NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 – BASIS OF PRESENTATION
These consolidated financial statements of Vanguard Energy Corporation (Vanguard or the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In the opinion of management, these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the results for the interim periods. Certain information, accounting policies and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been omitted pursuant to Securities and Exchange Commission (SEC) rules and regulations. These financial statements should be read along with Vanguard’s audited financial statements as of September 30, 2013.
Default on 2012 Convertible Promissory Notes and Pending Sale of Oil & Gas Properties
– On March 31, 2014 the Company failed to make the scheduled interest payments on its 2012 Convertible Promissory Notes. As a result, the note holders are entitled to declare the notes in default, in which case the principal amount of the notes, plus all accrued and unpaid interest would be immediately due and payable. For this reason, the 2012 Convertible Promissory Notes are classified as current obligations within the consolidated balance sheet at March 31, 2014.
The Company’s inability to make the interest payment to the note holders was the result of the expenditure of considerable capital to work over some of the Company’s wells. The costs of that work far exceeded the Company’s expectations and yet the work was required in order to get the wells back into production. This depleted the Company’s cash position far below its expectations. Further, although the initial work on those wells was successful in boosting production momentarily, further complications resulted in lower production than anticipated, which has not been adequate to replenish the cash expended and enable the Company to make required interest payments.
With a view to paying its note holders, the Company has entered into an agreement to sell all of its oil and gas properties to Vast Petroleum Corporation (Vast) for $5,500,000. The sale of the Company’s oil and gas properties to Vast is contingent upon a number of conditions, including the following:
●
|
the approval of the sale by the holders of a majority of the Company’s outstanding shares of common stock;
|
●
|
the approval of note holders owning notes in the principal amount of approximately $5,505,700; and
|
●
|
the approval of holders owning a majority of the membership interests in Vanguard Net Profits, LLC to sell the net profit interests to the Company for $230,619.
|
The transaction is expected to close by the end of May 2014 and be effective as of April 1, 2014. The sale of the Company’s oil and gas properties would represent the sale of substantially all of the Company’s assets. An impairment charge of $880,213 was recognized during the quarter ended March 31, 2014 for the amount by which the carrying value of the Company’s oil and gas properties exceeded the estimated net proceeds from the planned sale.
VANGUARD ENERGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
If the transaction with Vast is completed, the Company plans to use the proceeds from the sale to purchase the net profits interest held by Vanguard Net Profits, LLC for $230,619 and pay the balance to the holders of the secured notes. The amount which will be paid to the note holders from the sale of the Company’s oil and gas properties will be less than the amount owed to the note holders. In consideration for accepting less than the full amount due on their notes, and releasing their lien on the Company’s oil and gas properties, the note holders, as a group, are expected to receive shares in the Company’s stock which shares, when issued, will represent 90% of the Company’s issued and outstanding shares.
Going Concern
– The above actions and events raise substantial doubt as to the ability of the Company to continue as a going concern. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the liquidation of liabilities in the normal course of business.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
As of March 31, 2014, Vanguard’s significant accounting policies were consistent with those discussed in the audited financial statements as of September 30, 2013.
Earnings Per Share –
Basic earnings per share have been calculated based upon the weighted-average number of common shares outstanding. Diluted earnings per share have been calculated based upon the weighted-average number of common and potential common shares. The calculation of diluted weighted-average shares outstanding for the three-month periods ended March 31, 2014 and 2013 excludes 19,261,860 and 17,610,960 shares, respectively, issuable pursuant to outstanding warrants, stock options and debt conversion features because their effect is anti-dilutive.
Recently Issued Accounting Pronouncements –
Various accounting standards updates have been recently issued, most of which represented technical corrections to the accounting literature or were applicable to specific industries. No new accounting pronouncements have been issued that are likely to have a material impact to the Company's consolidated financial statements.
NOTE 3 – OIL AND GAS ACQUISITIONS
By agreement dated March 15, 2011, the Company entered into a farmout agreement with an unrelated third party pertaining to a 100-acre lease in the Batson Dome Field. As of March 31, 2014, the Company had drilled five wells on the lease. Pursuant to the farmout agreement, as amended in January 2013, the Company has the option of drilling additional wells on the lease; provided however, that if it does not drill at least three wells in any twelve month period the right to drill any additional wells on the lease will terminate. As of March 31, 2014, the Company has not drilled any wells on the property in the last 12 months effectively terminating the lease.
VANGUARD ENERGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
By agreement dated May 25, 2011, the Company entered into a farmout agreement with an unrelated third party pertaining to a 100-acre lease in the Batson Dome Field. Pursuant to the agreement, the Company had the obligation to commence drilling a well on the lease by June 14, 2012. In June 2012, the Company paid $10,000 to extend the agreement, whereby it had an obligation to commence drilling by June 14, 2013. The Company requested that this agreement be extended for another year for payment of $10,000, which was approved in November 2013. The Company is subject to commence drilling of the first well by June 14, 2014, and completing the well if warranted. The Company has the option of drilling additional wells on the lease; provided however, that unless the Company commences drilling each well within 180 days of the date the latest well is completed or abandoned, the right to drill any additional wells on the lease will terminate. The estimated cost of drilling and completing any well on this lease is approximately $1,000,000. As of March 31, 2014 the Company has not drilled any wells on this lease and will not drill any wells prior to the expiration date of June 14, 2014.
By agreement dated January 6, 2012, the Company entered into a three-year farmout agreement with an unrelated third party pertaining to another 70-acre lease in the Batson Dome Field. The estimated cost of drilling and completing any well on this lease is approximately $1,000,000.
By agreement dated May 1, 2012, the Company entered into a farmout agreement with an unrelated third party pertaining to another 45-acre lease in the Hull-Daisetta Field. Pursuant to the agreement, the Company had the obligation to commence drilling a well on the lease by January 31, 2013. In January 2013, the agreement was amended, whereby the Company now has an obligation to commence drilling by January 31, 2014. The lease has expired as of January 31, 2014, as the Company did not drill any wells on this lease.
Through certain acquisitions in 2010, the Company owns a ninety percent (90%) working interest in mineral leases for 230 acres in the Batson Dome Field. C.F.O., Inc. owns the remaining ten percent (10%) working interest and is the operator for the mineral leases pursuant to a joint operating agreement between the Company and C.F.O., Inc. C.F.O., Inc. is controlled by Delton Drum, an officer of the Company since 2010. The Company has recorded a receivable from C.F.O., Inc. for its 10% share of capital expenditures. At March 31, 2014, this amount totaled $1,757 which was paid in full in April 2014.
NOTE 4 – LONG-TERM DEBT
2010 Convertible Promissory Notes –
In December 2010, the Company completed the sale of $3,400,000 in Convertible Promissory Notes, due and payable on October 31, 2012 and convertible, at the holder’s option, into common stock of the Company at $1.00 per share at any time after April 30, 2011. The 2010 Convertible Promissory Notes bore interest at 8% per year, payable quarterly. In addition, the note holders were issued 1,700,000 Series A warrants to purchase the Company’s common stock at $4.00 per share any time on or before October 31, 2014 and were additionally granted a twenty percent (20%) net profits interest payable quarterly from any net profits generated from wells drilled and completed with the proceeds of the notes.
VANGUARD ENERGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
During 2012, $3,075,000 of the 2010 Convertible Promissory Notes outstanding was surrendered in exchange for new 2012 Convertible Promissory Notes as discussed below. The remaining notes, which had an outstanding principal balance of $325,000, were repaid in October 2012.
2012 Convertible Promissory Notes –
During 2012, the Company sold $8,254,500 of Convertible Promissory Notes, due and payable on June 30, 2015 and convertible at the holder’s option, into common stock of the Company at $1.25 per share. The Convertible Promissory Notes bear interest at 15% per year, payable quarterly. Of the total amount raised, $5,179,500 represented new cash investors and $3,075,000 represented investors from the 2010 convertible note offering who chose to roll their investment in that earlier offering into the Company's new offering. Net proceeds from this financing:
●
|
were used to pay the 2010 Convertible Promissory Notes remaining outstanding on October 31, 2012 ($325,000), and
|
●
|
have been used to fund an accelerated developmental drilling program in the Company's oil fields located in Southeast Texas
|
Except in certain circumstances, the conversion price of the 2012 Convertible Promissory Notes will be lowered if the Company sells any additional shares of common stock or any securities convertible into common stock, at a price below the then applicable conversion price. The conversion price will also be proportionately adjusted in the event of any stock split, or capital reorganization. The Company may prepay the Notes upon twenty days written notice to the Note holders.
Direct costs of $813,780 were incurred in connection with the issuance of the 2012 Convertible Promissory Notes. The Company recognized a loss on debt extinguishment of $410,639 related to the investors who chose to roll their investment in the 2010 Convertible Promissory Notes into the new offering. The placement agents for this offering received a cash commission of $619,905 as well as 537,360 Series E warrants. Each Series E warrant entitles the holder to purchase one share of the Company’s common stock. The Series E warrants may be exercised at any time on or before June 30, 2017 at a price of $1.55 per share.
The Company’s gross outstanding balance of the 2012 Convertible Promissory Notes was $8,254,500 as of March 31, 2014. As of March 31, 2014, the unamortized discount on the 2012 Convertible Promissory Notes totaled $329,380. Interest expense for the amortization of debt issuance cost and discount on the notes for the six-month period ended March 31, 2014 was $265,666. The effective interest rate of the 2012 Convertible Promissory Notes was 17.71% as of March 31, 2014. Accrued interest included in Other Liabilities at March 31, 2014 and 2013 was $309,544.
VANGUARD ENERGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Net Profits Interest Participation Liability
–
The 20% net profits interest granted with the issuance of the 2010 Convertible Promissory Notes is owned by Vanguard Net Profits, LLC, a Texas limited liability company (the “Fund”). The Company has a 1% interest in the Fund and is the Fund’s manager on behalf of the notes holders who own the remaining interest.
The Company has recognized a participation liability related to the net profits interest granted. This participation liability is reflected in the liability section of the balance sheet at its estimated fair value of $402,391 as of March 31, 2014. The Company estimated the fair value of the participation liability utilizing a present value factor of 10 applied to proved developed reserves associated with the wells drilled and completed with the proceeds of the notes. At any time, the Company may purchase the net profits interests held by the Fund for $3,400,000.
The Company incurred expense associated with the net profits interest granted during the six-month period ended March 31, 2014 of $63,160. This amount is reported as interest expense in the statement of operations. The Company also made payments of $84,577 under this arrangement during the six-month period ended March 31, 2014.
NOTE 5 – INCOME TAXES
The Company estimates its annual effective income tax rate in recording its quarterly provision for income taxes in the various jurisdictions in which the Company operates. Statutory tax rate changes and other significant or unusual items are recognized as discrete items in the quarter in which they occur. The Company recorded no income tax expense for the three-month period ended March 31, 2014 because the Company estimates it will record no income tax expense for the year ended September 30, 2014. The Company recorded no income tax expense for the three-month period ended March 31, 2013. The Company has a valuation allowance that fully offsets net deferred tax assets.
NOTE 6 – COMMITMENTS AND CONTINGENCIES
The Company’s material future contractual obligations as of March 31, 2014 were as follows:
|
|
Total
|
|
|
2014
|
|
|
2015
|
|
|
2016
|
|
|
Thereafter
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Convertible notes
|
|
$
|
8,254,500
|
|
|
$
|
8,254,500
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
The contractual maturity of the convertible notes is June 30, 2015. However, on March 31, 2014 the Company failed to make the scheduled interest payments. As a result, the note holders are entitled to declare the notes in default, in which case the principal amount of the notes, plus all accrued and unpaid interest would be immediately due and payable.
Except as shown above, the Company had no contractual capital commitments outstanding at March 31, 2014. The Company is presently attempting to sell its Batson Dome field. Although no sale occurred, the Company spent approximately $960,000 during the six month period ending March 31, 2014 but will not spend any more for the remainder of the fiscal year 2014 for work over of wells in the Batson Dome Field or for various other projects.
VANGUARD ENERGY CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 7 – FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table summarizes the financial liabilities measured at fair value on a recurring basis as of March 31, 2014 and September 30, 2013:
|
|
|
|
|
March 31, 2014
|
|
|
September 30, 2013
|
|
|
|
Level
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Participation liability
|
|
|
3
|
|
|
$
|
402,391
|
|
|
$
|
465,551
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
|
|
|
$
|
402,391
|
|
|
$
|
465,551
|
|
The following table presents a reconciliation of those liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3):
|
|
Participation Liability
|
|
|
Total
|
|
|
|
|
|
|
|
|
Balance at September 30, 2013
|
|
$
|
465,551
|
|
|
$
|
465,551
|
|
Purchases, issuances and settlements
|
|
|
(63,160
|
)
|
|
|
(63,160
|
)
|
|
|
|
|
|
|
|
|
|
Balance at March 31, 2014
|
|
$
|
402,391
|
|
|
$
|
402,391
|
|
NOTE 8 – SUPPLEMENTAL CASH FLOW INFORMATION
|
|
Six Month ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
681,669
|
|
|
$
|
603,088
|
|
Interest capitalized (non-cash)
|
|
|
3,677
|
|
|
|
45,935
|
|
|
|
|
|
|
|
|
|
|
Noncash investing and financing activities:
|
|
|
|
|
|
|
|
|
Capital expenditures included in accounts payable
|
|
|
(36,189
|
)
|
|
|
(15,278
|
)
|
Asset retirement obligations incurred
|
|
|
-
|
|
|
|
9,792
|
|
* * * * *
FORWARD LOOKING STATEMENTS
The information contained in this Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties, including among other things, statements regarding our capital needs, business strategy and expectations. Any statement which does not contain a historical fact may be deemed to be a forward-looking statement. In some cases, you can identify forward-looking statements by terminology such as "may", "will", "should", "expect", "plan", "intend", "anticipate", "believe", "estimate", "predict", "potential" or "continue", the negative of such terms or other comparable terminology. In evaluating forward looking statements, you should consider various factors outlined in our latest Form 10-K, filed with the U.S. Securities Exchange Commission (“SEC”) on March 31, 2014, and, from time to time, in other reports we file with the SEC. These factors may cause our actual results to differ materially from any forward-looking statement. We disclaim any obligation to publicly update these statements, or disclose any difference between our actual results and those reflected in these statements.