Notes to Unaudited Financial Statements
NOTE 1 – ORGANIZATION AND BUSINESS OPERATIONS
Nature of Operations
The Company is an independent natural gas and oil company
engaged in the exploration, development, exploitation, and acquisition of natural gas and oil reserves in North America. The
Company’s primary area of focus is the State of New Mexico, particularly southeastern New Mexico.
Reverse Acquisition
Effective December 27, 2010, the Company completed a 1-for-55
reverse split of its common stock in accordance with Article 78.207 of the Nevada Revised Statutes (the “Reverse Split”). The
Reverse Split resulted in a decrease in the Company’s authorized share capital from 2,000,000,000 shares of common stock,
par value $0.001 per share, to 36,363,637 shares of common stock, par value, $0.001 per share, with a corresponding decrease in
the number of issued and outstanding shares of the Company’s common stock from 135,933,086 shares to 2,471,511 shares (after
accounting for fractional share interests being rounded up to the next whole number). Completion of the Reverse Split
was a condition precedent for the merger with Pure Gas Partners II, L.P. (“Pure”).
Effective January 3, 2011, the Company completed the merger
with Pure Energy Group, Inc. (“Pure Sub”) as contemplated pursuant to the Agreement and Plan of Merger dated December
2, 2010 (the “Pure Merger Agreement”) among the Company, Doral Acquisition Corp., the Company’s wholly owned
subsidiary (“Doral Sub”), Pure and Pure Sub, a wholly owned subsidiary of Pure (Pure Sub and Pure being collectively
referred to herein as the “Pure Energy Group”).
Pursuant to the provisions of the Pure Merger Agreement,
all of Pure’s oil and gas assets and liabilities were transferred to Pure Sub. Pure Sub was then merged with and into Doral
Sub, with Doral Sub continuing as the surviving corporation as a wholly owned subsidiary of the Company (the “Pure Merger”).
Upon completion of the Pure Merger, the outstanding shares of Pure Sub were converted into an aggregate of 9,981,536 shares of
the Company’s common stock. As a result of the Pure Merger, the previous Pure shareholders own approximately 80% of the Company’s
total outstanding shares on a fully diluted basis, with the Company’s previous stockholders owning the remaining 20%.
The purchase price of the assets of the Company arising from
the reverse acquisition with the Pure Energy Group was $8,085,984, representing eighty percent (80%) of the appraised value of
2,471,511 post-split shares of the Company which were issued and outstanding immediately prior to the reverse acquisition. The
allocation of the purchase price and the purchase price accounting is based upon estimates of the assets and liabilities effectively
acquired on January 3, 2011 in accordance with ASC topic 805,
Business Combinations
.
The allocation of the purchase price is as follows:
Cash and cash equivalents
|
|
$
|
(62,798
|
)
|
Accounts receivable
|
|
|
94,810
|
|
Prepaid expenses and other current assets
|
|
|
5,769
|
|
Proved oil and gas properties
|
|
|
10,336,219
|
|
Property and equipment
|
|
|
12,643
|
|
Other assets
|
|
|
228,268
|
|
Total assets
|
|
|
10,614,911
|
|
Accounts payable
|
|
|
(378,079
|
)
|
Accounts payable- related party
|
|
|
(69,917
|
)
|
Accrued liabilities
|
|
|
(182,110
|
)
|
Long-term debt
|
|
|
(1,018,322
|
)
|
Notes payable to related party
|
|
|
(250,000
|
)
|
Asset retirement obligation
|
|
|
(630,499
|
)
|
Purchase price
|
|
$
|
8,085,984
|
|
NOTE 1 – ORGANIZATION AND BUSINESS OPERATIONS (continued)
The statements of income include the results of operations
for Cross Border Resources, Inc. commencing on January 4, 2011. As a result, information provided for the nine months ended September
30, 2011 presented below includes the actual results of operations from January 4, 2011 to September 30, 2011 and the combined
historical financial information for the Cross Border Resources, Inc. (formerly Doral Energy) and Pure for the period January 1,
2011 to January 3, 2011. The following pro forma information is not necessarily indicative of the results of future operations:
|
|
Three Months
Ended
September 30, 2011
|
|
|
Nine Months
Ended
September 30, 2011
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
1,900,393
|
|
|
$
|
5,596,314
|
|
Operating income (loss)
|
|
|
(610,973
|
)
|
|
|
(811,086
|
)
|
Net income (loss)
|
|
|
(249,555
|
)
|
|
|
(483,982
|
)
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per share
|
|
$
|
(0.02
|
)
|
|
$
|
(0.03
|
)
|
Basis for Presentation
The condensed consolidated financial statements include the
accounts of Cross Border Resources, Inc. and its subsidiaries. The condensed consolidated financial statements and related footnotes
are presented in accordance with generally accepted accounting principles in the United States (“GAAP”). The condensed
balance sheet as of December 31, 2011 and the unaudited condensed statements of operations and cash flows for the nine months ended
September 30, 2011 include the accounts of the Predecessor for the period of January 1, 2011 to January 3, 2011 and the accounts
of Pure and the Company for the period January 4, 2011 (date of reverse acquisition as discussed below) to September 30, 2011 (collectively,
“Cross Border Resources, Inc.” or the “Company”). The comparative balance sheet as of September 30, 2012
and the unaudited condensed statements of operations and cash flows for the nine-month period ended September 30, 2012 represent
the accounts of the Company. The business combination has been accounted for as a reverse acquisition wherein Pure is treated as
the acquirer for accounting purposes.
The Company has prepared the accompanying unaudited interim
financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and
in the opinion of management, such financial statements reflect all adjustments necessary to present fairly the consolidated financial
position of the Company at September 30, 2012 and its results of operations and cash flows for the periods presented. The Company
has omitted certain information and disclosures normally included in annual financial statements prepared in accordance with GAAP
pursuant to those rules and regulations, although the Company believes that the disclosures it has made are adequate to make the
information presented not misleading. These unaudited interim financial statements should be read in conjunction with the Company’s
audited consolidated financial statements and related footnotes included in its most recent Annual Report on Form 10-K.
In preparing the accompanying financial statements, management
has made certain estimates and assumptions that affect reported amounts in the financial statements and disclosures. The results
of operations for the interim periods are not necessarily indicative of the results the Company expects for the full fiscal year.
The Company has not made any changes in its significant accounting policies from those disclosed in its most recent Annual Report
on Form 10-K.
Going Concern
These consolidated financial statements have been prepared
on the basis of accounting principles applicable to a going concern. These principles assume that the Company will be able to realize
its assets and discharge its obligations in the normal course of operations for the foreseeable future.
At September 30, 2012, the Company had a working capital
deficit of $3,442,267 and outstanding debt (consisting of a line of credit, creditors payable, change in control payments, and
notes payable) of $12,240,408. Because of the working capital deficit, the Company was not in compliance with the covenants of
its line of credit with Texas Capital Bank (“TCB”). Of the outstanding debt, $367,309 was due September 30, 2012 under
an unsecured promissory note payable to Green Shoe Investments, Ltd and $396,969 is due September 30, 2012 under an unsecured promissory
note payable to Little Bay Consulting, SA. The Company currently does not have sufficient funds to repay these obligations. The
Company is exploring available financing options, including the sale of debt, equity, or assets. If the Company is unable to finance
its operations on acceptable terms or at all, its business, financial condition and results of operations may be materially and
adversely affected. As a result of the working capital deficiency, there is substantial doubt regarding the Company’s ability
to continue as a going concern. The accompanying financial statements do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from
the possible inability of the Company to continue as a going concern.
Interim financial statements
The unaudited financial information furnished herein reflects
all adjustments, which in the opinion of management are necessary to fairly state the Company’s financial position and the
results of its operations for the periods presented. This report on Form 10-Q should be read in conjunction with the
Company’s financial statements and notes thereto included in the amended audited financial statements for the fiscal period
ended December 31, 2011 as filed on Form 10-K/A on August 31, 2012. The Company assumes that the users of the interim financial
information herein have read or have access to the amended audited financial statements for the preceding fiscal year and that
the adequacy of additional disclosure needed for a fair presentation may be determined in that context. Accordingly, footnote disclosure,
which would substantially duplicate the disclosure contained in the amended audited financial statements for the fiscal period
ended December 31, 2011 has been omitted. The results of operations for the three and nine month periods ended September 30, 2012
are not necessarily indicative of results for the entire year ending December 31, 2012.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Oil and Gas Properties
The Company uses the successful efforts method of accounting
for oil and gas producing activities. Costs to acquire mineral interests in oil and gas properties, to drill and equip
exploratory wells that find proved reserves, to drill and equip development wells and related asset retirement costs are capitalized. Costs
to drill exploratory wells that do not find proved reserves, geological and geophysical costs, and costs of carrying and retaining
unproved properties are expensed.
Unproved oil and gas properties that are individually significant
are periodically assessed for impairment of value, and a loss is recognized at the time of impairment by providing an impairment
allowance. Capitalized costs of producing oil and gas properties, after considering estimated residual salvage values,
are depreciated and depleted by the unit-of-production method.
On the sale or retirement of a complete unit of a proved
property, the cost, and related accumulated depreciation, depletion, and amortization are eliminated from the property accounts,
and the resultant gain or loss is recognized. On the retirement or sale of a partial unit of proved property, the cost
is charged to accumulated depreciation, depletion, and amortization with a resulting gain or loss recognized in income.
On the sale of an entire interest in an unproved property
for cash or cash equivalent, gain or loss on the sale is recognized, taking into consideration the amount of any recorded impairment
if the property had been assessed individually.
Cash and Cash Equivalents
The Company considers all highly liquid investments with
original maturities of three months or less to be cash equivalents.
Accounts Receivable - Production
Accounts receivable consist of amounts due from customers
for oil and gas sales and partners for joint interest billings and are considered fully collectible by the Company as of September
30, 2012 and December 31, 2011. The Company determines when receivables are past due based on how recently payments
have been received.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(continued)
Revenue Recognition
The Company recognizes oil and natural gas revenue from its
interests in producing wells when oil and natural gas is produced and sold from those wells.
Property and Equipment
Property and equipment are stated at cost. Depreciation
of office furniture and equipment is provided using the straight-line method based on estimated useful lives ranging from three
to 15 years.
Asset Retirement Obligations
The Company accounts for asset retirement obligations under
the provisions of ASC 410,
Asset Retirement and Environmental Obligations
, which provides for an asset and liability approach
to accounting for Asset Retirement Obligations (ARO). Under this method, when legal obligations for dismantlement and
abandonment costs, excluding salvage values, are incurred, a liability is recorded at fair value and the carrying amount of the
related oil and gas properties is increased. Accretion of liability is recognized each period using the interest method
of allocation and the capitalized cost is depleted over the useful life of the related asset.
Income Taxes
The Company is a taxable entity for federal or state income
tax purposes for which an income tax provision has been made in the accompanying financial statements. Deferred income
tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities
that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in
which the differences are expected to affect taxable income. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable
for the period plus or minus the change during the period in deferred tax assets and liabilities. Differences between the enacted
tax rates and the effective tax rates are primarily the result of timing differences in the recognition of depletion and accretion
expenses. These differences do not create a material variance between the enacted tax rate and the effective tax rate.
Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenues, expenses and related disclosures. Actual results could differ from those estimates
and assumptions. Significant estimates include volumes of oil and gas reserves used in calculating depletion of proved
oil and natural gas properties and costs to abandon oil and gas properties.
Management believes that it is reasonably possible that the
following material estimates affecting the financial statements could significantly change in the coming year: (1) estimates of
proved oil and gas reserves, and (2) forecast forward price curves for natural gas and crude oil. The oil and gas industry in the
United States has historically experienced substantial commodity price volatility, and such volatility is expected to continue
in the future. Commodity prices affect the level of reserves that are considered commercially recoverable; significantly influence
the Company’s current and future expected cash flows; and impact the PV10 derivation of proved reserves.
Financial Instruments
The Company’s financial instruments include cash and
cash equivalents, receivables, payables, and debt and are accounted for under the provisions of ASC Topic 825,
Financial Instruments
. The
carrying amount of these financial instruments as reflected in the balance sheets, except for long-term, fixed-rate debt, approximates
fair value. The Company estimates the fair value of its long-term, fixed-rate debt generally using discounted cash flow
analysis based on the Company’s current borrowing rates for similar types of debt.
Recently Issued Accounting Pronouncements
From time to time, new accounting pronouncements are issued
by the Financial Accounting Standards Board (“FASB”) that are adopted by the Company as of the specified effective
date. If not discussed, management believes that the impact of recently issued standards, which are not yet effective, will
not have a material impact on the Company’s financial statements upon adoption.
NOTE 3– ASSET RETIREMENT OBLIGATIONS
The following is a description of the changes to the Company’s
asset retirement obligations for the period ended September 30, 2012 and December 31, 2011:
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
(As Restated)
|
|
Asset retirement obligations at beginning of year
|
|
$
|
1,186,260
|
|
|
$
|
508,588
|
|
Disposal of assets
|
|
|
(64,291
|
)
|
|
|
|
|
Asset retirement obligations acquired in acquisition
|
|
|
—
|
|
|
|
630,499
|
|
Revision of previous estimates
|
|
|
—
|
|
|
|
(158,452
|
)
|
Accretion expense
|
|
|
52,146
|
|
|
|
84,428
|
|
Additions
|
|
|
48,489
|
|
|
|
121,197
|
|
Asset retirement obligations at end of period
|
|
$
|
1,222,604
|
|
|
$
|
1,186,260
|
|
NOTE 4– OIL AND NATURAL GAS PROPERTIES AND OTHER
EQUIPMENT
Oil and natural gas properties
The following table sets forth the capitalized costs under
the successful efforts method for oil and natural
gas properties:
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
(As Restated)
|
|
Oil and natural gas properties
|
|
$
|
44,387,812
|
|
|
$
|
34,986,566
|
|
Less accumulated depletion and impairment
|
|
|
(12,212,145
|
)
|
|
|
(9,667,031
|
)
|
Net oil and natural gas properties capitalized costs
|
|
$
|
32,175,667
|
|
|
$
|
25,319,535
|
|
At September 30, 2012, the capitalized costs of the Company’s
oil and natural gas properties included $10,336,219 relating to acquisition costs of proved properties which are being amortized
by the unit-of-production method using total proved reserves and $28,448,457 relating to exploratory well costs and additional
development costs which are being amortized by the unit-of-production method using proved developed reserves.
Capitalized costs related to proved oil and natural gas properties,
including wells and related equipment and facilities, are evaluated for impairment based on the Company’s analysis of undiscounted
future net cash flows. If undiscounted future net cash flows are insufficient to recover the net capitalized costs related to proved
properties, then the Company recognizes an impairment charge in income equal to the difference between carrying value and the estimated
fair value of the properties. Estimated fair values are determined using discounted cash flow models. The discounted cash flow
models include management’s estimates of future oil and natural gas production, operating and development costs, and discount
rates. In June 2012, the Company recorded a $1,775,796 impairment charge related to its Wolfberry assets located in the Texas counties
of Dawson, Howard, Martin and Borden. The impairment charge represents the difference between the properties’ carrying value
and their estimated fair market value. The impairment expense is included in impairment of oil & gas properties in the accompanying
Consolidated Statements of Operations. Effective August 1, 2012, the Company sold its Wolfberry assets, described above, for a
purchase price of $2,250,000. As a result of the sale, the Company recorded a loss of $47,607.
Uncertainties affect the recoverability of these costs as
the recovery of the costs outlined above are dependent upon the Company obtaining and maintaining leases and achieving commercial
production or sale.
NOTE 4– OIL AND NATURAL GAS PROPERTIES AND OTHER
EQUIPMENT (continued)
Other property and equipment
The historical cost of other property and equipment, presented
on a gross basis with accumulated depreciation is summarized as follows:
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
(As Restated)
|
|
Other property and equipment
|
|
$
|
203,107
|
|
|
$
|
222,461
|
|
Less accumulated depreciation
|
|
|
(136,274
|
)
|
|
|
(126,473
|
)
|
Net property and equipment
|
|
$
|
66,833
|
|
|
$
|
95,988
|
|
NOTE 5 – STOCKHOLDERS’ EQUITY AND EARNINGS
PER SHARE
Stock Options
At September 30, 2012, options to purchase 87,500 shares
of stock at $4.80 per share remain outstanding, all of which are held by current, or former, members of the Company’s Board
of Directors.
Earnings (Loss) Per Common Share
The Company reports basic earnings (loss) per common share,
which excludes the effect of potentially dilutive securities, and diluted earnings (loss) per common share, which includes the
effect of all potentially dilutive securities unless their impact is anti-dilutive. The following are reconciliations of the numerators
and denominators of basic and diluted earnings per share:
|
|
Three Month Periods
|
|
|
Nine Month Periods
|
|
|
|
September 30, 2012
|
|
|
September 30, 2011
|
|
|
September 30, 2012
|
|
|
September 30, 2011
|
|
Net income (loss) (numerator):
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) – basic
|
|
$
|
(605,973
|
)
|
|
$
|
(249,555
|
)
|
|
$
|
596,929
|
|
|
$
|
(471,068
|
)
|
Weighted-average shares (denominator):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares – basic
|
|
|
16,151,946
|
|
|
|
16,151,946
|
|
|
|
16,151,946
|
|
|
|
14,539,309
|
|
Dilution effect of warrants, treasury method (1)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Dilution effect of stock options, treasury method (2)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Weighted-average shares – diluted
|
|
|
16,151,946
|
|
|
|
16,151,946
|
|
|
|
16,151,946
|
|
|
|
14,539,309
|
|
Earnings (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.04
|
)
|
|
|
(0.02
|
)
|
|
$
|
0.04
|
|
|
|
(0.03
|
)
|
Diluted
|
|
$
|
(0.04
|
)
|
|
|
(0.02
|
)
|
|
$
|
0.04
|
|
|
|
(0.03
|
)
|
|
(1)
|
Warrants to purchase 3,603,125 shares of the Company’s common stock were excluded from
this calculation because they were anti-dilutive during the periods presented.
|
|
(2)
|
Stock options to purchase 87,500 shares of the Company’s common stock were excluded from
this calculation because they were anti-dilutive during the periods presented.
|
NOTE 6 – RELATED PARTY TRANSACTIONS
The Company paid $163,000 in consulting fees in the nine
month period ended September 30, 2011to BDR Consulting, Inc. (“BDR”), a member of CCJ/BDR Investments, L.L.C., who
owned a combined 64.108% limited partnership interest in Pure Gas Partners, L.P. The president of BDR also served on
the Board of Directors and was the Chief Executive Officer of Pure Energy Group, Inc. BDR’s services have not been used since
the termination agreement in June 2011.
On April 11, 2012, the Company advanced its then Chief Executive
Officer, E. Willard Gray, II, $119,575 related to the change in control provisions in Mr. Gray’s employment agreement. At
June 30, 2012, $42,070 remained outstanding (shown as Accounts receivable - related party on the Balance Sheet), which was deducted
from the second change of control payment to him from the Company in July 2012.
During the nine months ended September 30, 2012, Red Mountain
Resources, Inc. incurred approximately $417,028 for general and administrative expenses and operating costs that will be reimbursed
by the Company for accounting services and attendance of certain of the Company’s directors and officers at the Company’s
annual meeting of stockholders and for costs associated with workovers on three of the Company’s salt water disposal wells,
of which $370,579 remained unpaid at September 30, 2012. The expenditures pertaining to the operating costs were incurred pursuant
to a technical services agreement between the Company and Red Mountain Resources, Inc.
NOTE 7 – LONG TERM - DEBT
At September 30, 2012 and December 31, 2011, long-term debt
consisted of the following items, excluding the operating line of credit (See Note 8):
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
(As Restated)
|
|
7½% Debentures, Series 2005
|
|
$
|
—
|
|
|
$
|
3,395,000
|
|
Total Long-term Debt
|
|
$
|
—
|
|
|
$
|
3,395,000
|
|
7½% Debentures, Series 2005
On March 1, 2005, Pure and Pure Sub issued 7 ½ % Debentures,
Series 2005, in the principal amount of $5,500,000 (the “Pure Debentures”. The Pure Debentures were secured by all
revenues of the issuer and all money held in the funds and accounts created under the Indenture. The Pure Debentures would have
matured on March 1, 2015, if not redeemed, with principal and interest payable semi-annually on March 1 and September 1. The Pure
Debentures were redeemed on March 1, 2012. As of September 30, 2012 and December 31, 2011, the balance payable was $0 and $3,395,000,
respectively. Interest expense related to the Pure Debentures for the nine months ended September 30, 2012 and 2011 was $43,708
and $223,505, respectively.
As permitted by the bond debt agreement, the Company purchased
bonds on the open market at its discretion. Pure Debentures held by the Company at September 30, 2012 and December 31, 2011 totaled
$0 and $100,000, respectively. These Pure Debentures were purchased at a discount of $16,719 during 2011. The Pure Debentures held
by the Company are shown as a reduction of bonds payable on the balance sheet as follows:
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
(As Restated)
|
|
Bonds Payable
|
|
$
|
—
|
|
|
$
|
3,495,000
|
|
Less: Bonds held by the Company
|
|
|
—
|
|
|
|
(100,000
|
)
|
Total
|
|
$
|
—
|
|
|
$
|
3,395,000
|
|
NOTE 7 – LONG TERM - DEBT (continued)
Notes Payable Green Shoe Investments
In connection with the merger, the Company, as the accounting
acquirer, assumed an unsecured loan from Green Shoe Investments Ltd. (“Green Shoe”) in the principal amount of $487,000
at an interest rate of 5.0%
On April 26, 2011, the Company entered into a Loan Agreement
with Green Shoe, and the Company executed and delivered a Promissory Note to Green Shoe in connection therewith. The
amount of the Promissory Note and the loan from Green Shoe (the “Green Shoe Loan”) was $550,936 and the purpose of
the Green Shoe Loan was to consolidate and extend all of the loans owed by the Company and its predecessors to Green Shoe including
without limitation the following: (i) loan dated May 9, 2008 in the principal amount of $100,000, (ii) loan dated May
23, 2008 in the principal amount of $150,000, (iii) loan dated July 18, 2008 in the principal amount of $50,000, (iv) loan dated
February 24, 2009 in the principal amount of $100,000, and (v) loan dated April 29, 2009 in the principal amount of $87,000 plus
accrued interest of $63,936. The Green Shoe Loan is unsecured.
Beginning March 31, 2011 (the effective date of the Promissory
Note), the amounts owed under the Promissory Note began to accrue interest at a rate of 9.99%, and the Promissory Note provided
that no payments of principal or interest were due until the maturity date of September 30, 2012. The Company is obligated
to pay all accrued interest and make a principal payment equal to one-third of the principal owed upon the closing of an equity
offering resulting in a specified amount of net proceeds to the Company. In addition, Green Shoe was granted the right
to convert the principal and interest owed into shares of common stock of the Company at a conversion price of $4.00 per share.
The principal balance of the note as of September 30, 2012 is $367,309.
The debt and associated accrued interest were not repaid
at maturity on September 30, 2012. The Company has been notified by the lender that it is in default on the note. The Company
is currently in discussions to convert the debt to equity and anticipates this will be resolved prior to the end of the fiscal
year.
Notes Payable Little Bay Consulting
In connection with the merger, the Company, as the accounting
acquirer, assumed an unsecured loan from Little Bay Consulting SA (“Little Bay”) in the principal amount of $520,000
at an interest rate of 5%.
On April 26, 2011, the Company entered into a Loan Agreement
with Little Bay, and the Company executed and delivered a Promissory Note to Little Bay in connection therewith. The
amount of the Promissory Note and the loan from Little Bay (the “Little Bay Loan”) was $595,423 and the purpose of
the Little Bay Loan was to consolidate and extend all of the loans owed by the Company and its predecessors to Little Bay including
without limitation the following: (i) loan dated March 7, 2008 in the original principal amount of $220,000, (ii) loan dated July
18, 2008 in the original principal amount of $100,000, and (iii) loan dated October 3, 2008 in the principal amount of $200,000
plus accrued interest of $75,423. The Little Bay Loan is unsecured.
Beginning March 31, 2011 (the effective date of the Promissory
Note), the amounts owed under the Promissory Note began to accrue interest at a rate of 9.99%, and the Promissory Note provided
that no payments of principal or interest were due until the maturity date of September 30, 2012. The Company is obligated
to pay all accrued interest and make a principal payment equal to one-third of the principal owed upon the closing of an equity
offering resulting in a specified amount of net proceeds to the Company. In addition, Little Bay was granted the right
to convert the principal and interest owed into shares of common stock of the Company at a conversion price of $4.00 per share.
The principal balance of the note as of September 30, 2012 is $396,969.
The debt and associated accrued interest were not repaid
at maturity on September 30, 2012. The Company has been notified by the lender that it is in default on the note. The Company
is currently in discussions to convert the debt to equity and anticipates this will be resolved prior to the end of the fiscal
year.
NOTE 8 – OPERATING LINE OF CREDIT
As of December 31, 2011, the borrowing base on the line of
credit was $4,500,000. Effective March 1, 2012, the borrowing base was increased to $9,500,000. The interest rate was calculated
at the greater of the adjusted base rate or 4%. The line of credit is collateralized by producing wells and matures on January
14, 2014. As the result of the sale of certain interests in oil and gas properties, effective August 1, 2012, the borrowing base
was reduced by $750,000 and that amount was repaid to TCB out of the sale proceeds.
As of September 30, 2012 and December 31, 2011, the outstanding
balance on the line of credit was $8,750,000 and $2,381,000, respectively.
As of September 30, 2012, the Company was in violation of
two covenants under its agreement with Texas Capital Bank TCB, the Current Ratio covenant and the negative covenant related
to past due invoices. The Company is seeking a waiver for the covenant violations.
NOTE 9 – CREDITORS PAYABLE
In 2002, the prior owner of Pure Sub filed a petition for
reorganization with the United States Bankruptcy Court. According to the plan of reorganization, three creditors were
to receive a combined amount of approximately $3,000,000 for their claims out of future net revenues of Pure Sub (defined as revenues
from producing wells net of lease operating expenses and other direct costs).
The net estimated revenue distribution due to creditors in
2013 based on 2012 net revenues is $758,167 as of September 30, 2012 and is presented as a current liability. As of September 30,
2012 and December 31, 2011, the combined creditors’ payable balance was $1,352,783 and $1,539,545, respectively.
NOTE 10 – COMMITMENTS AND CONTINGENCIES
The Company is subject to federal and state laws and regulations
relating to the protection of the environment. Environmental risk is inherent to oil and natural gas operations and the Company
could be subject to environmental cleanup and enforcement actions. The Company manages this environmental risk through
appropriate environmental policies and practices to minimize the impact to the Company.
As reported in our 10-Q for the period ended June 30, 2011,
on May 4, 2011, Clifton M. (Marty) Bloodworth filed a lawsuit in the State District Court of Midland County, Texas, against Doral
West Corp. d/b/a Doral Energy Corp. and Everett Willard Gray II. Mr. Bloodworth alleges that Mr. Gray, as CEO of the Company, made
false representations which induced Mr. Bloodworth to enter into an employment contract that was subsequently breached by the Company.
The claims that Mr. Bloodworth has alleged are: breach of his employment agreement with Doral, common law fraud, civil conspiracy
breach of fiduciary duty, and violation of the Texas Deceptive Trade Practices-Consumer Protection Act. Mr. Bloodworth is seeking
damages of approximately $280,000. Mr. Gray and the Company deny that Mr. Bloodworth’s claims have any merit.
NOTE 11 – PRICE RISK MANAGEMENT ACTIVITIES
ASC 815-25 (formerly SFAS No. 133 “Accounting for Derivative
Instruments and Hedging Activities”) requires that all derivative instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of each derivative are recorded each period in current earnings or other comprehensive income,
depending on whether the derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction.
When choosing to designate a derivative as a hedge, management formally documents the hedging relationship and its risk-management
objective and strategy for undertaking the hedge, the hedging instrument, the item, the nature of the risk being hedged, how the
hedging instrument’s effectiveness in offsetting the hedged risk will be assessed, and a description of the method of measuring
effectiveness. This process includes linking all derivatives that are designated as cash-flow hedges to specific cash flows associated
with assets and liabilities on the balance sheet or to specific forecasted transactions. Based on the above, management has determined
the swaps noted below do not qualify for hedge accounting treatment.
At September 30, 2012, we had a net derivative asset of $321,491,
as compared to a net derivative liability of $84,994 at the prior year end. The change in net derivative asset/liability is recorded
as non-cash mark-to-market income or loss. Mark-to-market income of $406,485 was recorded in the nine months ended September 30,
2012, as compared to $400,786 in the same period of the prior year. Net realized hedge settlement gain for the nine months ended
September 30, 2012 totaled $108,416 as compared to $51,892 in the same period of the prior year. The combination of these two components
of derivative expense/income is reflected in “Other Income (Expense)” on the Statements of Operations as “Gain
(loss) on derivatives.”
As of September 30, 2012, the Company had crude oil swaps
in place relating to a total of 4,000 Bbls per month, as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value of Outstanding
Derivative Contracts
(1)
as of
|
|
Transaction
|
|
|
|
|
|
|
|
|
Price Per
|
|
|
Volumes Per
|
|
|
September 30,
|
|
|
December 31,
|
|
Date
|
|
|
Type
(2)
|
|
|
Beginning
|
|
|
Ending
|
|
|
Unit
|
|
|
Month
|
|
|
2012
|
|
|
2011
|
|
|
March
2011
|
|
|
|
Swap
|
|
|
|
04/01/2011
|
|
|
|
02/28/20
13
|
|
|
$
|
104.55
|
|
|
|
1,000
|
|
|
$
|
57,189
|
|
|
$
|
83,594
|
|
|
November
2011
|
|
|
|
Swap
|
|
|
|
12/01/2011
|
|
|
|
11/30/2014
|
|
|
$
|
93.50
|
|
|
|
2,000
|
|
|
|
41,630
|
|
|
|
(168,588
|
)
|
|
February
2012
|
|
|
|
Swap
|
|
|
|
03/01/2012
|
|
|
|
02/28/2014
|
|
|
$
|
106.50
|
|
|
|
1,000
|
|
|
|
222,672
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
321,491
|
|
|
$
|
(84,994
|
)
|
(1) The fair value of the Company’s outstanding transactions is presented on the balance sheet by counterparty. Currently all of our derivatives are with the same counterparty. The balance is shown as current or long-term based on our estimate of the amounts that will be due in the relevant time periods at currently predicted price levels. Amounts in parentheses indicate liabilities.
|
|
(2) These crude oil hedges were entered into on a per barrel delivered price basis, using the NYMEX - West Texas Intermediate Index, with settlement for each calendar month occurring following the expiration date, as determined by the contracts.
|
NOTE 12 – FAIR VALUE MEASUREMENTS
Cross Border Resources, Inc. commodity derivatives are measured
at fair value in the financial statements. The Company’s financial assets and liabilities are measured using input from three
levels of the fair value hierarchy. A financial asset or liability classification within the hierarchy is determined based on the
lowest level input that is significant to the fair value measurement. The three levels are as follows:
|
Level 1 –
|
Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that Cross Border Resources, Inc. has the ability to access at the measurement date.
|
|
|
|
|
Level 2 –
|
Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
|
|
|
|
|
Level 3 –
|
Unobservable inputs reflect Cross Border Resources, Inc’s judgments about the assumptions market participants would use in pricing the asset of liability since limited market data exists. The Company develops these inputs based on the best information available, using internal and external data.
|
The following table presents the Company’s assets and
liabilities recognized in the balance sheet and measured at fair value on a recurring basis as of September 30, 2012:
|
|
Input Levels for Fair Value Measurements
|
|
Description
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Current Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity derivatives, current portion
|
|
$
|
—
|
|
|
$
|
197,549
|
|
|
$
|
—
|
|
|
$
|
197,549
|
|
Other Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity derivatives, long-term
|
|
|
|
|
|
|
123,942
|
|
|
|
|
|
|
|
123,942
|
|
|
|
$
|
—
|
|
|
$
|
321,491
|
|
|
$
|
—
|
|
|
$
|
321,491
|
|
The fair value of derivative assets is determined using
forward price curves derived from market price quotations, externally developed and commercial models, with internal and external
fundamental data inputs. Market price quotations are obtained from independent energy brokers and direct communication with market
participants.
NOTE 13 – SUBSEQUENT EVENTS
On November 7, 2012, the Company issued 150,000 shares (the
“Shares”) of its common stock to Everett Willard Gray II, in full satisfaction of any remaining amounts owed to Mr.
Gray by the Company pursuant to Mr. Gray’s employment agreement with the Company, dated as of January 31, 2011 and amended
as of March 6, 2012 and April 20, 2012 (as amended, the “Employment Agreement”). Mr. Gray resigned as the Company’s
Chairman and Chief Executive Officer effective May 31, 2012 in connection with the transactions described in the Company’s
Current Report on Form 8-K filed on April 24, 2012. The Employment Agreement provided for him to receive severance payments of
$478,298, payable in installments, of which $239,149 remained to be paid.