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

FORM 10-Q

(Mark One)

x Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarter Ended September 30, 2015.

o Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 (No fee required)
For the transition period from _______ to _______.

Commission file number : 001-36247

TORCHLIGHT ENERGY RESOURCES, INC.

(Name of registrant in its charter)

Nevada
74-3237581
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)

5700 West Plano Pkwy, Suite 3600
Plano, Texas 75093
(Address of Principal Executive Offices)
 
(214) 432-8002
(Issuer's Telephone Number, Including Area Code)

 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No x

As of November 9, 2015 , there were 31,240,273 shares of the registrant’s common stock outstanding (the only class of common stock).  
 

 
1

 
 
 
FORM 10-Q

TABLE OF CONTENTS

Note About Forward-Looking Statements
3
     
PART I
FINANCIAL INFORMATION
4
     
Item 1.
Consolidated Financial Statements
4
     
 
Consolidated Balance Sheets (Unaudited)
4
     
 
Consolidated Statements of Operations (Unaudited)
5
     
 
Consolidated Statements of Cash Flows (Unaudited)
6
     
 
Notes to Consolidated Financial Statements (Unaudited)
7
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
15
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
21
     
Item 4.
Controls and Procedures
21
     
PART II
OTHER INFORMATION
22
     
Item 1.
Legal Proceedings
22
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
22
     
Item 5.
Other Information
22
     
Item 6.
Exhibits
22
     
 
Signatures
24










 

 





 
2

 

 
NOTE ABOUT FORWARD-LOOKING STATEMENTS
 
 
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, among other things, statements regarding plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements, which are other than statements of historical facts. Forward-looking statements may appear throughout this report, including without limitation, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report and in our Annual Report on Form 10-K for the year ended December 31, 2014, and in particular, the risks discussed in our Form 10-K under the caption “Risk Factors” in Item 1A therein, and those discussed in other documents we file with the Securities and Exchange Commission (“SEC”). Important factors that in our view could cause material adverse effects on our financial condition and results of operations include, but are not limited to, risks associated with the company's ability to obtain additional capital in the future to fund planned expansion, the demand for oil and natural gas, general economic factors, competition in the industry and other factors that may cause actual results to be materially different from those described herein as anticipated, believed, estimated or expected. We undertake no obligation to revise or publicly release the results of any revision to any forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
 
As used herein, the “Company,” “we,” “Torchlight,” “our,” and similar terms include Torchlight Energy Resources, Inc. and its subsidiaries, unless the context indicates otherwise.
 
 

 
 

 
 
















 
3

 

PART I   FINANCIAL INFORMATION
 
ITEM 1.  FINANCIAL STATEMENTS
 
TORCHLIGHT ENERGY RESOURCES, INC.
           
CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited)
           
             
   
September 30,
   
December 31,
 
   
2015
   
2014
 
ASSETS
 
Current assets:
           
Cash
  $ 1,891,607     $ 179,787  
Accounts receivable
    85,534       223,371  
Production revenue receivable
    301,896       210,435  
Note receivable
    507,154       515,748  
Prepayments - development costs
    10,000       20,602  
Prepaid expenses
    -       29,634  
Total current assets
    2,796,191       1,179,577  
                 
Investment in oil and gas properties, net
    14,224,686       34,498,681  
Office equipment
    46,448       55,150  
Debt issuance costs, net
    12,959       353,733  
Other assets
    123,222       63,223  
                 
TOTAL ASSETS
  $ 17,203,505     $ 36,150,364  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current liabilities:
               
Accounts payable
  $ 4,419,534     $ 4,018,306  
Accrued liabilities
    678,750       240,000  
Related party payables
    90,000       90,000  
Convertible promissory notes, (Series A) net of discount of
               
   $700,178 at December 31, 2014
    -       7,417,420  
Notes payable within one year
    451,704       829,719  
Due to working interest owners
    37,348       73,439  
Interest payable
    258,000       383,741  
Total current liabilities
    5,935,336       13,052,625  
                 
Convertible promissory notes, (Series B) net of discount of $437,919 at September 30, 2015 and $625,457 at December 31, 2014
    4,131,581       3,944,043  
Asset retirement obligation
    37,544       35,951  
                 
Commitments and contingencies
    -       -  
                 
Stockholders’ equity:
               
Preferred stock, par value $.001, 10,000,000 shares authorized,
               
   135,000 shares issued and outstanding
    135       -  
Common stock, par value $0.001 per share; 100,000,000 shares authorized;
    31,242       23,235  
 31,240,273 issued and outstanding at September 30, 2015
               
23,235,441 issued and outstanding at December 31, 2014
               
Additional paid-in capital
    60,455,550       43,108,752  
Warrants outstanding
    14,719,039       7,636,320  
Accumulated deficit
    (68,106,920 )     (31,650,561 )
Total stockholders' equity
    7,099,045       19,117,745  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 17,203,505     $ 36,150,364  
                 
The accompanying notes are an integral part of these consolidated financial statements.


 
4

 
 
TORCHLIGHT ENERGY RESOURCES, INC.
 
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
 
                         
                         
                         
   
THREE MONTHS
   
THREE MONTHS
   
NINE MONTHS
   
NINE MONTHS
 
   
ENDED
   
ENDED
   
ENDED
   
ENDED
 
   
September 30, 2015
   
September 30, 2014
   
September 30, 2015
   
September 30, 2014
 
Revenue
                       
Oil and gas sales
  $ 400,030     $ 1,941,715     $ 1,442,857     $ 4,214,720  
SWD and royalties
    415       12,305       57,485       61,269  
                                 
Cost of revenue
    (159,082 )     (429,353 )     (669,626 )     (1,005,588 )
                                 
Gross income
    241,363       1,524,667       830,717       3,270,401  
                                 
                                 
Operating expenses:
                               
General and administrative expense
    3,359,679       2,295,901       12,255,704       9,435,148  
Impairment expense
    -       -       22,438,114       -  
Depreciation, depletion and amortization
    203,348       777,016       902,153       1,739,719  
Total operating expenses
    3,563,027       3,072,917       35,595,971       11,174,867  
                                 
                                 
Other income (expense)
                               
Other income
    -       -       (962 )     -  
Interest income
    (0 )     14       (0 )     70  
Interest and accretion expense
    60,958       (1,266,099 )     1,692,067       (5,402,543 )
Loss on sale
    -       -       -       -  
Total other income (expense)
    60,958       (1,266,085 )     1,691,105       (5,402,473 )
                                 
                                 
Net loss before taxes
    (3,382,622 )     (2,814,335 )     (36,456,359 )     (13,306,939 )
                                 
Provision for income taxes
    -       -       -       -  
                                 
Net (loss)
  $ (3,382,622 )   $ (2,814,335 )   $ (36,456,359 )   $ (13,306,939 )
                                 
                                 
                                 
Loss per share:
                               
Basic and Diluted
  $ (0.16 )   $ (0.15 )   $ (2.23 )   $ (0.85 )
Weighted average shares outstanding:
                               
Basic and Diluted
    21,533,966       18,231,409       16,349,023       15,687,540  
                                 
  The accompanying notes are an integral part of these consolidated financial statements.

 
5

 
 
TORCHLIGHT ENERGY RESOURCES, INC.
           
CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited)
           
   
NINE MONTHS
   
NINE MONTHS
 
   
ENDED
   
ENDED
 
   
September 30, 2015
   
September 30, 2014
 
Cash Flows From Operating Activities
           
Net (loss)
  $ (36,456,359 )   $ (13,306,939 )
Adjustments to reconcile net loss to net cash from operations:
               
Stock based compensation
    9,382,259       5,834,186  
Accretion of convertible note discounts
    1,228,161       4,676,739  
Impairment expense
    22,438,114       -  
Depreciation, depletion and amortization
    902,153       1,739,719  
Change in:
               
Accounts receivable
    48,975       96,258  
Note receivable
    8,594       (294,318 )
Production revenue receivable
    (91,461 )     (972,026 )
Prepayment of development costs
    10,602       (636,635 )
Prepaid expenses
    29,634       (15,231 )
Debt issuance costs
    -       (150,000 )
Other assets
    (59,999 )     (4,471 )
Accounts payable and accrued liabilities
    1,198,036       2,706,835  
Due to working interest owners
    (36,092 )     (217,934 )
Asset retirement obligation
    1,593       10,073  
Interest payable
    467,550       88,885  
Capitalized interest
    (577,576 )     (260,096 )
Net cash provided by (used) in operating activities
    (1,505,816 )     (704,955 )
                 
Cash Flows From Investing Activities
               
Investment in oil and gas properties
    (4,369,187 )     (16,363,979 )
Acquisition of office equipment
    (1,191 )     (53,960 )
Proceeds from sale of Leases
    1,951,918       -  
Net cash used in investing activities
    (2,418,460 )     (16,417,939 )
                 
Cash Flows From Financing Activities
               
Proceeds from sale of common stock
    1,300,000       10,632,791  
Proceeds from sale of preferred stock
    13,500,000       -  
Repayment of convertible notes
    (8,859,011 )     -  
Proceeds from warrant exercise
    -       706,782  
Proceeds from promissory notes
    412,000       4,623,195  
Repayment of promissory notes
    (716,893 )     (90,258 )
Net cash provided by financing activities
    5,636,096       15,872,510  
                 
Net increase (decrease) in cash
    1,711,820       (1,250,384 )
Cash - beginning of period
    179,787       1,811,713  
                 
Cash - end of period
  $ 1,891,607     $ 561,329  
                 
Supplemental disclosure of cash flow information:
               
Non cash transactions:
               
Common stock issued for services
  $ 783,668     $ 1,249,077  
Common stock issued for mineral interests
  $ -     $ 5,136,879  
Warrants issued for services
  $ 1,080,000     $ 4,663,865  
Common stock issued in conversion of promissory notes
  $ 150,000     $ 2,185,535  
Warrants issued in connection with promissory notes
  $ 439,800     $ 562,354  
Beneficial conversion feature on promissory notes
  $ -     $ 195,466  
Common stock issued in warrant exercises
  $ -     $ 1,240,000  
Cash paid for interest
  $ 1,108,059     $ 855,703  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
6

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
1. NATURE OF BUSINESS

Torchlight Energy Resources, Inc. was incorporated in October 2007 under the laws of the State of Nevada as Pole Perfect Studios, Inc. (“PPS”).  From its incorporation to November 2010, the company was primarily engaged in business start-up activities.

On November 23, 2010, we entered into and closed a Share Exchange Agreement (the “Exchange Agreement”) between the major shareholders of PPS and the shareholders of Torchlight Energy, Inc. (“TEI”).  As a result of the transactions effected by the Exchange Agreement, at closing TEI became our wholly-owned subsidiary, and the business of TEI became our sole business.  TEI was incorporated under the laws of the State of Nevada in June 2010.  We are engaged in the acquisition, exploitation and/or development of oil and natural gas properties in the United States.  In addition to TEI, we also operate our business through our wholly-owned subsidiaries Torchlight Energy Operating, LLC, a Texas limited liability company , and Hudspeth Oil Corporation, a Texas corporation.

On December 10, 2010, we effected a 4-for-1 forward split of our shares of common stock outstanding.  All owners of record at the close of business on December 10, 2010 (record date) received three additional shares for every one share they owned.  All share amounts reflected throughout this report take into account the 4-for-1 forward split.

Effective February 8, 2011, we changed our name to “Torchlight Energy Resources, Inc.”  In connection with the name change, our ticker symbol changed from “PPFT” to “TRCH.”

The Company is engaged in the acquisition, exploration, development and production of oil and gas properties within the United States. The Company’s success will depend in large part on its ability to obtain and develop profitable oil and gas interests.

2. GOING CONCERN

These consolidated financial statements have been prepared in accordance with generally accepted accounting principles applicable to a going concern, which assumes that the Company will be able to meet its obligations and continue its operations for its next fiscal year.

At September 30, 2015, the Company had not yet achieved profitable operations. We had a net loss of approximately $36.5 million for the nine months ended September 30, 2015 and had accumulated losses of $68,106,920 since our inception to September 30, 2015, and expect to incur further losses in the development of our business.  Working Capital as of September 30, 2015 was negative $3,139,145. The Company’s ability to continue as a going concern is dependent on its ability to generate future profitable operations and/or to obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due.  Management’s plan to address the Company’s ability to continue as a going concern includes:  (1) obtaining debt or equity funding from private placement or institutional sources; (2) obtain loans from financial institutions, where possible; (3) participating in joint venture transactions with third parties; or (4) divestiture of certain assets of the Company.  Although management believes that it will be able to obtain the necessary funding to allow the Company to remain a going concern through the methods discussed above, there can be no assurances that such methods will prove successful.  The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
Planned Divestiture of Hunton Project

On April 8, 2015, we announced that we are seeking to divest certain of our Hunton assets located in Logan and Kingfisher Counties, Oklahoma.  

On October 14, 2015, Husky Ventures, (Husky) the operator of the Company’s properties in the Chisholm Trail AMI in Oklahoma, entered into an agreement to sell Husky’s Chisholm Trail working interests to Gastar Exploration Inc. with an expected closing date of November 30, 2015.
 
On November 5, 2015 Torchlight entered into an agreement with Husky Ventures to transfer its interests in Chisholm Trail assets to Husky in exchange for the cancellation of the Company’s entire liability to Husky on Joint Interest Billings in the approximate amount of $2.9 million. The agreement was executed with the intention of Husky including the Torchlight interests in producing properties and undeveloped acreage in Chisholm Trail as part of the Husky sale to Gastar. Torchlight will then participate in the proceeds of Husky’s sale to Gastar in accordance with the terms of Torchlight’s agreement with Husky.  Alternatively, if the Gastar transaction does not close, Torchlight and Husky will work to locate a different purchaser, and Torchlight will participate in the proceeds of any other sale of the Chisholm Trail assets if Husky effects such sale within one-year from October 31, 2015.  Regardless of whether Husky effects a sale to Gastar or any other party, the liability to Husky on Joint Interest Billings will remain extinguished, under the terms of Torchlight’s agreement with Husky.
 
The effective date of the transfer of the properties is to be July 1, 2015. For reporting purposes in this Form 10-Q for the quarter ended September 30, 2015 the July through September net revenue from the Chisholm Trail properties of approximately $90,000 is included in the accompanying Consolidated Statement of Operations. Upon closing, there will be an adjustment to the sale proceeds for the net revenue attributable to the period from July 1, 2015 through the actual closing date (including the $90,000) to reflect the revenue and lease operating expense cut off adjustment back to July 1.

 
7

 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
2. GOING CONCERN - continued
 
The projected total proceeds from the sale attributable to the Torchlight interests is approximately $4,600,000 from which the Company’s outstanding joint interest billing account payable of approximately $2.9 million will be paid in full to the operator with the remaining balance of the proceeds, estimated to be $1,400,000 after expenses in connection with the transaction, to be received by the Company in cash.
 
Gain on the sale will be recorded in the fourth quarter, 2015 to the extent that the net proceeds from the final sale closing exceed the book value of the Chisholm Trail wells and leases as adjusted by the impairment expense recorded as of June 30, 2015. The gain is estimated at approximately $600,000.
 
3. SIGNIFICANT ACCOUNTING POLICIES

The Company maintains its accounts on the accrual method of accounting in accordance with accounting principles generally accepted in the United States of America. Accounting principles followed and the methods of applying those principles, which materially affect the determination of financial position, results of operations and cash flows are summarized below:

Use of estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and certain assumptions that affect the amounts reported in these consolidated financial statements and accompanying notes. Actual results could differ from these estimates.

Basis of presentation —The financial statements are presented on a consolidated basis and include all of the accounts of Torchlight Energy Resources Inc. and its wholly owned subsidiaries, Torchlight Energy, Inc., Torchlight Energy Operating, LLC, and Hudspeth Oil Corporation. All significant intercompany balances and transactions have been eliminated.
 
Risks and uncertainties – The Company’s operations are subject to significant risks and uncertainties, including financial, operational, technological, and other risks associated with operating an emerging business, including the potential risk of business failure.

Concentration of risks – The Company’s cash is placed with a highly rated financial institution, and the Company periodically reviews the credit worthiness of the financial institutions with which it does business. At times the Company’s cash balances are in excess of amounts guaranteed by the Federal Deposit Insurance Corporation.
 
Fair value of financial instruments – Financial instruments consist of cash, accounts receivable, accounts payable, notes payable to related party, and convertible promissory notes. The estimated fair values of cash, accounts receivable, accounts payable, and related party payables approximate the carrying amount due to the relatively short maturity of these instruments. The carrying amounts of the convertible promissory notes approximate their fair value giving affect for the term of the note and the effective interest rates.

For assets and liabilities that require re-measurement to fair value the Company categorizes them in a three-level fair value hierarchy as follows:

·Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
·Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration.
·Level 3 inputs are unobservable inputs based on management’s own assumptions used to measure assets and liabilities at fair value.

A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

Accounts receivable and Production revenue receivable – Accounts receivable consist of uncollateralized oil and natural gas revenues due under normal trade terms, as well as amounts due from working interest owners of oil and gas properties for their share of expenses paid on their behalf by the Company. Management reviews receivables periodically and reduces the carrying amount by a valuation allowance that reflects management’s best estimate of the amount that may not be collectible. As of September 30, 2015 and December 31, 2014 no valuation allowance was considered necessary.

Investment in oil and gas properties – The Company uses the full cost method of accounting for exploration and development activities as defined by the Securities and Exchange Commission (“SEC”). Under this method of accounting, the costs of unsuccessful, as well as successful, exploration and development activities are capitalized as properties and equipment. This includes any internal costs that are directly related to property acquisition, exploration and development activities but does not include any costs related to production, general corporate overhead or similar activities.

Oil and gas properties include costs that are excluded from costs being depleted or amortized. Oil and natural gas property costs excluded represent investments in unevaluated properties and include non-producing leasehold, geological, and geophysical costs associated with leasehold or drilling interests and exploration drilling costs. The Company allocates a portion of its acquisition costs to unevaluated properties based on relative value. Costs are transferred to the full cost pool as the properties are evaluated over the life of the reservoir.

 
8

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3. SIGNIFICANT ACCOUNTING POLICIES - continued
 
Capitalized interest – The Company capitalizes interest on unevaluated properties during the periods in which they are excluded from costs being depleted or amortized.  During the nine months ended September 30, 2015 and the year ended December 31, 2014, the Company capitalized $577,576 and $371,116, respectively, of interest on unevaluated properties.

Depreciation, depletion, and amortization – The depreciable base for oil and natural gas properties includes the sum of all capitalized costs net of accumulated depreciation, depletion, and amortization (“DD&A”), estimated future development costs and asset retirement costs not included in oil and natural gas properties, less costs excluded from amortization. The depreciable base of oil and natural gas properties is amortized on a unit-of-production method.
 
Ceiling test – Future production volumes from oil and gas properties are a significant factor in determining the full cost ceiling limitation of capitalized costs. Under the full cost method of accounting, the Company is required to periodically perform a “ceiling test” that determines a limit on the book value of oil and gas properties. If the net capitalized cost of proved oil and gas properties, net of related deferred income taxes, plus the cost of unproved oil and gas properties, exceeds the present value of estimated future net cash flows discounted at 10 percent, net of related tax affects, plus the cost of unproved oil and gas properties, the excess is charged to expense and reflected as additional accumulated DD&A. The ceiling test calculation uses a commodity price assumption which is based on the unweighted arithmetic average of the price on the first day of each month for each month within the prior 12 month period and excludes future cash outflows related to estimated abandonment costs. The Company recognized impairment of $22,438,114 on its oil and gas properties during the three months ended June 30, 2015. No impairment was recognized at September 30, 2015 or at December 31, 2014. Due to the volatility of commodity prices, should oil and natural gas prices decline in the future, it is possible that an additional write-down could occur. Proved reserves are estimated quantities of crude oil, natural gas, and natural gas liquids, which geological and engineering data demonstrate with reasonable certainty to be recoverable from known reservoirs under existing economic and operating conditions. The independent engineering estimates include only those amounts considered to be proved reserves and do not include additional amounts which may result from new discoveries in the future, or from application of secondary and tertiary recovery processes where facilities are not in place or for which transportation and/or marketing contracts are not in place. Estimated reserves to be developed through secondary or tertiary recovery processes are classified as unevaluated properties.
 
The determination of oil and gas reserves is a subjective process, and the accuracy of any reserve estimate depends on the quality of available data and the application of engineering and geological interpretation and judgment. Estimates of economically recoverable reserves and future net cash flows depend on a number of variable factors and assumptions that are difficult to predict and may vary considerably from actual results. In particular, reserve estimates for wells with limited or no production history are less reliable than those based on actual production. Subsequent re-evaluation of reserves and cost estimates related to future development of proved oil and gas reserves could result in significant revisions toproved reserves.  Other issues, such as changes in regulatory requirements, technological advances, and other factors which are difficult to predict could also affect estimates of proved reserves in the future.

Gains and losses on the sale of oil and gas properties are not generally reflected in income. Sales of less than 100% of the Company’s interest in the oil and gas property are treated as a reduction of the capital cost of the field, with no gain or loss recognized, as long as doing so does not significantly affect the unit-of-production depletion rate. Costs of retired equipment, net of salvage value, are usually charged to accumulated depreciation.

Asset retirement obligations – Accounting principles require that the fair value of a liability for an asset’s retirement obligation (“ARO”) be recorded in the period in which it is incurred if a reasonable estimate of fair value can be made, and that the corresponding cost be capitalized as part of the carrying amount of the related long-lived asset. The liability is accreted to its then-present value each subsequent period, and the capitalized cost is depleted over the useful life of the related asset. Abandonment cost incurred is recorded as a reduction to the ARO liability.

Inherent in the fair value calculation of an ARO are numerous assumptions and judgments including the ultimate settlement amounts, inflation factors, credit adjusted discount rates, timing of settlement, and changes in the legal, regulatory, environmental, and political environments. To the extent future revisions to these assumptions impact the fair value of the existing ARO liability, a corresponding adjustment is made to the oil and gas property balance. Settlements greater than or less than amounts accrued as ARO are recorded as a gain or loss upon settlement.

Asset retirement obligation activity is disclosed in Note 10.

Share-based compensation – Compensation cost for equity awards is based on the fair value of the equity instrument on the date of grant and is recognized over the period during which an employee is required to provide service in exchange for the award. Compensation cost for liability awards is based on the fair value of the vested award at the end of each period.

Revenue recognition – The Company recognizes oil and gas revenues when production is sold at a fixed or determinable price, persuasive evidence of an arrangement exists, delivery has occurred and title has transferred, and collectability is reasonably assured.

 
9

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3. SIGNIFICANT ACCOUNTING POLICIES - continued
 
Basic and diluted earnings (loss) per share Basic earnings (loss) per common share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share is computed in the same way as basic earnings (loss) per common share except that the denominator is increased to include the number of additional common shares that would be outstanding if all potential common shares had been issued and if the additional common shares were dilutive.  The Company has not included potentially dilutive securities in the calculation of loss per share for any periods presented as the effects would be anti-dilutive.

Environmental laws and regulations – The Company is subject to extensive federal, state, and local environmental laws and regulations. Environmental expenditures are expensed or capitalized depending on their future economic benefit. The Company believes that it is in compliance with existing laws and regulations.

Recent accounting pronouncements
 
On August 27, 2014, the FASB issued ASU 2014-15, which provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of the Company’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. The ASU applies to all entities and is effective for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted.
 
In May 2014, the FASB issued ASU 2014-09 that introduces a new five-step revenue recognition model in which an entity should recognize 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. This ASU also requires disclosures sufficient to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company is currently evaluating the new guidance to determine the impact it will have on its consolidated financial statements.
 
In April 2014, the FASB issued ASU 2014-08, which includes amendments that change the requirements for reporting discontinued operations and require additional disclosures about discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations - that is, a major effect on the organization’s operations and financial results should be presented as discontinued operations. Additionally, the ASU requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The new standard is effective in the first quarter of 2015 for public organizations with calendar year ends. Early adoption would be permitted for any annual or interim period for which an entity’s financial statements have not yet been made available for issuance. The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements.
 
Other recently issued or adopted accounting pronouncements are not expected to have, or did not have, a material impact on the Company’s financial position or results from operations.

Subsequent events The Company evaluated subsequent events through November 9, 2015 , the date of issuance of the financial statements. Subsequent events are disclosed in Note 11.
 
4. RELATED PARTY PAYABLES

As of September 30, 2015, related party payables consisted of accrued and unpaid compensation to two of our executive officers totaling $90,000.

5. COMMITMENTS AND CONTINGENCIES

The Company is subject to contingencies as a result of environmental laws and regulations.  Present and future environmental laws and regulations applicable to the Company’s operations could require substantial capital expenditures or could adversely affect its operations in other ways that cannot be predicted at this time.  As of September 30, 2015, no amounts had been recorded because no specific liability has been identified that is reasonably probable of requiring the Company to fund any future material amounts.
 
6. STOCKHOLDERS’ EQUITY

The Company has authorized 10,000,000 shares of preferred stock with par value of $.001.
 
 
 
10

 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
6. STOCKHOLDERS’ EQUITY - continued
 
On June 9, 2015, under a Securities Purchase Agreement, we sold to certain accredited investors an aggregate of $9,800,000 in shares of Series A Convertible Preferred Stock, amounting to a total of 98,000 shares of the Series A Convertible Preferred Stock at a purchase price of $100 per share.  The designations, preferences, limitations, restrictions and relative rights of the Series A Convertible Preferred Stock are as follows: (i) a stated value of $100 per share; (ii) mandatory conversion one year after issuance (provided no insolvency event has occurred and subject to the restriction described in the following clause “(iv)”), with each holder having the right to convert at its election any time before that; (iii) a conversion price of $1.15 per shares of common stock; (iv) until stockholder approval is obtained, holders may not convert (and there shall not be any mandatory conversion) if such conversion will result in such holder beneficially owning in excess of 19.9% of our common stock; (v) a dividend in an annual amount equal to 12% on the outstanding stated value of each share payable in common stock or cash at the holder’s election; (vi) each holder shall be entitled to the number of votes equal to the number of shares of common stock into which such shares of Series A Convertible Preferred Stock could be converted; (vii) in the event of any voluntary or involuntary liquidation, dissolution or winding up, the holders will be entitled to be paid out of the assets available for distribution to our stockholders, before any payment is be made to the holders of common stock; and (viii) the holders will have the right to participate in up to 100%, in the aggregate, on a pro-rata basis, of any subsequent private placement offerings by us of our equity securities, on identical terms and conditions as set forth in such subsequent offering for so long as the holder owns the Series A Convertible Preferred Stock.
 
The preferred investors were provided 20% warrant coverage. A total of 1,704,346 warrants were issued with a five-year term and an exercise price of $1.40 per share of common stock. The warrants also provide that, until stockholder approval is obtained, holders may not exercise if such exercise will result in such holder beneficially owning in excess of 19.9% of our common stock.
 
At closing of the Securities Purchase Agreement, proceeds from the offering were used to pay off, in full, the holders of the 12% Series A Secured Convertible Promissory Notes (the “Senior Notes”), subject to the release of all liens and security interests.

On September 9, 2015, at our Annual Meeting of Stockholders, stockholders approved authorizing holders of Series A Preferred to convert preferred stock and exercise warrants received in connection therewith into a number of shares of common stock that would result in the holder beneficially owning in excess of 19.99% of our common stock.

On September 28, 2015, we sold a total of 37,000 shares of Series B Convertible Preferred Stock (the “Series B Preferred”) to certain investors at a purchase price of $100 per share for total consideration of $3,700,000 (the designation for the Series B Preferred is described below). Under the terms of the sale, we provided each investor 50% warrant coverage and accordingly issued the investors a total of 911,330 five-year warrants to purchase shares of our common stock at an exercise price of $2.23 per share. The warrants provide that holders may not exercise the warrant if such exercise will result in such holder beneficially owning in excess of 4.99% of our common stock. Additionally, under the terms of the transaction, we provided the investors registration rights under which a registration statement covering the shares of common stock underlying the Series B Preferred and warrants is to be filed within 30 days of closing.

This sale of Series B Preferred was effected through a Securities Purchase Agreement which was amended on September 23, 2015.  Under the amendment, the investors were provided the registration rights described above, the conversion price of the Series B Preferred was $2.03, the exercise price of the warrants was $2.23, and a blocker provision was added to the warrants whereby holders may not exercise if such exercise will result in the holder owning in excess of 4.99% of our common stock.

We filed the Certificate of Designation for the Series B Preferred with the Secretary of State of Nevada on September 25, 2015. The designations, preferences, limitations, restrictions and relative rights of the Series B Preferred are as follows: (i) a stated value of $100 per share; (ii) mandatory conversion one year after issuance, with each holder having the right to convert at its election any time before that; (iii) a conversion price of $2.03 per shares of common stock; (iv) a dividend in an annual amount equal to 12% on the outstanding stated value of each share payable in common stock or cash at the holder’s election; (v) each holder shall be entitled to the number of votes equal to the number of shares of common stock into which such shares of Series B Preferred could be converted; and (vi) in the event of any voluntary or involuntary liquidation, dissolution or winding up, the holders will be entitled to be paid out of the assets available for distribution to our stockholders, before any payment is made to the holders of common stock, but after the payment to the holders of Series A Convertible Preferred Stock.

The proceeds from the offering were used to reduce outstanding accounts payable and short term notes payable balances.
 
During the three months ended September 30, 2015 the Company issued 468,734 shares of common stock as compensation for services, with a total value of $783.668.

During the three months ended September 30, 2015 the Company issued 319,390 shares of common stock in payment of dividends payable on Series A Convertible Preferred Stock due on September 30, 2015. The total dividend value was $536.527. The dividend was payable in common stock with the number of shares determined by dividing the dividend payable amount by the conversion price on the preferred of $1.15. The dividend value was increased by $169.227 for accounting purposes to reflect the difference between the closing price of the common stock on September 30 of $1.68 and the $1.15 per share used to compute the number of shares required to pay the preferred dividend at September 30, 2015.

During the three months ended September 30, 2015 the Company issued 600,000 shares of common stock in conversion of a short term note payable, with a total value of $150,000.
 
 
11

 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
6. STOCKHOLDERS’ EQUITY - continued
 
During the three months ended September 30, 2015, the Company issued 750,000 warrants as compensation for services with a total value of $1,080,000.
 
During the three months ended September 30, 2015, the Company issued 390,000 warrants in connection with short term loans having a total value of $439.800.
 
A summary of stock options and warrants outstanding as of September 30, 2015 by exercise price and year of expiration is presented below:
 
Exercise
   
Expiration Date in
       
Price
   
2015
   
2016
   
2017
   
2018
   
2019
   
2020
   
Total
 
                                             
$ 0.50                         800,000                   800,000  
$ 1.00       -       -       150,000       -       -             150,000  
$ 1.40                                               1,704,346       1,704,346  
$ 1.57                                               3,750,000       3,750,000  
$ 1.73                               100,000                       100,000  
$ 1.75       705,000       1,135,714       -       -       -               1,840,714  
$ 1.79                                               225,000       225,000  
$ 1.80                                               850,000       850,000  
$ 2.00       -       1,035,271       126,000       1,696,380       -               2,857,651  
$ 2.03                               750,000                       750,000  
$ 2.09       -       -       -       2,800,000       -               2,800,000  
$ 2.23                                               911,330       911,330  
$ 2.29                               80,000                       80,000  
$ 2.31                               250,000                       250,000  
$ 2.50       -       100,000       -       -       85,750               185,750  
$ 2.82       -       -       -       38,174       -               38,174  
$ 3.00       -       100,000       -       -       -               100,000  
$ 4.50       -       -       -       -       700,000               700,000  
$ 5.00       -       8,391       190,000       -       -               198,391  
$ 6.00       -       -       -       577,501       330,341               907,842  
$ 7.00       -       -       -       -       700,000               700,000  
          705,000       2,379,376       466,000       7,092,055       1,816,091       7,440,676       19,899,198  
 
At September 30, 2015 the Company had reserved 19,899,198 common shares for future exercise of warrants plus 8,521,739 common shares for future conversion of issued preferred stock.
 
Warrants issued in relation to the promissory notes issued (see note 9) were valued using the Black Scholes Option Pricing Model. The assumptions used in calculating the fair value of the warrants issued are as follows:

Risk-free interest rate
0.78%
Expected volatility of common stock
175% - 253%
Dividend yield
0.00%
Discount due to lack of marketability
20-30%
Expected life of warrant
3 years - 5 years
 
 
 
 
12

 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
7. CAPITALIZED COSTS
 
The following table presents the capitalized costs of the Company as of September 30, 2015 and December 31, 2014:

   
9/30/2015
   
12/31/2014
 
             
Evaluated costs subject to amortization
  $ 29,719,312     $ 24,276,483  
Unevaluated costs
    11,765,963       14,152,415  
Impairment expense
    (22,438,114 )     -  
Total capitalized costs
    19,047,161       38,428,898  
Less accumulated depreciation, depletion  and amortization
    (4,822,475 )     (3,930,217 )
Net capitalized costs
  $ 14,224,686     $ 34,498,681  
 
8. INCOME TAXES

Income taxes are accounted for under the asset and liability method.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss carry forwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  A valuation allowance is established to reduce deferred tax assets if it is more likely than not that the related tax benefits will not be realized.  The Company has placed a 100% valuation allowance against the net deferred tax asset because future realization of these assets is not assured.
 
Authoritative guidance for uncertainty in income taxes requires that the Company recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an examination.  Management has reviewed the Company’s tax positions and determined there were no uncertain tax positions requiring recognition in the consolidated financial statements.  The Company’s tax returns remain subject to Federal and State tax examinations for all tax years since inception as none of the statutes have expired.  Generally, the applicable statutes of limitation are three to four years from their respective filings.

Estimated interest and penalties related to potential underpayment on any unrecognized tax benefits are classified as a component of tax expense in the statement of operation.  The Company has not recorded any interest or penalties associated with unrecognized tax benefits for any periods covered by these financial statements.
 
The Company had a net deferred tax asset related to federal net operating loss carryforwards of $31,095,266 and $24,089,942 at September 30, 2015 and December 31, 2014, respectively.  The federal net operating loss carryforward will begin to expire in 2030.  Realization of the deferred tax asset is dependent, in part, on generating sufficient taxable income prior to expiration of the loss carryforwards.  The Company has placed a 100% valuation allowance against the net deferred tax asset because future realization of these assets is not assured.
 
9. PROMISSORY NOTES

Series “A” Convertible Promissory Notes
 
The 12% Series “A” Secured Convertible Promissory  Notes total outstanding principal balance of $8,117,598 plus interest, was due in full at their maturity date of March 31, 2015.  On June 9, 2015, under a Securities Purchase Agreement, we sold to certain accredited investors an aggregate of $9,800,000 in shares of Series A Convertible Preferred Stock. Proceeds from the offering were used to pay off, in full, the holders of the 12% Series A Secured Convertible Promissory Notes (the “Senior Notes”), and all liens and security interests previously held by the Series “A” Convertible Note Holders were released.
 
Series “B” Convertible Subordinated Promissory Notes
 
During the quarter ended June 30, 2014, the Company issued $3,197,500 in principal value of 12% Series B Convertible Unsecured Promissory Notes. The Series B Notes due and payable on June 30, 2017, provide for conversion into common stock at a price of $4.50 per share and included the issuance of one warrant for each $22.50 of principal amount purchased.  The Company issued a total of 142,111 of these five-year warrants to purchase common stock at an exercise price of $6.00 per share.  The value of the warrant shares was $405,016 and the amount recorded for the beneficial conversion feature was $195,466.  These amounts were recorded as a discount on the Series B Notes.
 
 
 
13

 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
9. PROMISSORY NOTES - continued
 
During the quarter ended September 30, 2014, the Company issued an additional $1,372,000 in principal value of Series B Convertible Unsecured Promissory Notes. The Series B Notes due and payable on June 30, 2017, provide for conversion into common stock at a price of $4.50 per share and included the issuance of one warrant for each $22.50 of principal amount purchased.  The Company issued a total of 60,974 of these five-year warrants to purchase common stock at an exercise price of $6.00 per share.  The value of the warrant shares was $157,388 and the amount recorded for the beneficial conversion feature was $-0-.  These amounts were recorded as a discount on the Series B Notes. The Company previously offered a reset of the conversion price downward to $1.00 to holders of the Series “B” Notes in exchange for a deferral of payment of accrued interest due on the Notes until December 31, 2015. Holders of notes totaling $2,000,000 of the total outstanding of $4,569,500 participated.
 
Notes Payable within one year
 
The Company is obligated on short term notes payable to third parties totaling $451,704 as of September 30, 2015.  The total of the balances will be payable on December 31, 2015.

Notes payable to related parties included in the detail above total $200,000.
 
10. ASSET RETIREMENT OBLIGATIONS

The following is a reconciliation of the asset retirement obligation liability through September 30, 2015:
 
Asset retirement obligation – December 31, 2013
  $ 24,382  
Estimated liabilities recorded
    7,789  
Accretion Expense
    3,780  
Asset retirement obligation – December 31, 2014
  $ 35,951  
Estimated liabilities recorded
    -  
Accretion Expense
    1,107  
Asset retirement obligation – March 31, 2015
  $ 37,058  
Estimated liabilities recorded
    -  
Accretion Expense
    819  
Removal of ARO for wells sold
    (1,152 )
Asset retirement obligation – June 30, 2015
  $ 36,725  
Estimated liabilities recorded
    -  
Accretion Expense
    819  
Removal of ARO for wells sold
    -  
Asset retirement obligation – September 30, 2015
  $ 37,544  

11. SUBSEQUENT EVENTS
 
On October 14, 2015, Husky Ventures, (Husky) the operator of the Company’s properties in the Chisholm Trail AMI in Oklahoma, entered into an agreement to sell Husky’s Chisholm Trail working interests to Gastar Exploration Inc. with an expected closing date of November 30, 2015.
 
On November 5, 2015 Torchlight entered into an agreement with Husky Ventures to transfer its interests in Chisholm Trail assets to Husky in exchange for the cancellation of the Company’s entire liability to Husky on Joint Interest Billings in the approximate amount of $2.9 million. The agreement was executed with the intention of Husky including the Torchlight interests in producing properties and undeveloped acreage in Chisholm Trail as part of the Husky sale to Gastar. Torchlight will then participate in the proceeds of Husky’s sale to Gastar in accordance with the terms of Torchlight’s agreement with Husky.  Alternatively, if the Gastar transaction does not close, Torchlight and Husky will work to locate a different purchaser, and Torchlight will participate in the proceeds of any other sale of the Chisholm Trail assets if Husky effects such sale within one-year from October 31, 2015.  Regardless of whether Husky effects a sale to Gastar or any other party, the liability to Husky on Joint Interest Billings will remain extinguished, under the terms of Torchlight’s agreement with Husky.
 
The effective date of the transfer of the properties is to be July 1, 2015. For reporting purposes in this Form 10-Q for the quarter ended September 30, 2015 the July through September net revenue from the Chisholm Trail properties of approximately $90,000 is included in the accompanying Consolidated Statement of Operations. Upon closing, there will be an adjustment to the sale proceeds for the net revenue attributable to the period from July 1, 2015 through the actual closing date (including the $90,000) to reflect the revenue and lease operating expense cut off adjustment back to July 1.
 
The projected total proceeds from the sale attributable to the Torchlight interests is approximately $4,600,000 from which the Company’s outstanding joint interest billing account payable of approximately $2.9 million will be paid in full to the operator with the remaining balance of the proceeds, estimated to be $1,400,000 after expenses in connection with the transaction, to be received by the Company in cash.
 
Gain on the sale will be recorded in the fourth quarter, 2015 to the extent that the net proceeds from the final sale closing exceed the book value of the Chisholm Trail wells and leases as adjusted by the impairment expense recorded as of June 30, 2015. The gain is estimated at approximately $600,000.

 
14

 

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Basis of Presentation of Financial Information

On November 23, 2010, the Share Exchange Agreement (the “Exchange Agreement” or “Transaction”) between Pole Perfect Studios, Inc. (“PPS”) and Torchlight Energy, Inc. (“TEI”) was entered into and closed, through which the former shareholders of TEI became shareholders of PPS. At closing, PPS abandoned its previous business. Consequently, as a result of the Transaction, the business of TEI became our sole business.  In addition to TEI, we also operate our business through our subsidiaries Torchlight Energy Operating, LLC and Hudspeth Oil Corporation.

Summary of Key Results

Overview

We are engaged in the acquisition, exploration, exploitation, and/or development of oil and natural gas properties in the United States.
 
The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited financial statements included herewith and our audited financial statements included with our Form 10-K for the year ended December 31, 2014.  This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future.  Such discussion represents only the best present assessment by our management.

We had no active operations prior to the inception of TEI on June 25, 2010 and had limited revenues prior to the year ended December 31, 2012.  

Current Projects

As of September 30, 2015 the Company had interests in five oil and gas projects: the Marcelina Creek Field Development in Wilson County, Texas, the Coulter Field in Waller County, Texas, the Ring Energy Joint Venture in Southwest Kansas, the Hunton play in partnership with Husky Ventures in Central Oklahoma and the Orogrande Project in Hudspeth County, Texas.
 
Marcelina Creek Field Development .

On July 6, 2010, TEI entered into a participation agreement with Bayshore Operating Corporation, LLC (“Bayshore”), which is currently the holder of an oil, gas, and mineral lease covering approximately 1,045 acres in Wilson County, Texas, known as the Marcelina Creek Field Development.  The Participation Agreement provides for the drilling of four wells. Three of the obligation wells have been drilled.  The first three wells include a horizontal re-entry well known as the Johnson-1-H, a vertical well known as the Johnson #4, and a lateral well known as the Johnson #2-H.  These three wells are presently producing a total of approximately 60 BOPD.  The remaining well is to be a vertical development well at a location to be determined within the existing lease. Drilling is anticipated in 2015.

Coulter Field

In January 2012, we entered into a farm-in agreement, titled the “Coulter Limited Partnership Agreement” (the “Coulter Agreement”), with La Sal Energy, LLC (“La Sal”).  La Sal owns a 100% working interest and a 75% net revenue interest in approximately 940 acres of oil, gas, and mineral leases in Waller County, Texas, on which the well known as “John Coulter #1-R” is located. This well is adjacent to the Katy Field, located on its northwestern up dip edge, which produces primarily from the Wilcox Sparks formation.

Our total investment in the project, including fracture stimulation, subsequent testing, purchase of additional interests and capitalized interest, amounted to $696,948 as of September 30, 2015.
 
The Coulter is a non-core, non-producing asset which we will attempt to monetize by sale of the lease. We presently have approximately 940 acres.
 
The Ring Energy Joint Venture, Southwest Kansas

In October 2013, we entered into a Joint Venture agreement with Ring Energy.  The agreement called for us to provide for $6.2 million in drilling capital to, in effect, match Ring Energy’s expenditures for leasing.  In exchange for this commitment, we would receive a 50% interest in each well bore drilled and the acreage unit it held, until we had spent $6.2 million.  At such time, we would then receive a 50% Working Interest in the entire lease block consisting of 17,000 +/- acres.  We were to provide $3.1 million in advance of the program commencing, which would cover approximately 5 wells to be drilled and completed.  Once the initial five wells are completed, we and Ring would evaluate the program and the drilling activity and determine if another five wells are to be drilled.  Should we continue with the program, we would then deposit another $3.1 million with Ring for drilling and completion of the next five wells.
 
 
 
15

 
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
 
We have made the initial $3.1 million deposit and the first five well drilling program is completed. Drilling operations commenced in March, 2014. Seven wells have been drilled – three are producing, one can be converted to a salt water disposal well, one was not completed, and two were plugged and abandoned.  Based upon results from drilling, the participants elected to suspend further drilling and obtain seismic data to guide continuing development. The seismic data is being analyzed at the date of this filing.   As of September 30, 2015, the Company had invested approximately $5,359,000 in the Ring Joint Venture.  The Company believes this project is still considered to be in the testing phase.

Hunton Play, Central Oklahoma

During the second quarter of 2013, Torchlight entered into an agreement with Husky Ventures to participate in the drilling of wells to the Hunton Formation in central Oklahoma. We continued to expand this relationship with Husky Ventures on a monthly basis as we expand our lease acreage in the contracted Areas of Mutual Interest (AMI’s). The transaction wherein the Company acquired Hunton properties from Xtreme Oil and Gas Inco included the acquisition of three Hunton wells, the Hancock, Robinson and Lenhart.  The Hancock and Robinson were producing wells but had small working interests of 1% and .25 of 1%, respectively. 
 
When Torchlight executed the agreement Husky had already drilled and completed 18 successful wells in the Hunton.  We estimated that Husky had spent, or caused to be spent, $125 million in what we considered a Research and Development project.  The results of Husky’s initial program lead them to develop certain drilling and completions techniques of which we could participate in and take advantage of.
 
The terms in our agreement with Husky are that we pay our proportionate costs of leases and operating expenses based on our working interest.   For leasing and drilling costs (the AFE), we carry Husky for 15% based on our working interest participation.  This is to compensate Husky for the initial program mentioned above and, additionally, the project coordination of the geological, leasing, legal and title opinions, survey and permitting, all drilling, frac design, completion and equipping, day to day operations, and accounting and filing all required monthly and annual reporting to all governmental agencies.

Torchlight believes this is an equitable agreement in that we have the benefit of the initial programs results while participating with a proven operator in areas that continue to provide us with outstanding results in a safe investment environment.
 
Specifically, we were able to negotiate a 15% working interest in approximately 3,700 acres in the Cimarron Area of Logan County in May, 2013.  Leasing continued monthly which resulted in the total acreage in which the Company has an interest increasing to approximately 5,200 as of September 30, 2015 (Net undeveloped acres = 160). Our net cumulative investment through September 30, 2015 in undeveloped acres in the Cimarron AMI was $733,723.

The first well in the Cimarron AMI, the Boeckman #1-H well, was spud and was subsequently completed and fracture stimulated in July, 2013.   We acquired a working interest in the Boeckman #1-H well and subsequently sold part of our ownership in the Boeckman well for $990,000. We agreed to a preferential payout to the purchaser equal to 50% of his acquired interest.  The agreement was amended in the first quarter of 2014 to include our agreement to advance funds under a note receivable from the purchaser to be repaid from the purchaser’s revenue preference subsequent to October, 2014.  

In the third quarter of 2013, we acquired from a third party for stock, a 15.3% working interest in 5011+/- acres in the Chisolm Trail AMI with Husky Ventures Inc. as the operator. Leasing also continued monthly in this AMI increasing the total acreage in which the Company has an interest to approximately 11,300 as of September 30, 2015 (Net undeveloped acres = 1,700).  Our net cumulative investment through September 30, 2015 in undeveloped acres in the Chisholm Trail AMI was $4,391,160.

In the fourth quarter of 2013 we entered into our third Area of Mutual Interest (AMI) with Husky Ventures, the Viking Prospect.  This AMI covers four townships in size. We acquired a 25% interest in 3,945 acres in the Viking. We subsequently acquired an additional 5% in May, 2014.   Leasing is continuing monthly so that we had an interest in approximately 8,800 total acres in which the Company has an interest as of September 30, 2015. (Net undeveloped acres = 2,600) Husky drilled the first two wells in the AMI in second quarter, 2014.  Our net cumulative investment through September 30, 2015 in undeveloped acres in the Viking AMI was $1,358,254.

In January of 2014, we again elected to continue to expand in the Hunton Play with Husky Ventures.  We contracted for a 25% Working Interest in approximately 5,000 acres in the R4 AMI consisting of eight townships in South Central Oklahoma. We subsequently acquired an additional 5% in May, 2014.  Leasing is continuing monthly so that the Company had an interest in approximately 11,600 total acres as of September 30, 2015 (Net undeveloped acres = 3,500). Our cumulative investment through September 30, 2015 in the R4 AMI was $2,834,514.

In February of 2014, we acquired a 10% Working Interest in a well in the Prairie Grove AMI from a non-consenting third party who elected not to participate in the well.

In July of 2014, we elected to further expand in the Hunton Play with Husky Ventures.  We contracted for a 25% Working Interest in the T4 AMI.  There is an active ongoing leasing program in this AMI so that the total acres in which the Company has an interest at September 30, 2015 totals approximately 4,300 acres (Net undeveloped acres = 1.100). Our cumulative investment through September 30, 2015 in the T4 AMI was $949,530.
 
 
16

 
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
 
On October 14, 2015, Husky Ventures, (Husky) the operator of the Company’s properties in the Chisholm Trail AMI in Oklahoma, entered into an agreement to sell Husky’s Chisholm Trail working interests to Gastar Exploration Inc. with an expected closing date of November 30, 2015.
 
On November 5, 2015 Torchlight entered into an agreement with Husky Ventures to transfer its interests in Chisholm Trail assets to Husky in exchange for the cancellation of the Company’s entire liability to Husky on Joint Interest Billings in the approximate amount of $2.9 million. The agreement was executed with the intention of Husky including the Torchlight interests in producing properties and undeveloped acreage in Chisholm Trail as part of the Husky sale to Gastar. Torchlight will then participate in the proceeds of Husky’s sale to Gastar in accordance with the terms of Torchlight’s agreement with Husky.  Alternatively, if the Gastar transaction does not close, Torchlight and Husky will work to locate a different purchaser, and Torchlight will participate in the proceeds of any other sale of the Chisholm Trail assets if Husky effects such sale within one-year from October 31, 2015.  Regardless of whether Husky effects a sale to Gastar or any other party, the liability to Husky on Joint Interest Billings will remain extinguished, under the terms of Torchlight’s agreement with Husky.
 
The effective date of the transfer of the properties is to be July 1, 2015. For reporting purposes in this Form 10-Q for the quarter ended September 30, 2015 the July through September net revenue from the Chisholm Trail properties of approximately $90,000 is included in the accompanying Consolidated Statement of Operations. Upon closing, there will be an adjustment to the sale proceeds for the net revenue attributable to the period from July 1, 2015 through the actual closing date (including the $90,000) to reflect the revenue and lease operating expense cut off adjustment back to July 1.

The projected total proceeds from the sale attributable to the Torchlight interests is approximately $4,600,000 from which the Company’s outstanding joint interest billing account payable of approximately $2.9 million will be paid in full to the operator with the remaining balance of the proceeds, estimated to be $1,400,000 after expenses in connection with the transaction, to be received by the Company in cash.

Gain on the sale will be recorded in the fourth quarter, 2015 to the extent that the net proceeds from the final sale closing exceed the book value of the Chisholm Trail wells and leases as adjusted by the impairment expense recorded as of June 30, 2015. The gain is estimated at approximately $600,000.
 
Orogrande Project, West Texas
 
On August 7, 2014, we entered into a Purchase Agreement with Hudspeth Oil Corporation (“Hudspeth”), McCabe Petroleum Corporation (“MPC”), and Greg McCabe. Mr. McCabe was the sole owner of both Hudspeth and MPC. Under the terms and conditions of the Purchase Agreement, at closing, we purchased 100% of the capital stock of Hudspeth which holds certain oil and gas assets, including a 100% working interest in 172,000 mostly contiguous acres in the Orogrande Basin in West Texas. This acreage is in the primary term under five-year leases that carry additional five-year extension provisions. As consideration, at closing we issued 868,750 shares of our common stock to Mr. McCabe and paid a total of $100,000 in geologic origination fees to third parties.  Additionally, Mr. McCabe will have an optional 10% working interest back-in after payout and a reversionary interest if drilling obligations are not met, all under the terms and conditions of a participation and development agreement.  Closing of the transactions contemplated by the Purchase Agreement occurred on September 23, 2014.
 
Of the 172,000 acres, 40,154 were scheduled for renewal in December, 2014.  The Company renewed the leases for the 40,154 acres during second quarter, 2015. Prior to March 31, 2015, the Company had the obligation to begin drilling its first well in order to hold the acreage block. The well was permitted and spudded and drilling began by March 31.

The Company finalized an agreement to sell a 5% working interest in the Orogrande acreage on June 30, 2015 with an effective date of April 1, 2015. Sale proceeds were $500,000 which were received in April, 2015. In addition, the Company issued 250,000 three year warrants with an exercise price of $.50 to the purchaser.

On September 23, 2015, our subsidiary, Hudspeth Oil Corporation (“HOC”), entered into a Farmout Agreement by and between HOC, Pandora Energy, LP (“Pandora”), Founders Oil & Gas, LLC (“Founders”), McCabe Petroleum Corporation and Greg McCabe (McCabe Petroleum Corporation and Greg McCabe are parties to the Farmout Agreement for limited purposes) for the entire Orogrande Project in Hudspeth County, Texas.  The Farmout Agreement provides for Founders to earn from HOC and Pandora (collectively, the “Farmor”) an undivided 50% of the leasehold interest in the Orogrande Project by Founder’s spending a minimum of $45 million on actual drilling operations on the Orogrande Project in the next two years.  Founders is to pay Farmor a total cost reimbursement of $5,000,000 in multiple installments as follows: (1) $1,000,000 at the signing of the Farmout Agreement, the balance of which was received on September 24, 2015; (2) within 90 days from the closing, Founders will frac and complete the Rich A-11 No. 1 Well; and (3) within five days of the spudding of each of the next eight wells drilled by Founders, Founders will pay to Farmor $500,000 resulting in the payment of the remaining amount; provided that, in the event that within 90 days after the fracing of the Rich Well, Founders notifies Farmor of its election not to drill any additional wells, Founders shall have no further obligation to make further payment.  Upon payment of the first $1,000,000, Farmor assigned to Founders an undivided 50% of the leasehold interest and a 37.5% net revenue interest in the leases subject to the terms of the Farmout Agreement (including obligations to re-assign to HOC and Pandora if the 50% interest in the entire Orogrande Project is not earned) and a proportionate share of the McCabe 10% BIAPO (back in after pay out) interest; provided, however, that for each well that Founders drills prior to earning the acreage, it will be assigned a 50% working interest in the wellbore and in the lease on which it sits.
 
 
17

 
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
 
Under a joint operating agreement (on A.A.P.L. Form 610 – 1989 Model Form Operating Agreement with COPAS 2005 Accounting Procedures) (“JOA”) also entered into on September 23, 2015, Founders Oil & Gas Operating, LLC is designated as operator of the leases.  Any variance to the operating plan will be determined by a Development Committee, which committee will be made up of members from Founders and Farmor, or their designees, to discuss and recommend the location of the drill wells, data to be gathered and the form of same.  As contemplated under the Farmout Agreement, starting within 90 days of the completion of the fracing on the Rich Well, and at all times subject to the 90 day continuous drilling clause, Founders has the option, but not the obligation, to retain the assigned interest as follows: (1) if Founders spends a minimum of $45 million on actual drilling operations while maintaining compliance with the continuous drilling clause, subject to reasonable delays resulting from reasonable Force Majeure conditions, Founders will have fulfilled its farmout obligations and will be entitled to retain the assigned interests. If Founders does not meet such obligations, it will reassign to Farmor the assigned interest except it will be entitled to retain its interest in the leases covering all wells drilled by Founders and the sections in which such wells are located. Additionally, Founders will resign as operator of the JOA as to all lands reassigned; and (2) Farmor will be carried in all drilling operations during the first two years and/or $45 million in drilling operations, whichever comes last, subject to Founders’ right to recoup certain expenses on “Gap Wells.”  After three years and after Founders has earned its working interest, either party may elect to market the acreage as an entire block, including operatorship.  Should an acceptable bid arise, and both parties agree, the block will be sold 100% working interest to that third party bidder.  However, if only one party wants to accept the outside offer, the other party (the party who wishes not to sell) has the right to purchase the working interest from the selling party.
 
Historical Results for the nine months ended September 30, 2015 and 2014:

Revenues and Cost of Revenues

For the nine months ended September 30, 2015, we had production revenue of $1,442,857 compared to $4,214,720 for the nine months ended September 30, 2014.  Refer to the table of production and revenue included below for quarterly changes in revenue.  Our cost of revenue, consisting of lease operating expenses and production taxes, was $669,626, and $1,005,588 for the nine months ended September 30, 2015 and 2014, respectively.
 
Results of operations for the nine months ended September 30, 2015 includes Impairment expense of $22,438,114 (which was recorded at June 30, 2015) to recognize the impact of industry conditions (decline in oil price of $46 per barrel ) on the carrying value of the Investment in Oil and Gas Properties on the Company’s Balance Sheet. The Impairment expense was substantially attributable to the Hunton properties in Oklahoma.
 
Impairment was calculated in two steps. The Ceiling Test as of June 30, 2015 comparing PV10 value of reserves to cumulative costs of evaluated properties (those in production or in development) resulted in Impairment expense of $16,406,993. The $6,031,121 balance of Impairment expense represents the downward adjustment in cumulative costs of unevaluated properties calculated by comparison of cumulative costs per books to fair value indicated by recent industry transactions.

No Impairment adjustment was recorded for the three months ended September 30, 2015.




 


 
18

 
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
 
Property
 
Quarter
   
Oil Production {BBLS}
   
Gas Production {MCF}
   
Oil Revenue
   
Gas Revenue
   
Total Revenue
 
                                     
Marcelina
  Q1 - 2014       3,888       0     $ 360,074     $ -     $ 360,074  
Oklahoma
  Q1 - 2014       2,326       7,366     $ 233,686     $ 49,210     $ 282,896  
Total Q1-2014
          6,214       7,366     $ 593,760     $ 49,210     $ 642,970  
                                               
Marcelina
  Q2 - 2014       4,546       0     $ 368,937     $ -       368,937  
Oklahoma
  Q2 - 2014       9,660       33,584     $ 899,709     $ 189,073       1,088,782  
Kansas
  Q2 - 2014       2,059       0     $ 172,316     $ -       172,316  
Total Q2-2014
          16,265       33,584     $ 1,440,962     $ 189,073     $ 1,630,035  
                                               
Marcelina
  Q3 - 2014       3,189       0     $ 289,230     $ -     $ 289,230  
Oklahoma
  Q3 - 2014       13,900       35,951     $ 1,346,858     $ 185,830     $ 1,532,688  
Kansas
  Q3 - 2014       1,257       0     $ 119,797     $ -     $ 119,797  
Total Q3-2014
          18,346       35,951     $ 1,755,885     $ 185,830     $ 1,941,715  
                                               
Marcelina
  Q4 - 2014       2,768       0     $ 118,132     $ -     $ 118,132  
Oklahoma
  Q4 - 2014       12,578       93,193     $ 663,053     $ 429,960     $ 1,093,013  
Kansas
  Q4 - 2014       744       0     $ 29,690     $ -     $ 29,690  
Total Q3-2014
          16,090       93,193       810,875       429,960       1,240,835  
                                               
Year Ended 12/31/14
      56,915       170,094     $ 4,601,482     $ 854,073     $ 5,455,555  
                                               
Marcelina
  Q1 - 2015       2,425       0     $ 98,787     $ -     $ 98,787  
Oklahoma
  Q1 - 2015       5,931       37,226     $ 277,574     $ 117,521     $ 395,095  
Kansas
  Q1 - 2015       979       0     $ 40,680     $ -     $ 40,680  
Total Q1-2015
          9,335       37,226       417,041       117,521       534,562  
                                               
Marcelina
  Q2 - 2015       1,957       0     $ 101,291     $ -     $ 101,291  
Oklahoma
  Q2 - 2015       5,495       32,348     $ 290,540     $ 97,374     $ 387,914  
Kansas
  Q2 - 2015       889       0     $ 19,060     $ -     $ 19,060  
Total Q2-2015
          8,341       32,348     $ 410,891     $ 97,374     $ 508,265  
                                               
Marcelina
  Q3 - 2015       2,177       0     $ 86,845     $ -     $ 86,845  
Oklahoma
  Q3 - 2015       4,550       31,275     $ 212,156     $ 87,791     $ 299,947  
Kansas
  Q3 - 2015       370       0     $ 13,238     $ -     $ 13,238  
Total Q3-2015
          7,097       31,275     $ 312,239     $ 87,791     $ 400,030  
                                               

 
19

 

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
 
We recorded depreciation, depletion, and amortization expense of $902,153 for the nine months ended September 30, 2015.
 
General and Administrative Expenses

Our general and administrative expenses for the nine months ended September 30, 2015 and 2014 were $12,255,704 and $9,435,148, respectively. Our general and administrative expenses consisted of consulting and compensation expense, substantially all of which was non-cash or deferred, accounting and administrative costs, professional consulting fees, and other general corporate expenses.  The change in general and administrative expenses for the quarters ended September 30, 2015 compared to 2014 is detailed as follows:
 
Increase(decrease) in non cash stock and warrant compensation
  $ 4,628,582  
Increase(decrease) in capital funding expense
  $ (191,346 )
Increase(decrease) in consulting expense
  $ (817,045 )
Increase(decrease) in professional fees
  $ (33,495 )
Increase(decrease) in investor relations expense
  $ (545,461 )
Increase(decrease) in travel expense
  $ (197,111 )
Increase(decrease) in salaries and compensation
  $ 85,043  
Increase(decrease) in general corporate expenses
  $ (108,611 )
         
Total Increase in General and Administrative Expenses
  $ 2,820,556  

Historical Results for the three months ended September 30, 2015 and 2014:

Revenues and Cost of Revenues

For the three months ended September 30, 2015, we had production revenue of $400,030 compared to $1,941,715 for the three months ended September 30, 2014. Refer to the table of production and revenue history above.  Our cost of revenue, consisting of lease operating expenses and production taxes, was $159,082, and $429,353 for the three months ended September 30, 2015 and 2014, respectively.
 
General and Administrative Expenses

Our general and administrative expenses for the three months ended September 30, 2015 and 2014 were $3,359,679 and $2,295,901, respectively. Our general and administrative expenses consisted of consulting and compensation expense, substantially all of which was non-cash or deferred, accounting and administrative costs, professional consulting fees, and other general corporate expenses.  The change in general and administrative expenses for the three months ended September 30, 2015 compared to 2014 is detailed as follows:
 
Increase(decrease) in non cash stock and warrant compensation
  $ 2,303,468  
Increase(decrease) in capital funding expense
  $ (45,818 )
Increase(decrease) in consulting expense
  $ (1,091,865 )
Increase(decrease) in professional fees
  $ (262,339 )
Increase(decrease) in investor relations expense
  $ (46,099 )
Increase(decrease) in travel expense
  $ (64,401 )
Increase(decrease) in salaries and compensation
  $ 414,360  
Increase(decrease) in general corporate expenses
  $ (143,528 )
         
Total Increase in General and Administrative Expenses
  $ 1,063,778  

 
 
 
20

 

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued
 
Liquidity and Capital Resources

At September 30, 2015, we had working capital (deficit) of ($3,139,145), current assets of $2,796,191 consisting of cash, accounts receivable, notes receivable, and prepaid expenses and total assets of $17,203,505 consisting of current assets, investments in oil and gas properties, and other assets. As of September 30, 2015, we had current liabilities of $5,935,336, consisting of, accounts payable (principally for development costs), payables to related parties, notes payable, and accrued interest. Stockholders’ equity was $7,099,045.
 
Cash flow provided by (used) in operating activities for the nine months ended September 30, 2015 was $(1,505,816) compared to $(704,955) for the nine months ended September 30, 2014, an increase of $800,861. Cash flow provided by (used) in operating activities for the nine months ended September 30, 2015 can be primarily attributed to net losses from operations of $36,456,359 which consists primarily of $22,438,114 of impairment expense, $12,255,704 in general and administrative expenses ($9,382,259 of which is non-cash, stock based compensation), depreciation, depletion and amortization of $902,153, and accretion of convertible note discounts of $1,228,161. Cash flow used in operating activities for the nine months ended September 30, 2014 can be primarily attributed to net losses from operations of $13,306,939, which consists primarily of $9,435,148 in general and administrative expenses ($5,834,186 of which is non-cash stock based compensation), depreciation, depletion, and amortization of $1,739,719, and accretion of convertible note discounts $4,676,739. We expect to continue to use cash flow in operating activities until such time as we achieve sufficient commercial oil and gas production to cover all of our cash costs.

Cash flow used in investing activities for the nine months ended September 30, 2015 was $2,418,460 compared to $16,417,939 for the nine months ended September 30, 2014.  Cash flow used in investing activities consists primarily of oil and gas investments in properties during the nine months ended September 30, 2015 and 2014.

Cash flow provided by financing activities for the nine months ended September 30, 2015 was $5,636,096 as compared to $15,872,510 for the nine months ended September 30, 2014.  Cash flow provided by financing activities consists primarily of proceeds from promissory notes, common stock issues, preferred stock issues, and warrant exercises.  We expect to continue to have cash flow provided by financing activities as we seek new rounds of financing and continue to develop our oil and gas investments.

Our current assets are insufficient to meet our current obligations or to satisfy our cash needs over the next twelve months and as such we will require additional debt or equity financing to meet our plans and needs.  We face obstacles in continuing to attract new financing due to our history and current record of net losses and working capital deficits.   Despite our efforts, we can provide no assurance that we will be able to obtain the financing required to meet our stated objectives or even to continue as a going concern.

We do not expect to pay cash dividends on our Common Stock in the foreseeable future.

Commitments and Contingencies

We are subject to contingencies as a result of environmental laws and regulations. Present and future environmental laws and regulations applicable to our operations could require substantial capital expenditures or could adversely affect our operations in other ways that cannot be predicted at this time.  As of September 30, 2015 and September 30, 2014, no amounts have been recorded because no specific liability has been identified that is reasonably probable of requiring us to fund any future material amounts.
 
As of September 30, 2015 the Company had interests in five oil and gas projects: the Marcelina Creek Field Development in Wilson County, Texas, the Coulter Field in Waller County, Texas, the Ring Energy Joint Venture in Southwest Kansas and the Hunton play in partnership with Husky Ventures in Central Oklahoma and the Orogrande Project in Hudspeth County, Texas. See the description under “Current Projects” above under “Overview” for more information and disclosure regarding commitments and contingencies relating to these projects.  

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable.
 
ITEM 4.   CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of September 30, 2015. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in the reports we submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms and that such information was accumulated and communicated to our principal executive officer and principal financial officer, in a manner that allowed for timely decisions regarding disclosure. 
 

 
21

 
 
ITEM 4.   CONTROLS AND PROCEDURES - continued
 
Changes in Internal Control over Financial Reporting

Our principal executive officer and principal financial officer have indicated that, upon evaluation, there were no changes in our internal control over financial reporting or other factors during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting

 
PART II   OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS
 
On February 16, 2012, we filed a lawsuit against Hockley Energy, Inc. and Frank O. Snortheim in the District Court of Harris County, Texas in connection with farmout agreements we entered into with Hockley Energy in November 2011.  The Company sued Hockley Energy and Snortheim for breach of contract, fraudulent inducement, promissory estoppel pertaining to failure to perform two farmout agreements entered into on November 4, 2011, the first relating to the Marcelina Creek prospect and the second relating to the East Stockdale prospect.  Under the Marcelina Farmout, Hockley Energy had an obligation to fund $2,231,250.00 no later than November 18, 2011.  They did not perform as promised.  On February 23, 2015, the Company obtained a summary judgment against Hockley Energy in the amount of $16,400,000 in damages and $21,877.77 in attorney fees.  We are currently seeking to enforce the judgment, but it is doubtful that any substantial portion of the judgment is recoverable from Hockley Energy.  The remaining claims against Snortheim have been set for trial the two-week period beginning on February 1, 2016.  There are no counterclaims pending.  Management is open to settlement discussions.  Because there are no counterclaims, the possibility of an adverse outcome is remote.
 
ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
During the three months ended September 30, 2015, we issued a total of 468,734 shares of common stock to consultants as compensation for services.

During the three months ended September 30, 2015, we issued a total of 319,390 shares of common stock to holders of the Company’s Series A Convertible Preferred Stock as payment of the dividend due September 30, 2015.

During the three months ended September 30, 2015, we issued a total of 750,000 warrants to consultants as compensation for services.

During the three months ended September 30, 2015, we issued a total of 390,000 warrants in connection with short term loans.

All of the above sales of securities described in this Item 2 were sold under the exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933 and the rules and regulations promulgated thereunder.  The issuances of securities did not involve a “public offering” based upon the following factors: (i) the issuances of securities were isolated private transactions; (ii) a limited number of securities were issued to a limited number of purchasers; (iii) there were no public solicitations; (iv) the investment intent of the purchasers; and (v) the restriction on transferability of the securities issued.

ITEM 6.  EXHIBITS
 
Exhibit No.
 
Description
2.1
 
Share Exchange Agreement dated November 23, 2010.  (Incorporated by reference from Form 8-K filed with the SEC on November 24, 2010.) *
     
3.1
 
Articles of Incorporation.  (Incorporated by reference from Form S-1 filed with the SEC on May 2, 2008.) *
     
3.2
 
Certificate of Amendment to Articles of Incorporation dated December 10, 2014. (Incorporated by reference from Form 10-Q filed with the SEC on May 15, 2015.) *
     
 
     
3.4
 
Amended and Restated Bylaws (Incorporated by reference from Form 8-K filed with the SEC on January 12, 2011.) *
     
4.1
 
Certificate of Designation for Series A Convertible Preferred Stock (Incorporated by reference from Form 8-K filed with the SEC on June 9, 2015.) *
     
4.2
 
Certificate of Designation for Series B Convertible Preferred Stock (Incorporated by reference from Form 8-K filed with the SEC on September 30, 2015.) *
 
 
 
22

 
 
ITEM 6.  EXHIBITS - continued
 
10.1
 
Agreement to Participate in Oil and Gas Development Joint Venture between Bayshore Operating Corporation, LLC and Torchlight Energy, Inc. (Incorporated by reference from Form 8-K filed with the SEC on November 24, 2010) *
     
10.2
 
Purchase and Sale Agreement between Torchlight Energy, Inc. and Xtreme Oil and Gas, Inc. effective April 1, 2013. (Incorporated by reference from Form 10-Q filed with the SEC on May 15, 2013.) *
     
10.3
 
Development Agreement between Ring Energy, Inc. and Torchlight Energy Resources, Inc. (Incorporated by reference from Form 8-K filed with the SEC on October 22, 2013.) *
     
10.4
 
Coulter Limited Partnership Agreement dated January 10, 2012 (Incorporated by reference from Form 10-Q filed with the SEC on August 14, 2014.) *
     
10.5
 
Promissory Note with Boeckman Well LLC dated May 1, 2013 and amendments thereto  (Incorporated by reference from Form 10-Q filed with the SEC on August 14, 2014.) *
     
10.6
 
12% Series A Secured Convertible Promissory Note (form of) (Incorporated by reference from Form 10-Q filed with the SEC on August 14, 2014.) *
     
10.7
 
Securities Purchase Agreement (form of), January 2014 (Incorporated by reference from Form 10-Q filed with the SEC on August 14, 2014.) *
     
10.8
 
Registration Rights Agreement (form of), January 2014 (Incorporated by reference from Form 10-Q filed with the SEC on August 14, 2014.) *
     
10.9
 
Purchase Agreement with Hudspeth Oil Corporation, McCabe Petroleum Corporation and Greg McCabe dated August 7, 2014 (Incorporated by reference from Form 10-Q/A filed with the SEC on October 21, 2014) *
 
10.10
 
Purchase and Sale Agreement between Torchlight Energy, Inc. and Zenith Petroleum Corporation (Incorporated by reference from Form 8-K filed with the SEC on June 10, 2014) *
     
10.11
 
Securities Purchase Agreement with Castleton Commodities Opportunities Master Fund, L.P. (Incorporated by reference from Form 8-K filed with the SEC on August 20, 2014) *
     
10.12
 
12% Series B Unsecured Convertible Promissory Note (form of) (Incorporated by reference from Form 10-Q filed with the SEC on August 14, 2015.) *
     
10.13
 
Securities Purchase Agreement (for Series A Convertible Preferred Stock) (Incorporated by reference from Form 10-Q filed with the SEC on August 14, 2015.) *
     
10.14
 
Employment Agreement (with John A. Brda) (Incorporated by reference from Form 8-K filed with the SEC on June 16, 2015.) *
     
10.15
 
Employment Agreement (with Willard G. McAndrew) (Incorporated by reference from Form 8-K filed with the SEC on June 16, 2015.) *
     
10.16
 
Employment Agreement (with Roger Wurtele) (Incorporated by reference from Form 8-K filed with the SEC on June 16, 2015.) *
     
10.17
 
Loan documentation and warrants with Eunis L. Shockey   (Incorporated by reference from Form 10-Q filed with the SEC on August 14, 2015.) *
     
10.18
 
Farmout Agreement between Hudspeth Oil Corporation, Founders Oil & Gas, LLC and certain other parties (Incorporated by reference from Form 8-K filed with the SEC on September 29, 2015) *
     
 
     
10.20  
Purchase and Sale Agreement with Husky Ventures, Inc. (Incorporated by reference from Form 8-K filed with the SEC on November 10, 2015) *

 
     
 
     
 
     
101.INS
 
XBRL Instance Document
101.SCH
 
XBRL Taxonomy Extension Schema
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase
101.DEF
 
XBRL Taxonomy Extension Definitions Linkbase
101.LAB
 
XBRL Taxonomy Extension Label Linkbase
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase
* Incorporated by reference from our previous filings with the SEC

 
23

 

 
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Torchlight Energy Resources, Inc.
   
  Date: November 10, 2015
/s/ John A. Brda
 
By: John A. Brda
 
Chief Executive Officer
   
 
 
  Date: November 10, 2015
/s/ Roger Wurtele
 
By: Roger Wurtele
 
Chief Financial Officer and Principal Accounting Officer

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
24

EXHIBIT 3.3
 
     
 
Secretary of State
204 North Carson Street, Suite 1
Carson City, Nevada 89701-4520
(775) 684 5708
Website: www.nvsos.gov
 
 
Filed in the office of
/s/ Barbara K. Cegavske
Barbara K. Cegavske
Secretary of State
State of Nevada
 
Document Number
20150408083-61
Filing Date and Time
09/15/2015  8:50 AM
Entity Number
E0768622007-2
 
Certificate of Amendment
(PURSUANT TO NRS 78.385 AND 78.390)

USE BLACK INK ONLY — DO NOT HIGHLIGHT
 
ABOVE SPACE IS FOR OFFICE USE ONLY

Certificate of Amendment to Articles of Incorporation
For Nevada Profit Corporations
(Pursuant to NRS 78.385 and 78.390 — After Issuance of Stock)

1. Name of corporation:

Torchlight Energy Resources, Inc.

2. The articles have been amended as follows: (provide article numbers, if available)

Article 3 is deleted and replaced in its entirety with the following:

“The total number of shares of stock that the Corporation will have authority to issue is 110,000,000, consisting of 100,000,000 shares of common stock, par value $0.001 per share (“Common Stock”), and 10,000,000 shares of preferred stock, par value $0.001 per share (“Preferred Stock”).

Shares of Preferred Stock of the Corporation may be issued from time to time in one or more series, each of which shall have such distinctive designation or title as shall be determined by the Board of Directors of the Corporation (“Board of Directors”) prior to the issuance of any shares thereof.  Preferred Stock shall have such voting powers, full or limited, or no voting powers, and such preferences and relative, participating, optional or other special rights and such qualifications, limitations or restrictions thereof, as shall be stated in such resolution or resolutions providing for the issue of such class or series of Preferred Stock as may be adopted from time to time by the Board of Directors prior to the issuance of any shares thereof.  The number of authorized shares of Preferred Stock may be increased or decreased (but not below the number of shares thereof then outstanding) by the affirmative vote of the holders of a majority of the voting power of all the then outstanding shares of the capital stock of the corporation entitled to vote generally in the election of the directors (the “Voting Stock”), voting together as a single class, without a separate vote of the holders of the Preferred Stock, or any series thereof, unless a vote of any such holders is required pursuant to any preferred stock designation.”

3. The vote by which the stockholders holding shares in the corporation entitling them to exercise a least a majority of the voting power, or such greater proportion of the voting power as may be required in the case of a vote by classes or series, or as may be required by the provisions of the articles of incorporation* have voted in favor of the amendment is:  67.408%

4. Effective date of filing: (optional) ________________________________________________
                                                                   (must not be later than 90 days after the certificate is filed)
 
5. Signature: (required)

X /s/ John A. Brda
Signature of Officer

*
 
If any proposed amendment would alter or change any preference or any relative or other right given to any class or series of outstanding shares, then the amendment must be approved by the vote, in addition to the affirmative vote otherwise required, of the holders of shares representing a majority of the voting power of each class or series affected by the amendment regardless to limitations or restrictions on the voting power thereof.

IMPORTANT: Failure to include any of the above information and submit with the proper fees may cause this filing to be rejected.

   
Nevada Secretary of State Amend Profit-After
This form must be accompanied by appropriate fees.
 
Revised: 3-6-09
 

EXHIBIT 10.19

 
SECURITIES PURCHASE AGREEMENT

This Securities Purchase Agreement (this “ Agreement ”) is dated as of September 16, 2015, by and among Torchlight Energy Resources, Inc. , a Nevada corporation (the “ Company ”), and each purchaser identified as such on the signature pages hereto (each, including its successors and permitted assigns, a “Purchaser” and collectively the “Purchasers” ).
 
Recitals
 
A.            The Company and each Purchaser is executing and delivering this Agreement in reliance upon the exemption from securities registration afforded by Section 4(a)(2) of the Securities Act of 1933, as amended (the “ Securities Act ”), and Rule 506 of Regulation D (“ Regulation D ”) as promulgated by the United States Securities and Exchange Commission (the “ Commission ”) under the Securities Act.
 
B.            The Company has authorized or will authorize the issuance and sale to Purchasers of up to an aggregate 40,000 shares of Series B Convertible Preferred Stock, par value $0.001 (the “Preferred Stock” ), having the rights, preferences, privileges and restrictions set forth in the Certificate of Designation to be filed with the State of Nevada upon the Closing (as hereinafter defined) in the form of Exhibit “A” attached to this Agreement (the “Certificate of Designation” ), which Preferred Stock will be convertible into shares of the Company’s common stock, par value $0.001 per share ( “Common Stock” ), in accordance with the terms and conditions set forth therein and the Certificate of Designation (as converted into shares of Common Stock, collectively the “Conversion Shares” ).
 
C.            Each Purchaser, severally and not jointly, wishes to purchase and the Company wishes to sell, upon the terms and conditions stated in this Agreement, the aggregate number of shares of Preferred Stock, at a purchase price of $100 per share, set forth opposite such Purchaser’s name on the Schedule of Purchasers attached hereto as Exhibit “B” (the “Schedule of Purchasers” ).
 
D.             The Company wishes to issue to each Purchaser, upon the terms and conditions stated in this Agreement, the aggregate number of warrants, in substantially the form attached hereto as Exhibit “C” (the “Warrants” ), to purchase shares of Common Stock at an exercise price and other terms as set forth therein (with the shares of Common Stock issued upon exercise of any of the Warrants being collectively referred to herein as the “Warrant Shares” ).  The Preferred Stock, the Conversion Shares, the Warrants and the Warrant Shares are collectively referred to herein as the “Securities.”
 
Now, Therefore, in consideration   of the mutual covenants contained in this Agreement, and for other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the Company and the Purchasers hereby agree as follows:
 
ARTICLE 1
 
AUTHORIZATION, SALE AND ISSUANCE OF SECURITIES
 
1.1             Authorization of Securities .
 
At or prior to the Closing, the Company shall have authorized the issuance and sale to the Purchasers of the Securities.
 

Securities Purchase Agreement
 
- 1 -

 
 
1.2           Sale and Purchase of Preferred Stock; Issuance of Warrants.
 
Subject to the terms and conditions set forth in this Agreement, at the Closing, the Company shall issue and sell to each Purchaser, and each Purchaser shall, severally and not jointly, purchase from the Company, the aggregate number of shares of Preferred Stock, at a purchase price of $100 per share, set forth opposite such Purchaser’s name on the Schedule of Purchasers.   Subject to the terms and conditions set forth in this Agreement, at the Closing, the Company shall issue Warrants to each Purchaser to purchase the aggregate number of initial Warrant Shares set forth opposite such Purchaser’s name on the Schedule of Purchasers.  The Warrants shall have an exercise price equal to $2.37 per initial Warrant Share, subject to adjustment as provided in the Warrants.
 
ARTICLE 2
 
CLOSING
 
2.1             Closing.   The closing of the transactions contemplated by this Agreement (the “Closing” ) shall take place upon the date of execution of the Farmout Agreement referenced in Section 2.3(a)(ii) below (the “Closing Date” ) at the offices of the Company, 5700 W. Plano Parkway, Suite 3600, Plano, Texas 75903, or at such other time and place as agreed upon by the parties hereto.
 
2.2             Delivery and Execution.   At the Closing, (a) Welsh LeBlanc, LLC (the “Escrow Agent” ) will deliver, in immediately available funds, the aggregate Escrow Funds (as defined below) to the Company constituting the aggregate purchase price for the Preferred Stock, (b) the Company shall deliver to each Purchaser one or more stock certificates, subject to the restrictions (and legend) expressly provided for in Section 4.1 hereof, evidencing the number of shares of Preferred Stock such Purchaser is purchasing as is set forth on the Schedule of Purchasers, and (c) the Company shall deliver to each Purchaser one or more Warrants, subject to the restrictions (and legend) expressly provided for in Section 4.1 hereof, evidencing the aggregate number of initial Warrant Shares such Purchaser is entitled to receive as is set forth on the Schedule of Purchasers.  As used in this Agreement, the term “Escrow Funds” shall mean the funds deposited in escrow by the Purchasers with the Escrow Agent.
 
2.3           Conditions to Closing.
 
(a)           The obligations of each Purchaser to acquire the Preferred Stock and the Warrant at the Closing is subject to the following on or prior to the Closing Date:
 
(i)            Certificate of Designation.   The Company shall have filed the Certificate of Designation with the State of Nevada.
 
(ii)            Definitive Farmout Agreement .  The Company’s subsidiary, Hudspeth Oil Corporation (“HOC”), shall have entered into a definitive Farmout Agreement (the “Farmout Agreement”) in connection with the letter of intent that HOC entered into with a third party on September 1, 2015.
 
(iii)            Representations and Warranties .  The representations and warranties made by the Company contained in this Agreement will be true and correct in all material respects as of the Closing Date, except for any such representations and warranties that are qualified by “materiality” or “Material Adverse Effect,” which shall be true and correct in all respects as of the Closing Date.
 

Securities Purchase Agreement
 
- 2 -

 

(iv)            Covenants .  All covenants, agreements and conditions contained in this Agreement to be performed by the Company on or prior to the Closing Date will have been performed or complied with in all material respects.
 
(v)            Delivery of Documents.   The Company shall have delivered the documents required to be delivered by the Company pursuant to Section 2.2 above.
 
(vi)            Corporate Resolution .  The Board of Directors of the Company shall have approved the transactions contemplated herein and authorize the execution, delivery and performance of this Agreement and the documents referred to herein to which it is or is to be a party as of the Closing Date, including but not limited to the issuance and delivery of the Securities.
 
(vii)            No Injunction .  No statute, rule, regulation, executive order, decree, ruling or injunction shall have been enacted, entered, promulgated or endorsed by any court or governmental authority of competent jurisdiction that prohibits the consummation of any of the transactions contemplated by this Agreement.
 
(viii)            No Suspension of Trading in Common Stock .  The Common Stock shall not have been suspended, as of the Closing Date, by the Commission.
 
(ix)            Termination .  This Agreement shall not have been terminated as to such Purchaser in accordance with Section 5.16 herein.
 
(b)           The Company’s obligation to sell and issue the Preferred Stock and the Warrants to a Purchaser at the Closing is subject to the fulfillment of the following on or prior to the Closing Date:
 
(i)            Representations and Warranties .  The representations and warranties made by such Purchaser contained in this Agreement will be true and correct in all material respects as of the Closing Date, except for any such representations and warranties that are qualified by “materiality” or “Material Adverse Effect,” which shall be true and correct in all respects as of the Closing Date.
 
(ii)            Covenants .  All covenants, agreements and conditions contained in this Agreement to be performed by such Purchaser on or prior to the Closing Date will have been performed or complied with in all material respects.
 
(iii)            Delivery of Documents.   Such Purchaser shall have delivered the documents and funds required to be delivered by such Purchaser pursuant to Section 2.2 above.
 
(iv)            Corporate Resolution .  Such Purchaser shall provide, if applicable, corporate resolutions of the Board of Directors which approve the transactions contemplated herein and authorize the execution, delivery and performance of this Agreement and the documents referred to herein to which it is or is to be a party dated as of the Closing Date.
 
(v)            No Injunction .  No statute, rule, regulation, executive order, decree, ruling or injunction shall have been enacted, entered, promulgated or endorsed by any court or governmental authority of competent jurisdiction that prohibits the consummation of any of the transactions contemplated by this Agreement.
 
(vi)            No Suspension of Trading in Common Stock .  The Common Stock shall not have been suspended, as of the Closing Date, by the Commission.
 

Securities Purchase Agreement
 
- 3 -

 

(vii)            Termination .  This Agreement shall not have been terminated by the Company in accordance with Section 5.16 herein.
 
ARTICLE 3
 
REPRESENTATIONS AND WARRANTIES
 
3.1             Representations and Warranties of the Company. The Company hereby represents and warrants to each Purchaser that the following statements are true and correct as of the date hereof and the Closing Date (except for the representations and warranties that speak as of a specific date, which shall be made as of such date):
 
(a)            Subsidiaries. The Company has no direct or indirect subsidiaries other than (i) Torchlight Energy, Inc., a Nevada corporation, (ii) Torchlight Energy Operating, LLC, a Texas limited liability company, and (iii) Hudspeth Oil Corporation, a Texas corporation.  Torchlight Energy, Inc., Torchlight Energy Operating, LLC and Hudspeth Oil Corporation are herein referred to collectively as the “Subsidiaries” .
 
(b)            Organization and Qualification. The Company and each of the Subsidiaries is an entity duly incorporated or otherwise organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization (as applicable), with the requisite corporate power and authority to own or lease and use its properties and assets and to carry on its business as currently conducted.  Neither the Company nor any Subsidiary is in violation or default of any of the provisions of its respective certificate or articles of incorporation, bylaws or other organizational or charter documents.  The Company and each of its Subsidiaries is duly qualified to conduct business and is in good standing as a foreign corporation or other entity in each jurisdiction in which the nature of the business conducted or property owned by it makes such qualification necessary, except where the failure to be so qualified or in good standing, as the case may be, would not, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect (as hereinafter defined), and no Proceeding (as hereinafter defined) has been instituted, is pending, or, to the Company’s Knowledge (as hereinafter defined), has been threatened in writing in any such jurisdiction revoking, limiting or curtailing or seeking to revoke, limit or curtail such power and authority or qualification.   “Material Adverse Effect” means any effect on the business, results of operations, prospects, assets or condition (financial or otherwise) of the Company that is material and adverse to the Company as a whole or hinder the performance of its material obligations hereunder or under the Transaction Documents (as defined below).   “Proceeding” means an action, claim, suit, investigation or proceeding (including, without limitation, an investigation or partial proceeding, such as a deposition), whether commenced or threatened.   “Company’s Knowledge”   or “Knowledge”   means with respect to any statement made to the knowledge of the Company, that the statement is based upon the actual knowledge of the officers of the Company who, as of the date hereof, have responsibility for the matter or matters that are the subject of the statement or the knowledge such officer or officers would have acquired after reasonable inquiry.
 
(c)            Authorization; Enforcement; Validity. The Company has the requisite corporate power and authority to enter into and to consummate the transactions contemplated by this Agreement, the schedules and exhibits attached hereto and the Warrants (collectively, the “Transaction Documents” ) and otherwise to carry out its obligations hereunder and thereunder.  The Company’s execution and delivery of each of the Transaction Documents to which it is a party and the consummation by it of the transactions contemplated hereby and thereby (including, but not limited to, the sale and delivery of the shares of Preferred Stock and the Warrants, the reservation for issuance and the subsequent issuance of the Conversion Shares upon conversion of the Preferred Stock, and the reservation for issuance and the subsequent issuance of the Warrant Shares upon exercise of the Warrants) have been duly authorized by all necessary corporate action on the part of the Company, and no further corporate action is required by the Company, its Board of Directors or its stockholders in connection therewith other than in connection with the Required Approvals and the filing by the Company of the Certificate of Designation with the State of Nevada.  Each of the Transaction Documents to which it is a party has been (or upon delivery will be) duly executed by the Company and is, or when delivered in accordance with the terms hereof, will constitute the legal, valid and binding obligation of the Company enforceable against the Company in accordance with its terms, except (i) as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors’ rights and remedies or by other equitable principles of general application, (ii) as limited by laws relating to the availability of specific performance, injunctive relief or other equitable remedies and (iii) insofar as indemnification and contribution provisions may be limited by applicable law.
 
 
Securities Purchase Agreement
 
- 4 -

 
 
(d)            No Conflicts. The execution, delivery and performance by the Company of the Transaction Documents to which it is a party and the consummation by the Company of the transactions contemplated hereby or thereby (including, but not limited to, the sale and delivery of the shares of Preferred Stock and the Warrants, the reservation for issuance and the subsequent issuance of the Conversion Shares upon conversion of the Preferred Stock and the reservation for issuance and the subsequent issuance of the Warrant Shares upon exercise of the Warrants) do not and will not (i) conflict with or violate any provisions of the Company’s or any Subsidiary’s certificate or articles of incorporation, or bylaws or otherwise result in a violation of the organizational documents of the Company or any Subsidiary, (ii) conflict with, or constitute a default (or an event that with notice or lapse of time or both would become a default) under, result in the creation of any lien upon any of the properties or assets of the Company or any Subsidiary or give to others any rights of termination, acceleration or cancellation (with or without notice, lapse of time or both) of, any indenture, loan or credit agreement or other material contract or (iii) subject to the Required Approvals (as hereinafter defined), conflict with or result in a violation of any law, rule, regulation, order, judgment, injunction, decree or other restriction of any court or governmental authority to which the Company or any Subsidiary is subject (including federal and state securities laws and regulations and the rules and regulations, assuming the correctness of the representations and warranties made by each Purchaser herein), or by which any property or asset of the Company or any Subsidiary is bound or affected, except in the case of clause (ii) and clause (iii) such as would not, individually or in the aggregate, have  or  reasonably be expected to result in a Material Adverse Effect.
 
(e)            Consents and Approvals. Neither the Company nor any of its Subsidiaries is required to obtain any consent, waiver, authorization or order of, give any notice to, or make any filing or registration with, any court or other federal, state, local or other governmental authority or other Person (as hereinafter defined) in connection with the execution, delivery and performance by the Company of the Transaction Documents (including, but not limited to, the sale and delivery of the shares of Preferred Stock and the Warrants, the reservation for issuance and the subsequent issuance of the Conversion Shares upon conversion of the Preferred Stock, and the reservation for issuance and the subsequent issuance of the Warrant Shares upon exercise of the Warrants), other than (i) the filing of a Notice of Sale of Securities on Form D with the Commission under Regulation D of the Securities Act, (ii) the filing of any requisite notices and/or applications pursuant to any state securities laws, (iii) the filing of any requisite notices and/or application(s) to the Principal Trading Market (as hereinafter defined) for the issuance and sale of the Securities and the listing of the Conversion Shares and Warrant Shares for trading or quotation, as the case may be, thereon in the time and manner required thereby, and (iv) any filings required in accordance with Form 8-K of the Securities Exchange Act of 1934, as amended (the “Exchange Act” ) (collectively, the Required Approvals ).   “Person” means an individual, corporation, partnership, limited liability company, trust, business trust, association, joint stock company, joint venture, sole proprietorship, unincorporated organization, governmental authority or any other form of entity not specifically listed herein.    “Principal Trading Market” means the Trading Market (as hereinafter defined) on which the Common Stock is primarily listed on and quoted for trading, which, as of the date of this Agreement and the Closing Date, shall be the NASDAQ Capital Market. “Trading Market” means whichever of the New York Stock Exchange, the American Stock Exchange, the NASDAQ Global Select Market, the NASDAQ Global Market, the NASDAQ Capital Market or the OTC Bulletin Board on which the Common Stock is listed or quoted for trading on the date in question.
 
 
Securities Purchase Agreement
 
- 5 -

 
 
(f)            Issuance of the Securities. The shares of Preferred Stock have been duly authorized and, when issued and paid for in accordance with the terms of the Transaction Documents, will be duly and validly issued, fully paid and nonassessable and free and clear of all liens suffered or permitted by the Company, other than restrictions on transfer provided for in the Transaction Documents or imposed by applicable securities laws, and shall not be subject to preemptive or similar rights.  The Conversion Shares issuable upon conversion of the Preferred Stock have been duly authorized and, when issued and paid for in accordance with the terms of the Transaction Documents and the Certificate of Designation will be duly and validly issued, fully paid and nonassessable, free and clear of all liens suffered or permitted by the Company, other than restrictions on transfer provided for in the Transaction Documents or imposed by applicable securities laws, and shall not be subject to preemptive or similar rights.  The Warrants have been duly authorized and, when issued and paid for in accordance with the terms of the Transaction Documents, will be duly and validly issued, free and clear of all liens suffered or permitted by the Company, other than restrictions on transfer provided for in the Transaction Documents or imposed by applicable securities laws, and shall not be subject to preemptive or similar rights. The Warrant Shares issuable upon exercise of the Warrants have been duly authorized and, when issued and paid for in accordance with the terms of the Transaction Documents and the Warrants will be duly and validly issued, fully paid and nonassessable, free and clear of all liens suffered or permitted by the Company, other than restrictions on transfer provided for in the Transaction Documents or imposed by applicable securities laws, and shall not be subject to preemptive or similar rights.  Assuming the accuracy of the representations and warranties of the Purchasers in this Agreement, the Securities will be issued in compliance with all applicable federal and state securities laws.  As of the Closing Date, the Company shall have reserved from its duly authorized capital stock the number of shares of Common Stock issuable upon conversion of the Preferred Stock (without taking into account any limitations on the conversion of the Preferred Stock set forth in the Certificate of Designation).  As of the Closing Date, the Company shall have reserved from its duly authorized capital stock the number of shares of Common Stock issuable upon exercise of the Warrants (without taking into account any limitations on the exercise of the Warrants set forth in the Warrants).
 
(g)            Capitalization. The number of shares and type of all authorized, issued and outstanding capital stock, options and other securities of the Company (whether or not presently convertible into or exercisable or exchangeable for shares of capital stock of the Company) has been set forth in the SEC Reports (as hereinafter defined) and has not changed since the date set forth in the most recently filed of the SEC Reports and may change thereafter to reflect stock issuances, convertible debt conversions, stock option exercises and grants and warrant exercises and grants.  Currently the Company has approximately 30,041,473 shares of common stock issued and outstanding.  All of the outstanding shares of the Company’s Common Stock and any other security of the Company have been duly and validly authorized, fully paid and nonassessable, have been issued in compliance with all federal and state securities laws, and none of such outstanding shares was issued in violation of any preemptive rights or similar rights to subscribe for or purchase securities.  No shares of Common Stock or any other security of the Company are entitled to preemptive rights and no Person (as defined below) has any right of first refusal, preemptive right, right of participation, or any similar right to participate in the transactions contemplated by the Transaction Documents or otherwise to subscribe for the Securities.  Furthermore, except as set forth in the Company’s SEC Reports or as provided by the Company to the Purchasers, there are no contracts, commitments, understandings, or arrangements by which the Company is or may become bound to issue additional shares of the capital stock of the Company or options, securities or rights convertible into shares of capital stock of the Company, and the issuance and sale of the Securities will not obligate the Company to issue shares of Common Stock or other securities to any Person (other than as contemplated in the Statement of Designation) and will not result in a right of any holder of Company securities to adjust the exercise, conversion, exchange or reset price under any of such securities.   The Company is not a party to, and it has no knowledge of, any agreement or understanding restricting the voting or transfer of any shares of the capital stock of the Company. The offer and sale of all capital stock, convertible securities, rights, or options of the Company issued prior to the Closing complied with all applicable federal and state securities laws, and no holder of such securities has a right of rescission or claim for damages with respect thereto which could have a Material Adverse Effect. As of the date hereof and as of the date of Closing, no dividends that have been declared and have accrued are unpaid.
 
 
Securities Purchase Agreement
 
- 6 -

 

(h)      SEC Reports. The Company has filed all reports, schedules, forms, statements and other documents required to be filed by it under the Exchange Act, including pursuant to Section 13(a) or 15(d) thereof, for twelve (12) months preceding and including the date hereof (the foregoing materials, including the exhibits thereto and documents incorporated by reference therein, being collectively referred to herein as the SEC Reports” ) on a timely basis or has received a valid extension of such time of filing and has filed any such SEC Reports prior to the expiration of any such extension, except where the failure to file on a timely basis would not have or reasonably be expected to result in a Material Adverse Effect (including, for this purpose only, any failure which would prevent any Purchaser from using Rule 144 to resell any Securities).  As of their respective filing dates, or to the extent corrected by any subsequent amendment, the SEC Reports complied in all material respects with the requirements of the Securities Act and the Exchange Act and the rules and regulations of the Commission promulgated thereunder.  Each material indenture, loan or credit agreement or other material contract to which the Company or any Subsidiary is a party or to which the property or assets of the Company or any of its Subsidiaries are subject has been filed as an exhibit, or duly incorporated by reference, to the SEC Reports or has been made available to Purchaser. The Company is not, and has not been in the last twelve calendar months, a “shell company” as defined in Section 405 of the Securities Act.
 
(i)            Financial Statements. The financial statements of the Company included in the SEC Reports comply in all material respects with applicable accounting requirements and the rules and regulations of the Commission with respect thereto as in effect at the time of filing. Such financial statements have been prepared in accordance with U.S. generally accepted accounting principles, as applied by the Company ( “GAAP” ), applied on a consistent basis during the periods involved, except as may be otherwise specified in such financial statements or the notes thereto and except that unaudited financial statements may not contain all footnotes required by GAAP, and fairly present in all material respects the financial position of the Company and its consolidated Subsidiaries taken as a whole as of and for the dates thereof and the results of operations and cash flows for the periods then ended, subject, in the case of unaudited statements, to normal, immaterial year-end audit adjustments.
 
(j)            Tax Matters. The Company and each of its Subsidiaries (i) has accurately and timely prepared and filed all foreign, federal and state income and all other tax returns, reports and declarations required by any jurisdiction to which it is subject or has timely filed extensions for such filings, (ii) has paid all taxes and other governmental assessments and charges that are material in amount, shown or determined to be due on such returns, reports and declarations, except those being contested in good faith, with respect to which adequate reserves have been set aside on the books of the Company, and (iii) has set aside on its books provisions reasonably adequate for the payment of all taxes for periods subsequent to the periods to which such returns, reports or declarations apply, except where the failure to so pay or file or set aside provisions for any such tax, assessment, charge or return would not have or reasonably be expected to result in a Material Adverse Effect.
 
 
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(k)            Material Changes. Since the date of the latest financial statements included within the SEC Reports, except as specifically disclosed in any SEC Reports filed with the Commission subsequent to the filing of the SEC Report that includes such financial statements, there have been no events, occurrences or developments that have had or would reasonably be expected to have, either individually or in the aggregate, a Material Adverse Effect.
 
(l)            Environmental Matters. To the Company’s Knowledge, the Company (i) is not in violation of any statute, rule, regulation, decision or order of any governmental agency or body or any court, domestic or foreign, relating to the use, disposal or release of hazardous or toxic substances or relating to the protection or restoration of the environment or human exposure to hazardous or toxic substances (collectively, Environmental Laws ), (ii) does not own or operate any real property contaminated with any substance that is in violation of any Environmental Laws, (iii) is not liable for any off-site disposal or contamination pursuant to any Environmental Laws, and (iv) is not subject to any claim relating to any Environmental Laws; which violation, contamination, liability or claim has had or would have a Material Adverse Effect; and there is no pending or, to the Company’s Knowledge, threatened investigation that might lead to such a claim.
 
(m)            Litigation. There is no Action (as hereinafter defined) which (i) adversely affects or challenges the legality, validity or enforceability of any of the Transaction Documents or the Securities or (ii) except as disclosed in the SEC Reports would, if there were an unfavorable decision, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect.  Other than publicly available correspondence between the Commission  and the Company, there has not been, within one year prior to the date hereof, and to the Company’s Knowledge there is not pending or contemplated, any investigation by the Commission involving the Company or any current director or officer of the Company.  The Commission has not issued any stop order or other order suspending the effectiveness of any registration statement filed by the Company or any of its Subsidiaries under the Exchange Act or the Securities Act.   “Action” means any action, suit, inquiry, notice of violation, Proceeding (including any partial Proceeding such as a deposition) or investigation pending or, to the Company’s Knowledge, threatened in writing against the Company, any Subsidiary or any of their respective properties or any officer, director or employee of the Company or any Subsidiary acting in his or her capacity as an officer, director or employee before or by any federal, state, county, local or foreign court, arbitrator, governmental or administrative agency, regulatory authority, stock market, stock exchange or trading facility.
 
(n)            Employment Matters. No material labor dispute exists or, to the Company’s Knowledge, is imminent with respect to any of the employees of the Company.  None of the Company’s or any Subsidiary’s employees is a member of a union that relates to such employee’s relationship with the Company, and neither the Company nor any of its Subsidiaries is a party to a collective bargaining agreement, and the Company and each Subsidiary believes that its relationship with its employees is good.  No executive officer of the Company (as defined in Rule 501(f) of the Securities Act) has notified the Company or any such Subsidiary that such officer intends to leave the Company or any such Subsidiary or otherwise terminate such officer's employment with the Company or any such Subsidiary.  To the Company’s Knowledge, no executive officer, to the Company’s Knowledge, is, or is now expected to be, in violation of any material term of any employment contract, confidentiality, disclosure or proprietary information agreement or non-competition agreement, or any other contract or agreement or any restrictive covenant in favor of a third party, and to the Company’s Knowledge, the continued employment of each such executive officer does not subject the Company or any Subsidiary to any liability with respect to any of the foregoing matters.  The Company and its Subsidiaries, to their Knowledge, are in compliance with all U.S. federal, state, local and foreign laws and regulations relating to employment and employment practices, terms and conditions of employment and wages and hours, except where the failure to be in compliance would not, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect.
 
 
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(o)            Compliance. Except as disclosed in the SEC Reports, neither the Company nor any of the Subsidiaries (i) is in default under or in violation of (and no event has occurred that has not been waived that, with notice or lapse of time or both, would result in a default by the Company or any of its Subsidiaries under), nor has the Company or any of its Subsidiaries received written notice of a claim that it is in default under or that it is in violation of, any indenture, loan or credit agreement or other material contract (whether or not such default or violation has been waived), (ii) is in violation of any order of any court, arbitrator or governmental body having jurisdiction over the Company or any Subsidiary or its properties or assets, or (iii) is in violation of, or in receipt of written notice that it is in violation of, any statute, rule or regulation of any governmental authority applicable to the Company.
 
(p)            Regulatory Permits. The Company and each of the Subsidiaries possesses all certificates, authorizations and permits issued by the appropriate federal, state, local or foreign regulatory authorities necessary to conduct its respective business as currently conducted and as described in the SEC Reports, except where the failure to possess such permits, individually or in the aggregate, has not and would not have or reasonably be expected to result in a Material Adverse Effect ( Material Permits ), and (i) neither the Company nor any of its Subsidiaries has received any notice of Proceedings relating to the revocation or modification of any such Material Permits and (ii) the Company has no Knowledge of any facts or circumstances that the Company would reasonably expect to give rise to the revocation or modification of any Material Permits.
 
(q)            Title to Assets. The Company and the Subsidiaries do not own any real property, except for interests in oil or gas properties that may be deemed real property under state law. The Company and the Subsidiaries have good and marketable title to all tangible personal and real property owned by them which is material to the business of the Company and the Subsidiaries, in each case free and clear of all liens except for such liens that do not and would not reasonably be expected to materially affect the value of such property and do not and would not reasonably be expected to materially interfere with the use made and proposed to be made of such property by the Company and the Subsidiaries and except for liens for the payment of federal, state or other taxes for which appropriate reserves have been made in accordance with GAAP and the payment of which is not delinquent or subject to penalties. Any real property and facilities held under lease by the Company and any of its Subsidiaries are held by them under valid, subsisting and enforceable leases with such exceptions as are not material and do not interfere with the use made or proposed to be made of such property and buildings by the Company and the Subsidiaries.
 
(r)            Intellectual Property. To the Company’s Knowledge, the Company or its Subsidiaries owns, possesses, licenses or has other rights to use all foreign and domestic patents, patent applications, trade and service marks, trade and service mark registrations, trade names, copyrights, licenses, inventions, trade secrets, technology and other proprietary rights and processes (collectively, the Intellectual Property ) necessary for the conduct of its businesses as now conducted and which the failure to so own, possess, license or have other rights to use would not have a Material Adverse Effect. Except where any such violations or infringements would not have a Material Adverse Effect, to the Company’s Knowledge (i) the Company’s or its Subsidiaries’ use of any such Intellectual Property in the conduct of its business as presently conducted does not infringe upon the rights of any third parties; (ii) there is no infringement by third parties of any such Intellectual Property; (iii) there is no pending or threatened action challenging the Company’s rights in or to any such Intellectual Property; (iv) there is no pending or threatened action challenging the validity or scope of any such Intellectual Property; and (v) there is no pending or threatened action that the Company infringes or otherwise violates any patent, trademark, copyright, trade secret or other proprietary rights of others.
 
 
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(s)            Insurance. The Company and each of the Subsidiaries are insured by insurers of recognized financial responsibility against such losses and risks and in such amounts as the Company believes to be prudent and customary in the businesses and locations in which the Company and the Subsidiaries are engaged. Neither the Company nor any of the Subsidiaries has received any notice of cancellation of any such insurance, nor, to the Company’s Knowledge, will the Company or any Subsidiary be unable to renew their respective existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business.
 
(t)            No Directed Selling Efforts or General Solicitation. Neither the Company nor, to its knowledge, any Person acting on its behalf has conducted any “general solicitation” or “general advertising” (as those terms are used in Regulation D) in connection with the offer or sale of any of the Securities.
 
(u)            Listing and Maintenance Requirements. The Common Stock is registered pursuant to Section 12(b) or 12(g) of the Exchange Act, and the Company has taken no action designed to terminate the registration of Common Stock under the Exchange Act nor has the Company received any notification that the Commission is contemplating terminating such registration.  Except as set forth in the SEC Reports, the Company has not, in the ten (10) months preceding the date hereof, received written notice from any Trading Market on which the Common Stock is listed or quoted to the effect that the Company is not in compliance with the listing or maintenance requirements of such Trading Market.
 
(v)            No Additional Agreements. The Company does not have any agreement or understanding with any Purchaser with respect to the transactions contemplated by the Transaction Documents other than as specified in the Transaction Documents.
 
3.2             Representations and Warranties of the Purchasers . Each Purchaser hereby, severally but not jointly, represents and warrants to the Company as of the date hereof and as of the Closing Date as follows:
 
(a)            Organization; Authority .
 
(i)            Entity .   If Purchaser   is an entity, such Purchaser is an entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization with the requisite corporate, partnership, limited liability company or other similar power and authority to enter into and to consummate the transactions contemplated by the Transaction Documents to which it is a party and otherwise to carry out its obligations hereunder and thereunder. The execution, delivery and performance by such Purchaser of the transactions contemplated by this Agreement have been duly authorized by all necessary corporate or, if such Purchaser is not a corporation, such partnership, limited liability company or other applicable like action, on the part of such Purchaser.  Each Transaction Document to which it is a party has been duly executed by such Purchaser, and when delivered by such Purchaser in accordance with the terms hereof, will constitute the valid and legally binding obligation of such Purchaser, enforceable against it in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors’ rights and remedies or by other equitable principles of general application or insofar as indemnification and contribution provisions may be limited by applicable law.
 
 
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(ii)            Natural Person .  If Purchaser is a natural person, he or she is of the full age of majority, with full power, capacity and authority to enter into and to consummate the transactions contemplated by the Transaction Documents to which he or she is a party and otherwise to carry out his or her obligations hereunder and thereunder, by and for himself or herself and his or her spouse, if any.  All action on the part of such Purchaser necessary for the authorization, execution, delivery and performance of the transactions contemplated by this Agreement by such Purchaser has been taken.  Each Transaction Document to which he or she is a party has been duly executed by such Purchaser, and when delivered by such Purchaser in accordance with the terms hereof, will constitute the valid and legally binding obligation of such Purchaser, enforceable against him or her in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, liquidation or similar laws relating to, or affecting generally the enforcement of, creditors’ rights and remedies or by other equitable principles of general application or insofar as indemnification and contribution provisions may be limited by applicable law.
 
(b)            No Conflicts . The execution, delivery and performance by such Purchaser of the Transaction Documents to which it is a party and the consummation by such Purchaser of the transactions contemplated hereby and thereby will not (i) result in a violation of the organizational documents of such Purchaser, (ii) conflict with, or constitute a default (or an event which with notice or lapse of time or both would become a default) under, or give to others any rights of termination, amendment, acceleration or cancellation of, any agreement, indenture or instrument to which such Purchaser is a party or (iii) result in a violation of any law, rule, regulation, order, judgment or decree (including federal and state securities laws) applicable to such Purchaser, except in the case of clauses (ii) and (iii) above, for such conflicts, defaults, rights or violations which would not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect on the ability of such Purchaser to perform its obligations hereunder.
 
(c)            Investment Intent . Such Purchaser understands that the Securities are “restricted securities” and have not been registered under the Securities Act or any applicable state securities law and is acquiring the Securities as principal for its own account and not with a view to, or for distributing or reselling such Securities or any part thereof in violation of the Securities Act or any applicable state securities laws, provided, however , that by making the representations herein, such Purchaser does not agree to hold any of the Securities for any minimum period of time and reserves the right, subject to the provisions of this Agreement, at all times to sell or otherwise dispose of all or any part of such Securities pursuant to an effective registration statement under the Securities Act or under an exemption from such registration and in compliance with applicable federal and state securities laws. Such Purchaser does not presently have any agreement, plan or understanding, directly or indirectly, with any Person to distribute or effect any distribution of any of the Securities (or any securities which are derivatives thereof) to or through any Person; such Purchaser is not a registered broker-dealer under Section 15 of the Exchange Act or an entity engaged in a business that would require it to be so registered as a broker-dealer.
 

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(d)            Purchaser Status . At the time such Purchaser was offered the Securities, it was, and at the date hereof it is, an “accredited investor” as defined in Rule 501(a) under the Securities Act.
 
(e)            Rule 144.   Such Purchaser understands that the Securities must be held indefinitely unless such Securities are registered under the Securities Act or an exemption from registration is available.  Such Purchaser acknowledges that such Person is familiar with Rule 144 of the rules and regulations of the Commission, as amended, promulgated pursuant to the Securities Act ( “Rule 144” ), and that such Purchaser has been advised that Rule 144 permits resales only under certain circumstances.  Such Purchaser understands that to the extent that Rule 144 is not available, such Purchaser will be unable to sell any Securities without either registration under the Securities Act or the existence of another exemption from such registration requirement.
 
(f)            General Solicitation . Such Purchaser acknowledges that the Securities were not offered to such Purchaser by means of any form of general or public solicitation or general advertising, or publicly disseminated advertisements or sales literature, including (i) any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media, or broadcast over television or radio, or (ii) any seminar or meeting to which such Purchaser was invited by any of the foregoing means of communications.
 
(g)            Experience of Purchaser . Such Purchaser, either alone or together with its representatives, has such knowledge, sophistication and experience in business and financial matters so as to be capable of evaluating the merits and risks of the prospective investment in the Securities, and has so evaluated the merits and risks of such investment. Such Purchaser is able to bear the economic risk of an investment in the Securities and, at the present time, is able to afford a complete loss of such investment.  Such Purchaser acknowledges that an investment in the Securities is speculative and involves a high degree of risk.
 
(h)            Access to Information . Such Purchaser acknowledges that it has had the opportunity to and has reviewed the SEC Reports and has been afforded (i) the opportunity to ask such questions as it has deemed necessary of, and to receive answers from, representatives of the Company concerning the terms and conditions of the offering of the Securities and the merits and risks of investing in the Securities; (ii) access to information about the Company and its respective financial condition, results of operations, business, properties, management and prospects sufficient to enable it to evaluate its investment; and (iii) the opportunity to obtain such additional information that the Company possesses or can acquire without unreasonable effort or expense that is necessary to make an informed investment decision with respect to the investment. Such Purchaser has sought such accounting, legal and tax advice as it has considered necessary to make an informed decision with respect to its acquisition of the Securities.
 
(i)            Independent Investment Decision . Such Purchaser has independently evaluated the merits of its decision to purchase Securities pursuant to the Transaction Documents. Such Purchaser understands that nothing in this Agreement or any other materials presented by or on behalf of the Company to such Purchaser in connection with the purchase of the Securities constitutes legal, tax or investment advice. Such Purchaser has consulted such legal, tax and investment advisors as it, in its sole discretion, has deemed necessary or appropriate in connection with its purchase of the Securities.
 
(j)            Reliance on Exemptions . Such Purchaser understands that the Securities are being offered and sold to it in reliance on specific exemptions from the registration requirements of United States federal and state securities laws and that the Company is relying in part upon the truth and accuracy of, and such Purchaser’s compliance with, the representations, warranties, agreements, acknowledgements and understandings of such Purchaser set forth herein in order to determine the availability of such exemptions and the eligibility of  such Purchaser to acquire the Securities.
 
 
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(k)            No Governmental Review . Such Purchaser understands that no United States federal or state agency or any other government or governmental agency has passed on or made any recommendation or endorsement of the Securities or the fairness or suitability of the investment in the Securities nor have such authorities passed upon or endorsed the merits of the offering of the Securities.
 
(l)            Regulation M . Such Purchaser is aware that the anti-manipulation rules of Regulation M under the Exchange Act may apply to sales of Common Stock and other activities with respect to the Common Stock by such Purchaser.
 
(m)            Residence . Such Purchaser’s principal executive offices (if such Purchaser is an entity) or principal residence (if such Purchaser is a natural person) are in the jurisdiction set forth immediately below such Purchaser’s name on the applicable signature page attached hereto.
 
(n)            Certain Fees . No Person will have, as a result of the transactions contemplated by this Agreement, any valid right, interest or claim against or upon the Company or such Purchaser for any commission, fee or other compensation pursuant to any agreement, arrangement or understanding entered into by or on behalf of such Purchaser.
 
The Company and each Purchaser acknowledge and agree that no party to this Agreement has made or makes any representations or warranties with respect to the transactions contemplated hereby other than those specifically set forth in this Article 3 and the Transaction Documents.
 
ARTICLE 4
 
OTHER AGREEMENTS OF THE PARTIES
 
4.1             Transfer Restrictions .
 
(a)            Compliance with Laws .   Notwithstanding any other provision of the Transaction Documents, Purchaser covenants that the Securities may be disposed of only pursuant to an effective registration statement under, and in compliance with the requirements of, the Securities Act, or pursuant to an available exemption from, or in a transaction not subject to, the registration requirements of the Securities Act, and in compliance with any applicable state and federal securities laws.  In connection with any transfer of the Securities other than pursuant to an effective registration statement, the Company may require the Purchaser to provide to the Company an opinion of counsel selected by the transferor and reasonably acceptable to the Company, the form and substance of which opinion shall be reasonably satisfactory to the Company, to the effect that such transfer does not require registration of such transferred Securities under the Securities Act.
 
(b)            Legends . Certificates evidencing the Securities shall bear the following restrictive legend in substantially the following form until such time as they are not required under applicable securities laws:
 
NEITHER THESE SECURITIES NOR THE SECURITIES ISSUABLE UPON CONVERSION OF THESE SECURITIES HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), OR APPLICABLE STATE SECURITIES LAWS.  THE SECURITIES MAY NOT BE OFFERED FOR SALE, SOLD, TRANSFERRED OR ASSIGNED (I) IN THE ABSENCE OF (A) AN EFFECTIVE REGISTRATION STATEMENT FOR THE SECURITIES UNDER THE SECURITIES ACT OR (B) AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS OR BLUE SKY LAWS AS EVIDENCED BY A LEGAL OPINION OF COUNSEL REASONABLY SATISFACTORY TO THE COMPANY AND ITS TRANSFER AGENT OR (II) UNLESS SOLD PURSUANT TO RULE 144 UNDER SAID ACT.
 
 
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The legend set forth in Section 4.1(b) shall be removed and the Company shall issue a certificate (or issue in an uncertificated form) without such legend or any other legend to the holder of the applicable Securities (or shares of Common Stock or other securities issuable upon conversion of the Securities) or, with respect to Common Stock only, to such holder’s broker or agent by electronic delivery at the applicable balance account at the Depository Trust Company, if (i) such Securities (or shares of Common Stock or other securities issuable upon conversion of the Securities) are sold pursuant to an effective registration statement under the Securities Act (provided that the relevant holder agrees to only sell such Securities (or shares of Common Stock or other securities issuable upon conversion of the Securities) during such time that the registration statement is effective and not withdrawn or suspended, and only as permitted by the registration statement) or (ii) such Securities (or shares of Common Stock or other securities issuable upon conversion of the Securities) are sold or transferred pursuant to, and in accordance with all requirements of, Rule 144 (including, if applicable, the volume, manner-of-sale and notice filing provisions of Rule 144).  The Company shall bear all costs incurred by it or a Purchaser (other than legal fees and expenses incurred by such Purchaser) directly relating to the removal of the legend in accordance with this Section, provided that the Company shall not be liable for any transfer taxes relating to the issuance of a new certificate or statement in the name of any Person other than the relevant Purchaser and its affiliates.

(c)            Acknowledgement . Each Purchaser hereunder acknowledges its primary responsibilities under the Securities Act and accordingly will not sell or otherwise transfer the Securities or any interest therein without complying with the requirements of the Securities Act. Only if there is an effective registration statement registering the shares of Common Stock underlying the Securities under the Securities Act or an exemption from registration is available, may a Purchaser hereunder sell the Securities.
 
4.2             Reservation of Common Stock.   The Company shall take all action necessary to at all times have authorized, and reserved for the purpose of issuance from and after the Closing Date, the number of shares of Common Stock issuable upon conversion of the Preferred Stock issued at the Closing (without taking into account any limitations on conversion of the Preferred Stock set forth in the Certificate of Designation).  The Company shall take all action necessary to at all times have authorized, and reserved for the purpose of issuance from and after the Closing Date, the number of shares of Common Stock issuable upon exercise of the Warrants issued at the Closing (without taking into account any limitations on exercise of the Warrants set forth in the Warrants).
 
4.3             Indemnification .
 
 
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(a)            Indemnification of Purchasers .  Subject to the provisions of this Section 4.3(a), the Company will indemnify and hold each Purchaser and its shareholders, members, partners, direct and indirect investors, directors, managers, officers, employees, affiliates and agents (and any other Persons with a functionally equivalent role of a Person holding such titles notwithstanding a lack of such title or any other title), each Person who controls such Purchaser (within the meaning of Section 15 of the Securities Act and Section 20 of the Exchange Act), and the shareholders, members, partners, direct and indirect investors, directors, managers, officers, employees, affiliates and agents (and any other Persons with a functionally equivalent role of a Person holding such titles notwithstanding a lack of such title or any other title) of such controlling persons (each, a “Purchaser Party”) harmless from any and all losses, liabilities, obligations, claims, contingencies, penalties, fees, damages, fines, charges, contingencies, costs and expenses, including all judgments, amounts paid in settlements, court costs and reasonable attorneys’ fees and disbursements and costs of investigation, defending or preparing to defend  that any such Purchaser Party may suffer or incur (irrespective of whether any such Purchaser Party is a party to the Proceeding for which indemnification hereunder is sought) as a result of or relating to (a) any misrepresentation or any breach of any of the representations, warranties, obligations, covenants or agreements made by the Company in this Agreement or in any other Transaction Document, (b) any Proceeding instituted against a Purchaser in any capacity, or any of them or their respective affiliates, with respect to any of the transactions contemplated by the Transaction Documents (unless such Proceeding is based upon a misrepresentation by such Purchaser or a breach of such Purchaser’s representations, warranties, obligations, covenants or agreements under any Transaction Document or any agreements or understandings such Purchaser may have with any such shareholder or any violations by such Purchaser of state or federal securities laws or any conduct by such Purchaser which constitutes fraud, gross negligence or willful misconduct), (c) any Proceeding brought or made against any Purchaser Party by a third party (including for these purposes a derivative Proceeding brought on behalf of the Company or any Subsidiary) and arising out of or relating to any transaction financed or to be financed in whole or in part, directly or indirectly, with the proceeds of the issuance of the Securities.  The indemnity agreements contained herein shall not be an exclusive remedy but shall be in addition to any cause of action or similar right in law or in equity of any Purchaser Party against the Company or others, and any liabilities the Company may be subject to pursuant to law.
 
(b)            Indemnification of Company .  Each Purchaser, severally and not jointly with the othe