1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Nature of business

Hyperdynamics Corporation (“Hyperdynamics,” the “Company,” “we,” “us,” and “our”) is a Delaware corporation formed in March 1996. Hyperdynamics has two wholly-owned subsidiaries, SCS Corporation Ltd (SCS), a Cayman corporation, and HYD Resources Corporation (HYD), a Texas corporation. Through SCS and its wholly-owned subsidiary, SCS 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.

Status of our Business

We have no source of operating revenue and there is no assurance when we will, if ever. On March 31, 2014, we had $26.1 million in cash and $19.2 million in restricted cash, which is held in escrow in connection with our drilling contract with AGR Peak Well Management Ltd. (“AGR”). We had $25.7 million in liabilities, which are comprised of current liabilities of $25.6 million, including $20.2 million of liabilities currently pending resolution of our dispute with AGR, and noncurrent liabilities of $0.1 million. We plan to use our existing cash to fund our general corporate needs, our legal and other professional fees and our expenditures associated with the Concession, including our share of future capital expenditures that are not paid by Tullow on our behalf. We have no other material commitments; however, we have incurred significant legal expenses in the nine months ended March 31, 2014, and it is likely that we will continue to incur significant expenses in the next several months.

On December 31, 2012, our wholly owned subsidiary, SCS, closed a sale to Tullow Guinea Ltd (“Tullow”), a subsidiary of Tullow Oil plc, of a 40% gross interest in the Concession. We now hold a 37% participating interest, with Dana Petroleum, PLC (“Dana”), which is a subsidiary of the Korean National Oil Corporation, holding the remaining 23% interest in the Concession. We refer to Tullow, Dana and us in the Concession as the “Consortium”.

We have drilled one exploratory well, the Sabu-1 well, which reached the planned total depth of 3,600 meters below the surface in February 2012. We determined the well to be non-commercial. As a result, we evaluated the costs associated with the well, subjected them to the Full-Cost Ceiling Test, resulting in a Full-Cost Ceiling Test write-down. See additional discussion in Note 2. As described in Note 7, we have filed suit for monetary damages against AGR, the manager of the Sabu-1 well, following unsuccessful negotiations to address mismanagement that led to significant well cost overruns. The trial is scheduled to begin on June 9, 2014. Payment of the remaining drilling costs is pending resolution of this dispute. AGR filed a countersuit for additional cost of $9.5 million on a gross basis or $7.3 million based on the 77% interest we then held, which we dispute and have excluded from our cost incurred to date. Resolution of this dispute may result in the recovery of a portion of the costs incurred to date; however, it is possible that the resolution of this dispute may result in additional liability associated with disputed costs as well as additional legal expenses. In addition, the court could require a party to pay a portion of the legal fees of the other party.

Since September 2013, we have received subpoenas from the United States Department of Justice (“DOJ”) and the United States Securities and Exchange Commission (“SEC”) requesting that we produce documents relating to our Concession in Guinea. See additional discussion in Note 7. We are unable to predict the outcome or future cost associated with the AGR case, other legal proceedings and the investigations being conducted by the DOJ and SEC; however, we incurred approximately $5.6 million in legal and other professional fees related to the investigations in the nine months ended March 31, 2014, and it is likely that we will incur significant expenses for legal and associated costs in the next several months.

Pursuant to the Share Purchase Agreement between Tullow and SCS (“SPA”), Tullow agreed to pay our participating interest share of costs associated with an exploration well up to a gross expenditure cap of $100 million. The Consortium currently estimates the well, when drilled, will cost approximately $115 million, which estimate is subject to change. We will be responsible for our 37% interest share of the cost in excess of the $100 million gross carry.

The Consortium planned to drill the exploration well in ultra-deepwater in the first half of calendar 2014. However, on March 11, 2014 Tullow unilaterally asserted its claim that there had been a Force Majeure event under the PSC with the Government of Guinea, the Joint Operating Agreement between SCS, Dana and Tullow (“JOA”) and the SPA. Tullow stated in its notice that the decisions by the DOJ and the SEC to open investigations into Hyperdynamics and SCS’ activities in obtaining and retaining the Concession rights constituted a Force Majeure event under the terms of the PSC, JOA and SPA. Tullow lifted its declaration of Force Majeure effective May 3, 2014. Diligent efforts are being made to satisfy the conditions to resuming petroleum operations which include clarification that the investigations of Hyperdynamics will not adversely affect Tullow’s operations under the PSC. We cannot predict the timing or outcome of these efforts.

Our costs related to the items referred to above and any additional expenses, or any negative outcomes, could adversely affect our liquidity and financial condition and results of operations. We also will be responsible for our participating interest share of costs in excess of $100 million gross costs associated with the ultra-deepwater exploration well when drilled, and such excess well costs could exacerbate our liquidity concerns. Absent cash inflows, we could exhaust our current available liquidity within the next twelve months. The timing and amount of our cash outflows are dependent on a number of factors including: legal and other professional fees related to the FCPA investigations, a negative outcome related to any of our legal proceedings and investigations, well costs exceeding our carry, or if we have unfavorable well results. As a result, absent cash inflows, there is substantial doubt as to whether we will have adequate capital resources to meet our current obligations as they become due and therefore be able to continue as a going concern. Our ability to meet our current obligations as they become due over the next twelve-months, and to be able to continue exploration, will depend on obtaining additional resources through sales of additional interests in the Concession, equity or debt financings, or through other means, although no assurance can be given that any of these actions can be completed.

Principles of consolidation

The accompanying unaudited consolidated financial statements include the accounts of Hyperdynamics and its wholly-owned subsidiaries. All 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 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, 2013. 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, 2013, 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.

Restricted cash

Included in restricted cash at March 31, 2014 is $19.2 million held in escrow which relates to our drilling contract with AGR. Under the terms of the drilling contract, we funded the escrow account for the sole purpose of funding our drilling project as overseen by AGR.

Joint interest receivable and allowance for doubtful accounts

We establish provisions for losses on accounts receivable if we determine that we 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 March 31, 2014 or June 30, 2013. At March 31, 2014 we had no receivable balance. At June 30, 2013, all of our accounts receivable balance was related to joint interest billings to Tullow and Dana Petroleum (E&P) Limited (“Dana”), who own 40% and 23% participating interests in the Concession, respectively.

Securities classified as available-for-sale and held to maturity

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. 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.

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 and nine month periods ended March 31, 2014 and 2013, respectively, as their effects are antidilutive due to our net loss for those periods.

Stock options to purchase approximately 1.1 million common shares at an average exercise price of $11.28 and warrants to purchase approximately 0.4 million shares of common stock at an average exercise price of $10.40 were outstanding at March 31, 2014. Using the treasury stock method, had we had net income, approximately 68,000 and 41,000 common shares attributable to our outstanding stock options would have been included in the fully diluted earnings per share for the three and nine month period ended March 31, 2014. There would have been no dilution attributable to our outstanding warrants to purchase common shares. Had we had net income, approximately 21,000 and 7,000 common shares attributable to our outstanding unvested restricted stock awards would have been included in the fully diluted earnings per share for the three and nine month period ended March 31, 2014

Stock options to purchase approximately 1.3 million common shares at an average exercise price of $14.64 and warrants to purchase approximately 1.7 million shares of common stock at an average exercise price of $23.44 were outstanding at March 31, 2013. Using the treasury stock method, had we had net income, approximately 24,000 and 46,000 common shares attributable to our outstanding stock options would have been included in the fully diluted earnings per share for the three and nine month periods ended March 31, 2013. There would have been no dilution attributable to our outstanding warrants to purchase common shares.

Contingencies

We are subject to legal proceedings, claims and liabilities. 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 7, Commitments and Contingencies, for more information on legal proceedings.

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. The carrying values of cash and cash equivalents, accounts receivable — joint interest and accounts payable approximate fair value. Available-for-sale securities, which consist entirely of Corporate Debt securities, were valued at the closing price reported in the active market in which the security was traded. As of March 31, 2014, there were no remaining investments on hand.

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 June 30, 2013:

	Carrying Value at		Fair Value Measurement at June 30, 2013
	June 30, 2013		Level 1		Level 2		Level 3
Assets:
Corporate debt securities	$	15,383	$	15,383	$	—	$	—

Foreign currency gains and losses from current operations

In accordance with ASC Topic 830, Foreign Currency Matters, the functional currency of our international subsidiaries is the U.S. Dollar. Gains and losses from foreign currency transactions arising from operating assets and liabilities have not been significant and are included in general, administrative and other operating expense. Net foreign currency transaction gains (losses) were $(0.1) million and $(0.6) million for the three and nine month periods ended March 31, 2014, as compared to $0.3 million and $0.1 million for the three and nine month periods ended March 31, 2013 respectively.

Recently issued or adopted accounting pronouncements

In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward exists, which requires that an entity present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. ASU 2013-11 eliminates diversity in practice for presentation of an unrecognized tax benefits when such a carryforward is available to reduce the taxable income or tax payable that would result from the disallowance of a tax position. This accounting guidance will be effective for our first quarter in fiscal 2015. We do not expect ASU 2013-11 to have any impact on our financial position or results of operations.