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EX-32 - CERTIFICATION - Jayhawk Energy, Inc.ex32.htm
EX-31 - CERTIFICATION - Jayhawk Energy, Inc.ex31.htm

             

 


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K/A

 

[x]       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended September 30, 2010

 

 [  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period From _____ to _____

 

Commission File Number 000-53311

 

JayHawk Energy, Inc.

(Exact name of small business issuer as specified in its charter)

 

Colorado

20-0990109

(State or other jurisdiction of incorporation or organization)

 (IRS Employer Identification No.)


6240 E. Seltice Way, Suite C

Post Falls, Idaho

(Address of principal executive office)

83854

(Postal Code)


(208) 667-1328

(Issuer's telephone number)

 

Securities registered under Section 12(b) of the Exchange Act:  None


Securities registered under Section 12(g) of the Exchange Act:  Common Stock, $0.001 par value


Indicate by check mark whether the issuer (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 [   ]


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [   ]   No [x] 


Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to Form 10-K.

Yes [   ]   No [x]   Delinquent filers are disclosed herein.


The Company had $ 684,707 in revenue during the year.

 

The aggregate market value of the Common Stock held by non-affiliates (as affiliates are defined in Rule 12b-2 of the Exchange Act) of the registrant, computed by reference to the average of the high and low sale price on January 11, 2011, was $8,720,290.


As of January 13, 2010 there were 51,295,825 shares of issuer’s common stock outstanding.



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EXPLANATORY NOTE

This Amendment No. 2 to the Report on Form 10K, SEC File No. 000-53311 is being filed solely for the purpose of including the Comany's Statement of Cash Flows which was inadvertantly omited from the previous filing.

 

JAYHAWK ENERGY, INC.

 

FORM 10-K

  

For the Fiscal Year Ended September 30, 2010




                          


TABLE OF CONTENTS

 

Part I

 

Page

Item 1 and 2

Description of Business and Properties

3

Item 1A

Risk Factors

6

Item 1B

Unresolved Staff Comments

9

Item 3

Legal Proceedings

9

Item 4

Submission of Matters to a Vote of Security Holders

9

 

 

 

Part II

 

Page

Item 5

Market for Common Equity and Related Stockholder Matters

10

Item 6

Selected Financial Data

10

Item 7

Management's Discussion and Analysis of Financial Condition and Results of Operations

10

Item 7A

Quantitative and Qualitative Disclosures About Market Risk

14

Item 8

Financial Statements

15

Item 9

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

35

Item 9A

Controls and Procedures

37

Item 9B

Other Information

38

 

 

 

Part III

 

Page

Item 10

Directors, Executive Officers and Corporate Governance

39

Item 11

Executive Compensation

40

Item 12

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

41

Item 13

Certain Relationships and Related Transactions, and Director Independence

41

Item 14

Principal Accounting Fees and Services

41

 

 

 

Part IV

 

Page

Item 15

Exhibits

42

 

Signatures

43

 

 

 

 

EXHIBIT 31.1

44

 

     Certification of Chief Executive Officer

 

 

EXHIBIT 31.2

45

 

     Certification of Chief Financial Officer

 

 

EXHIBIT 32.1

46

 

    Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

EXHIBIT 32.2

47

 

    Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 


 




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PART I


DISCLOSURES REGARDING FORWARD-LOOKING STATEMENTS


Portions of this Annual Report of JayHawk Energy, Inc. on Form 10-K, and the information appearing under "Legal Proceedings" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," generally, and specifically therein under the captions "Liquidity and Capital Resources" contain forward-looking statements and involve uncertainties that could materially affect the expected results of operations, liquidity, cash flows and business prospects.  Words such as "estimate," "may," "might," "anticipates," "believes," "expects," "plans," “intends," “objectives” and similar expressions that convey the uncertainty of future events or outcomes generally identify forward-looking statements. The reader should not place undue reliance on these forward-looking statements, which speak only to the date of this report.


ITEMS 1 and 2.  DESCRIPTION OF BUSINESS and PROPERTIES


General

 

Unless the context otherwise requires, in this report, the term “JayHawk” or “Company”, we, or our, refer to JayHawk Energy, Inc., a Colorado Corporation, and its wholly owned subsidiary, JayHawk Gas Transportation Corporation.  JayHawk's executive offices are located at 6240 E. Seltice Way, Suite C, Post Falls, Idaho 83854.   Our telephone number is (208) 667-1328.  JayHawk reports its operations using a fiscal year ending September 30 and the operations reported on this Form 10-K, are presented on a consolidated basis.


JayHawk began leasing their office space of approximately 900 sq. ft. on July 1, 2008 from Marlin Property Management, Inc., a related party (see Note 12 of the Notes to the Consolidated Financial Statements).  The monthly rental payment is $1,500.  The Company closed its former office located in Broomfield, CO., in September of 2008.  We believe that our current office space and facilities are sufficient to meet our present needs and do not anticipate the need to secure any additional space.


The Company files Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, registration statements and other items with the Security and Exchange Commission (SEC).  JayHawk provides access free of charge to all of these SEC filings, as soon as reasonably practicable after filing on its internet site located at www.jayhawkenergy.com.  In this report on Form 10-K, the language “this fiscal year, or current fiscal year” refers to the 12 month period ending September 30, 2010.


In addition, the public may read and copy any materials JayHawk files with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549.  The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  The SEC maintains an internet site (www.sec.gov.) that contains reports, proxy and information statements regarding issuers, like JayHawk, that file electronically with the SEC.


Business Development


JayHawk Energy, Inc. was incorporated in Colorado on April 5, 2004 as Bella Trading Company, Inc.  We were originally formed to offer for sale, traditional ethnic and contemporary jewelry, as well as accessories, imported from Nepal and Thailand. During the third quarter of the fiscal year ending September 30, 2007, we decided to change management, enter the oil and gas business, and cease all activity in the retail jewelry industry.  At that time we changed our name to JayHawk Energy, Inc. and shifted our focus to the acquisition, exploration, development, production and sale of natural gas, crude oil, and natural gas liquids, primarily from conventional reservoirs within North America.


We initiated this new focus in July of 2007 with the acquisition of certain oil, gas and mineral leases totaling approximately 35,000 gross acres, located in Bourbon County, Kansas within the Cherokee basin, referred to as the Uniontown properties.   This acreage is leased for the development of coal-bed methane and conventional oil and gas reserves.  We continued our development strategy in the 2nd quarter of the year ending September 30, 2008, acquiring a 65% gross working interest in 5 producing oil wells located in the Williston Basin of North Dakota, along with the right to develop the oil, gas and mineral resources on 15,500 acres of leases in this same area.


In March and April of 2008 the Company augmented its initial investment in southeast Kansas with the acquisition of additional assets, referred to as the Girard properties, including leased acreage, adjacent to the Uniontown properties, 34 gas wells, and a 16 mile natural gas pipeline.  During July and August of 2008 the Company completed drilling, casing and tying-in of an additional 20 gas wells.




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Our strategy is to increase shareholder value through strategic acquisitions, drilling and development, and by prudently managing our balance sheet.  We believe in creating opportunities for our shareholders through acquisition and through the “drill-bit.”  In this regard, the Company’s investments to date have been concentrated in essentially coal bed methane gas properties, located in southeast Kansas, and oil producing properties in northwest North Dakota.


Due to a lack of funding, during the fiscal year ending September 30, 2009, no new additional acreage was acquired and no new development or drilling took place.  This lack of funding contributed to management’s decision in August of 2009 to enter into a joint venture agreement with DK True Energy Development (DKTED) for the continued development of our coal-bed methane wells of the Girard properties.  DKTED has contributed $250,000 through the date of this report to acquire an interest in the Girard properties.  This is more fully discussed in the Management Discussion and Analysis, Item 7 of Part II,  and in Notes 14 and 15 to the Consolidated Financial Statements, of this Form 10-K.


As of September 30, 2010, we remain an early stage oil and gas company led by an experienced management team focused on exploration and production of oil and natural gas.  Our immediate business plan is to focus our efforts on further developing the as yet undeveloped acreage in Southeast Kansas and to drill two or more wells in the Candak, North Dakota properties.  Our main priority will be given to projects with near term cash flow potential, although consideration will be given to projects that may not be as advanced from a technical standpoint but demonstrate the potential for significant upside.  Future development activities will be determined by our ability to access sources of sufficient funding.


Oil and Gas Properties


S.E. Kansas - Uniontown Properties – Located in S.E. Kansas, these properties consist of the leased acreage and wells within the leased area drilled by previous operators.  Mud logs and cores have been taken to identify coal properties and gas contents.  There have been at least 11 gas bearing coals identified within the Cherokee Group from depths of 250 – 750 feet, with typical thicknesses of 1 to 4 feet, yielding total net coal thickness ranges from 20 to 38 feet.  Gas contents have been measured between 22 – 124 standard cubic feet per ton.  No production tests have yet been conducted.


S.E. Kansas - Girard Properties - Adjacent to the Uniontown Project is the Girard Project in Crawford County Kansas which we acquired on March 31, 2008.  With this transaction JayHawk acquired 34 wells, of which 7 were tied into a pipeline also acquired at this time (more fully described immediately following).  This acquisition provided JayHawk infrastructure necessary for future development of existing and acquired leased acreage, and during July and August of 2008 we completed drilling and casing an additional 20 gas wells.  Our acreage position in both Bourbon and Crawford counties Kansas was enhanced again with the acquisition from Missouri Gas Partners of certain oil, gas and mineral rights to 11,462 leased acres in June of 2008.  As of September 30, 2010, we have 20 producing gas wells tied-in to the pipeline.  As of September 30, 2010 we had a total of 34,677 leased acres in Kansas, and are producing and selling an average of 105 mcf daily of coal bed methane gas.  Since June of 2008 through September of 2010, our gas production and sales has contributed $272,695 in net revenues.


JayHawk Gas Transportation Company - Associated with the acquisition of the Girard properties in March of 2008, the Company acquired a 16 mile pipeline.  In May of 2008, the Company established a 100% owned and controlled subsidiary, "JayHawk Gas Transportation Corporation" to hold and manage the assets associated with the pipeline.  This pipeline is tied into a 2 million cubic foot sales pipeline and allows for substantial growth.


North Dakota - Crosby (formerly Candak) Project – On January 16, 2008, we acquired a 65% working interest in five producing oil wells, historically referred to as the Candak properties but currently referred to as the Crosby properties more properly reflecting the pool designation of the properties, located in the Williston Basin area, of North Dakota.  In addition to the five producing wells, we acquired certain oil, gas, and mineral rights in a 15,500-acre land position.  The Crosby properties provide stable production of approximately 60 Bbls of light to medium crude oil daily from the five existing wells.  Since their acquisition and through September 30, 2010 these five wells have produced and sold in excess of 59,000 Bbls. and generated net revenues to JayHawk of $2,200,260.


During the year ending September 30, 2010, JayHawk drilled two vertical wells on the Crosby property in order to develop the Mississippian reservoir further within the pool.  The wells exhibited marginal production potential after attempts to stimulate flow and are currently shut-in.  One of these wells will be converted to water disposal in order to reduce operating expense.  The second wells is being considered for horizontal drilling to test the potential for Bakken reservoir production on the land in which the Company has acquired the Bakken drilling rights.  The second well which the Company is considering would test the Bakken formation.  JayHawk, in its acquisition of leases during 2010, acquired Bakken rights along with the Mississippian rights in section 28-164N-97W at the Crosby property.  Activity in the Bakken has been moving northward from the well developed Bakken fields in Mountrail and McKenzie Counties to the south.  Recent drilling into the Bakken shale  formation and the underlying Three Forks shale have yielded promising production results within 10 miles of the Crosby pool.  The Company is also looking at strategies to



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redeploy redundant production equipment on the property in order to streamline the production system and to increase overall efficiency.


Reserves - For the North Dakota properties, the independent petroleum engineering firm of McDaniel & Associates Consultants, Ltd. of Calgary, Alberta Canada, prepared the estimates of our proved developed and proved undeveloped reserves as of September 30, 2009 and 2010.  The  future net cash flows (and related present value) attributable proved and probable reserves were calculated for each well and the properties in total as of these respective dates.  Proved developed reserves are defined as estimated quantities of oil, natural gas and natural gas liquids which upon analysis of geological and engineering data, appear with reasonable certainty to be recoverable  in the future from known oil and gas reservoirs under existing economic and operating conditions.  Proved undeveloped reserves are those reserves which can be expected to be recovered from new wells with existing equipment and operating methods.


Estimated quantities of proved reserves for the North Dakota, Crosby properties for the year end September 30, 2010 are presented below:


 

 

 

 

 

 

In Barrels

 

Reserve Value ($)

Proved Developed Reserves

 

                    53,400

 

 $              1,490,500

Proved Undeveloped Reserves

 

                    26,000

 

                      49,800

Probable Reserves

 

 

 

                    25,200

 

                    665,400

 

Total proved reserves

 

 

                104,600

 

 $           2,205,700



The Kansas properties identified above as the Girard and Uniontown projects have not been evaluated and no independent estimates of proved reserves have yet been made.  Additional information about the Company’s proved oil and gas reserves are presented under Supplemental Oil and Gas Disclosures in the accompanying Consolidated Financial Statements.


Employees


During the year ending September 30, 2010 JayHawk employed six individuals.  Administrative and executive functions are carried out by three individuals located in Post Falls, Idaho.  Two of these individuals are compensated as independent contractors.  Oil production operations are overseen by the Company’s President and a field superintendent located in the Williston Basin area of North Dakota.  Both of these individuals were compensated as independent contractors.  Additionally one employee functioned as the field superintendent of the Girard and Uniontown properties and was responsible for the gas production operations.  Going forward, and for the foreseeable future, we plan to outsource our geological, geophysical, drilling and petroleum engineering requirements to independent consultants and contractors.


Competitive Business Conditions


We are a junior oil and gas exploration company. We compete with other companies for financing and for the acquisition of new oil and gas properties. Many of the oil and gas exploration companies with whom we compete have greater financial and technical resources than those available to us. Accordingly, these competitors may be able to spend greater amounts on acquisitions of oil and gas properties of merit, on exploration of their properties and on development of their properties. In addition, they may be able to afford more geological expertise in the targeting and exploration of oil and gas properties. This competition could result in competitors having properties of greater quality and interest to prospective investors who may finance additional exploration and development. This competition could have an adverse impact on our ability to achieve the financing necessary for us to conduct further exploration of our acquired properties.


We will also compete with other junior oil and gas exploration companies for financing from a limited number of investors that are prepared to make investments in junior oil and gas exploration companies. The presence of competing junior oil and gas exploration companies may have an adverse impact on our ability to raise additional capital in order to fund our exploration programs if investors are of the view that investments in competitors are more attractive based on the merit of the oil and gas properties under investigation and the price of the investment offered to investors.  Additionally, there is competition for other resources, including, but not limited to, professional geologists, camp staff, helicopter or float planes, mineral exploration supplies and drill rigs.


Patents and Trademarks


We do not own, either legally or beneficially, any patent or trademark.






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Governmental Regulations


Our oil and gas operations are subject to various federal, state and local governmental regulations. Matters subject to regulation include discharge permits for drilling operations, drilling and abandonment bonds, reports concerning operations, the spacing of wells, pooling of properties and taxation. From time to time, regulatory agencies have imposed price controls and limitations on production by restricting the rate of flow of oil and gas wells below actual production capacity in order to conserve supplies of oil and gas. The production, handling, storage, transportation and disposal of oil and gas, by-products thereof, and other substances and materials produced or used in connection with oil and gas operations are also subject to regulation under federal, state and local laws and regulations relating primarily to the protection of human health and the environment. To date, we have incurred no cost related to complying with these laws, for remediation of existing environmental contamination and for plugging and reclamation of our oil and gas exploration property. The requirements imposed by such laws and regulations are frequently changed and subject to interpretation, and we are unable to predict the ultimate cost of compliance with these requirements or their effect on our operations.


ITEM 1A.  RISK FACTORS RELATED TO OUR BUSINESS


JayHawk is subject to various risks and uncertainties in the course of its business.  The following summarizes some, but not all, of the risks and uncertainties that may adversely affect our business, financial condition or results of operations.


Going Concern – As shown in the accompanying consolidated financial statements, we have incurred operating losses since inception.  As of September 30, 2010, we have limited financial resources with which to achieve our objectives and obtain profitability and positive cash flows.  Achievement of our objectives will be dependent upon our ability to obtain additional financing, to locate profitable mineral properties and generate revenue from our current and planned business operations, and control costs.  We plan to fund our future operation by joint venturing, obtaining additional financing from investors, and attaining additional commercial production.  However, there is no assurance that we will be able to achieve these objectives.


Commodity Price Risk:  Our estimated proved reserves, revenue, operating cash flows, and operating margins are highly dependent on the prices of crude oil and natural gas.  A substantial or extended decline in oil or natural gas prices would reduce our operating results and cash flows and could impact our rate of growth and carrying value of our assets.  Prices for liquid hydrocarbons and natural gas are very volatile.  Our revenues, operating results and ability to grow in the future are highly dependent on the prices we receive for our oil and natural gas.  Many factors beyond our control influence the price we receive for our production.  These include, but are not limited to, general economic conditions worldwide, political instability in other parts of the world, changes in weather patterns, price and availability of alternative sources of energy, and government regulation.

  

Technical Risk:  Our exploration and development operations are subject to many risks which may affect our ability to profitably extract oil and natural gas reserves or achieve targeted returns.  In addition, continued growth requires that we acquire and successfully develop additional oil and natural gas reserves.


Our exploration and development activities will depend in part on the evaluation of data obtained through geophysical testing and geological analysis, as well as test drilling activity.  The results of such studies and tests are subjective, and no assurances can be given that exploration and development activities based on positive analysis will produce oil or natural gas in commercial quantities or costs.  As developmental and exploratory activities are performed, further data required for evaluation of our oil and natural gas interests will become available.  The exploration and development activities that will be undertaken by us are subject to greater risks than those associated with the acquisition and ownership of producing properties.  The drilling of development wells, although generally consisting of drilling to reservoirs believed to be productive, may result in dry holes or a failure to produce oil and natural gas in commercial quantities.  Moreover, any drilling of exploratory wells is subject to significant risk of dry holes.

 

Our commercial success depends on our ability to find, acquire, develop and commercially produce oil and natural gas reserves.  Without the continual addition of new reserves, any existing reserves and the production thereof will decline over time as such existing reserves are depleted. A future increase in our reserves will depend not only on our ability to explore and develop any properties we may have from time to time, but also on our ability to select and acquire suitable producing properties or prospects.  No assurance can be given that we will be able to continue to locate satisfactory properties for acquisition or participation.  Moreover, if such acquisitions or participations are identified, we may determine that current markets, terms of acquisition and participation or pricing conditions make such acquisitions or participations economically disadvantageous.  There is no assurance that commercial quantities of oil and natural gas will be discovered or acquired by us.

 

Catastrophic Risk:  Our oil and natural gas operations are subject to unforeseen operating hazards which may damage or destroy assets.  Although we maintain a level of insurance coverage consistent with industry practices against property or casualty losses unique circumstances to any particular event may make the coverage inadequate.  Oil and natural gas exploration, development and production operations are subject to all the risks and hazards typically associated with such operations, including hazards such as



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fire, explosion, blowouts, sour gas releases and spills, each of which could result in substantial damage to oil and natural gas wells, production facilities, other property and the environment or in personal injury.

  

Competitive Risk:  The petroleum industry is highly competitive and very capital intensive.  If we are unable to successfully compete with the large number of oil and natural gas producers in our industry, we may not be able to achieve profitable operations.  We encounter competition from numerous companies in each of our activities, including acquiring rights to explore for crude oil and natural gas.  Our competitors include oil and natural gas companies that have substantially greater financial resources, staff and facilities than us.  Our ability to increase reserves in the future will depend not only on our ability to explore and develop our existing properties, but also on our ability to select and acquire suitable producing properties or prospects for exploratory drilling.  Competitive factors in the distribution and marketing of oil and natural gas include price and methods and reliability of delivery.  Competition may also be presented by alternate fuel sources.

 

Regulatory and Environment Risk:  We are subject to various regulatory requirements, including environmental regulations, and may incur substantial costs to comply and remain in compliance with those requirements.  Our oil and gas operations are subject to environmental hazards such as oil spills, produced water spills, gas leaks and ruptures and discharges of substances or gases that could expose us to substantial liability.  Our operations are also subject to numerous laws and regulations at the federal, state and local levels, including regulation relating to matters such as the exploration for and the development, production, marketing, pricing, transmission and storage of oil and natural gas, as well as environmental and safety matters.  Failure to comply with applicable regulations could result in fines or penalties being owed to third parties or governmental entities, the payment of which could have a material adverse effect on our financial condition or results of operations.  Our operations are subject to significant laws and regulations, which may adversely affect our ability to conduct business or increase our costs.


Environmental legislation provides for, among other things, restrictions and prohibitions on spills, releases or emissions of various substances produced in association with oil and natural gas operations. The legislation also requires that wells and facility sites be operated, maintained, abandoned and reclaimed to the satisfaction of the applicable regulatory authorities. Compliance with such legislation can require significant expenditures and a breach may result in the imposition of fines and penalties.


The discharge of oil, natural gas or other pollutants into the air, soil or water may give rise to liabilities to governments and third parties and may require us to incur costs to remedy such discharge. No assurance can be given that environmental laws will not result in a curtailment of production or a material increase in the costs of production, development or exploration activities or otherwise adversely affect our financial condition, results of operations or prospects.  We could incur significant liability for damages, clean-up costs and/or penalties in the event of discharges into the environment, environmental damage caused by us or previous owners of our property or non-compliance with environmental laws or regulations. In addition to actions brought by governmental agencies, we could face actions brought by private parties or citizens groups.  Any of the foregoing could have a material adverse effect on our financial results.

 

Market Risk:  The marketability and price of oil and natural gas that may be acquired or discovered by us will be affected by numerous factors beyond our control.  Our ability to market our natural gas may depend upon our ability to acquire space on pipelines that deliver natural gas to commercial markets. We may also be affected by deliverability uncertainties related to the proximity of our reserves to pipelines and processing facilities, by operational problems with such pipelines and facilities, and by government regulation relating to price, taxes, royalties, land tenure, allowable production, the export of oil and natural gas and by many other aspects of the oil and natural gas business.

 

Financial Risks:  Our business may be harmed if we are unable to retain our interests in existing leases.  All of our properties are held under interests in oil and gas mineral leases, some of which expire within the next twelve months. If we fail to meet the specific requirements of each lease, especially future drilling and production requirements, the lease may be terminated or otherwise expire. We cannot be assured that we will be able to meet our obligations under each lease. The termination or expiration of our working interest relating to any lease would harm our business, financial condition and results of operations.

 

Estimation Risks:  Our reserve estimates, like all estimates, are subject to numerous uncertainties and may be inaccurate.  There are numerous uncertainties inherent in estimating quantities of oil or natural gas reserves and cash flows to be derived from, including many factors beyond our control. The reserve and associated cash flow information set forth herein represents estimates only. In general, estimates of economically recoverable oil and natural gas reserves and the future net cash flows wherefrom are based upon a number of variable factors and assumptions, such as historical production from the properties, production rates, ultimate reserve recovery, timing and amount of capital expenditures, marketability of oil and natural gas, royalty rates, the assumed effects of regulation by governmental agencies and future operating costs, all of which may vary from actual results. All such estimates are to some degree speculative, and classifications of reserves are only attempts to define the degree of speculation involved. For those reasons, estimates of the economically recoverable oil and natural gas reserves attributable to any particular group of properties, classification of such reserves based on risk of recovery and estimates of future net revenues expected wherefrom prepared by



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different engineers, or by the same engineers at different times, may vary. Our actual production, revenues, taxes and development and operating expenditures with respect to our reserves will vary from estimates thereof and such variations could be material.

 

Estimates of proved or unproved reserves that may be developed and produced in the future are often based upon volumetric calculations and upon analogy to similar types of reserves rather than actual production history. Estimates based on these methods are generally less reliable than those based on actual production history. Subsequent evaluation of the same reserves based upon production history and production practices will result in variations in the estimated reserves and such variations could be material.

   

Default Risks:  Our properties are held in the form of licenses, leases and working interests in operating agreements and leases. If we or the holder of a lease fail to meet the specific requirements of the lease, license or operating agreement the specific instrument may terminate or expire. There can be no assurance that any of the obligations required to maintain each license or lease will be met, although we exercise our commercially reasonable efforts to do so. The termination or expiration of our licenses or leases or the working interests relating to a license or lease may have a material adverse effect on our results of operations and business.


 

Risk of Loss of Key Personnel:  Our success depends in large measure on certain key personnel, including our President, Chief Executive Officer, and Chief Financial Officer.  The loss of the services of such key personnel could have a material adverse effect on us.  Although we are looking into acquiring key person insurance, we do not currently have such insurance in effect for these key individuals. In addition, the competition for qualified personnel in the oil and natural gas industry is intense and there can be no assurance that we will be able to continue to attract and retain all personnel necessary for the development and operation of our business.


Risks Related to our Common Stock:  Shares of our common stock may continue to be subject to price volatility and illiquidity because our shares are thinly traded and may never become eligible for trading on a national securities exchange.  While we may at some point be able to meet the requirements necessary for our common stock to be listed on a national securities exchange, we cannot assure you that we will ever achieve a listing of our common stock. Initial listing is subject to a variety of requirements, including minimum trading price and minimum public “float” requirements, and could also be affected by the general skepticism of such markets concerning companies that are the result of mergers with inactive publicly-held companies. There are also continuing eligibility requirements for companies listed on public trading markets. If we are unable to satisfy the initial or continuing eligibility requirements of any such market, then our stock may not be listed or could be delisted. This could result in a lower trading price for our common stock and may limit your ability to sell your shares, any of which could result in you losing some or all of your investments.


Our common stock is subject to the “penny stock” rules of the Securities and Exchange Commission and the trading market in our securities is limited, which makes transactions in our stock cumbersome and may reduce the value of an investment in our stock.  The Securities and Exchange Commission (the “SEC”) has adopted Rule 3a51-1 which establishes the definition of a “penny stock,” for the purposes relevant to us, as any equity security that (i) has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, or (ii) is not registered on a national securities exchange or listed on an automated quotation system sponsored by a national securities exchange. For any transaction involving a penny stock, unless exempt, Rule 15g-9 of the Securities and Exchange Act of 1934, as amended, requires:


 

that a broker or dealer approve a person’s account for transactions in penny stocks; and

 

 the broker or dealer receives from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.

 

In order to approve a person’s account for transactions in penny stocks, the broker or dealer must:


 

obtain financial information and investment experience objectives of the person; and

 

make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.


The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the SEC relating to the penny stock market, which, in highlight form:


  

sets forth the basis on which the broker or dealer made the suitability determination; and

  

attests that the broker or dealer received a signed, written agreement from the investor prior to the transaction.

 

Disclosure also has to be made about the risks of investing in penny stocks in both public offerings and in secondary trading, and about the commissions payable to the broker-dealer and the registered representatives, as well as current quotations for the



8





securities, and the rights and remedies available to an investor in cases of fraud in penny stock transactions. Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks.  Generally, brokers may be less willing to execute transactions in securities subject to the “penny stock” rules.  This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.

 

The market valuation of energy companies, such as us, frequently fluctuate due to factors unrelated to the past or present operating performance of such companies.  Our market valuation may fluctuate significantly in response to a number of factors, many of which are beyond our control, including:

 

 

changes in securities analysts’ estimates of our financial performance, although there are currently no analysts covering our stock;

  

fluctuations in stock market prices and volumes, particularly among securities of energy companies;

  

changes in market valuations of similar companies;

  

announcements by us or our competitors of significant contracts, new technologies, acquisitions, commercial relationships, joint ventures or capital commitments;

  

variations in our quarterly operating results;

  

fluctuations in oil and natural gas prices; and

  

additions or departures of key personnel.


Dividends:  Investors should not look to dividends as a source of income.  In the interest of reinvesting initial profits back into our business, we do not intend to pay cash dividends in the foreseeable future.  Consequently, any economic return will initially be derived, if at all, from appreciation in the fair market value of our stock, and not as a result of dividend payments.

 

ITEM 1B.  UNRESOLVED STAFF COMMENTS


None


ITEM 3.  LEGAL PROCEEDINGS.

None


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.


There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report Form 10-K.



9





PART II


ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.


Market Information


Our common stock is quoted on the OTC Bulletin Board under the symbol "JYHW.OB". For the periods indicated, the following table sets forth the high and low bid prices per share of JayHawk’s common stock since inception of trading. These prices represent inter-dealer quotations without retail markup, markdown, or commission and may not necessarily represent actual transactions.


 

 

 

 

 

2010

 

2009

 

 

 

 

 

High

Low

 

High

Low

1st Quarter end December 31

 $                        0.92

 $                        0.22

 

 $                        1.06

 $                        0.13

2nd Quarter end March 31

                           2.16

                           0.80

 

                           0.56

                           0.17

3rd Quarter end June 30

                           1.08

                           0.30

 

                           0.64

                           0.20

4th Quarter end September 30

                           0.34

                           0.19

 

                           0.50

                           0.25


 Holders

As of September 30, 2010, there were 95 stockholders of record who owned 48,980,326 shares of common stock.  The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various security brokers, dealers, and registered clearing agencies. The transfer agent of our common stock is Corporate Stock Transfer Company at 3200 Cherry Creek Drive South, Suite #340, Denver, Colorado, 80209.


Description of Securities


The authorized capital stock of the Company consists of 200,000,000 of the common stock, at $0.001 par value, and 10,000,000 shares of preferred stock, at $0.001 par value.  The shares of preferred stock may be issued in one or more series.  The designations, powers, rights, preferences, qualifications, restrictions, and limitations of each series of preferred stock shall be established from time to time by the Board of Directors in accordance with Colorado law.


Dividends


Holders of common and preferred stock are entitled to receive dividends as may be declared by the Board of Directors. The Board of Directors is not restricted from paying any dividends but is not obligated to declare a dividend. No dividends have ever been declared and it is not anticipated that dividends will ever be paid, but will be dependent upon our financial condition, results of operations, capital requirements, and such other factors as the Board of Directors deem relevant.


ITEM 6.  SELECTED FINANCIAL DATA


The Registrant is a “smaller reporting company” as defined Rule 10(f)(1) of Regulation S-K, and as such is not required to present the information required under this Item.


ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS


The following information should be read in conjunction with the consolidated financial statements and the notes thereto contained elsewhere in this report. All notes referred to in this Management Discussion and Analysis refer to the notes to the Consolidated Financial Statements presented in Item 8.  The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Information in this Item 7, "Management's Discussion and Analysis or Plan of Operation," and elsewhere in this 10-K that does not consist of historical facts, are "forward-looking statements."


 Statements accompanied or qualified by, or containing words such as "may," "will," "should," "believes," "expects," "intends," "plans," "projects," "estimates," "predicts," "potential," "outlook," "forecast," "anticipates," "presume," and "assume" constitute forward-looking statements, and as such, are not a guarantee of future performance. The statements involve factors, risks and uncertainties including those discussed in the “Risk Factors” section contained elsewhere in this report, the impact or occurrence of which can cause actual results to differ materially from the expected results described in such statements.


Investors should not place undue reliance on forward-looking statements as predictive of future results. The Company disclaims any obligation to update the forward-looking statements in this report.



10






Overview

 

This overview is presented in chronological order as to dates the respective transactions were completed.  It should be read in conjunction with the "Notes to the Consolidated Financial Statements" presented in Item 8, specifically Note 10 relative to Common Stock, and Note 4 and Note 5 relative to Asset Impairments.


On June 21, 2007, we changed our name from Bella Trading Company, Inc. to JayHawk Energy, Inc. and shifted our focus from the retail jewelry industry to the oil and gas business.  Our new business plan was to acquire oil and gas properties for exploration and development with the intent to bring the projects to feasibility at which time we would either contract out the operations or joint venture the project to qualified interested parties.  We implemented this plan on July 25, 2007 with the acquisition of certain oil, gas, and mineral leases to approximately 35,000 gross acres located in Bourbon County, Kansas (“Uniontown project”).  The assets were purchased for a total purchase price of $2.2 million.


On January 16, 2008, JayHawk purchased a 65% working interest in 5 producing oil wells located in the Williston Basin of North Dakota, along with the right to develop the oil, gas and mineral resources on 15,500 acres of leases in this same area.  In consideration for these properties JayHawk paid JED Oil $3.5 million in cash.  The cash used to complete this transaction was raised in the private placement transaction (Note 9 of the Notes to the Consolidated Financial Statements).


On March 31, 2008, JayHawk closed a transaction, initiated with an agreement dated February 18, 2008, whereby JayHawk acquired a 16 mile pipeline, associated easements, oil, gas and mineral leases to approximately 6,500 gross acres, 34 gas wells, compressor, and other field equipment.  In consideration for these assets JayHawk exchanged $1 million in cash and 1 million shares of our common stock (See Note 8 of the Notes to the Consolidated Financial Statements).


On April 18, 2008, JayHawk entered into an agreement to acquire oil and natural gas rights to 1,336 gross acres and 14 completed but non-producing gas wells, in exchange for $300,000 in cash and 50,000 shares of the Registrants common stock (See Note 8 of the Notes to the Consolidated Financial Statements).


On June 30, 2008, the Company agreed to purchase oil, gas and mineral leases on 11,462 gross acres, located in Crawford and Bourbon counties Kansas, and 5 completed and cased gas wells.  In consideration for these assets JayHawk paid $140,000 in cash and was obligated to issue 286,550 shares of its common stock as the leases were assigned at the rate of 25 shares per acre (See Note 8 of the Notes to the Consolidated Financial Statements).


On July 22, 2008, the former purchaser of our North Dakota crude oil production, SemCrude, L.P, filed a Chapter 11 bankruptcy proceeding in the United States Bankruptcy Court, District of Delaware.  At the time of their filing we had not been paid for the crude oil they had taken from our properties for the months of June and July 2008.  As a consequence, we had an outstanding receivable exceeding $283,000 and offsetting allowance for doubtful accounts of $119,763 at September 30, 2009.  The amount was subsequently paid.  (See Note 3 of the Notes to the Consolidated Financial Statements).


During the 4th quarter of the year ending September 30, 2009 the Company completed a signed letter agreement with DK True Energy Development Limited ("DKTED”) which allows DKTED to earn up to an 85% working interest in JayHawk's Coal Bed Methane ("CBM") project in southeast Kansas (the Girard project).  This interest can be earned by DKTED after paying the Company $500,000 and spending a minimum of $1,300,000 over a three year period.  DKTED has the option to cap its participation and working interest at 42.5% after paying the Company $250,000 and spending $300,000 on workovers of existing wells during the first year, in what is described as the “Primary Program”.  As of September 30, 2010, DKTED had paid JayHawk the initial $250,000 obligation.  See Note 14, Subsequent Events, and Note 15, Commitments and Contingencies.


In September 2009, we completed a full analysis of the Crosby North Dakota property in which JayHawk is the operator.  At that time, there were five producing Ratcliffe formation oil wells with gross production of approximately 60 barrels of oil produced per day.  Considering that large mineral interests held in the area by JayHawk and its joint venture partners, the area was considered a prime opportunity for exploitation of the reserves attributable to the reservoir as determined by management’s analysis of the Crosby pool and other analogue oil pools within the same depositional fairway of the Crosby pool.  Many of these analogue pools had been successfully developed by other operators and had returned significant additional production and reserves associated with that drilling exploitation.  Corroboration for the development of the pool was also given by the independent engineering assessment performed by McDaniel Associates of Calgary, Alberta, Canada who had been commissioned by JayHawk to perform an independent third party report for the Company’s yearend in both 2008 and 2009.


In March 2010, JayHawk commenced the drilling of the first of two vertical wells on the Crosby property located on the western side of the acreage position.  These wells were inferred to be in the thick part of the reservoir and were offsetting some of the better producing wells in the pool.  Both wells were ultimately drilled and tested oil in the Ratcliffe target formation and despite early



11





encouraging results, both wells produced oil at marginal rates over a longer production period and were eventually shut in during September of 2010.  Both wells are currently shut in pending further remedial action.  Should either of the wells be determined to be non-commercial, the well may be converted to water disposal in order to reduce trucking and disposal costs associated with the existing producing wells.


While the management and third party engineering assessments were both favorable in terms of the development potential of the Crosby pool, risk factors associated with any drilling of oil and gas resources are common.  These risk factors are associated with changing parameters within the reservoir and include, but are not limited to; non-deposition of reservoir, reduced porosity and permeability of reservoir rock when present, structural changes to the reservoir which may preclude the trapping of hydrocarbons, drainage of existing reserves by other wells, mechanical problems while drilling which may prevent production, rising costs due to unforeseen circumstances which may result in wells becoming non-commercial, lower than anticipated production rates due to changes in reservoir quality which were un-anticipated, well bore damage by drilling which may prevent commercial production of hydrocarbons, catastrophic failure during drilling which may prevent the well from reaching its intended target or other unforeseen events which may mitigate the economic success of a drilling operation.

 

 We have not entered into commodity swap arrangements or hedging transactions, and although we have no current plans to do so, we may enter into commodity swap and/or hedging transactions in the future in conjunction with oil and gas production. We have no off-balance sheet arrangements.

 

Our forecast for the period for which our financial resources will be adequate to support our operations involves risks and uncertainties and actual results could fail as a result of a number of factors.  Our future financial results continue to depend primarily on (1) our ability to discover commercial quantities of oil and gas; (2) the market price for oil and gas; (3) our ability to continue to source and screen potential projects; and (4) our ability to fully implement our exploration and development program with respect to these and other matters. We cannot assure that we will be successful in any of these activities or that the prices of oil and gas prevailing at the time of production will be at a level allowing for profitable production.


Results of Operations


For the years ending September 30, 2010 and 2009 we report gross revenues of $684,707 and $588,410, respectively, from the sales of oil and natural gas.  Details of these two revenue components follow:    


Oil Revenues:  As commented on in Note 2 to the Consolidated Financial Statements for the period ended September 30, 2010, the Company recognizes revenues only to the extent of its net working interest, which is the remainder after deduction of the outside working and royalty interests and the deduction of severance and production taxes.


For the years ended September 30, 2010 and 2009 JayHawk sold a gross 19,282 Bbls and 17,990 Bbls respectively.  Gross working interest in the revenues generated from the five North Dakota oil wells were $612,607 and $479,598 respectively.  Gross receipts reconciled to JayHawk net working interest, or revenue recognized is reflected in the following table:


 

 

 

 

 

 

 

 

2010

 

2009

Gross Sales Value

 

 

 

 

 

 $     1,217,310

 

 $          898,950

 

Less: Distributable to Outside Interest, Production and Severance Taxes

 

 

 

          (604,704)

 

            (419,352)

JayHawk's Gross Revenue

 

 

 

 

 

 

 $        612,607

 

 $          479,598


The increase in gross revenues evidenced here is attributable to the equivalent increase between the two periods in the average price received for a barrel of oil.  For the year ending September 30, 2010 the average price we received for a barrel of oil was $63.13.  During the comparable period ending September 30, 2009 the average price received per barrel was $49.97.     

 

Gas Revenues:  During the first quarter ending December 31, 2009, the Company entered into an agreement whereby 42.5 percent of the gas revenues generated from the Girard properties were assigned to a joint venture partner in exchange for $250,000.  Therefore, the net gas revenues accruing to the Company for the year ending September 30, 2010 are reported net of our joint venture partner's interest.    


Revenues derived from gas sales for the years ending September 30, 2010 and 2009 were $72,101 and $108,812.  Average monthly prices received for each thousand cubic feet (mcf) of gas sold during the period end September 30, 2010 have remained volatile, ranging from a high of $5.41, received for the sale of January 2010 production,  to a low of $3.21 received for November 2009 production.  The average price received for the 12 month period ending September 30, 2010 was $4.13 per mcf.


Exploration Expenses:  There were no exploration expenses incurred during the years ending September 30, 2010 or 2009.



12






Production Expenses:  Production expenses are comprised of production taxes, field labor, maintenance, chemicals, fuel, and salt water disposal, less amounts charged other working interests in the particular wells.  These expenses associated with the Company’s North Dakota oil operations increased from $291,007 for the year ending September 30, 2009 to $286,464 for the year ending September 30, 2010.  The Kansas gas operations saw production expenses declining from $187,638 to $26,060 between the same periods.  This is a result of the joint venture agreement whereby the joint venture partner pays most production expenses.


Depreciation, depletion, amortization, and asset impairment expense: The aggregate of these expenses for the years ending September 30. 2010 and 2009 are detailed below.  The total for the 2008 fiscal year end includes a provision of $1,474,000 as a valuation allowance for those leases associated with the unproved properties described as the Uniontown project (Note 4) and the annual accretion of the asset retirement obligation, explained in Note 8 to the Consolidated Financial Statements.


 

 

 

 

 

 

Year Ended September 30, 2010

 

Year Ended September 30, 2009

Asset Impairment Expense (Note 5)

 

 $               811,339

 

 $                           -   

Unproved Property Amortization Expense (Note 4)

 

                  287,472

 

                    291,396

Proved Property Depreciation and Depletion (Note 5)

 

                  672,698

 

                    753,406

Accretion in annual Asset Retirement Obligation (Note 9)

 

                    14,084

 

                      12,804

Depreciation of Office Furniture & Equipment  (Note XX)

 

                    11,990

 

                      11,971

 

Total

 

 

 

 

 $          1,797,583

 

 $           1,069,577


As discussed generally in Note 2, and specifically in Note 4, of "Notes to the Consolidated Financial Statements," JayHawk periodically reviews and assesses its unproved properties to determine if they have been impaired.  During the year ending September 30, 2008, management made a review of the portfolio of leases acquired in the Uniontown transaction of July 2007, and decided, based on geology and proximity to our pipeline, to allow approximately half of the original Uniontown leases acquired, to expire.  Further, given the Company's inability at this time to fund development of any acreage, we have provided a valuation for potential loss equal to two-thirds, 67%, of the original cost of this leased acreage. Under U.S. Generally Accepted Accounting Principles, losses on write-downs of assets are not considered extraordinary losses.  Accordingly, this amount is included in operating expenses.


General and Administrative Expenses:  General and administrative expenses have been increased to $1,292,359 for the 12 months ending September 2010 from $659,713 for the comparable period end September 30, 2009.


 

 

 

 

 

 

Year Ended September 30, 2010

 

Year Ended September 30, 2009

Salaries, Wages and Compensation

 

 $               841,913

 

 $             242,500

Consulting, Legal & Professional Fees

 

                  328,018

 

                114,560

All other operating expenses combined

 

                  122,429

 

                302,653

 

Total General and Administrative Expenses

 

 $          1,292,359

 

 $           659,713


Included in Salaries, Wages and Compensation is a non-cash Stock Option grant in the amount of $200,560 awarded to certain directors, officers and employees of the Company as part of the 2009 Stock Option Incentive Plan.  Officers previously compensated at less than market rate were paid in full during the year ended September 30, 2010.


Other Income and Expense:  Detail of the aggregate of this classification is disclosed in the following table:


 

 

 

 

 

 

Year Ended September 30, 2010

 

Year Ended September 30, 2009

Net Interest Expense

 

 

 $               137,851

 

 $                 101,890

Bad Debt Expense (Note 3)

 

 

                            -   

 

                      27,001

Capital Raising Costs

 

 

                  161,766

 

                      91,958

Note Discount & Accretion Expense

 

                  759,146

 

                    522,248

Debt Conversion Expense

 

 

               1,466,978

 

 

Loss on Disposal of Asset

 

 

                    78,137

 

 

Interest and other income

 

 

                 (160,256)

 

                      (5,490)

 

Total Other Income and Expense

 

 $          2,443,622

 

 $               737,607


The increase in interest expense for the year ending September 30, 2010 is attributable to the fact that it reflects interest on both the $800,000 convertible note as well as interest for the $1,500,000 convertible debentures whereas in the year ending September 30, 2009, interest was accrued on the note for only two months, August and September.  Additionally, interest expense is reported net of interest income, of which there was a minimal amount in the more recent year end than in the year ending September 30, 2009.  




13





Liquidity and Capital Resources:  At September 30, 2010 and 2009, the balances of our cash and cash equivalents were $56,280 and $5,658, respectively.  Our accounts receivable and other current assets, (net of an allowance for doubtful accounts) totaled $229,759 and $296,051, respectively.  Subsequent to year-end, in October, we received $115,029 from the current purchasers of our crude oil and gas production, representing proceeds of September sales, included in accounts receivable at September 30, 2010.


Our current liabilities exceed our current assets by $1,357,465, whereas at September 30, 2009, our working capital, defined as current assets less current liabilities was a negative $1,004,158.  The purchaser of our June and July 2008 crude oil production, SemCrude, LLC, took that period’s production just prior to filing for bankruptcy protection, and without paying, for the product taken.  The increase in liabilities at September 30, 2010 is also attributable to costs incurred in the drilling of two new wells in the Crosy project.


To fully carry out our business plans we need to raise a substantial amount of additional capital, or obtain industry joint venture financing, which we are currently seeking. We can give no assurance that we will be able to raise such capital. We have limited financial resources until such time that we are able to generate such additional financing or cash flow from operations. Our ability to establish profitability and positive cash flow is dependent upon our ability to exploit our mineral holdings, generate revenue from our planned business operations and control our exploration cost.  Should we be unable to raise adequate capital or to meet the other above objectives, it is likely that we would have to substantially curtail our business activity, and that our investors would incur substantial losses of their investment.


The accompanying Consolidated Financial Statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.  As reflected in the accompanying Consolidated Financial Statements we are an independent oil and gas company with a limited operating history and losses since inception. These factors, among others, may indicate that the Company will be unable to continue as a going concern for reasonable period of time.


The Consolidated Financial Statements do not include any adjustments relating to the recoverability and classification of assets and liabilities that might be necessary should the Company be unable to continue as a going concern.  Our continuation as a going concern is dependent upon our ability to obtain additional operating capital, and ultimately, to attain profitability. We intend to acquire additional operating capital through equity offerings to fund our business plan.  There is no assurance that we will be successful in raising additional funds.



Cash Flows:  Net cash provided by operations decreased primarily due to less cash being received for the Company’s crude oil sales.  In both fiscal years ending at September 30, 2010 and 2009 cash used in operating activities exceeded cash provided by operating activities by $405,610 and $246,054, respectively.


During the year ending September 30, 2010 we used $1,851,988 in investment activities as compared to $30,971 during the comparable period ending September 30, 2009.  Cash flows provided from financing activities were $1,497,000 and $200,000 for the year ended September 30, 2010 and 2009, respectively.


Commitments:  At September 30, 2010 the Company has no commitments to make any capital expenditures.  Any potential future capital expenditures will be dependent on concluding adequate and successful financing arrangements.   


The Company was obligated under its original office lease agreement, expiring July 1, 2011, to make payments of $1,500 per month.  Management was successful in renegotiating this to $1,000 per month beginning in April 2009.  The total commitment by year is $12,000 for the period ending September 30, 2010 and $7,000 in 2011.


ITEM 7A.  QUANTITATIVE and QUALITATIVE DISCLOSURES ABOUT MARKET RISK.


The Registrant has no investments in any market risk sensitive instruments either held for trading purposes or entered into for other than trading purposes.   



14





ITEM 8.  FINANCIAL STATEMENTS.


JAYHAWK ENERGY, INC.

INDEX TO FINANCIAL STATEMENTS


 

 

Page

 

 

 

 

 

 

Report of Independent Registered Public Accounting Firm – BehlerMick PS

 

 

16

 

 

 

 

 

 

Consolidated Statements of Operations

 

        

19

 

 

 

 

 

 

Consolidated Statements of Changes in Stockholder’s Equity

 

 

20

 

 

 

 

 

 

Consolidated Statements of Cash Flows

 

   

21

 

 

 

 

 

 

Notes to Consolidated Financial Statements

 

 

22

 




15










REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders

JayHawk Energy, Inc.



We have audited the accompanying consolidated balance sheets of JayHawk Energy, Inc. as of September 30, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the two-year period ended September 30, 2010. JayHawk Energy, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.


We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.


In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of JayHawk Energy, Inc. as of September 30, 2010 and 2009, and the results of its operations and its cash flows for each of the years in the two-year period ended September 30, 2010 in conformity with accounting principles generally accepted in the United States of America.


The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company’s accumulated deficit and lack of revenues raise substantial doubt about its ability to continue as a going concern. Management’s plans regarding the resolution of this issue are also discussed in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.




/s/BehlerMick PS

BehlerMick PS

Spokane, Washington

January 13, 2011




16





ITEM 8.  FINANCIAL STATEMENTS.


JayHawk Energy, Inc.

Consolidated Balance Sheets

Assets

September 30, 2010

 

September 30, 2009

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

 $                 56,280

 

 $                     5,658

 

Trade accounts receivable, less allowance for doubtful

 

 

 

 

 

   accounts of $nill and $119,763 at September 30, 2010 and 2009, respectively (Note 3)

 

                  225,415

 

                    293,507

 

Other current assets

 

                      4,344

 

                        2,544

Total Current Assets

 

                  286,039

 

                    301,709

 

 

 

 

 

 

 

Plant, Property and Equipment

 

 

 

 

 

Unproved oil and gas properties, net of allowances for impairment  of $1,474,000  

 

 

 

 

 

   and accumulated amortization of $693,403 and $405,931 at September 30, 2010

 

               2,126,445

 

                 2,265,673

 

   2009, respectively.  (Note 4).

 

 

 

 

 

Proved and developed oil & gas properties, net allowances for impairment of $811,339  

 

 

 

 

 

  and accumulated DD&A of  $2,027,269 and $1,366,565 at September 30, 2010

 

 

 

 

 

  and 2009, respectively (Note 5)

 

               6,647,808

 

                 6,256,238

 

Computers, office equipment, furniture and leasehold improvements, net of allowance

 

 

 

 

 

    for depreciation of $25,296 and $13,307, respectively.

 

                    19,616

 

                      31,605

Total Net Plant, Property and Equipment

 

               8,793,869

 

                 8,553,516

 

 

 

 

 

 

 

Other Long-Term Assets  (Note 6)

 

                    56,900

 

                      55,100

 

 

 

 

 

 

 

Total Assets

 

 $            9,136,808

 

 $              8,910,325

 

 

 

 

 

 

.

Liabilities and Stockholders' Equity

 

 

 

Current Liabilities

 

 

 

 

 

Accounts payable

 

 $            1,101,847

 

 $                 267,165

 

Due to other working and oyalty interests

 

                  135,384

 

                    107,905

 

Other payables, interest & taxes accrued

 

                  178,358

 

                    130,797

 

Note payable in less than one year (Note 7)

 

                  227,914

 

                    800,000

Total Current Liabilities

 

               1,643,504

 

                 1,305,867

Long Term Liabilities  (Note 8)

 

               1,161,074

 

                    265,844

 

 

 

 

 

 

 

Total Liabilities

 

               2,804,578

 

                 1,571,711

 

 

 

 

 

 

 

Commitments and Contingencies (Note 15)

 

                              -

 

                                -

Stockholders' Equity (Deficit)

 

 

 

 

 

Preferred Stock, $.001 par value; 10,000,0000 shares authorized, no shares issued

 

 

 

 

 

   and outstanding.

 

                              -

 

                                -

 

Common Stock, $.001 par value; 200,000,000 shares authorized; 48,980,326 shares issued

 

 

 

 

 

   and outstanding at September 30, 2010 and 44,509,496 shares issued

 

 

 

 

 

   and outstanding at September 30, 2009 (Note 9)

 

                    48,980

 

                      44,509

 

Additional paid-in capital

 

             17,108,319

 

               12,821,792

 

Stock issuance obligation (Notes 7 and 10)

 

                              -

 

                    136,000

 

Accumulated deficit

 

            (10,825,069)

 

               (5,663,688)

Total Stockholders' Equity

 

               6,332,230

 

                 7,338,613

 

 

 

 

 

 

 

Total Liabilities and Stockholders' Equity

 

 $            9,136,808

 

 $              8,910,325

 

“The accompanying notes are an integral part of these consolidated financial statements”




17






JayHawk Energy, Inc.

Consolidated Statements of Operations

 

 

 

 

 

 

Year Ended September 30, 2010

 

Year Ended September 30, 2009

Revenue

 

 

 

 

 

 

 

 

Oil sales

 

 $               612,607

 

 $                 479,598

 

Gas sales

 

                    72,101

 

                    108,812

Total Gross Revenues

 

 

 

 

                  684,707

 

                    588,410

 

 

 

 

 

 

 

 

 

Costs and Operating Expenses

 

 

 

 

 

 

 

Exploration costs

 

                              -

 

                                -

 

Production costs-North Dakota

 

                  286,464

 

                    211,507

 

Production costs-Kansas

 

                    26,060

 

                    187,638

 

Depreciation, depletion, amortization and asset impairment expense

 

               1,797,583

 

                 1,069,577

 

General and administrative

 

               1,292,359

 

                    659,714

 

Other expense

 

               2,443,622

 

                    737,607

Total Costs and Expenses

 

               5,846,088

 

                 2,866,043

 

 

 

 

 

 

 

 

 

Loss from continuing operations before income tax

 

              (5,161,381)

 

               (2,277,633)

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

                            -   

 

                              -   

Deferred tax benefit

 

                            -   

 

                              -   

 

 

 

 

 

 

 

 

 

Net loss from continuing operations

 

              (5,161,381)

 

               (2,277,633)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss and total comprehensive loss

 

 $           (5,161,381)

 

 $            (2,277,633)

 

 

 

 

 

 

 

 

 

Basic and diluted loss per share (Note 10)

 

 $                    (0.11)

 

 $                     (0.05)

 

 

 

 

 

 

 

 

 

Basic weighted average number shares outstanding

 

             47,512,481

 

               43,699,043

 

 

 

 

 

 

 

 

 

“The accompanying notes are an integral part of these consolidated financial statements”




18







Jayhawk Energy, Inc.

Consolidated Statement of

Stockholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Shares

 

Stock Par Value

 

Additional Paid-In Capital

 

Retained Earnings or (Deficit)

 

Stock Issuance Obligation

 

Total

Balance at September 30, 2008

 

          42,810,929

 

 $        42,812

 

 $12,400,784

 

 $   (3,386,055)

 

 $        47,559

 

 $     9,105,099

October 31, 2008 issuance for services

 

                    25,000

 

                    25

 

             16,725

 

 

 

 

 

                16,750

Janaury 12, 2009 issurance for non

 

 

 

 

 

 

 

 

 

 

 

                       -   

  renewed leases and services

 

                    74,575

 

                    74

 

             74,184

 

 

 

            (47,559)

 

                26,699

January 12, 2009 issurance for services

 

                    51,000

 

                    51

 

             20,859

 

 

 

 

 

                20,910

February 5, 2009 Private placement

 

               1,000,000

 

               1,000

 

           199,000

 

 

 

                     -   

 

              200,000

March 2, 2009 issue obligation

 

 

 

 

 

 

 

 

 

             14,555

 

                14,555

April 20, 2009 issue for services

 

                    85,400

 

                    85

 

             14,470

 

 

 

            (14,555)

 

                       -   

May 20, 2009 issue for services

 

                    40,000

 

                    40

 

               7,960

 

 

 

 

 

                  8,000

June 4, 2009 issue for services

 

                    49,800

 

                    50

 

               7,420

 

 

 

 

 

                  7,470

July 31, 2009 issue for services

 

                  139,167

 

                  139

 

             28,199

 

 

 

                     -   

 

                28,338

July 31, 2009 issue obligation in lieu of

 

 

 

 

 

 

 

 

 

 

 

 

  extension fee and interest

 

 

 

 

 

 

 

 

 

           136,000

 

              136,000

August 5, 2009 issue for services

 

                  203,625

 

                  204

 

             40,521

 

 

 

                     -   

 

                40,725

September 3, 2009 issue for services

 

                    30,000

 

                    30

 

             11,670

 

 

 

 

 

                11,700

Loss for the year ending September 30, 2009

 

 

 

 

 

 

 

         (2,277,633)

 

 

 

         (2,277,633)

Balance at September 30, 2009

 

 

          44,509,496

 

 $        44,509

 

 $12,821,792

 

 $   (5,663,688)

 

 $      136,000

 

 $     7,338,613

October 2, 2009 issue for services

 

                    30,000

 

                    30

 

             11,370

 

                       -   

 

                     -   

 

                11,400

October 11, 2009 issue for services

 

                    30,000

 

                    30

 

               8,370

 

                       -   

 

                     -   

 

                  8,400

November 16, 2009 issue for promissory note extinguishment

 

                  544,000

 

                  544

 

           135,456

 

                       -   

 

          (136,000)

 

                       -   

December 31, 2009 warrant valuation and beneficial conversion of debentures issued

 

                            -   

 

                     -   

 

           900,000

 

                       -   

 

                     -   

 

              900,000

December 31, 2009 stock warrants issued for payment of services

 

                            -   

 

                     -   

 

             54,263

 

 

 

                     -   

 

                54,263

January 8, 2010 cashless exercise of warrants for share issuance

 

               1,398,065

 

               1,398

 

              (1,398)

 

                       -   

 

                     -   

 

                       -   

January 27, 2010 cashless exercise of warrants for share issuance

 

                  713,322

 

                  713

 

                 (713)

 

                       -   

 

                     -   

 

                       -   

February 25, 2010 conversion of note payable

 

               1,600,000

 

               1,600

 

           853,543

 

                       -   

 

                     -   

 

              855,143

February 25, 2010 cost of conversion of promissory note

 

                            -   

 

                     -   

 

        1,466,978

 

                       -   

 

                     -   

 

           1,466,978

April 1, 2010 issue in lieu of interest

 

                    21,666

 

                    22

 

             16,228

 

                       -   

 

                     -   

 

                16,250

April 23, 2010 warrant valuation and beneficial conversion of debentures issued

 

                            -   

 

                     -   

 

           600,000

 

                       -   

 

                     -   

 

              600,000

May 4, 2010 issue for services

 

                    11,000

 

                    11

 

               5,159

 

                       -   

 

                     -   

 

                  5,170

June 28, 2010 conversion of debenture

 

                    10,000

 

                    10

 

               2,990

 

                       -   

 

                     -   

 

                  3,000

July 20, 2010 issue in lieu of interest

 

                  112,777

 

                  113

 

             33,721

 

                       -   

 

                     -   

 

                33,833

September 2, 2010 issuance of stock options

 

                            -   

 

                     -   

 

           200,560

 

                       -   

 

                     -   

 

              200,560

Loss for the year ending September 30, 2009

 

                            -   

 

                     -   

 

                     -   

 

         (5,161,381)

 

                     -   

 

         (5,161,381)

Balance at September 30, 2009

 

 

          48,980,326

 

 $        48,979

 

 $17,108,319

 

 $ (10,825,069)

 

 $                  -   

 

 $     6,332,229

 

“The accompanying notes are an integral part of these consolidated financial statements”




19






JayHawk Energy, Inc.

Statement of Consolidated Cash Flows

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended September 30, 2010

 

Year Ended September 30, 2009

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

Net loss from operations

 

 $           (5,161,381)

 

 $            (2,277,633)

 

Adjustments to reconcile net loss to net cash used:

 

 

 

 

 

 

by operating activities:

 

 

 

 

 

 

Depreciation, depletion, amortization and impairment

 

                  972,160

 

                 1,249,259

 

 

Provision for impairment of proved reserves

 

                  811,339

 

 

 

 

Accretion in annual asset retirement obligations

 

                    14,084

 

                      12,804

 

 

Amortization of discount on note payable

 

                  759,146

 

 

 

 

Common stock issued for stock issuance costs

 

                  161,068

 

 

 

 

Debt Conversion Expense

 

               1,466,978

 

 

 

 

Loss on disposition of asset

 

                    78,137

 

                              -   

 

 

Common stock issued in lieu of interest

 

                    79,222

 

 

 

 

Common stock issued in consideration for services

 

                    50,083

 

                    311,147

 

 

Stock options expense

 

                  200,560

 

                              -   

 

 

(Increase) Decrease in accounts receivable, net

 

                    68,092

 

                    120,355

 

 

(Increase) Decrease in other current assets

 

                     (1,800)

 

                      13,483

 

 

(Increase) Decrease in other long term assets

 

                     (1,800)

 

                              -   

 

 

Increase (Decrease) in accounts payable

 

                  834,682

 

                  (209,030)

 

 

Increase in accruals and other current liabilities

 

                    75,040

 

                    533,561

 

Net cash used by operating activities

 

                405,610

 

                (246,054)

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

Proved oil and gas property additions

 

              (1,953,743)

 

                    (18,600)

 

Unproved oil and gas property additions

 

                 (148,245)

 

                      (1,160)

 

Sale of joint interest in Kansas properties

 

 

                  250,000

 

 

 

Other property additions

 

                            -   

 

                    (11,211)

 

Net cash used by operating activities

 

              (1,851,988)

 

                    (30,971)

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from the sale of common stock

 

                            -   

 

                    200,000

 

Borrowings with note payable

 

               1,500,000

 

                              -   

 

Common stock issued for reduction of note payable

 

                     (3,000)

 

 

 

Net cash provided by financing activities

 

               1,497,000

 

                    200,000

 

 

 

 

 

 

 

 

 

NET (DECREASE) IN CASH AND CASH EQUIVALENTS

 

                    50,622

 

                    (77,025)

 

 

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

 

                      5,658

 

                      82,683

 

 

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS AT END OF YEAR

 

 $                 56,280

 

 $                     5,658

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flows and Non-cash Investing and Financing Activity:

 

 

 

Income taxes paid

 

 $                         -   

 

 $                           -   

 

Interest paid with common stock

 

 $                 50,083

 

 $                   96,000

 

“The accompanying notes are an integral part of these consolidated financial statements”

 

 

 

 

 

 

 

 

 




20





JayHawk Energy, Inc.

Notes to the Consolidated Financial Statements

September 30, 2010


Note 1 – Organization and Description of Business


Nature of Operations – JayHawk Energy, Inc. (the Company, we, or JayHawk) and its wholly owned subsidiary, is engaged in the acquisition, exploration, development, production and sale of natural gas, crude oil and natural gas liquids primarily from conventional reservoirs within North America.  The Company incorporated in Colorado on April 5, 2004 as Bella Trading Company, Inc.  During the second quarter ending June 30, 2007, we changed management and entered the oil and gas business, and ceased all activity in retail jewelry.  On June 21, 2007, the Company changed its name to JayHawk Energy, Inc.  Since then, the Company has devoted its efforts principally to the raising of capital, organizational infrastructure development, the acquisition of oil and gas properties and exploration activities.  To date, the Company has acquired three main properties, the Uniontown in Kansas, the Crosby in North Dakota, and Girard in Kansas.  The Company also formed a wholly owned subsidiary to transport our gas in Kansas, called Jayhawk Gas Transportation Company.  This is the basis for which financial statements are consolidated.  The accompanying financial statements as of and for the periods ended September 30, 2010 and 2009 are prepared using the accrual basis of accounting in accordance with generally accepted accounting principles in the United States of America (“US GAAP”) and have been consistently applied in the preparation of the Consolidated Financial Statements.


Note 2 – Summary of Significant Accounting Policies


Going Concern – As shown in the accompanying financial statements,  the Company has incurred operating losses since inception.  As of September 30, 2010, we have limited financial resources with which to achieve our objectives and obtain profitability and positive cash flows.  Achievement of our objectives will be dependent upon our ability to obtain additional financing, to locate profitable mineral properties and generate revenue from our current and planned business operations, and control costs.  We plan to fund our future operation by joint venturing, obtaining additional financing from investors, and attaining additional commercial production.  However, there is no assurance that the Company will be able to achieve these objectives.


Joint Venture Operations – In instances where the Company’s oil and gas activities are conducted jointly with others, the Company’s accounts reflect only its proportionate interest in such activities.


Use of estimates - The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the respective reporting periods.  A change in accounting estimate is accounted for prospectively over the current and future years.  


Income or loss per common share - Basic income per share is calculated based on the weighted average number of common shares outstanding.  Diluted income per share assumes exercise of stock options and warrants and conversion of convertible debt and preferred securities, and preferred securities, provided the effect is not antidilutive.  As each of the two fiscal periods covered by these financial statements reflects net losses from operations, all of our warrants have an anti-dilutive effect on per common share amounts.


Revenue and Cost Recognition - The Company uses the sales method of accounting for oil and gas revenues. Under this method, revenues are recognized based on the actual volumes of gas and oil sold to purchasers. The volume sold may differ from the volumes we are entitled to, based on our individual interest in the property.  Periodically, imbalances between production and nomination volumes can occur for various reasons.  In cases where imbalances have occurred, a production imbalance receivable or liability will be recorded.  Costs associated with production are expensed in the period in which they are incurred.


Revenue Source -All of the Company’s direct operating revenues originate from oil production from its property in Crosby, North Dakota or from natural gas production from its property in Girard Kansas. Each revenue stream is sold to a single customer through month to month contracts.  While this creates a customer concentration, there are alternate buyers of the production in the event the sole customer is unable or unwilling to purchase.


Cash equivalents - We consider all highly liquid debt instruments purchased with maturity of three months or less to be cash equivalents.


Property, plant and equipment - JayHawk follows the method of accounting for oil and gas property as promulgated in Accounting Standards Codification (ASC) topic 932, Extractive Activities – Oil and Gas.  Under this method of accounting, costs to acquire mineral interests in oil and natural gas properties, to drill and equip exploratory wells that find proved reserves, and to drill and equip development wells, are capitalized.  Costs to drill exploratory wells that do not find proved reserves, geological and geophysical



21





costs and costs of carrying and retaining unproved properties are expensed.


We calculate depletion, depreciation and amortization (DD&A) of capitalized cost of proved oil and gas properties on a field-by-field basis using the units-of-production method based upon proved reserves. In computing DD&A we will take into consideration restoration, dismantlement and abandonment cost and the anticipated proceeds from equipment salvage.  When applicable, we will apply the provisions of ASC topic 410, Accounting for Asset Retirement Obligations, which provides guidance on accounting for dismantlement and abandonment cost (see Note 9).


 

Support equipment and other property, plant and equipment related to oil and gas production are depreciated on a straight-line basis over their estimated useful lives which range from 5 to 35 years.  Property, plant and equipment unrelated to oil and gas producing activities is recorded at cost and depreciated on a straight-line basis over the estimated useful lives of the assets, which range from 3 to 25 years.


Impairment of Long-Lived Assets - The Company evaluates its long-term assets annually for impairment or when circumstances or events occur that may impact the fair value of the assets.  The fair value of geothermal property is primarily evaluated based upon the present value of expected revenues directly associated with those assets.  An impairment loss would be recognized if the carrying amount of a capitalized asset is not recoverable and exceeds its fair value. Management believes that there have not been any circumstances that have warranted the recognition of losses due to the impairment of long-lived assets as of September 30, 2010.

 

Sales of Producing and Non-producing Property - We account for the sale of a partial interest in a proved property as normal retirement. We recognize no gain or loss as long as this treatment does not significantly affect the unit-of-production depletion rate. We recognize a gain or loss for all other sales of producing properties and include the gain or loss in the results of operations.  We account for the sale of a partial interest in an unproved property as a recovery of cost when substantial uncertainty exists as to recovery of the cost applicable to the interest retained. We recognize a gain on the sale to the extent that the sales price exceeds the carrying amount of the unproved property. We recognize a gain or loss for all other sales of non-producing properties and include the gain or loss in the results of operations. 

 

Asset Retirement Obligation - We follow ASC topic 410, “Accounting for Asset Retirement Obligations”, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made.  The associated asset retirement costs will be capitalized as part of the carrying amount of the long-lived asset.  The carrying value of a property associated with the capitalization of an asset retirement cost will be included in proved oil and gas property in the balance sheets.  The future cash outflows for oil and gas property associated with settling the asset retirement obligations will be accrued in the balance sheets, and will be excluded from ceiling test calculations.  Our asset retirement obligation will consist of costs related to the plugging of wells and removal of facilities and equipment on its oil and gas properties (see Note 8).  


Income Tax and Accounting for Uncertainty - Income taxes are determined using the liability method in accordance with ASC topic 740.  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. Deferred tax assets and liabilities are measured using the 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 the period that includes the enactment date. In addition, a valuation allowance is established to reduce any deferred tax asset for which it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.


ASC Topic 740 recognizes that the ultimate deductibility of positions taken or expected to be taken on tax returns is often uncertain.  It provides guidance on when tax positions claimed by an entity can be recognized and guidance on the dollar amount at which those positions are recorded.  In order to recognize the benefits associated with a tax position taken the entity must conclude that the ultimate allowability of the deduction is more likely than not.  If the ultimate allowability of the tax position exceeds 50% (more likely than not), the benefit associated with the position is recognized at the largest dollar amount that has more than a 50% likelihood of being realized upon ultimate settlement.  Differences between tax positions taken in a tax return and recognized in accordance with the guidance will generally result in (1) an increase in income taxes currently payable or a reduction in an income tax refund receivable or (2) an increase in a deferred tax liability or a decrease in a deferred tax asset, or both (1) and (2).


Stock Options Granted to Employees and Non-employees - The Company follows financial accounting standards that require the measurement of the value of employee services received in exchange for an award of an equity instrument based on the grant-date fair value of the award.  For employees, directors and officers, the fair value of the awards are expensed over the vesting period.  The current vesting period for all options is eighteen months.




22





Non-employee stock-based compensation is granted at the Board of Director’s discretion to award select consultants for exceptional performance.  Prior to issuance of the awards, the Company was not under any obligation to issue the stock options.  Subsequent to the award, the recipient was not obligated to perform any services.  Therefore, the fair value of these options was expensed on the grant date, which was also the measurement date.


Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment.  In addition, judgment is also required in estimating the amount of share-based awards that are expected to be forfeited.  If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.


Short term benefits and compensated absences - Wages, salaries, bonuses and social security contributions are recognized as an expense in the year in which the associated services are rendered by employees. Short term accumulating compensated absences such as paid annual leave are recognized when services are rendered by employees that increase their entitlement to future compensated absences. The company has not accrued compensated absences because the amount cannot be reasonably estimated.  


New Accounting Pronouncements - In January 2010, the FASB issued Accounting Standards Update No. 2010-03 “Extractive Activities – Oil and Gas, Accounting Standards Codification (ASC) Topic 932: Oil and Gas Reserve Estimation and Disclosures”.  The objective is to align the oil and gas reserve estimation and disclosure requirements of ASC Topic 932 with the requirements in the SEC final rule “Modernization of the Oil and Gas Reporting Requirements” described in the preceding paragraph.  This includes updating the reserve estimation requirements for changes in practice and technology that have occurred over the last several decades and expanding the disclosure requirements for equity method investments.  The amendments in this Update 2010-03 are effective for interim and annual periods ending on or after December 31, 2009, and should be applied on a prospective basis.  The Company adopted this Update without a material effect on its results of operations and financial position.


Note 3 - Trade Accounts Receivable


At September 30, 2010 trade accounts receivable represents those amounts the Company is owed for its oil and gas production delivered during the month of September 2010 and amounts due from other working interests for their respective percentages of joint operating costs and drilling costs.


  At September 30, 2009, trade accounts receivable also included a net amount anticipated to be collected from the SemCrude bankruptcy.  The previous purchaser of our North Dakota crude oil, SemCrude, took delivery of JayHawk's 2008 June and July production and,  before compensating the Company, filed a Chapter 11 bankruptcy proceeding.  Management established an allowance for 100% of the value of the June deliveries, equivalent to $119,763, charging bad debt expense for an equal amount.  Since August of 2008 all crude oil production was delivered to a new purchaser.

  

On February 25, 2010 the Company received $224,183 in complete settlement of this litigation and the receivable and associated allowance were accordingly eliminated.  Proceeds for the September 2010 deliveries, valued at $109,074, were subsequently received in October 2010.  Amounts receivable for September natural gas deliveries, $6,533 were also received in October 2010. Specifically, trade accounts receivable are detailed as follows:


 

 

 

 

 

September 30, 2010

 

September 30, 2009

Due for crude oil delivered in June & July-SemCrude

 

 $                         -   

 

 $                 283,485

 

Less:  Allowance for doubtful collections

 

                            -   

 

                  (119,763)

Due for crude oil delivered in September 2010 and 2009

 

                  193,297

 

                    109,074

Due for natural gas delivered in September 2010 and 2009

 

                      6,533

 

                        5,955

Due from joint operating agreement working interests

 

                    25,585

 

                      14,756

 

TOTAL:

 

 

 $               225,415

 

 $                 293,507



Note 4 – Unproved Properties and Impairment


The total of JayHawk's investment in unproved properties at September 30, 2010 and 2009 consists of the following capitalized costs respectively:



23






 

 

 

 

 

September 30, 2010

 

September 30, 2009

Name

 

 

 

 

 

 

Kansas Uniontown Project

 

 $            2,494,479

 

 $              2,494,479

 

Less: allowance for impairment

 

              (1,474,000)

 

               (1,474,000)

 

Less: accumulated amortization

 

                 (256,487)

 

                  (162,734)

Net investment in Uniontown Project

 

 $               763,992

 

 $                 857,745

 

 

 

 

 

 

 

 

Kansas Girard Project

 

 $            1,652,284

 

 $              1,651,124

 

Less: accumulated amortization

 

                 (436,916)

 

                  (243,196)

Net investment in Girard Project

 

 $            1,215,368

 

 $              1,407,928

 

 

 

 

 

 

 

 

North Dakota Project

 

 $               147,085

 

 $                           -   

 

Less: accumulated amortization

 

                            -   

 

                              -   

Net investment in North Dakota Project

 

 $               147,085

 

 $                           -   

 

 

 

 

 

 

 

 

Total Unproved Oil and Gas Properties

 

 $            2,126,445

 

 $              2,265,673

 

 

 

 

 

 

 

 


As discussed in Note 2, we amortize the lease bonuses paid to acquire specific acreage over the life of the lease, generally three years, through the lease expiration date.


Impairment of Uniontown Project:  In addition to amortizing the capitalized lease costs, JayHawk periodically reviews and assesses its' unproved properties to determine whether or not they have been impaired.  A property is considered impaired if it will not or cannot be developed.  At that time an allowance is established to revalue the capitalized cost and a provision of equal amount is provided as an operating expense.  Management made a review of the portfolio of leases acquired in the Uniontown transaction of July 2007 and decided, based on geology and proximity to our pipeline, to permit approximately one-third of the original leases acquired to expire without renewal. Further, given the Company's inability at that time to fund development of any acreage, justification existed at the time for the creation of an impairment valuation.  The impairment allowance was estimated at two-thirds, 67 percent, of the original investment.


Note 5 – Proved and Developed Oil & Gas


The capitalized cost, net of depreciation, depletion and amortization (DD&A) of the proved oil and gas properties was $6,647,808, at September 30, 2010, and $6,256,238 at September 30, 2009.  These net capitalized costs are comprised of the following; detailed by property:


 

 

 

 

 

 

September 30, 2010

 

September 30, 2009

Crosby, North Dakota Properties

 

 

 

 

 

Proved Reserves

 

 $            2,357,753

 

 $              2,357,753

 

Field Equipment

 

               1,224,580

 

                 1,200,247

 

Capitalized Drilling Costs

 

               1,929,410

 

                              -   

 

Less Allowance for Impairment

 

                 (811,339)

 

 

 

Less Accumulated DD&A

 

              (1,608,152)

 

               (1,117,265)

Net Capitalized Costs

 

 $            3,092,252

 

 $              2,440,735

 

 

 

 

 

 

 

 

 

Girard, Kansas Properties

 

 

 

 

 

 

Field Equipment

 

 $               705,903

 

 $                 796,033

 

Capitalized Drilling Costs

 

                  662,899

 

                    662,899

 

Less Accumulated DD&A

 

                 (130,364)

 

                    (76,402)

Net Capitalized Costs

 

 $            1,238,438

 

 $              1,382,530

 

 

 

 

 

 

 

 

 

JayHawk Gas Transportation

 

 

 

 

 

 

Field Equipment

 

 

 

 $            2,605,871

 

 $              2,605,871

 

Less Accumulated DD&A

 

 

                 (288,753)

 

                  (172,897)

Net Capitalized Costs

 

 $            2,317,118

 

 $              2,432,973

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Proved Oil and Gas Properties

 

 $            6,647,808

 

 $              6,256,238



24









Ceiling Test – The Company has performed ceiling tests to determine that the carrying amounts in our financial statements do not exceed the net present value of the reserve estimates for the respective properties, of Crosby, North Dakota and Girard, Kansas.  For the Girard properties management determined that the net values reflected in the financial statements did not exceed the net discounted present value of the reserves estimated by the independent reserve engineers.


Impairment of Crosby Project:  JayHawk periodically reviews and assesses its' proved properties to determine whether or not they have been impaired.  A property is considered impaired if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value.  The carrying amount of a long-lived assets is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset.  The impairment loss shall be measured as the amount by which the carrying amount of the long-lived asset exceeds its fair value.  Based upon estimates provided by independent reserve engineers, Management has determined an impairment of $811,339 exists on the Crosby property. The impairment allowance was established to approximate the write-down of the impairment loss for the period.


Note 6 – Other Long-Term Assets – Other assets consists of various deposits.  Detail is disclosed in the following table:


 

 

 

 

 

 

September 30, 2010

 

September 30, 2009

 

 

 

 

 

 

 

 

 

Rental Security Deposit

 

 

 

 $                   1,500

 

 $                     1,500

Bond Deposit - State of Kansas

 

 

                      5,400

 

                        3,600

Bond Deposit - State of North Dakota

 

 

                    50,000

 

                      50,000

 

Total

 

 $                 56,900

 

 $                   55,100

 

 

 

 

 

 

 

 

 


Note 7 – Notes Payable due in less than one year


On July 30, 2008 JayHawk signed a convertible promissory note in the amount of $800,000 for cash received of an equal amount.  The original note provided for interest to be paid at the maturity date of July 30, 2009, computed at a rate of 12 percent per annum.  The note and accrued interest was convertible into share of common stock at $1.75 per share.  On July 30, 2009, the note was amended to extend the maturity date to July 30, 2010.  Under the amended agreement interest continued to be accrued and the holder continued the right to convert the outstanding principal balance and unpaid accrued interest to shares of the Company's common stock, at the conversion price of $1.75.


On February 25, 2010 the $800,000 principal of the note payable and currently accrued interest was converted to 1.6 million shares of the Company’s common stock.  Accounting Standards Codification (ASC) Topic 470-20-40-16 requires expense to be recognized when convertible debt is converted to equity securities of the debtor to the extent that the fair value of the securities and other consideration transferred exceeds the fair value of securities issuable pursuant to the original conversion terms.  Management made an assessment of the modified terms of conversion and determined that the fair value of the 1.6 million shares on the date of issuance was $2,112,000 and exceeded the value of shares issuable pursuant to the amended agreement of $645,022, by $1,466,978.  This amount was charged to non-cash debt conversion expense and is included in Other Expense on the Consolidated Statement of Operations.


On September 1, 2010 the Company entered into a short-term promissory note with a vendor for its balance of accounts payable.  The initial principal balance of $272,373 is due and payable in six (6) equal payments of $46,729 including interest at a rate of 12% per annum.  The final payment is due February 25, 2011.


Note 8 - Long-term Liabilities


Long-term liabilities at September 30, 2010 are comprised of an asset retirement obligation of $154,928 and convertible debentures of $756,146, net of discounts for the imputed fair value of common stock purchase warrants attached to the debentures and the imputed fair value of the conversion feature of the debentures.  At September 30, 2009 the only long-term liability was the asset retirement obligation reflected in the amount of $140,844.  The composition of long-term liabilities existing at September 30, 2010 and September 30, 2009 is reflected in the following table:



25






 

 

 

 

 

 

September 30, 2010

 

September 30, 2009

 

 

 

 

 

 

 

 

 

Asset retirement obligation

 

 

 $               154,928

 

 $               140,844

Investment in Joint Venture Girard

 

 

                  250,000

 

                  125,000

Long-term notes (debentures) payable face value

 

 

               1,497,000

 

                            -   

 

Less: Unamortized discount(s)

 

 

 

 

                            -   

 

   Imputed fair value of common stock purchase warrants

 

 

                 (285,887)

 

                            -   

 

   Imputed fair value of beneficial conversion feature

 

 

                 (454,967)

 

                            -   

Total long-term liabilities

 

 $            1,161,074

 

 $               265,844

 

 

 

 

 

 

 

 

 


During the year ended September 30, 2010, the Company issued 10 percent convertible debentures with a face value of $1,500,000.  The first tranche of the total financing, with a face value of $900,000, was issued during the first quarter end December 31, 2009.  In April of the third quarter ended June 30, 2010 additional debentures with a face value of $600,000 were issued.  All of the debentures have a two year maturity and were issued with attached common stock purchase warrants.  The effective interest rate on the debentures is 10 percent per annum.  Interest of $102,642 was expensed and is included in "Other expense" on the Consolidated Statements of Operations for the Year Ending September 30, 2010.  Interest accrued at year end of $37,500 is included on the Consolidated Balance Sheets  in "Other payables, interest and taxes accrued".


The debentures are convertible at any time after the original issue date into a number of shares of the Company’s common stock, determined by dividing the amount to be converted by a conversion price of  $0.30 per share.  Additionally, the attached common share purchase warrants, expire 42 months from the original issue date and permit the holders two exercisable options.  The warrant were exercisable by purchase of the Company’s common stock for cash at an exercise price of $0.45, or alternatively, in a cashless exercise, the number of shares being determined in accordance with a predetermined formula based on the Company’s then current stock price.


During the second quarter ended March 31, 2010, the holders of the debentures and the common stock purchase warrants associated with the first $900,000 issuance, exercised all 3,000,000 warrants to acquire 2,111,388 shares of the Company’s common stock in two separate cashless exercises on January 6 and January 27.  Warrants attached to the debentures issued in April 2010 ($600,000 face amount) total 2,000,000 and remain to be exercised as the election of the debenture holders at an exercise price of $0.45 per share.


The debentures are secured by all assets of the Company except those specifically excluded in the agreement which include all Kansas properties and related assets.


Long term notes (debentures) will mature as follows:


Year ending September 30,

 

 

 

2011

 

 

 $                         -   

2012

 

 

               1,497,000

2013

 

 

                            -   

2014

 

 

                            -   

2015

 

 

                            -   

 

 

 

 

 

 

 $            1,497,000


In accordance with ASC Topic 470, the Company allocated the proceeds to detachable warrants and convertible instruments based upon their relative fair values of the debt instrument without the warrants and the warrants themselves at the time of issuance.  The fair value of the warrants was determined following the guidance of ASC Topic 718; using the Black-Scholes option model (using a risk free interest rate of .06 percent, volatility of 99.3 percent, exercise price of $0.30, current market values of $0.43 and $0.70 per share and an expected life of 3.5 years) with the value allocated to the warrants reflected in Stockholders’ Equity and a debt discount.  Based upon the respective fair values as of the original agreement dates $1,500,000 was allocated to discounts associated with the common stock purchase warrants and the beneficial conversion features.  Giving effect to the monthly amortization of the discount, the exercise of all purchase warrants associated with the first $600,000 tranche, and the conversion of $3,000 in principal conversion, $740,854 of the discount remains to be amortized over the remaining life of the debentures.  This $740,854 consists of the remaining unamortized imputed fair value of the common stock purchase warrants of $285,887 and imputed fair value of the beneficial conversion feature of $454,967.  These amounts are and will continue to be amortized over the remaining life of the underlying convertible debentures.




26





Note 9 - Asset Retirement Obligation


In the period in which an asset retirement obligation is incurred or becomes reasonably estimable, the Company recognizes the fair value of the liability if there is a legal obligation to dismantle the asset and reclaim or remediate the property at the end of its useful life. The Company estimates the timing of the asset retirement based on an economic life determined by reference to similar properties and/or reserve reports.  The liability amounts are based on future retirement cost estimates and incorporate many assumptions such as expected economic recoveries of oil and gas, time to abandonment, future inflation rates and the adjusted risk-free rate of interest. When the liability is initially recorded, the Company capitalizes the cost by increasing the related property balances. This initial capitalized cost is depreciated or depleted over the useful life of the asset.


The Company has identified potential asset retirement obligations at the Girard, Kansas and Crosby, North Dakota operating sites.  These retirement obligations are determined based on the estimated cost to comply with abandonment regulations established by the Kansas Corporation Commission and the State of North Dakota.  The Company's engineers have estimated the cost, in today's dollars, to comply with these regulations.  These estimates have been projected out to the anticipated retirement date 15 years in the future, at an assumed inflation rate of 1.5 percent.  The anticipated future cost of remediation efforts in North Dakota, and Kansas, are $204,685, and $281,547, respectively.  These amounts were discounted back at an assumed interest rate of 10 percent, to arrive at a net present value of the obligation. The amount of the annual increase in the obligation is charged to "accretion expense" and for the period ending September 30, 2010 and 2009, was computed to be $14,084 and $12,804, respectively.

    

The ending balance of the asset retirement obligation at September 30, 2010 is $154,928.  The asset retirement obligation is included in the Balance Sheet classification "Long-term Liabilities."  The following table summarizes the change in the asset retirement obligation since the beginning of the fiscal year ending September 30, 2009:


 

 

 

 

 

 

Year Ended September 30, 2010

Year Ended September 30, 2009

 

 

 

 

 

 

 

 

 

Beginning balance

 

 

 $           140,844

 

 $        128,040

Liabilities incurred

 

 

                         -   

 

                       -   

Liabilities settled

 

 

                         -   

 

                       -   

Accretion expense

 

 

                 14,084

 

              12,804

Revision to estimated cash flows

 

                         -   

 

                       -   

 

Totals

 

 

 

 

 $           154,928

 

 $        140,844


Note 10 - Common Stock


Issuances and Private Placements:  The following transactions reflect issuances of shares of the Company’s common stock and are presented by date of completion in chronological order.  Transactions described as private placements were completed in reliance upon that certain exemption from the registration and prospectus delivery requirements of the Securities Act of 1933, which exemption is specified by the provisions of Section 5 of that act and Regulation S.


Fiscal Year End September 30, 2010


At September 30, 2009, the number of the Company’s common shares issued and outstanding was 44,509,496.  During the year end September 30, 2010 this number increased by 4,470,830  shares to 48,980,326.  The specific issuances of the common stock are detailed below:


October 2, 2009 - The Company issued 30,000 shares of common stock to one vendor for services rendered.  These shares were valued at $0.38 per share.  The fair value of the aggregate issuance approximated the value of the services rendered.


October 30, 2009 - The Company issued 30,000 shares of common stock to one vendor for services rendered.  These shares were valued at $0.28 per share.  The fair value of the aggregate issuance approximated the value of the services rendered


November 16, 2009 - As discussed in Note 7, the Company issued 544,000 shares of common to fulfill the stock issuance obligation recognized on July 30, 2009.  This obligation was recognized as the result of amending the original $800,000 short-term convertible promissory note, signed in July 2008.  The original note had a one-year maturity, maturing July 30, 2009, and provided for interest to be paid upon maturity, computed at a rate of 12 percent per annum.  The amendment extended the maturity date to July 30, 2010.  Accrued interest to the date of the amendment was $96,000.  This along with a 5 percent extension fee of $40,000 was converted to



27





shares of the Company’s restricted common stock, at the rate of $0.25 per share.  The total amount of $136,000 was reflected as a stock issuance obligation as at September 30, 2009.  


January 6 and 27, 2010 - Holders of the debentures and the common stock purchase warrants, more fully described in Note 8, exercised their rights under those warrants to acquire 2,111,388 shares of the Company’s common stock in two separate cashless exercises.  As a result, the Company issued  1,398,065 shares, and 713,322 shares, in each of the respective transactions.


February 25, 2010 - As discussed in Note 7, the Company issued 1,600,000 shares of common stock for the conversion of the $800,000 convertible note payable reflected at September 30, 2009, and the accrued interest through February 25, 2010 of $55,143 at $0.53 per share.


April 01, 2010 - The Company issued 21,666 shares of common stock in lieu of paying interest, to one investor in the 10% convertible debentures, with cash.  The interest totaled $16,250 and was converted to shares at a price of $0.75 per common share.


May 04, 2010 - The Company issued 11,000 shares of common stock in lieu of paying cash for the rental of field equipment.   The value of the services was determined to be equivalent to the value of the shares issued at the closing stock price of that day, $0.47 per share, or $5,170.


June 28, 2010 - The Company issued 10,000 shares of common stock in conversion of $3,000 of principal  to one of the holder’s of the 10% convertible debentures, in agreement with the terms thereof (see Note 8).


July 20, 2010 - The Company issued the holders of the debentures 112,777 shares of the Company’s common stock in lieu of interest due and payable, totaling $33,833 as of July 01, 2010.  These shares were valued at $0.30 per share.


Fiscal Year End September 30, 2009


October 31, 2008 – The Company issued 25,000 shares valued at $0.67 for consulting services rendered.


January 12 2009 – The Company issued 74,575 shares of  common stock to Missouri Gas Partners.  Of this amount 22,225 shares represented the total "Stock Issuance Obligation" of $47,559 existing at December 31, 2008.  This represented the residual from the June 30, 2008 transaction, wherein JayHawk agreed to release 25 shares per acre as individual oil and gas mineral leases were renewed.  The remaining 52,350 shares were issued in recognition of the Company's obligation to issue 25 shares per acre for 2,094 acres in lieu of lease renewal.  These shares were valued at $0.51 per share, the fair market value of a share on the day the obligation was recognized.


Also on January 12, 2009, an additional 51,000 shares were issued to two individual consultants, in exchange for services provided.   These shares were all valued at $0.41 per share; the fair market value on the date of the transaction.  This approximates the value of the services provided.


February 5, 2009 - A private placement of 1,000,000 common shares was completed.  The shares were issued to one private investor in consideration for $200,000 in cash that was used as working capital.  The private placement was completed in reliance upon exemption from registration and prospectus delivery requirements of the Securities Act of 1933, which exemption is specified by the provisions of Section 4 of that Act.


April 20, 2009 - The Company issued 85,400 shares of  common stock to three vendors as compensation for services rendered.  These shares were valued at $0.20 per share; the fair market value on the date of the transaction for two of the vendors, and at $0.15 per share for the third.  This approximated the value of the services provided.


May 20, 2009 - 40,000 shares of common stock were issued to one vendor in lieu of cash payment for services provided.  These shares were valued at $0.20 per share; with the fair value of the aggregate issuance approximating the value of the services rendered.


June 4, 2009 – 49,800 shares of common stock were issued to one vendor for services rendered.  These shares were valued at $0.15 per share.  The fair value of the aggregate issuance approximated the value of the services rendered.


July 30, 2009 – As discussed in Note 6, on July 30, 2009 the Note Payable in the amount of $800,000 matured.  A stock issuance obligation to the note holder was created for the accrued interest of $96,000 and a fee, of $40,000, for extending the date for payment of the principal amount.  The total $136,000 was recorded as a stock issuance obligation at September 30, 2009.  The number of shares of common stock applicable to the issuance obligation was computed by converting the $136,000 obligation at a $0.25 per share, representing 544,000 of common stock.  




28





July 31, 2009 - The Company issued 49,800 shares of common stock to two vendors as compensation for services rendered.  These shares were valued at $0.20 per share; the fair market value on the date of the transaction for each of the vendors.


August 4, 2009 - The Company issued 203,625 shares of common stock to a vendor for settlement of past due obligations.  These shares were also valued at $0.20 per share to approximate the value of the services previously provided.

 

September 3, 2009 – The Company issued 30,000 shares of common stock, valued at $0.39 to a vendor for services rendered.


NOTE 11 - Stock Based Compensation


The Company’s board of directors approved a stock option plan on August 11, 2009.   The purpose of the Plan is to provide employees and consultants of the Corporation and its Subsidiaries with an increased incentive to make significant and extraordinary contributions to the long-term performance and growth of the Corporation and its Subsidiaries, to join the interests of employees and consultants with the interests of the shareholders of the Corporation, and to facilitate attracting and retaining employees and consultants of exceptional ability.    The total number of shares available for grant under the terms of the Plan is 4,000,000.  The stock option price shall be the Fair Market Value of the share at the date of issuance, but may be changed by the Board of Directors or designee from time to time.  The stock options are non-transferable and shall expire not more than five (5) years from the date of the granting.

The Company recognizes compensation expense using the straight-line method of amortization.  Historically, the Company has issued new shares to satisfy exercises of stock options and the Company expects to issue new shares to satisfy any future exercises of stock options.  


During the quarter ended September 30, 2010, the Company granted 2,790,000 stock options to employees, contractors, board members and consultants exercisable at a price of $0.20 per share until September 2015.


At September 30, 2010, the Company had 2,790,000 options granted and outstanding.


The following table reflects the summary of stock options outstanding at September 30, 2010 and changes during the year ended September 30, 2010:


 

 

 

 

 

 

 

Number of shares under options

Weighted Average Exercise Price Per Share

Weighted Average Fair Value

Aggregate Intrinsic Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance outstanding, September 30, 2009

 

 

                     -   

 

 $                -   

 

 $                -   

 

 $                -   

 

Forfeited

 

 

 

 

                     -   

 

                   -   

 

                   -   

 

                   -   

 

Exercised

 

 

 

 

                     -   

 

                   -   

 

                   -   

 

                   -   

 

Granted

 

 

 

 

          2,790,000

 

 $             0.20

 

           558,000

 

           438,873

Balance outstanding, September 30, 2010

 

 

          2,790,000

 

 $             0.20

 

 $        558,000

 

 $        438,873


The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model using the assumptions noted in the following table.  Expected volatilities are based on historical volatility of the Company’s stock.  The Company uses historical data to estimate option volatility within the Black-Scholes model.  The expected term of options granted represents the period of time that options granted are expected to be outstanding, based upon past experience and future estimates and includes data from the Plan.  The risk-free rate for periods within the expected term of the option is based upon the U.S. Treasury yield curve in effect at the time of grant.  The Company currently does not foresee the payment of dividends in the near term. Changes in the subjective input assumptions can materially affect the fair value estimate and, therefore, the existing models do not necessarily provide a reliable measure of the fair value of the Company’s stock options


The fair value of the stock options granted was estimated using the Black-Scholes option-pricing model and is amortized over the vesting period of the underlying options.  The assumptions used to calculate the fair value are as follows:


Year Ended September 30, 2010

 

 

 

 

 

 

 

 

 

 

Dividend yield

 

 

 

 

                      -   

Expecteed volatility

 

 

 

 

99.30%

Risk free interest rate

 

 

 

1.43%

Expected life (years)

 

 

 

 5 years

 

 

 

 

 

 

 

A summary of the status of the Company’s nonvested stock options outstanding at September 30, 2010 is presented as follows:



29






 

 

 

 

 

 

 

Number of options

 

Weighted Average Grant Date Fair Value Per Share

Weighted Average Grant Date Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonvested, September 30, 2009

 

 

 

                        -   

 

 

 $                   -   

 

 $                   -   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Granted

 

 

 

 

            2,790,000

 

 

 $                0.20

 

 $     558,000.00

 

Vested

 

 

 

 

          (1,275,000)

 

 

 $                0.20

 

 $   (255,000.00)

 

Forfeited

 

 

 

 

                        -   

 

 

 $                   -   

 

 $                   -   

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonvested, September 30, 2010

 

 

 

            1,515,000

 

 

 $                     0

 

 $          303,000

 

 

 

 

 

 

 

 

 

 

 

 

 


As of September 30, 2010, there was $238,313 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan.  That cost is expected to be recognized over a weighted-average period of 1.1 years.  The total fair value of options vested at September 30, 2010 was $303,000.


Note 12 - Share Purchase Warrants


When warrants to purchase common stock at a specified exercise price are sold the proceeds received are allocated between the value of the stock and the value of the warrants.  To make this allocation we use the Black-Scholes option pricing model.  This is a subjective exercise involving the use of various estimates, including the risk-free interest rate, the option or contract life, and the expected volatility of the underlying security.


In conjunction with the issuance of the $1,5000,000 note payable, described in Note 8, 166,000 warrants were issued for services provided in execution of the debentures.  The warrants were valued at $54,263 using the Black-Scholes option pricing model with the following assumptions:  risk free interest rate of 0.067, volatility of 99%, exercise price of $0.28, current market price of $0.45 per share and an expected life of 3.5 years.


A summary of the Company's share purchase warrants outstanding at September 30, 2010 is presented as follows:


 

 

 

 

 

 

 

Broker Warrants

Broker Warrant Exercise Price

Share Purchase Warrants

Warrant Exercise Price

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, September 30, 2009

 

 

 

 

                     -   

 

 $                -   

 

                   -   

 

 $                -   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Granted

 

 

 

 

             166,000

 

 $             0.45

 

        2,000,000

 

 $             0.45

 

Exercised

 

 

 

 

 

 

 

 

 

 

 

 

Forfeited

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, September 30, 2010

 

 

 

 

             166,000

 

 $                  0

 

        2,000,000

 

 $             0.45

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Note 13 – Loss per Common Share


The Company follows ASC 260, Earnings Per Share which requires the reporting of basic and diluted earnings/loss per share.  We calculate basic loss per share by dividing the net loss by the weighted average number of outstanding common shares during the period.  We calculate diluted loss per share by dividing net loss by the weighted average number of outstanding common shares, including all potentially dilutive securities during the period.  For the periods ending September 30, 2010 and 2009 the weighted average number of shares was 47,512,481and 43.699,043, respectively.  Additionally, all of our outstanding warrants have an anti-dilutive effect on our per common share amounts.


Note 14 - Related Party Transactions


On July 1, 2008, we subleased office space for $1,500 per month from Marlin Property Management, LLC an entity owned by the spouse of our CEO.  We believe this office space and facilities are sufficient to meet our present needs, and do not anticipate any difficulty securing alternative or additional space, as needed, on terms acceptable to us.  In April 2009, the Company renegotiated the



30





monthly payment to $1,000 per month.


Note 15 - Income Tax

 

The Company follows the guidance of Topic 740, Income Taxes, to account for income taxes, which requires the establishment of deferred tax assets and liabilities for the recognition of future deductions or taxable amounts and operating loss and tax credit carry forwards. Deferred federal income tax expense or benefit is recognized as a result of the change in the deferred tax asset or liability during the year using the currently enacted tax laws and rates that apply to the period in which they are expected to affect taxable income. Valuation allowances are established, if necessary, to reduce deferred tax assets to the amounts that will more likely than not be realized.  Additionally, the Company follows the guidance provided by ASC Topic 740 which recognizes that the ultimate deductibility of positions taken or expected to be taken on a tax return is often uncertain.  It provides guidance on when tax positions claimed by an entity can be recognized (See Note 2, Summary of Significant Accounting Policies – Income Tax Accounting for Uncertainty).  


The Company's provision for income taxes reflects the U.S. federal income taxes calculated at the maximum federal corporate statutory rate of 34%, U.S. state taxes calculated at the statutory rate of 4.15% net of any federal income tax benefit calculated at their combined rates of 19.15% net of any U.S. federal income tax benefits. These rates are our effective tax rates.


At September 30, 2010, we have available for federal income tax purposes a net operating loss carry-forward of approximately $3,019,849, expiring at various times from 2025 through 2028 that may be used to offset future taxable income. Therefore, we have provided no provision for income tax.  The computation and reconciliation with the operating losses from inception is disclosed in the following table for the fiscal years ending September 30, 2007, 2009, and 2010:


 

 

 

 

 

2007

 

2008

 

2009

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

Net operating loss before taxes:

 

 $           (257,713)

 

 $        (3,128,342)

 

 $      (2,277,632)

 

 $      (5,161,381)

 

Add back temporary differences:

 

                         -   

 

                         -   

 

                       -   

 

                       -   

 

 

Allowance for impairment

 

 

                         -   

 

             1,474,000

 

                       -   

 

             811,339

 

 

Excess depreciation and amortization

                         -   

 

                129,106

 

             370,776

 

                       -   

 

 

Expenses not deducted currently

 

                         -   

 

                         -   

 

             102,804

 

             200,560

 

Add back permanent differences:

 

                         -   

 

                         -   

 

                       -   

 

                       -   

 

 

Accretion and amortization of note

 

 

 

 

 

 

 

 

 

  discount

 

 

                         -   

 

                         -   

 

             522,248

 

             759,146

 

 

Other

 

 

                  40,000

 

                    4,154

 

                    750

 

                       -   

Net operating loss to carry-forward

 

 $           (217,713)

 

 $        (1,521,082)

 

 $      (1,281,054)

 

 $      (3,390,336)


Deferred tax assets have been recognized for this net operating loss carry-forward of approximately $578,300 at September 30, 2010.  This has been calculated using effective tax rates of 4.15% and 15% for State and Federal (total 19.15%). We have not recorded a benefit from our net operating loss carryforward because realization of the benefit is uncertain and, therefore, a valuation allowance of $578,300 has been provided for the deferred tax assets. The following table reports our carry forward by year and the related deferred tax assets by year from April 5, 2004 (inception) through September 30, 2009:


Tax Year End

 

 

 

NOL Carry-forward

 

Deferred Tax Asset

September 30, 2006 (from inception)

 

 $                 32,433

 

 $                   11,027

September 30, 2007

 

                  185,280

 

                      62,995

September 30, 2008

 

               1,521,082

 

                    517,168

September 30, 2009

 

               1,281,054

 

                    435,558

September 30, 2010

 

               3,390,336

 

                 1,152,714

 

Total available

 

 $            6,410,185

 

 $              2,179,463

 

Less: Valuation Allowance

 

 

 

               (2,179,463)

Net Deferred Tax Asset

 

 

 

 $                          -   

 

 

 

 

 

 

 

 

 


The Company analyzed its tax positions taken on it Federal and State tax returns for the open tax years ending September 30, 2007, 2008, 2009 and 2010.  Based on our analysis, the Company determined that there are no uncertain tax positions and that the Company should prevail upon examination by the taxing authorities.


At September 30, 2010, the Company has net operating loss carry forwards of approximately $6,410,185 ($3,019,849 in 2006, 2007, 2008 and 2009), which expire in the years 2023 to 2030.  The change in the allowance account from September 30, 2009 to September 30, 2010 was $1,601,163.



31





Although we believe that our estimates are reasonable, no assurance can be given that the final tax outcome of these matters will not be different than that which is reflected in our tax provisions.  Ultimately, the actual tax benefits to be realized will be based on future taxable earnings levels, which are difficult to predict.


The Company may be assessed penalties and interest related to the underpayment of income taxes.  Such assessments would be treated as a provision of income tax expense on our financial statements.  For the year ended September 30, 2010, no income tax expense has been realized as a result of our operations and no income tax penalties and interest have been accrued related to uncertain tax positions.  The Company files income tax returns in the U.S. federal jurisdiction and in the State of Idaho.  These filings are subject to a three year statute of limitations.  Our evaluation of income tax positions included the fiscal years ended September 30, 2009, 2008 and 2007 which could be subject to agency examinations as of September 30, 2010.  No filings are currently under examination.  No adjustments have been made to reduce our estimated income tax benefit at fiscal year end.  Any valuations relating to these income tax provisions will comply with U.S. generally accepted accounting principles.


Note 16 - Subsequent Events


October 1, 2010 - The Company issued 124,999 shares of its $0.001 par value common stock in lieu of paying interest with cash, to holders of 10% convertible debentures described in Note 8.  The interest totaled $37,500 and was converted to shares at a price of $0.30 per common share.


On October 18, 2010 - The Company entered into a Securities Purchase Agreement with certain institutional investors wherein the Company agreed to sell and the purchasers agreed to purchase $500,000 of Secured Convertible Debentures (“Debentures”).  The Debentures provide for interest to be paid quarterly, at the rate of 10 percent per annum, and are due two years from the date of this initial closing. The Debentures are secured by a lien on the Company’s assets, including its  properties in North Dakota but not including certain assets of the Company in Kansas.


The Debentures are convertible at any time after the original issue date into a number of shares of the registrant’s common stock, determined by dividing the amount to be converted by a conversion price of $0.18 per share, or an aggregate of 2,777,778 shares.  In addition to the Debentures the purchasers were issued an aggregate of 1,805,556 common share purchase warrants, each having a term of 42 months, expiring April of 2014, and giving the purchasers the right to purchase JayHawk’s common shares at an exercise price of $0.45 per share.


October 20, 2010 - The Company issued 111,000 shares of common stock to one of the holder’s of a 10% convertible debentures, in agreement with the terms thereof referenced above in the subsequent event of October 18, 2010, who elected to convert the principal amount of $20,000 to 111,000 shares.   These shares were all valued at $0.18 per share.


October 21, 2010 - The Company issued 200,000 shares of common stock to one of the holder’s of a 10% convertible debentures, in agreement with the terms thereof referenced above in the subsequent event of October 18, 2010, who elected to convert the principal amount of $36,000 to 200,000 shares.   These shares were all valued at $0.18 per share.


October 25, 2010 - The Company issued 1,125,000 shares of common stock to three of the holder’s of a 10% convertible debentures, in agreement with the terms thereof referenced above in the subsequent event of October 18, 2010, who elected to convert the principal amount of $202,500 to 1,125,000 shares.   These shares were all valued at $0.18 per share.


October 27, 2010 - The Company issued 150,000 shares of common stock to one of the holder of a 10% convertible debentures, in agreement with the terms thereof referenced above in the subsequent event of October 18, 2010, who elected to convert the principal amount of $27,000 to 150,000 shares.   These shares were all valued at $0.18 per share.


November 8, 2010 - The Company issued 55,556 shares of common stock to one of the holder’s of a 10% convertible debentures, in agreement with the terms thereof referenced above in the subsequent event of October 18, 2010, who elected to convert the principal amount of $10,000 to 55,556 shares.   These shares were all valued at $0.18 per share.


November 24, 2010 - The Company issued 55,556 shares of common stock to one of the holder’s of a 10% convertible debentures, in agreement with the terms thereof referenced above in the subsequent event of October 18, 2010, who elected to convert the principal amount of $10,000 to 55,556 shares.   These shares were all valued at $0.18 per share.


November 30, 2010 - The Company issued 55,556 shares of common stock to one of the holder’s of a 10% convertible debentures, in agreement with the terms thereof referenced above in the subsequent event of October 18, 2010, who elected to convert the principal amount of $10,000 to 55,556 shares.   These shares were all valued at $0.18 per share.


December 7, 2010 - The Company issued 283,709 shares of common stock to one of the holder’s of a 10% convertible



32





debentures, in agreement with the terms thereof referenced above in the subsequent event of October 18, 2010, who elected to convert the principal amount of $50,000 to 277,777 shares plus accrued interest of $944 to 5,932 shares.  These shares were all valued at $0.18 per share.


Note 15 – Commitments and Contingencies  


There is no pending litigation or proceeding involving any director or officer of the Company for which indemnification is being sought.  On July 1, 2008, we leased our office space for a period of three years for a fixed monthly rental of $1,500.  In March of 2009 the lease was renegotiated and the monthly rental amount reduced to $1,000.  Accordingly, our commitment to make these lease payments for the years ending September 30, 2010 and 2011, is $12,000 and $6,000, respectively.


During the 4th quarter of the year ending September 30, 2009 the Company completed a signed letter agreement with DK True Energy Development Limited ("DKTED”) which allows DKTED to earn up to an 85% working interest in JayHawk's Coal Bed Methane ("CBM") project in southeast Kansas (the Girard project).  The agreement permits DKTED to complete its participation and working interest at 42.5 percent after paying the Company $250, 000 and spending $300,000 on workovers of existing wells during the first year.  As of September 30, 2009, DKTED had paid JayHawk $125,000 of the initial $250,000 cash payment obligation.  Subsequently (see Note 14, Subsequent Events) DKTED paid the Company the remaining $125,000 of the initial $250,000 cash payment obligation.  Upon presenting evidence of having performed the work and spending the $300,000 in the initial workover budget, the Company will be committed to transfer to DKTED a 42.5 percent working interest in the Girard, Kansas assets and operations.


On September 28, 2010, the Company hired its current Chief Financial Officer.  Terms of employment include a stock option award of 240,000 shares of the Company’s common stock at such time as the Company can issue such options, and which will vest over a three year period (see Note 11).    


SUPPLEMENTARY OIL AND GAS DISCLOSURES


The following unaudited information regarding the Company’s oil and natural gas activities and reserves is presented pursuant to the disclosure requirements promulgated by the Securities Exchange Commission (SEC) and the FASB, and includes (I) costs incurred, capitalized costs and results of operations relating to oil and gas activities, (II) net proved oil and gas reserves, and (3) a standardized measure of discounted future net cash flows relating to proved oil and gas reserves, including reconciliation of changes therein.


I - COSTS INCURRED, CAPITALIZED COSTS, AND RESULTS OF OPERATIONS

RELATING TO OIL AND GAS OPERATIONS (UNAUDITED)


Costs Incurred in Oil and Gas Producing Activities (in $000’s)


Costs incurred in oil and natural gas property acquisitions, exploration and development are summarized as follows, in $000’s:


 

 

 

 

 

 

2010

 

2009

Property acquisitions

 

 

 

 

 

 

Unproved properties

 

 

 $                 148

 

 $               1,944

 

Proved properties (includes wells, equipment and related facilities   acquired with proved reserves)

                 1,954

 

                       -   

Exploration

 

 

 

                     -   

 

                  6,161

Production and development capital expenditures

 

                     -   

 

                  1,327

Total

 

 

 

 

 $              2,102

 

 $               9,432


 Capitalized Costs Relating to Oil and Gas Producing Activities


Evaluated and unevaluated capitalized costs related to JayHawk’s oil and natural gas producing activities are summarized as follow in $000’s:


 

 

 

 

 

 

12 Months End

 

 

 

 

 

 

 

 

 

September 30,

 

 

 

Property Acquisitions

 

 

2010

 

2009

 

 

Unproved Properties

 

 

 $              4,294

 

 $               4,145

 

 

Proved Properties

 

 

                 2,358

 

                  2,358

 

Wells, equipment and related facilities

 

                 7,124

 

                  5,265

 

 

Total capitalized costs

 

 

 $            13,776

 

 $             11,768

 

Less: Allowance for depreciation, depletion, amortization and lease impairment

 

               (5,001)

 

                (3,246)

 

Total

 

 

 

 

 $              8,774

 

 $               8,522

 



33








We will continue to evaluate our unevaluated properties; however, the timing of the ultimate evaluation and disposition of the properties has not been determined.


Results of Operations for Oil and Gas Producing Activities


The results of operations shown below exclude non-oil and gas producing activities, corporate overhead items, interest expense and other income, expense, gains and losses.  Therefore, these results are on a different basis than results of operations reported upon in the consolidated statement of operations.


All operations were conducted in the United States.  The Company produces crude oil in North Dakota and natural gas in southeast Kansas.  Because of limited funding, exploration activities were not conducted during the years ended September 30, 2010 and 2009:


 

 

 

 

 

 

Year Ended

 

 

 

 

 

 

 

 

September 30,

 

 

 

 

 

 

 

 

2010

 

2009

Operating Revenue

 

 

 $           684,707

 

 $             588,410

Costs and expenses

 

 

 

 

 

 

Exploration expenses

 

 

                      -   

 

                        -   

 

Producrtion expenses

 

 

              260,413

 

                399,145

 

General and administrative expenses

 

                52,112

 

                 30,000

 

Depreciation, depletion and amortization

 

              960,170

 

             1,044,803

Total costs and expenses

 

 

 $      1,272,695

 

 $        1,473,948

 

 

 

 

 

 

 

 

 

Results of operations before income taxes

 

             (587,987)

 

              (885,538)

 

Provision for income taxes

 

 

                      -   

 

                        -   

Net results for operations

 

 

 $        (587,987)

 

 $         (885,538)


II – OIL AND GAS RESERVE QUANTITIES (UNAUDITED)


The Company’s oil and gas reserves are calculated in accordance with SEC standards and definitions as set forth in Rule 4-10 of Regulation S-X.  Proved developed reserves are defined as estimated quantities of oil, natural gas and natural gas liquids which upon analysis of geological and engineering data, appear with reasonable certainty to be recoverable  in the future from known oil and gas reservoirs under existing economic and operating conditions.  Proved undeveloped reserves are those reserves which can be expected to be recovered from new wells with existing equipment and operating methods.


The Company’s reserve estimation and reporting process involves an annual independent third party reserve determination and appraisal.  The reserve estimates reported below are determined independently by the consulting firm of McDaniel & Associates Consultants, Ltd. and are consistent with internal estimates.  The Company provided McDaniel & Associates with engineering, geological and geophysical data, actual production histories and other information necessary for the reserve determination.  The reserve estimates were prepared based on economic and operating conditions existing at September 30, 2010 and 2009.


All of JayHawk Energy’s oil and gas reserves are within the continental United States in the states of North Dakota and Kansas.  Based on the evaluation described in the preceding paragraph, presented below (in barrels) is a summary of changes to the Company’s net interest in proved developed and proved undeveloped reserves for the years ending September 30, 2010 and 2009:


 

 

 

 

 

 

Proved

 

Proved

 

Total Proved

 

 

 

 

 

 

Developed

 

2009

 

Reserves

At September 30, 2007

 

 

                      -   

 

                      -   

 

                       -   

 

Revisions of previous estimates

 

                      -   

 

                      -   

 

                       -   

 

Purchase of minerals in place

 

               79,700

 

                      -   

 

                 79,700

 

Production

 

 

 

              (13,000)

 

                      -   

 

               (13,000)

At September 30, 2008

 

 

               66,700

 

                      -   

 

                 66,700

 

Revisions of previous estimates

 

                 6,560

 

               88,500

 

                 95,060

 

Purchase of minerals in place

 

                      -   

 

                      -   

 

                       -   

 

Production

 

 

 

              (12,860)

 

                      -   

 

               (12,860)

At September 30, 2009

 

 

               60,400

 

               88,500

 

               148,900

 

Revisions of previous estimates

 

               12,300

 

              (62,500)

 

               (50,200)

 

Purchase of minerals in place

 

                      -   

 

                      -   

 

                       -   

 

Production

 

 

 

              (19,300)

 

                      -   

 

               (19,300)

At September 30, 2010

 

 

               53,400

 

               26,000

 

                 79,400



34





JayHawk Energy, Inc.

Notes to Consolidated Financial Statements – (Continued)


III – STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS

RELATING TO PROVED OIL AND GAS RESERVES (UNAUDITED)


Future net cash flows are calculated by applying year-end oil and gas prices (adjusted for price changes provided by contractual arrangements) to estimated future production of proved oil and gas reserves, less estimated future development and production costs, which are based on year-end costs and existing economic assumptions.  The discounted future net cash flow estimates do not include exploration expenses, interest expense or corporate general and administrative expenses.  The selling prices of crude oil and natural gas are highly volatile.  The year-end prices, which are required to be used for the discounted future net cash flows may not be representative of future selling price.  For the fiscal year September 30, 2010 the discounted net cash flow estimates will use selling price estimates based on the average selling price of the prior twelve months (this year ending September 30, 2010, as discussed under the topic “New Accounting Pronouncements”.  The following table presents the estimated future cash flows related to the Company’s proved oil reserves.



 

 

 

 

 

 

 

 

Present Value

 

 

 

 

 

 

 

 

of

 

 

 

 

 

 

Reserves

 

Future Cash

 

 

 

 

 

 

In Barrels

 

Flows

Proved developed reserves

 

                53,400

 

             1,491,000

Proved undeveloped reserves

 

 

                26,000

 

                 49,800

 

Total proved reserves

 

 

                79,400

 

 $          1,540,800

 

 

 

 

 

 

 

 

 










35





ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.


None


ITEM 9A.  CONTROLS AND PROCEDURES


EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES


In connection with the preparation of this annual report on Form 10-K, an evaluation was carried out by JayHawk’s management, with the participation of the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)) as of September 30, 2010.  Disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures.


Based on that evaluation, JayHawk’s management concluded, as of the end of the period covered by this report, that the Company’s disclosure controls and procedures were not effective in recording, processing, summarizing, and reporting information required to be disclosed, within the time periods specified in the Securities and Exchange Commission’s rules and forms.

  

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING


Management of JayHawk Energy, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting.  The Company’s internal control over financial reporting is a process, under the supervision of the Chief Executive Officer and the Chief Financial Officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with United States generally accepted accounting principles (GAAP).  Internal control over financial reporting includes those policies and procedures that:


·

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the Company’s assets;

·

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and the Board of Directors; and

·

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.


Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.


The Company’s management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2010, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).  As a result of this assessment, management identified a material weakness in internal control over financial reporting.


A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.


The material weakness identified is described below.


Communication failures between individuals executing transactions and individuals accounting for transactions led to the identification of certain required disclosures to the financial statements. Additionally, due to insufficient staffing, it was not possible to ensure appropriate segregation of duties between incompatible functions, and formalized monitoring procedures have not been established or implemented.


As a result of the material weakness in internal control over financial reporting described above, the Company’s management has concluded that, as of September 30, 2010, the Company’s internal control over financial reporting was not effective based on the criteria in Internal Control – Integrated Framework issued by COSO.



36






This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting.  We were not required to have, nor have we, engaged our independent registered public accounting firm to perform an audit of internal control over financial reporting pursuant to the rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.



CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING


As of the end of the period covered by this report, there have been no changes in internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) during the quarter ended September 30, 2010, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


ITEM 9B – OTHER INFORMATION


None.



37






PART III


ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS.


DIRECTORS AND EXECUTIVE OFFICERS

Name

 

Age

 

Position

Lindsay E. Gorrill

 

48

 

Chief Executive Officer and Director

Kelly J. Stopher

 

48

 

Chief Financial Officer

Marshall Diamond-Goldberg

 

56

 

President, Director & Chairman of Reserve Reporting

Matthew J. Wayrynen

 

49

 

Chairman of the Board and of Compensation Committee

Jeffrey W. Bright

 

46

 

Director, Chairman of Nominating Committee

Tyrone Docherty

 

50

 

Director, Chairman of Audit Committee


Directors are elected to serve until the next annual meeting of stockholders and until their successors are elected and qualified.  Directors are compensated at the rates of $8,000 per year.  The Chairmen of the Audit Committee is compensated an additional $4,000 per year.  Each other committee chairman is compensated an additional $2,000 per year.  Officers are elected by the Board of Directors and serve until their successors are appointed by the Board of Directors. Biographical resumes of each officer and director are set forth below.


Lindsay E. Gorrill - CEO


Mr. Lindsay Gorrill is a C.A. and has university degrees in Finance and Marketing. Mr. Gorrill has a background in acquisitions, company building, financial markets and world exposure. Mr. Gorrill has served as Chief Executive Officer, Chief Financial Officer and as a member of our Board of Directors since July 2007.  He has also served as President, Chief Executive Officer and Treasurer of Star Gold Corp., a company quoted on the OTC Bulletin Board since February 2008.  Mr. Gorrill has also served as a member of the board of directors of Yaterra Ventures Corp, a company quoted on the OTC Bulletin Board since August 2008.  He has served as President, Chief Operating Officer and as a member of the board of directors of Berkley Resources Inc., a company listed on the TSX Venture Exchange, since July 2004. .Additionally, since April 2009, Mr. Gorrill has served as President, Chief Executive Officer and Chief Financial Officer of Canada Fluorspar Inc., a company listed on the TSX Venture Exchange.  He has also been a member of the board of directors of Golden Odyssey Mining Inc., a TSX Venture Exchange listed company since September 2009. 


Kelly J. Stopher - CFO


Mr. Kelly Stopher was appointed Chief Financial Officer of the Company on September 28, 2010. Mr. Stopher’s has developed strategies to implement financial management systems, internal control policies and procedures, and financial reporting and modeling for small-cap companies  From March, 20010 through September, 2010, Mr. Stopher worked for Allied Security.  Mr. Stopher worked as the business manager for Wells Fargo Bank, Spokane, WA, from April 2006 through August 2009.  From September 2004 through January 2006, he acted as the CFO of Weldon Barber, Spokane, WA.  From October 2003 through September 2004, he was a sales associate for Kiemle & Hagood Company, in Spokane, WA.  And from January 2001 through March 2003 he worked as an account executive for Aston Business solutions in Boise, ID.  Prior that Mr. Stopher worked as CFO for Lee Read Jewelers in Boise, ID and spent 5 years in public accounting with Langlow Tolles & Company in Tacoma, WA.  Mr. Stopher also serves as Chief Financial Officer for Star Gold Corp., a company quoted on the OTC Bulletin Board. and was appointed to that position in October 2010.  Mr. Stopher holds a bachelors degree from Washington State University in Business Administration - Accounting.


Matthew J. Wayrynen - Director

Mr. Wayrynen was appointed to the Board of Directors on April 30, 2008.  Mr. Wayrynen is a citizen of Canada.  He also serves as a director of Golden Odyssey Mining Inc. (since 2009), as a director of Avino Silver & Gold Mines, Ltd. (since 2004), as a director and President of American Uranium Corporation (since 2010) and as a director, President and CEO of Berkley Resources, Inc. (since 2003).  Prior to these positions Mr. Wayrynen was a broker with Golden Capital Securities, located in Vancouver, British Columbia.  Mr. Wayrynen is not an officer or director of any other U.S. reporting company. 


Tyrone Docherty - Director


Mr. Docherty was appointed to the Board of Directors on July 10, 2008.  Mr. Docherty is a citizen of Canada and is presently the CEO and a director of Golden Odyssey Mining.  Prior to this position he was president and CEO of Quinto Mining Corporation from June 1977 to June 2008.  Mr. Docherty is not an officer or director of any other U.S. reporting company



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Jeffrey W. Bright - Director


Mr. Bright was appointed to the Board of Directors on April 30, 2008.  Mr. Bright is a citizen of Canada.  Mr. Bright has worked as an attorney since 2003, currently with Agrium Inc.., located in Calgary Alberta, Canada.  He is a member of the Association of International Petroleum Negotiators, and the Canadian and American Bar Associations.  Mr. Bright is not an officer or director of any other U.S. reporting entity.


Marshall Diamond-Goldberg – President and Director

Mr. Diamond-Goldberg was appointed to the Board of Directors on July 29, 2008.  Mr. Diamond-Goldberg is a citizen of Canada.  He has been employed as a geologist and consultant providing related services in Calgary, Alberta, Canada since 1980.  Since 1997, Mr. Goldberg has been the President of Marlin Consulting Corporation (not to be confused with Marlin Property Management) providing services to oil and gas companies.  Mr. Diamond-Goldberg is a member of the American Societies of Professional Geologists, as well as the Association of Professional Engineers, Geologists and Geophysicists of Alberta.  Mr. Diamond-Goldberg is also an officer and a director of Legend Oil & Gas Ltd. an OTC listed company and a U.S. reporting entity.


COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934


Section 16(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) requires the Company's directors and executive officers, and persons who own more than ten percent of a registered class of the Company's equity securities, to file with the Commission initial reports of ownership and reports of changes in ownership of the Company's Common Stock and other equity securities of the Company. Officers, directors and greater than ten percent shareholders are required by the Commission's regulations to furnish the Company with copies of all Section 16(a) forms they filed.

 

We have been provided with copies of all forms (3, 4 and 5) filed by officers, directors, or ten percent shareholders within three days of such filings. Based on our review of such forms that we received, or written representations from reporting persons that no Forms 5s were required for such persons, we believe that, during all prior fiscal periods, all Section 16(a) filing requirements have been satisfied on a timely basis for members of the Board of Directors and Executive Officers.


Code of Ethics

 

Our Board of Directors has adopted a Code of Business Conduct and Ethics Compliance Program and an Insider Trading Policy providing guidelines with respect to transactions in Company securities and is applicable to all directors, officers, employees and consultants who receive or have accesses to material non-public Company information.

 

Corporate Governance

 

Audit Committee


On June 30, 2008 JayHawk established an audit committee of its Board of Directors, appointed Mr. Don Siemens as its Chairman, and adopted a "Code of Ethics" to promote honest and ethical conduct, proper disclosure of financial information and compliance with applicable laws, rules and regulations by all of the Company's employees and members of the board of directors.  On June 15, 2009 the Company accepted the resignation Mr. Siemens.  This was not the result of any disagreement as to policy, practices, or procedures.  Simultaneously with the resignation of Mr. Siemens the Company appointed Mr. Tyrone Docherty to the board of directors and Chairman of the Audit Committee.


Compensation Committee


Mathew J. Wayrynen has served as Chairman of the Compensation Committee since August 27, 2008.  Lindsay Gorrill and Tyrone Docherty also serve on the Compensation Committee.

 

Nominating Committee


Jeff W. Bright was appointed Chairman of the Nominating Committee. On August 27, 2008, Lindsay Gorrill and Matthew Wayrynen also serve as members of the Nominating Committee.




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Reserves Committee


Marshall Diamond-Goldberg has served as the Chairman of the Reserves Committee since August 27, 2008.  Lindsay Gorrill and Jeff W. Bright also serve on the Reserves Committee.


Compensation Committee Interlocks and Insider Participation


Mathew J. Wayrynen has served as the Chairman of the Compensation Committee since August 27, 2008.  Lindsay Gorrill and Tyrone Docherty also serve as members of the compensation committee.

 

None of our directors or executive officers serves as a member of the board of directors or compensation committee of any other entity that has one or more of its executive officers serving as a member of our board of directors.

 

Director Compensation

 

The table below sets forth, for the last fiscal years, the compensation earned by our non-employee directors:


Name

 

Fees Earned or Paid in Cash ($)

Stock Awards

Option Awards

Non-Equity Incentive Plan Compensation

Nonqualified Deferred Compensation Earnings

All Other Compensation ($)

Total

 

 

 

($)

($)

($)

($)

 

($)

 

 

 

 

 

 

 

 

 

Matt Wayrynen

 

 $                      11,250

 $                    -   

 $         15,730

 $                  -   

 $                  -   

 $                  -   

 $      26,980

Tyrone Docherty

 

                            5,500

                       -   

            15,730

                     -   

                     -   

                     -   

         21,230

Jeff Bright

 

                            4,250

                       -   

            11,798

                     -   

                     -   

                     -   

         16,048

 

 

 $                      21,000

 $                    -   

 $         43,258

 $                  -   

 $                  -   

 $                  -   

 $      64,258

 

 

 

 

 

 

 

 

 


 ITEM 11.  EXECUTIVE COMPENSATION.


Each individual's total compensation consisted only of cash paid as salary or as a monthly fee to an independent contractor.  The following amounts were paid to the respective individuals.


Name And

Year

Salary

Bonus

Stock

Option

Non-Equity Incentive Plan Compensation

Nonqualified Deferred Compensation Earnings

All other Compensation

 

Total

Principal Position

($)

($)

Awards

Awards

($)

($)

($)

 

($)

 

 

 

($)

($)

 

 

 

 

 

Lindsay Gorrill, CEO

2010

 $      150,000

               -   

           -   

 $          86,516

                                     -   

                             -   

 $                    1,000

 

 $      237,516

Marshall Diamond-Goldberg, President

2010

         176,000

               -   

           -   

             58,988

                                     -   

                             -   

                       3,000

 

         237,988

Kelly Stopher, CFO

2010

             2,864

               -   

           -   

                     -   

                                     -   

                             -   

                            -   

 

             2,864

 

 

 $      328,864

 $            -   

 $        -   

 $        145,504

 $                                  -   

 $                          -   

 $                    4,000

 

 $      478,368


The amounts in the Option Awards column reflect the dollar amount recognized and expensed for financial statement reporting purposes for the years ended September 30, 2010, in accordance with ASC Topic 718 of awards of stock options and thus do not represent aggregate fair value of grants. The Company used the Black-Scholes option price calculation to value the options granted in 2010 and using the following assumptions: risk-free rate of 0.06% and 5.35%; volatility of 0.99; actual term and exercise price of options granted. See Note 16 to the Consolidated Financial Statements for more details on option issuances.  See Note 11 Stock Based Compensation in the Notes to the Consolidated Financial Statements.




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Employment Agreements with Executive Officers


The Company’s president, Mr. Marshall Diamond-Goldberg entered into an employment agreement with the company to be compensated initially at a rate of $5,000 per month, increasing to $8,000 per month upon completion of the $1.5 million funding under the Securities Purchase Agreement dated December 11, 2009 disclosed in Note 8, Subsequent Events.  Additionally, he received 2 percent of the funds received with the first two tranches of the aggregate $1.5 million, and a stock option award of 400,000 shares of the Company’s common stock at such time the Company can issue such options.  Mr. Diamond-Goldberg subsequently received a monthly fee of $15,000.  As part of expense reduction initiatives, Mr. Diamond -Goldberg voluntarily reduced his monthly fee to $12,000.


The Company's Chief Financial Officer, Mr. Kelly Stopher entered into an employment agreement with the company to be compensated initially at a rate of $7,000 per month and a stock option award of 240,00 shares of the Company's common stock.  As part of overall expense reduction initiatives, Mr. Stopher's voluntarily reduced his compensation to $5,000 per month.


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.


The following table sets forth certain information regarding beneficial ownership of our common stock as of September 30, 2010:

 

· by each person who is known by us to beneficially own more than 5% of our common stock;

· by each of our officers and directors; and

· by all of our officers and directors as a group.


NAME AND ADDRESS OF OWNER

TITLE OF CLASS 

NUMBER OF SHARES OWNED (1)

 

PERCENTAGE OF CLASS (2)

 

Lindsay E. Gorrill

 Common Stock

 

 

 

6240 E. Seltice Way, Suite C

 

 

 

 

Post Falls, ID  

 

4,000,000

 

8.20%

Marshall Diamond Goldberg

 Common Stock

 

 

 

 Box 34 Site 5 RR2

 

 

 

Okotoks, Alberta T1S 1A2

 

49,800

 

0.10%

Kelly J. Stopher

 Common Stock

 

 

 

6240 E. Seltice Way, Suite C

 

 

 

Post Falls, ID  

 

1,000

 

0.00%

 

 

 

 

 

All Officers and Directors 

Common Stock

4,050,800

 

 

 

 

 

 

 


(1) Beneficial Ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of common stock subject to options or warrants currently exercisable or convertible, or exercisable or convertible within 60 days of September 30, 2010 are deemed outstanding for computing the percentage of the person holding such option or warrant but are not deemed outstanding for computing the percentage of any other person.


(2) Percentage based on 48,980,326 shares of common stock outstanding as of September 30, 2010.




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Outstanding Equity awards at fiscal year ended September 30, 2010


 

Option Awards

Name

Number of Securities Underlying Unexercised Options (#)

Number of Securities Underlying Unexercised Options (#)

Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#)

Option Exercise Price ($)

Option Expiration Date

Exercisable

Unexercisable

Lindsay Gorrill, CEO

550,000

550,000

-  

$0.20

9/2/2015

Diamond-Goldberg, President

375,000

375,000

-  

$0.20

9/2/2015

Kelly Stopher, CFO

-  

-  

240,000

$0.20

9/28/2015

 

925,000

925,000

240,000

 

 


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.


Since the beginning of our prior fiscal year, there have been no transactions, or proposed transactions, which have materially affected or will materially affect us in which any director, executive officer or beneficial holder of more than 10% of the outstanding common stock, or any of their respective relatives, spouses, associates or affiliates, has had or will have any direct or material indirect interest. We have no policy regarding entering into transactions with affiliated parties.


ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.


Audit Fees

 

The aggregate fees billed by our predecessor auditors, for professional services rendered for the audit of the Company's annual financial statements for the years ended September 30, 2010 and 2009, and for the reviews of the financial statements included in the Company's Quarterly Reports on Form 10-Q during the fiscal years were $32,275 and $35,419, respectively.  These amounts do not include any fees billed by our current auditors, BehlerMick.

 

All Other Fees


No other fees have been billed in the last two years for products and services provided by the principal accountant other than the services reported pursuant to the above portions of this Item 14.


Our board of directors acts as the audit committee and had no “pre-approval policies and procedures” in effect for the auditors’ engagement for the audit years 2010 and 2009.


PART IV

ITEM 15.  EXHIBITS.


Exhibit No.

Description


3.1 

Articles of Incorporation, filed as an exhibit to the registration statement on Form SB-2 filed with the Securities and Exchange Commission (the "Commission") on December 7, 2004, and incorporated herein by reference.


3.2 

Certificate of Amendment to Articles of Incorporation, filed as an exhibit to the 8-K filed with the Commission on June 25, 2007, and incorporated herein by reference.


3.3

Bylaws, filed as an exhibit to the registration statement on Form SB-2 filed with the Commission on December 7, 2004, and incorporated herein by reference.


10.1

Promissory Note of April 12, 2007 with Berrigan Portfolio, Inc., filed as an exhibit to the 8-K filed with the Commission on April 17, 2007, and incorporated herein by reference.


10.2

Asset Purchase and Sale agreement of July 25, 2007 with Armstrong Investments, Inc., filed as an exhibit to the 8-K filed with the Commission on July 26, 2007, and incorporated herein by reference.



42








10.3

Form of Warrant Agreement of July 25, 2007 with Armstrong Investments, Inc. and Berrigan Portfolio, Inc., filed as an exhibit to the 8-K filed with the Commission on July 26, 2007, and incorporated herein by reference.

14.1

Code of Ethics

23.1

Consent of Independent Registered Public Accounting Firm

23.2

Consent of Auditor

 31.1

Certification of Chief Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended


 31.2 

Certification of Chief Financial Officer pursuant to Rule 13a-14 and Rule 15d 14(a), promulgated under the Securities and Exchange Act of 1934, as amended


 32.1

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer)


 32.2

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer)


 99.1

2009 Stock Incentive Plan for Employees, Contractors, Consultants, Advisors and Board Members

 

 

 

 

 

 

 

 

 

 

 



 



43





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.


JAYHAWK ENERGY, INC.


Date:  January 13, 2011

By: /s/ LINDSAY E. GORRILL

 

Lindsay E. Gorrill

 

Chief Executive Officer, President, and Chairman of the Board

 

 


Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Name

Position

Date

 

 

 

By: /s/ LINDSAY E. GORRILL

Lindsay E. Gorrill

Chief Executive Officer and Chairman of the Board

January 13, 2011

 

 

 

By: /s/ Marshall Diamond Goldberg

Marshall Diamond Goldberg

President

January 13, 2011

 

 

 

By: /s/ KELLY J. STOPHER

Kelly J. Stopher

Chief Financial Officer

January 13, 2011

 

Directors: 




44