ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

3 Months Ended

Sep. 30, 2011

ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Nature of business

Hyperdynamics Corporation (“Hyperdynamics,” the “Company,” “we,” and “our”) is a Delaware corporation formed in March 1996. Hyperdynamics has three wholly-owned subsidiaries, SCS Corporation (SCS), HYD Resources Corporation (HYD) and Hyperdynamics Oil & Gas Limited. Through SCS and its wholly-owned subsidiary, SCS Corporation Guinea SARL (SCSG), which is a Guinea limited liability company formed under the laws of the Republic of Guinea (“Guinea”) located in Conakry, Guinea, Hyperdynamics focuses on oil and gas exploration offshore the coast of West Africa. Our exploration efforts are pursuant to a Hydrocarbon Production Sharing Contract, as amended (the “PSC”).  We refer to the rights granted under the PSC as the “Concession.” SCS began operations in oil and gas exploration, seismic data acquisition, processing, and interpretation in late fiscal 2002. In April 2004, Hyperdynamics acquired HYD. Hyperdynamics Oil & Gas Limited was formed in February 2011 in the United Kingdom to support business development activities.

Principles of consolidation

The accompanying unaudited consolidated financial statements include the accounts of Hyperdynamics and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States and the rules of the Securities and Exchange Commission (“SEC”), and should be read in conjunction with the audited financial statements and notes thereto contained in our Annual Report filed with the SEC on Form 10-K for the year ended June 30, 2011. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein.  The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements which would substantially duplicate the disclosures contained in the audited financial statements for the most recent fiscal year ended June 30, 2011, as reported in the Form 10-K, have been omitted.

Use of estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and expenses at the balance sheet date and for the period then ended. Actual results could differ from these estimates.

Cash and cash equivalents

Cash equivalents are highly liquid investments with an original maturity of three months or less.  We maintain our cash in bank deposit accounts which, at times, exceed the federally insured limits.  At September 30, 2011, we had approximately $36,139,000 in excess of FDIC limits.  We have not experienced any losses in such accounts.

Restricted cash

Included in restricted cash is $34,670,000 held in escrow which relates to our drilling contract with AGR Peak Well Management Ltd (“AGR”). Under the terms of the drilling contract, we will fund the escrow account for the sole purpose of funding our drilling project as overseen by AGR. As work is performed and invoiced, AGR will submit draw documents to us and funds will be released under the terms of the agreement.

Joint interest receivable and allowance for doubtful accounts

The Company establishes provisions for losses on accounts receivable if it determines that it will not collect all or part of the outstanding balance. Accounts receivable are written down to reflect management’s best estimate or realizability based upon known specific analysis, historical experience, and other currently available evidence of the net collectible amount. There is no allowance for doubtful accounts as of September 30, 2011 or June 30, 2010. At September 30, 2011, all of our accounts receivable balance was related to joint interest billings to Dana Petroleum (E&P) Limited (“Dana”), which owns a 23% participating interest in our Guinea Concession.

Securities classified as available-for-sale

Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Marketable equity securities and debt securities not classified as held-to maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax (if any), reported in other comprehensive income. Realized gains and losses, and declines in value deemed to be other-than-temporary, are included in earnings.

The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in earnings.

Earnings per share

Basic loss per common share has been computed by dividing net loss by the weighted average number of shares of common stock outstanding during each period and after any preferred stock dividend requirements. In period of earnings, diluted earnings per common share are calculated by dividing net income available to common shareholders by weighted-average common shares outstanding during the period plus weighted-average dilutive potential common shares.  Diluted earnings per share calculations assume, as of the beginning of the period, exercise of stock options and warrants using the treasury stock method.  Convertible securities are included in the calculation during the time period they are outstanding using the if-converted method.

All potential dilutive securities, including potentially dilutive options, warrants and convertible securities, if any, were excluded from the computation of dilutive net loss per common share for the three months ended September 30, 2011 and 2010, respectively, as their effects are antidilutive due to our net loss for those periods.

Stock options to purchase approximately 10.1 million common shares at an average exercise price of $2.18 and warrants to purchase approximately 3.9 million shares of common stock at an average exercise price of $1.26 were outstanding at September 30, 2011. Using the treasury stock method, had we had net income, approximately 4.0 million common shares attributable to our outstanding stock options and 2.8 million common shares attributable to our outstanding warrants to purchase common shares would have been included in the fully diluted earnings per share calculation for the quarter ended September 30, 2011.

Stock options to purchase approximately 7.6 million common shares at an average exercise price of $0.85 and warrants to purchase approximately 10.0 million shares of common stock at an average exercise price of $1.28 were outstanding at September 30, 2010. Using the treasury stock method, had we had net income, approximately 1.1 million common shares attributable to our outstanding stock options and 1.9 million common shares attributable to our outstanding warrants to purchase common shares would have been included in the fully diluted earnings per share calculation for the quarter ended September 30, 2010.

Contingencies

We are subject to legal proceedings, claims and liabilities which arise in the ordinary course of business. We accrue for losses associated with legal claims when such losses are probable and can be reasonably estimated. These accruals are adjusted as additional information becomes available or circumstances change. Legal fees are charged to expense as they are incurred.  See Note 9, Commitments and Contingencies, for more information on legal proceedings.

Accumulated Other Comprehensive Income, net of tax

We follow the provisions of ASC 220, Comprehensive Income, which establishes standards for reporting comprehensive income. In addition to net income, comprehensive income or loss includes all changes to equity during a period, except those resulting from investments and distributions to the owners of the Company. At September 30, 2011, we had a balance in “Accumulated other comprehensive loss, net of income tax” on the accompanying balance sheet of $648,000. The components of accumulated other comprehensive loss and related tax effects for 2011 were as follows (in thousands):

	Gross Value		Tax Effect		Net of Tax Value
Accumulated other comprehensive loss at June 30, 2011	$	349	$	—	$	349
Change in fair value of available-for-sale securities	299		—		299
Accumulated other comprehensive loss at September 30, 2011	$	648	$	—	$	648

There is no tax effect of the unrealized loss in other comprehensive loss given our full valuation allowance against deferred tax assets. There was no comparable balance in accumulated other comprehensive loss at September 30, 2010.

Financial instruments

The accounting standards (ASC 820, Fair Value Measurements and Disclosures) regarding fair value of financial instruments and related fair value measurements define fair value, establish a three-level valuation hierarchy for disclosures of fair value measurement, and enhance disclosure requirements for fair value measures.

The three levels are defined as follows:

· Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

· Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

· Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. As of September 30, 2011, we held investments which were classified as available for sale securities and therefore must be recorded at their fair value at each reporting date. Available-for-sale investments, which consist entirely of publicly traded Corporate Debt securities, are valued at the closing price reported in the active market in which the debt is traded.

Additionally, we have determined that certain warrants outstanding during the periods covered by these financial statements qualified as derivative financial instruments under the provisions of FASB ASC Topic No. 815-40, Derivatives and Hedging — Contracts in an Entity’s Own Stock. These warrant agreements included provisions designed to protect holders from a decline in the stock price (‘down-round’ provision) by reducing the exercise price in the event we issue equity shares at a price lower than the exercise price of the warrants.  As a result of this down-round provision, the exercise price of these warrants could be modified based upon a variable that is not an input to the fair value of a ‘fixed-for-fixed’ option as defined under FASB ASC Topic No. 815-40 and consequently, these warrants must be treated as a liability and recorded at fair value at each reporting date.

The fair value of these warrants was determined using a lattice model, with any change in fair value during the period recorded in earnings as “Other income (expense) — Gain (loss) on warrant derivative liability.” As a result, the derivative warrant liability was carried on the balance sheet at its fair value.

Significant Level 3 inputs used to calculate the fair value of the warrants include the stock price on the valuation date, expected volatility, risk-free interest rate and management’s assumptions regarding the likelihood of a future repricing of these warrants pursuant to the down-round provision.

The $771,000 change in fair value during the quarter ended September 30, 2010, was recorded as an increase to the derivative liability and as a non-cash loss in our statement of operations. All of the remaining warrants underlying this derivative liability were exercised in October 2010. At September 30, 2011 and June 30, 2011, there was no remaining derivative liability balance.

The following table sets forth by level within the fair value hierarchy, our financial assets and liabilities (in thousands) that were accounted for at fair value on a recurring basis as of September 30, 2011:

	Carrying Value at September 30,		Fair Value Measurement at September 30, 2011
	2011		Level 1		Level 2		Level 3
Assets:
Corporate debt securities	$	54,383	$	54,383	$	—	$	—

	Carrying Value at		Fair Value Measurement at September 30, 2011
	June 30, 2011		Level 1		Level 2		Level 3
Assets:
Corporate debt securites	$	55,368	$	55,368	$	—	$	—

See discussion of changes in the fair value of available-for-sale securities within Note 4.

Subsequent events

We evaluated all subsequent events from September 30, 2011 through the date of the issuance of the consolidated financial statements. See Note 10.

Recently issued or adopted accounting pronouncements

In June 2011, the FASB issued an update to ASC 220, Comprehensive Income. This ASU requires entities to present components of comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements that would include reclassification adjustments for items that are reclassified from other comprehensive income to net income on the face of the financial statements. The amendments in this update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, which will be fiscal 2013 for Hyperdynamics. The amendments in this update should be applied retrospectively and early application is permitted. We are currently evaluating which presentation option we will utilize for comprehensive income in our consolidated financial statements.