Notes
to Condensed Financial Statements
March
31, 2016
(Unaudited)
NOTE
1 – ORGANIZATION AND NATURE OF BUSINESS
GulfSlope
Energy, Inc. (the “Company,” “GulfSlope,” “our” and words of similar import), a Delaware corporation,
is an independent crude oil and natural gas exploration company whose interests are concentrated in the United States Gulf of
Mexico federal waters offshore Louisiana in less than 800 feet of water depth. The Company has leased 23 federal Outer Continental
Shelf blocks (referred to as “prospect,” “portfolio” or “leases” in this Report) and licensed
2.2 million acres of three-dimensional (3-D) seismic data in its area of concentration.
Since
March 2013, we have been singularly focused on identifying high-potential oil and gas prospects. We have licensed 3-D seismic
data covering approximately 2.2 million acres and have evaluated this data using advanced interpretation technologies. As a result
of these analyses, we have identified and acquired leases on 19 prospects that we believe may contain economically recoverable
hydrocarbon deposits, and we plan to continue to conduct more refined analyses of our prospects as well as target additional lease
and property acquisitions. Our activities have been focused exclusively in the federal waters of the Gulf of Mexico. We have
given preference to areas with water depths of 800 feet or less where production infrastructure already exists, which we believe
will allow for any discoveries to be developed faster and less expensively with the goal to reduce economic risk while increasing
returns.
As
of March 31, 2016, we have no proved reserves. We expect that any drilling activities on our prospects will commence in late fiscal
year 2016, or the first half of fiscal year 2017 at the earliest.
NOTE
2 – SIGNIFICANT ACCOUNTING POLICIES
The
condensed financial statements included herein are unaudited. However, these condensed financial statements include all adjustments
(consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of financial
position, results of operations and cash flows for the interim periods. The results of operations for interim periods are not
necessarily indicative of the results to be expected for an entire year. The preparation of financial statements in accordance
with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts
reported in the Company’s condensed financial statements and accompanying notes. Actual results could differ materially
from those estimates.
Certain
information, accounting policies, and footnote disclosures normally included in the financial statements prepared in accordance
with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted in this Form
10-Q pursuant to certain rules and regulations of the Securities and Exchange Commission (“SEC”). The condensed financial
statements should be read in conjunction with the audited financial statements for the year ended September 30, 2015, which were
included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2015 and filed with the Securities
and Exchange Commission on December 29, 2015.
Cash
and Cash Equivalents
GulfSlope
considers highly liquid investments with insignificant interest rate risk and original maturities to the Company of three months
or less to be cash equivalents. Cash equivalents consist primarily of interest-bearing bank accounts and money market funds.
The Company’s cash positions represent assets held in checking and money market accounts. These assets are generally available
on a daily or weekly basis and are highly liquid in nature
Liquidity/Going
Concern
The
Company has incurred accumulated losses as of March 31, 2016 of $29,567,608. Further losses are anticipated in developing our
business. As a result, our auditors have expressed substantial doubt about our ability to continue as a going concern. As of
March 31, 2016, we had $60,094 of unrestricted cash on hand. The Company estimates that it will need to raise a minimum
of $3 million to meet its obligations and planned expenditures through December 31, 2016. The Company plans to
finance its operations through the issuance of equity, debt financings or joint ventures, further sale of working interests
in prospects or bridge financing. Our policy has been to periodically raise funds through sale of equity on a limited basis,
to avoid undue dilution while at the early stages of execution of our business plan. Short term needs have been historically
funded through loans from executive management and other related parties. There are no assurances that financing will be
available with acceptable terms, if at all. If the Company is not successful in obtaining adequate financing, operations
would need to be curtailed or ceased, including those associated with being a public reporting company. The financial statements do
not include any adjustments that might result from the outcome of this uncertainty.
Full
Cost Method
The
Company uses the full cost method of accounting for oil and gas exploration and development activities. Under the full cost method
of accounting, all costs associated with the exploration for and development of oil and gas reserves are capitalized on a country-by-country
basis into a single cost center (“full cost pool”). Such costs include land acquisition costs, geological and geophysical
(“G&G”) expenses, carrying charges on non-producing properties, costs of drilling both productive and non-productive
wells and overhead charges directly related to acquisition, exploration and development activities. All of the Company’s
oil and gas properties are located within the United States, its sole cost center.
The
costs of unproved properties and related capitalized costs are withheld from the depletion base until such time as they are either
developed or abandoned. When proved reserves are assigned or the property is considered to be impaired, the cost of the property
or the amount of the impairment is added to costs subject to depletion and full cost ceiling calculations. Capitalized costs that
are directly associated with unproved properties acquired by the Company during the current quarter are included in the full cost
pool. As of March 31, 2016, the Company had no proved reserves.
Companies
that use the full cost method of accounting for oil and natural gas exploration and development activities are required to perform
a ceiling test calculation each quarter. The full cost ceiling test is an impairment test prescribed by SEC Regulation S-X Rule
4-10. The ceiling test is performed quarterly, on a country-by-country basis, utilizing the average of prices in effect on the
first day of the month for the preceding twelve-month period. The ceiling limits such pooled costs to the aggregate of the present
value of future net revenues attributable to proved crude oil and natural gas reserves discounted at 10% plus the lower of cost
or market value of unproved properties less any associated tax effects. If such capitalized costs exceed the ceiling, the Company
will record a write-down to the extent of such excess as a non-cash charge to earnings. Any such write-down will reduce earnings
in the period of occurrence and results in a lower depreciation, depletion and amortization rate in future periods. A write-down
may not be reversed in future periods even though higher oil and natural gas prices may subsequently increase the ceiling.
Proceeds
from property sales will generally be credited to the full cost pool, with no gain or loss recognized, unless such a sale would
significantly alter the relationship between capitalized costs and the proved reserves attributable to these costs. A significant
alteration would typically involve a sale of 25% or more of the proved reserves related to a single full cost pool.
Basic
and Dilutive Earnings Per Share
Basic
earnings per share (“EPS”) is computed by dividing net income (loss) (the numerator) by the weighted average number
of common shares outstanding for the period (denominator). Diluted EPS is computed by dividing net income (loss) by the weighted
average number of common shares and potential common shares outstanding (if dilutive) during each period. Potential common
shares include stock options, warrants, and restricted stock. The number of potential common shares outstanding relating
to stock options, warrants, and restricted stock is computed using the treasury stock method.
As
the Company has incurred losses for the six months ended March 31, 2016 and 2015, the potentially dilutive shares are anti-dilutive
and are thus not added into the loss per share calculations. As of March 31, 2016 and 2015, there were 52,947,389 and 53,842,250
potentially dilutive shares, respectively.
Recent
Accounting Pronouncements
In
May 2014, the FASB issued Accounting Standards Update No. 2014-09 (“ASU No. 2014-09”), which requires an entity to
recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers.
The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. The new standard is effective
for annual reporting periods beginning after December 15, 2016. Early application is not permitted. The standard permits
the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU No.
2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition
method nor has it determined the effect of the standard on its ongoing financial reporting.
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
No. 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, and early application is permitted. We are currently evaluating the accounting implication
and do not believe the adoption of ASU 2014-15 to have material impact on our consolidated financial statements, although there
may be additional disclosures upon adoption.
On February 25, 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842)
. The new guidance establishes the principles to report transparent and economically neutral information
about the assets and liabilities that arise from leases. The new guidance is effective for fiscal years beginning after December
15, 2018, including interim periods within those fiscal years, and early application is permitted for all organizations. The Company
has not yet selected the period during which it will implement this pronouncement.
The
Company has evaluated all other recent accounting pronouncements and believes that none of them will have a significant effect
on the Company’s financial statements.
NOTE
3 – OIL AND NATURAL GAS PROPERTIES
In
March 2014, the Company bid on 23 blocks in the Central Gulf of Mexico Lease Sale 231, conducted by the Bureau of Ocean Energy
Management (“BOEM”). The Company was awarded 21 blocks and paid total consideration of $8,126,972, for the leases
and the first year lease rental payments. In March 2015, the Company competitively bid on four blocks in the Central Gulf
of Mexico Lease Sale 235 conducted by BOEM. The Company was awarded two blocks and paid total consideration of $340,547, for the
leases and the first year lease rental payments.
In
March 2014, the Company entered into a farm-out letter agreement with Texas South Energy, Inc. (“Texas South”), a
related party, relating to five prospects located within the blocks the Company bid on at the Central Gulf of Mexico Lease Sale
231 and received $8.2 million from Texas South. In September 2015, the Company completed the March 2014 farm-out agreement
with Texas South and Texas South funded the final $1.8 million under the agreement for a total purchase price of $10 million and
acquired a 20% working interest in five prospects. Texas South is obligated to pay its proportionate share of the net annual
rental costs related to the prospects. The Company will be the operator of record. In accordance with full cost requirements,
the Company recorded the proceeds from the transaction as an adjustment to capitalized costs with no gain recognition.
During
the period October 1, 2014 to September 30, 2015, the Company incurred $3,231,780 in consulting fees and salaries and benefits
associated with full-time geoscientists, and $921,124 associated with technological infrastructure, third party hosting services
and seismic data. The Company properly capitalized these G&G costs because the Company acquired specific unevaluated properties
during the period that these costs relate to. At March 31, 2015, a portion of these costs, $93,052, specifically related
to properties that were not yet acquired were subject to the ceiling limitation test and immediately impaired.
During
the period October 1, 2015 to March 31, 2016, the Company incurred $1,030,943 in consulting fees and salaries and benefits associated
with full-time geoscientists, and $364,593 associated with technological infrastructure, third party hosting services and seismic
data. The Company properly capitalized these G&G costs because the Company owned the specific properties that these costs
relate to.
These
above capitalized exploration costs net of impairment amounts, when added to our lease acquisition costs net of the sale of
the working interest, result in $6,952,719, the amount of unproved oil and natural gas properties on the Company’s
condensed balance sheet at March 31, 2016.
NOTE
4 – RELATED PARTY TRANSACTIONS
During
April through September 2013, the Company entered into convertible promissory notes whereby it borrowed a total of $6,500,000
from John Seitz, its current chief executive officer. The notes are due on demand, bear interest at the rate of 5% per annum,
and are convertible into shares of common stock at a conversion price equal to $0.12 per share of common stock (the then
offering price of shares of common stock to unaffiliated investors). In May 2013, John Seitz converted $1,200,000 of the
aforementioned debt into 10,000,000 shares of common stock, which shares were issued in July 2013. In June of 2014, the
Company entered into a promissory note whereby it borrowed a total of $1,160,000 from Mr. Seitz. The note is not convertible,
due on demand and bears interest at a rate of 5% per annum. Additionally, during June through August 2015, the Company
entered into promissory notes with John Seitz whereby it borrowed a total of $1,250,000. The notes are not convertible,
due on demand and bear interest at the rate of 5% per annum. During January through March 2016, the Company executed
promissory notes totaling $126,000 with Mr. Seitz. These notes are due on demand, bear interest at the rate of 5% per
annum, and the principal amount is convertible at the option of the holder into securities issued by the Company in a
future offering, at the same price and terms received by investors. As of March 31, 2016 the total amount owed to John Seitz,
our CEO, is $7,836,000. There was a total of $579,773 of unpaid interest associated with these loans included in
accrued liabilities within our balance sheet as of March 31, 2016.
In
August 2015, the Company entered into promissory notes whereby it borrowed a total of $245,000 from Dr. Ronald Bain, its
current president and chief operating officer, and his affiliate ConRon Consulting, Inc. These notes are not
convertible, due on demand and bear interest at the rate of 5% per annum. During February 2016, the Company entered into a
promissory note for $22,000 with Dr. Bain. This note is due on demand, bears interest at the rate of 5% per annum,
and the principal amount is convertible at the option of the holder into securities issued by the Company in a future
offering, at the same price and terms received by investors. As of March 31, 2016, the total amount owed to Dr. Bain and his
affiliate was $267,000. There was a total of $7,849 accrued interest associated with these loans and the Company has
recorded interest expense for the same amount.
During
March 2016, the Company entered into a promissory note for a total of $80,000 with the Morris Family Partnership, L.P.,
an affiliate of Mr. Paul Morris, a director of the Company. The note is due on demand and bears interest at the rate of 5%
per annum and the principal amount is convertible at the option of the holder into securities issued by the Company in
a future offering, at the same price and terms received by investors. At March 31, 2016, there was a total of $189
accrued interest associated with this loan and the Company has recorded interest expense for the same
amount.
Domenica
Seitz, CPA, has provided accounting consulting services to the Company. During the three month period ended March31, 2016, services
provided were valued at $14,880 based on market-competitive salaries, time devoted and professional rates. The Company has
accrued these amounts, and they are reflected in the March 31, 2016 condensed financial statements.
John
Seitz has not received a salary since May 31, 2013, the date he commenced serving as our chief executive officer and accordingly,
no amount has been accrued on our financial statements. Prior to serving as Chief Executive Officer, John Seitz served as a Company
consultant and the Company accrued and subsequently paid $120,000 of consulting compensation owed to Mr. Seitz. As of March 31,
2016, Mr. Seitz beneficially owns 247,392,944 shares of the Company’s common stock (includes shares issuable upon conversion
of the principal amount plus accrued interest of convertible notes held by Mr. Seitz). The Company recognizes that his level of
stock ownership significantly aligns his interests with shareholders’ interests. From time to time, the Compensation Committee
may consider compensation arrangements for Mr. Seitz given his continuing contributions and leadership.
NOTE
5 – COMMON STOCK/PAID IN CAPITAL
In
September 2014, the Company awarded 3,030,000 shares of restricted stock to six employees under the Company’s 2014 Omnibus
Incentive Plan, one-half of which vested in September 2015 and the remaining half vests in September 2016.
Shares
of the restricted stock awards have been and will be issued to the recipients according to the vesting terms.
For
the period October 1 to March 31, 2016 the Company recorded a liability for 243,425 shares of its common stock owed to one
vendor as consideration for services rendered in the ordinary course of business. These shares have not yet been issued and are
reflected on the balance sheet as stock payable.
In
March 2016, the Company issued 520,273 shares of common stock to one vendor as consideration for services rendered in the ordinary
course of business.
NOTE 6–
STOCK-BASED COMPENSATION
Stock-based
compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized over the required
vesting period. The Company recognized $202,650 and $408,044 in stock-based compensation during the three and six months ended
March 31, 2016, and $212,529 and $430,737 in stock-based compensation during the three and six months ended March 31, 2015, respectively. A
portion of these costs, $112,050 and $112,438, were capitalized to unproved properties and the remainder were recorded as general
and administrative expenses for the three months ended March 31, 2016 and 2015, respectively. For the six months ended March 31,
2016 and 2015, $225,746 and $225,444, respectively, were capitalized to unproved properties.
The
following table summarizes the Company’s stock option activity during the three months ended March 31, 2016:
|
|
Number of Options
|
|
Weighted Average Exercise Price
|
|
Weighted Average Remaining Contractual Term (in years)
|
Outstanding at September 30, 2015
|
|
|
2,000,000
|
|
|
|
—
|
|
|
|
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Cancelled
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
Outstanding at March 31, 2016
|
|
|
2,000,000
|
|
|
$
|
0.12
|
|
|
|
3.31
|
|
Vested and expected to vest
|
|
|
2,000,000
|
|
|
$
|
0.12
|
|
|
|
3.31
|
|
Exercisable at March 31, 2016
|
|
|
2,000,000
|
|
|
|
—
|
|
|
|
—
|
|
As
of March 31, 2016 there was no unrecognized stock-based compensation cost related to the stock option grant. There was no
intrinsic value for options outstanding as of March 31, 2016. As of March 31, 2016 there was $262,250 of unrecognized stock-based
compensation cost related to restricted stock grants that is expected to be expensed over a period of six months.
NOTE 7–
COMMITMENTS AND CONTINGENCIES
In
March 2013, the Company licensed certain seismic data pursuant to two agreements. With respect to the first agreement, as
of September 30, 2015, the Company has paid $6,135,500 in cash, with no additional amount due. With respect to the second
agreement, as March 31, 2016, the Company has paid $3,009,195 in cash and is obligated to pay $1,003,065 during fiscal 2016.
In
July 2013, the Company entered into a two-year office lease agreement. The agreement calls for monthly payments of approximately
$20,200 for the first twelve months and $20,500 for the second twelve months. In addition, the Company paid a security deposit
of $18,760 in July 2013. The office lease has been extended through June 30, 2016 and the monthly payment has remained the same.
In
May 2014, the Company entered into an agreement with a seismic data reprocessing company in which the Company agreed to purchase
an aggregate of $3 million of reprocessing services, of which $1.5 million will be paid in cash and the remaining amount by the
issuance of 2 million shares of our common stock using the valuation of $0.75 per share. As of March 31, 2016 approximately
$1,146,000 of services have been provided under this agreement.
In
October 2015, the Company purchased a directors and officers’ insurance policy for $259,936 and financed $235,861 of the
premium by executing a note payable. The balance of the note payable at March 31, 2016 is $119,034.
NOTE 8
– SUBSEQUENT EVENTS
The Company is currently in the process of raising up to
$1 million through the issuance of convertible promissory notes and warrants. As of May 16, 2016, the Company has sold
$235,000 of this private placement. Related party participation in the issuance of convertible promissory notes and warrants
to date is in the amount of $150,000.