that might result from this uncertainty.
NOTE
4 - OIL & GAS PROPERTIES
In
January 2014, the Company entered into a contract for sale with the owner of mineral interests in 86.69 acres in Lavaca County,
Texas (the “Acreage”) pursuant to which the Company acquired a 37.5% interest in the Acreage’s mineral rights,
including the oil and gas rights (the “Acquired Interest”). In exchange for the Acquired Interest, the Company paid
the seller $270,000 in cash and issued the seller 2,000,000 shares of the Company’s common stock, valued at $100,000. During
the six months ended June 30, 2016, the Company earned revenues of $6,664 associated with these interests. In June 2016, the Company
entered into a contract for sale with James M. Askew, an affiliate, to sell its mineral interests in 86.69 acres in Lavaca County,
Texas in which the Company owns a 37.5% interest in the Acreage’s mineral rights, in consideration of Mr. Askew, former
chief executive officer and sole director, forgiving $170,000 of indebtedness owed to him. The Company recorded impairment expense
of $200,000 associated with these interests.
In
March 2014, the Company entered into a farm out letter agreement with GulfSlope Energy, Inc. (“GulfSlope”), relating
to certain prospects located within 2.2 million acres of 3D seismic licensed and interpreted by GulfSlope. At the time the farm
out agreement was entered into, the Company’s chief executive officer and sole director, Mr. Askew, was also a director
of GulfSlope. Mr. Askew resigned as a director of GulfSlope effective March 27, 2014. Under the terms of the farm-out letter agreement,
as amended in September 2015, the Company acquired contractual rights to a 20% working interest in six prospects for aggregate
consideration of $10,000,000. In accordance with the agreement, the Company has paid its proportionate share of the net rental
costs related to the prospects. GulfSlope is the operator of record. The mineral interests are unproved as of June 30, 2017.
In
May 2016, the Company entered into a letter agreement with GulfSlope and paid $400,000 for the right to enter into mutually agreeable
future definitive agreements to provide for the participation by the Company in drilling one well on Vermilion Area, South Addition
Block 378 (“Canoe Prospect”) and one well on Vermilion Area South Addition Block 375 (“Selectron Prospect”).
In June 2016, EnerGulf Resources Inc. (“EnerGulf”) paid the Company $400,000 to participate in the Canoe Prospect
and the Selectron Prospect. Subject to the negotiation of future definitive agreements with GulfSlope and EnerGulf and financing
being raised by the Company, it is expected that operations shall commence on these prospects and the Company and EnerGulf shall
participate in the drilling of one or more wells to approximately 5,000’ MD/TVD on each of the Canoe Prospect and Selectron
Prospect by the end of 2017.
In
January 2017, the Company entered into an asset purchase agreement with Sydson Energy, Inc. (“Sydson Energy”) and
Sydson Resources, L.P. (“Sydson Resources” and collectively with Sydson Energy, “Sydson”), where Sydson
assigned to us certain onshore oil and gas assets and interests and certain tangible assets and additionally, certain employees
and a consultant of Sydson have agreed to become employees and a consultant of the Company. Sydson is a private oil and gas company
with land operations in Texas and Louisiana that has been in business since 1982. The oil and gas assets include the following:
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In the Bayou Bouillon
Field, St. Martin and Iberville Parishes, Louisiana, we were to acquire a 37.5% working interest in the Sugarberry South Project
comprising 420 acres. However, Texas South was unable to obtain sufficient capital to fulfill certain requirements of the
Purchase and Sale Agreement with Thyssen Petroleum for the Sugarberry South project related to earning additional acreage
rights beyond the Sugarberry No. 6 well. The agreement has now been terminated except for Texas South’s rights to a
50% working interest in the Sugarberry No. 6 well. The Company is in discussion with Thyssen Petroleum on other
farmout activity related to deeper zones at Bayou Bouillon.
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In Texas, we acquired
a 50% working interest in the undrilled acreage above 4,500’ in the West Tuleta Field, Bee County, Texas comprised of
approximately 1,800 gross acres and 900 net acres with a net revenue interest of approximately 75%. The primary drilling objectives
are the Vicksburg and Hockley sands which are structurally high on this acreage to historic downdip production from these
sands totaling over 500,000 BO.
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In the adjacent
Ray Field, also in Bee County, Texas, we acquired a 50% working interest in the undrilled, acreage on the Walton, Campbell,
and Ray leases comprising approximately 75 gross acres with a net revenue interest of approximately 75%. The primary drilling
objectives on this acreage are also the Vicksburg and Hockley sands updip to prior production, also above 3,700’.
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In other areas of
Southeast Texas, we acquired an interest in a proprietary 85 square mile 3-D seismic survey targeting Lower Wilcox Sands at
approximately 10,000’. There are eight currently defined and mapped prospects in which we intend to acquire leases that
are apparent on the seismic data and match the geologic setting of three existing Lower Wilcox fields within the boundaries
of the survey.
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Northwest of that
survey, we intend to acquire leases covering approximately 1,000 acres for horizontal projects above 6,000’ in the Austin
Chalk and Buda Lime formation. These projects are adjacent to substantial prior production and contain both conventional and
unconventional oil targets.
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In
connection with the asset acquisition, certain officers and employees of Sydson have become officers, a consultant and employees
of the Company, including Michael J. Mayell as chief executive officer, James L. Gunderson as manager of land, Robert F. Goldstein
as a geological consultant, and Lecia Alexander as controller. Certain other non-executive employees and consultants of Sydson
became at-will employees of the Company. John B. Connally III joined our board as chairman.
In
connection with the asset acquisition, the Company acquired a variety of proprietary seismic data, computer equipment, furniture
and fixtures and other office equipment.
The
consideration payable by the Company to Sydson and affiliates was (i) 100 million shares of Company common stock to Michael J.
Mayell valued at $845,000 and (ii) $250,000 through a promissory note originally due March 5, 2017, and was amended to January
1, 2019.
In
conjunction with the acquisition, the Company agreed to pay $1,250,000 of Sydson’s future development costs attributable
to its retained working interests in the oil and gas prospects conveyed to the Company and carried interests to casing point
for Sydson’s working interests on the first well in each of the West Tuleta prospect, Ray Field prospect and the Wilinda
prospect.
The
purchase price of this asset acquisition is summarized below:
Furniture & Fixtures, Software, Equipment
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$
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35,556
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Deposit – office rent
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8,340
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Prepaid expenses
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27,616
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Note Payable – insurance
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(6,822
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)
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Leasehold rights
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1,030,310
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Total purchase price
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|
$
|
1,095,000
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NOTE
5 - COMMON STOCK
The
Company has 950,000,000 shares of common stock authorized with a par value of $0.001. As of June 30, 2017 the Company has 781,290,670
shares of common stock issued and outstanding. During the six months ended June 30, 2017, the Company sold 15,250,000 shares of
stock at a price of $.02 per share for a total of $305,000. The Company issued 112,550,000 shares of stock for services rendered
valued between $0.005 and $0.00845, including 65.1 million shares to Mr. Connally and 27 million shares to Mr. Askew. Mr. Mayell
was issued 100,000,000 shares in January, 2017 in connection with the asset purchase from Sydson.
NOTE
6 - RELATED PARTY TRANSACTIONS
In
September 2013, the Company entered into a one-year employment agreement with its former director and chief executive officer
James Askew. The agreement provided for a one-time issuance of 69,000,000 shares of common stock, $75,000 cash signing bonus,
and $35,000 cash compensation per month. Per the agreement, Mr. Askew was paid a $75,000 cash bonus in September 2013, and issued
69,000,000 shares of the Company’s common stock in September 2013. In March 2014, Company entered into an indemnification
agreement with Mr. Askew tracking the statutory provisions of the Nevada Statutes and extended the term of the agreement for one
year. In September 2015, James Askew’s employment agreement was further amended to extend the term of the agreement to September
30, 2018. During the year ended October 31, 2016, the Company made cash payments and issued Mr. Askew 14 million shares of common
stock in exchange for $280,000 of the accrued compensation. Additionally, in accordance with the employment agreement, the Company
paid Mr. Askew $420,000 for compensation and a $50,000 bonus for the fiscal year ended October 31, 2016. During the two month
period ending December 31, 2016, the Company paid him $105,000 in compensation, $9,000 in bonuses and $38,030 for expense reimbursements.
A prepayment of the January 2017 consulting agreement of $35,000 was included in the $105,000 compensation payments.
Mr.
Askew, our former chief executive officer and director for over three years, is currently a key consultant to the Company. He
resigned effective January 3, 2017 and signed a consulting agreement which is discussed in more detail in footnote 9 “Commitments
and Contingencies”.
The
Company had received unsecured advances during 2013 and prior from a prior director in the amount of $52,152. The amount of $42,324
due to the related party was written off during the quarter ended March 31, 2017 and recorded as “Other Income” as
a result of the expiration of the applicable statute of limitations. The remaining balance of $9,828 is recorded within the ‘Due
to related party’ line on the balance sheet.
In
March 2014, the Company acquired 5,000,000 shares of restricted GulfSlope common stock from the Company’s former sole officer
and director James Askew for a purchase price of $268,000. At the time of the acquisition, Mr. Askew was also a director of GulfSlope.
Mr. Askew resigned as a director of GulfSlope effective March 27, 2014. During the fiscal year ended October 31, 2016, the Company
recorded an unrealized loss of $185,000 to adjust the investment securities to fair market value.
In
February 2016, the Company sold the 5,000,000 shares of GulfSlope common stock with a cost value of $268,000 for cash proceeds
of $50,000 and recorded a realized loss of $218,000.
Mr.
Mayell, our current chief executive officer and director effective January 4, 2017, is President of Sydson Energy, Inc. and Sydson
Resources, LP (“Sydson”). During the six months ended June 30, 2017, Sydson and Mr. Mayell paid invoices on behalf
of the Company. As of June 30, 2017, the Company owes Sydson $93,464 and Mr. Mayell $1,299 which are reported on the balance sheet
as “Accounts payable - related party”.
As
of June 30, 2017, the Company has accrued five months of Mr. Askew’s consulting agreement totaling $175,000. This accrual
is reported on the balance sheet as “Accrued expenses – related party”.
The
Company has $210,000 of compensation accrued to Mr. Mayell and $150,000 to Mr. Connally as of June 30, 2017. Payroll taxes totaling
$32,136 related to the accrued compensation has been accrued. These accruals total $392,136 and are reported within “Accrued
expenses – related party – long term” on the balance sheet. The due dates for these liabilities are December
31, 2019 as a result of amendments dated March 1, 2017 to the compensation agreements.
In
January 2017, the Company issued shares of stock to the following related parties: Mr. Askew 27 million shares, Mr. Mayell 100
million shares and Mr. Connally 65.1 million shares. See note 9 “Commitments and contingencies” for additional information.
As
discussed in Note 7, the Company owes Sydson $250,000 plus accrued interest – long term totaling $12,763 on a note related
to the acquisition of Sydson assets.
Also
discussed in Note 7, Mr. Mayell and JTB Energy LLC have loaned the Company $500,000, plus accrued interest – long term totaling
$6,111. JTB Energy LLC is a related party of Mr. Mayell.
NOTE
7 - NOTES PAYABLE
Effective
March 23, 2017 the Company extended an unsecured promissory note with an accredited investor in the amount of $1,700,000 to a
payment date of January 1, 2019. The note was reduced by the assignment of a $131,645 note receivable from EnerGulf Resources
to the investor. As of June 30, 2017 the outstanding principal balance was $1,568,355 and is included in “Notes Payable
– long term” on the balance sheet. During the outstanding period, the note is convertible at the option of the investor
up to $800,000 of the outstanding principal and accrued interest into common shares at $0.04 per share
The
Company had received unsecured advances during 2013 and prior from a prior director in the amount of $52,152. The amount of $42,324
due to the related party was written off during the quarter ended March 31, 2017 and recorded as “Other Income” as
a result of the expiration of the applicable statute of limitations. The remaining balance of $9,828 is recorded within the ‘Due
to related party’ line on the balance sheet.
In
connection with the Sydson asset acquisition, part of the consideration was an unsecured $250,000 note payable to Sydson due March
1, 2017. The note has been amended effective March 23, 2017 to extend the due date to January 1, 2019 and to charge a fixed rate
of 10% interest on the note. The balance of $250,000 is included in “Notes payable-related party” in the long term
section of the balance sheet.
During
April 2017, the Company received a loan of $125,000 from Mr. Mayell and a loan of $125,000 from JTB Energy, LLC. Both loans are
secured by the $10,000,000 offshore leases, payable upon demand with interest rates of 10% per annum. During the outstanding period,
the notes are convertible at the option of the investor up to the outstanding principal and accrued interest into common shares
at $0.02 per share. These loans are both considered related party transactions.
During
June 2017, the Company received an additional loan of $125,000 from Mr. Mayell and an additional loan of $125,000 from JTB Energy,
LLC. Both loans are secured by the $10,000,000 offshore leases, all payable upon demand with interest rates of 10% per annum.
During the outstanding period, the notes are convertible at the option of the investor up to the outstanding principal and accrued
interest into common shares at $0.02 per share. These loans are both considered related party transactions.
NOTE
8 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The
Company’s financial instruments are cash and accounts payable. The recorded values of cash and accounts payable approximate
their fair values based on their short-term nature.
NOTE
9 - COMMITMENTS AND CONTINGENCIES
See
Note 6 for a discussion of Mr. Askew’s employment agreement and the Company’s financial obligations with respect thereto.
Mr. Askew resigned as an executive officer and director of Texas South in January 2017 and entered into a consulting agreement
with the Company that began on January 5, 2017 and terminates on December 31, 2019, and such term shall be extended for an additional
one-year period upon December 31 of each calendar year, commencing on December 31, 2017, provided that neither the Company nor
consultant notify the other on or prior to 90 days before the applicable December 31
st
that either party does not intend
to extend this agreement. The Company shall pay to Mr. Askew $35,000 net per month and issued Mr. Askew 27 million shares of Company
common stock. Upon termination of Mr. Askew by the Company other than for cause, Mr. Askew is entitled to receive three years
of his then consulting compensation as severance.
The
Company entered into an employment agreement with John B. Connally III to serve as chairman of the board that began on January
5, 2017 and terminates on December 31, 2019. Upon December 31 of each calendar year, commencing on December 31, 2017, the term
shall be extended for one additional year, provided that neither the Company nor Mr. Connally notify the other on or prior to
90 days before the applicable December 31
st
date that either party does not intend to extend this agreement. The Company
shall pay to Mr. Connally a base salary of $420,000 per annum, issued him 65.1 million shares, and Mr. Connally shall be entitled
to standard and customary benefits. Mr. Connally has agreed to standard non-disclosure provisions. Upon termination of Mr. Connally
by the Company other than for cause, Mr. Connally is entitled to receive three years of his then compensation as severance.
The
Company entered into an employment agreement with Mr. Mayell on January 4, 2017 that terminates on December 31, 2019. Upon December
31 of each calendar year, commencing on December 31, 2017, the term shall be extended for one additional year, provided that neither
the Company nor Mr. Mayell notify the other on or prior to 90 days before the applicable December 31
st
date that either
party does not intend to extend this agreement. The Company shall pay to Mr. Mayell a base salary of $420,000 per annum and Mr.
Mayell shall be entitled to standard and customary benefits. Mr. Mayell has agreed to standard non-disclosure and non-competition
provisions. Upon termination of Mr. Mayell by the Company other than for cause, Mr. Mayell is entitled to receive three years
of his then compensation as severance.
Effective
March 1, 2017 the above mentioned agreements with Mr. Connally and Mr. Mayell were amended to extend the due dates. The payments
are now due at the end of the terms of the agreements, which is December 31, 2019. These liabilities are accrued in the financial
statements for the six months ended June 30, 2017, however they are now reported as long term on the balance sheet.