ITEM
1.
BUSINESS.
General
Lucas
Energy, Inc., a Nevada corporation, is an independent oil and natural gas company based in Houston, Texas with a field office
in Gonzales, Texas. Lucas Energy, Inc. (herein the “Company,” “Lucas,” “Lucas Energy,” or
“we”) is engaged in the acquisition and development of crude oil and natural gas from various known productive geological
formations, including the Austin Chalk and Eagle Ford formations, primarily in Gonzales, Wilson and Karnes Counties, south of
the city of San Antonio, Texas. Incorporated in Nevada in December 2003 under the name Panorama Investments Corp., the Company
changed its name to Lucas Energy, Inc. effective June 9, 2006. All of our oil and gas interests and equipment existing as of December
16, 2015 are held by our wholly-owned Texas subsidiary, CATI Operating LLC (“CATI”).
Our
primary value drivers are our Eagle Ford Shale reserves which must be developed to unlock their full potential. We believe the
market conditions driving us toward the need for a larger entity of greater size and financial mass are even more essential in
the current environment. In order to develop the significant Eagle Ford reserves at our disposal, we believe that we must become,
or become part of, a larger organization with ample cash flow and greater access to capital. Measures such as return on equity,
liquidity and stock multiples have led us to conclude that the market, in general, views small-cap and mid-cap exploration and
production companies as having greater potential than microcaps. The larger companies tend to have access to more favorable debt
financing, receive greater analyst coverage, trade with greater liquidity and consequently, often have higher share prices.
In
December 2015, we entered into an Asset Purchase Agreement, as purchaser, with twenty-one separate sellers (the “Sellers”).
Pursuant to the Asset Purchase Agreement and subject to the terms and conditions thereof, we agreed to acquire from the Sellers
working interests in producing properties and undeveloped acreage in Texas and Oklahoma, including varied interests in two largely
contiguous acreage blocks in the liquids-rich Mid-Continent region of the United States, and related wells, leases, records, equipment
and agreements associated therewith as well as producing shale properties in Glasscock County, Texas, in consideration for, among
other things, the issuance of 13,009,664 shares of common stock to the Sellers, and the issuance of 552,000 shares of to-be designated
Series B Preferred Stock to one of the Sellers, upon approval of such issuances by our stockholders. If the Acquisition closes,
we expect that our production will increase and it will allow us to expand our geographic footprint into the Mid-continent, re-brand
our organization and redirect our strategic vision. The Asset Purchase Agreement is described in greater detail under “Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” – “Asset Purchase
Agreement”, below.
In
April 2016, we entered into a Securities Purchase Agreement pursuant to which we issued a redeemable convertible subordinated
debenture, with a face amount of $530,000, convertible into 163,077 shares of common stock at a conversion price equal to $3.25
per share and a warrant to purchase 1,384,616 shares of common stock at an exercise price equal to $3.25 per share (the “First
Warrant”). The debenture had a 5.0% original issue discount and we received $500,000 in connection with the sale of such
debenture. The holder agreed that it will exercise the First Warrant, upon satisfaction of certain conditions, for the sum of
$4.5 million.
Also
in April 2016, we entered into a Stock Purchase Agreement pursuant to which we agreed, subject to certain conditions, including
the closing of the acquisition described above, to issue 527 shares of Series C redeemable convertible preferred stock (with a
face value of $5.26 million) at a 5% original issue discount, convertible into 1,618,462 shares of common stock at a conversion
price of $3.25 per share, and a warrant to purchase 1,111,112 shares of common stock at an exercise price of $4.50 per share.
If fully funded, the sale of the securities contemplated by the Stock Purchase Agreement, coupled with the Securities Purchase
Agreement above, would represent $14.5 million in additional funding for the Company.
The
Securities Purchase Agreement and Stock Purchase Agreement are described in greater detail below under “Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations” - “Liquidity and Capital Resources”
- “Financing”.
Our
management is focused on achieving greater stockholder value through a turbulent period. Specifically, our immediate efforts include:
(i) closing the transactions described above (i.e., the acquisition and funding agreements), (ii) attempting to re-finance our
current debt with some combination of new debt and equity, and (iii) considering the potential acquisition of oil and gas properties
for equity; all in an effort to stabilize our company and provide an increased base of operating cash flow. Our future expectations
continue to include an increase in production through development of our acreage, increased profitability margins by evaluating
and optimizing our production, and executing our business plan with the goal of increasing property values, reserves, and expanding
our asset base.
At
March 31, 2016, we had leasehold interests (working interests) in approximately 8,395 gross acres, or 8,309 net acres. Our total
net developed and undeveloped acreage as measured from the surface to the base of the Austin Chalk formation was approximately
8,309 net acres. In deeper formations, we had approximately 1,909 net acres in the Eagle Ford oil window.
For
the year ending March 31, 2016, we produced an average of approximately 61 net barrels of oil equivalent per day (Boepd) from
26 active well bores, of which 10 wells accounted for more than 80% of our production. The ratio between the gross and net production
varies due to varied working interests and net revenue interests in each well. We operate over 90% of our producing wells, except
two wells producing from the Eagle Ford of which are being operated by an affiliate of Marathon Oil Corporation, of which we have
a 15% working interest on each well. Our production sales totaled 22,190 barrels of oil equivalent (Boe), net to our interest,
for the fiscal year ended March 31, 2016.
At
March 31, 2016, our total estimated net proved reserves were 4.3 million Boe, of which 3.8 million barrels (Bbls) were crude oil
reserves, and 2.5 billion cubic feet (Bcf) were natural gas reserves. Of these quantities, approximately 97% and 100%, respectively,
are classified as proved undeveloped.
As
of March 31, 2016, we employed seven full-time employees. We also utilized three contractors on an “as-needed” basis
to carry out various functions, including but not limited to field operations, land administration, corporate activity and information
technology maintenance. We believe that our relationships with our employees are satisfactory. No employee is covered by a collective
bargaining agreement.
We
have an experienced management team with proven acquisition, operating and financing capabilities. Mr. Anthony Schnur, our Chief
Executive Officer, has over twenty years of extensive oil and gas and financial management experience. He has developed strategic
business plans, raised debt and equity capital, and provided asset management, cash flow forecasts, transaction modeling and development
planning for both start-ups and special situations. On three separate occasions in his career, Mr. Schnur has been asked to lead
work-out/turn-around initiatives in the E&P space. Further, the Company’s Vice President of Asset Development (a non-executive
position), Mr. Ken Sanders, is a seasoned petroleum engineer, with over thirty years of experience in both the execution of exploration
and development prospects and the management of independent exploration and production companies as well as leading a publically-traded
E&P through a successful financial turnaround.
In
order to expand our operations in accordance with our business plan, we intend to hire additional employees with expertise in
the areas of corporate development, petroleum engineering, geological and geophysical sciences and accounting, as well as hiring
additional technical, operations and administrative staff. We are not currently able to estimate the number of employees that
we will hire during the next twelve months since that number will depend upon the rate at which our operations expand and upon
the extent to which we engage third parties to perform required services, and the availability of adequate funding.
Reverse
Stock Split
Pursuant
to the authorization provided by the Company’s stockholders at the Company’s March 25, 2015 annual meeting of stockholders,
and in order to meet the continued listing standards of the NYSE MKT, the Board of Directors of the Company approved the filing
of a Certificate of Amendment to the Company’s Articles of Incorporation with the Secretary of State of Nevada to effect
a 1-for-25 reverse stock split of all of the outstanding shares of the Company’s common stock which was effective on July
15, 2015 (the “Reverse Split”). The effect of the Reverse Split was to combine each 25 shares of outstanding common
stock prior to the Reverse Split into one new share subsequent to the Reverse Split, with no change in authorized shares or par
value per share, and to reduce the number of common stock shares outstanding from approximately 35.1 million shares to approximately
1.4 million shares (prior to rounding fractional shares up to the nearest whole share) upon the effectiveness of the Reverse Split.
Proportional adjustments were also made to the conversion and exercise prices of the Company’s outstanding convertible preferred
stock, warrants and stock options, and to the number of shares issued and issuable under the Company’s stock incentive plans.
All issued and outstanding shares of common stock, conversion terms of preferred stock, options and warrants to purchase common
stock and per share amounts contained in the financial statements incorporated herein by reference have been retroactively adjusted
to reflect the Reverse Split for all periods presented in accordance with SAB TOPIC 4C.
Industry
Segments
Lucas
Energy’s operations are all crude oil and natural gas exploration and production related.
Operations
and Oil and Gas Properties
We
operate in known productive areas in order to decrease geological risk. Our holdings are located in an increased area of current
industry activity in Gonzales, Wilson and Karnes counties in Texas. We concentrate on three vertically adjoining formations in
Gonzales, Wilson and Karnes counties: the Austin Chalk, Eagle Ford and Buda formations, listed in the order of increasing depth
measuring from land surface. The development of the Eagle Ford as a high potential producing zone has heightened industry interest
and success. Lucas’s acreage position is in the oil window of the Eagle Ford trend and has approximately 8,395 acres in
the Gonzales, Karnes and Wilson Counties, Texas area.
Austin
Chalk
The
Company’s original activity started in Gonzales County by acquiring existing shut-in and stripper wells and improving production
from those wells. Most of the wells had produced from the Austin Chalk. The Austin Chalk is a dense limestone, varying in thickness
along its trend from approximately 200 feet to more than 800 feet. It produces by virtue of localized fractures within the formation.
Eagle
Ford
On
Lucas Energy’s leases, the Eagle Ford is a porous limestone with organic shale matter. The Eagle Ford formation directly
underlies the Austin Chalk formation and is believed to be the primary source of oil and natural gas produced from the Austin
Chalk. Reservoir thickness in the area of the Company’s leases varies from approximately 60 feet to 80 feet.
Buda
The
Buda limestone underlies the Eagle Ford formation separated by a 10 foot to 20 foot inorganic shale barrier. Its thickness varies
from approximately 100 feet to more than 150 feet in this area. The Buda produces from natural fractures and matrix porosity and
is prospective across this whole area.
Marketing
We
operate exclusively in the onshore United States oil and natural gas industry. Our crude oil production sales are to gatherers
and marketers with national reputations. Our sales are made on a month-to-month basis, and title transfer occurs when the oil
is loaded onto the purchaser’s truck. Crude oil prices realized from production sales are indexed to published posted refinery
prices, and to published crude indexes with adjustments on a contract basis.
Currently,
any natural gas production is associated gas resulting from crude oil production and is currently very nominal. We expect that
as we drill our proved undeveloped opportunities, we would have an increase in production of natural gas and natural gas liquids.
We
generally sell a significant portion of our oil and gas production to a relatively small number of customers. For the year ended
March 31, 2016, 100% of our consolidated product revenues were attributable to Shell Trading (US) Company, our current and only
customer as of March 31, 2016. We are not dependent upon any one purchaser and have alternative purchasers readily available
at competitive market prices if there is disruption in services or other events that cause us to search for other ways to sell
our production.
We
actively manage our crude oil inventory in field tanks and have engaged a marketing company to negotiate our crude and natural
gas contracts.
Competition
We
are in direct competition for properties with numerous oil and natural gas companies and partnerships exploring various areas
of Texas and elsewhere. Many competitors are large, well-known oil and natural gas and/or energy companies, although no single
entity dominates the industry. Many of our competitors possess greater financial and personnel resources, enabling them to identify
and acquire more economically desirable energy producing properties and drilling prospects than us. Additionally, there is competition
from other fuel choices to supply the energy needs of consumers and industry.
Regulation
Our
operations are subject to various types of regulation at the federal, state and local levels. These regulations include requiring
permits for the drilling of wells; maintaining hazard prevention, health and safety plans; submitting notification and receiving
permits related to the presence, use and release of certain materials incidental to oil and natural gas operations; and regulating
the location of wells, the method of drilling and casing wells, the use, transportation, storage and disposal of fluids and materials
used in connection with drilling and production activities, surface plugging and abandonment of wells and the transporting of
production. Our operations are also subject to various conservation matters, including the number of wells which may be drilled
in a unit and the unitization or pooling of oil and natural gas properties. In this regard, some states allow the forced pooling
or integration of tracts to facilitate exploration, while other states rely on voluntary pooling of lands and leases, which may
make it more difficult to develop oil and gas properties. In addition, state conservation laws establish maximum rates of production
from oil and natural gas wells, generally limiting the venting or flaring of natural gas, and impose certain requirements regarding
the ratable purchase of production. The effect of these regulations is to possibly limit the amounts of oil and natural gas we
can produce from our wells and to limit the number of wells or the locations at which we can drill.
In
the United States, legislation affecting the oil and natural gas industry has been pervasive and is under constant review for
amendment or expansion. Pursuant to such legislation, numerous federal, state and local departments and agencies issue recommended
new and extensive rules and regulations binding on the oil and natural gas industry and its individual members, some of which
carry substantial penalties for failure to comply. These laws and regulations have a significant impact on oil and natural gas
drilling, natural gas processing plants and production activities, increasing the cost of doing business and, consequently, affect
profitability. Insomuch as new legislation affecting the oil and natural gas industry is common-place and existing laws and regulations
are frequently amended or reinterpreted, we may be unable to predict the future cost or impact of complying with these laws and
regulations. We consider the cost of environmental protection a necessary and manageable part of our business. We have historically
been able to plan for and comply with new environmental initiatives without materially altering our operating strategies.
Insurance
Matters
We
maintain insurance coverage which we believe is reasonable per the standards of the oil and natural gas industry. It is common
for companies in this industry to not insure fully against all risks associated with their operations either because such insurance
is unavailable or because premium costs are considered prohibitive. A material loss not fully covered by insurance could have
an adverse effect on our financial position, results of operations or cash flows. We maintain insurance at industry customary
levels to limit our financial exposure in the event of a substantial environmental claim resulting from sudden, unanticipated
and accidental discharges of certain prohibited substances into the environment. Such insurance might not cover the complete amount
of such a claim and would not cover fines or penalties for a violation of an environmental law.
Other
Matters
Environmental
.
Our exploration, development, and production of oil and natural gas, including our operation of saltwater injection and disposal
wells, are subject to various federal, state and local environmental laws and regulations. Such laws and regulations can increase
the costs of planning, designing, installing and operating oil, natural gas, and disposal wells. Our domestic activities are subject
to a variety of environmental laws and regulations, including but not limited to, the Oil Pollution Act of 1990 (OPA), the Clean
Water Act (CWA), the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), the Resource Conservation
and Recovery Act (RCRA), the Clean Air Act (CAA), and the Safe Drinking Water Act (SDWA), as well as state regulations promulgated
under comparable state statutes. We are also subject to regulations governing the handling, transportation, storage, and disposal
of naturally occurring radioactive materials that are found in our oil and gas operations. Civil and criminal fines and penalties
may be imposed for non-compliance with these environmental laws and regulations. Additionally, these laws and regulations require
the acquisition of permits or other governmental authorizations before undertaking certain activities, limit or prohibit other
activities because of protected areas or species, and impose substantial liabilities for cleanup of pollution.
Under
the OPA, a release of oil into water or other areas designated by the statute could result in us being held responsible for the
costs of remediating such a release, certain OPA specified damages, and natural resource damages. The extent of that liability
could be extensive, as set forth in the statute, depending on the nature of the release. A release of oil in harmful quantities
or other materials into water or other specified areas could also result in us being held responsible under the CWA for the costs
of remediation, and civil and criminal fines and penalties.
CERCLA
and comparable state statutes, also known as “Superfund” laws, can impose joint and several and retroactive liability,
without regard to fault or the legality of the original conduct, on certain classes of persons for the release of a “hazardous
substance” into the environment. In practice, cleanup costs are usually allocated among various responsible parties. Potentially
liable parties include site owners or operators, past owners or operators under certain conditions, and entities that arrange
for the disposal or treatment of, or transport hazardous substances found at the site. Although CERCLA, as amended, currently
exempts petroleum, including but not limited to, crude oil, natural gas and natural gas liquids, from the definition of hazardous
substance, our operations may involve the use or handling of other materials that may be classified as hazardous substances under
CERCLA. Furthermore, the exemption may not be preserved in future amendments of the act, if any.
RCRA
and comparable state and local requirements impose standards for the management, including treatment, storage, and disposal, of
both hazardous and non-hazardous solid wastes. We generate hazardous and non-hazardous solid waste in connection with our routine
operations. From time to time, proposals have been made that would reclassify certain oil and natural gas wastes, including wastes
generated during drilling, production and pipeline operations, as “hazardous wastes” under RCRA, which would make
such solid wastes subject to much more stringent handling, transportation, storage, disposal, and clean-up requirements. This
development could have a significant impact on our operating costs. While state laws vary on this issue, state initiatives to
further regulate oil and natural gas wastes could have a similar impact. Because oil and natural gas exploration and production,
and possibly other activities, have been conducted at some of our properties by previous owners and operators, materials from
these operations remain on some of the properties and in some instances, require remediation. In addition, in certain instances,
we have agreed to indemnify sellers of producing properties from which we have acquired reserves against certain liabilities for
environmental claims associated with such properties. While we do not believe that costs to be incurred by us for compliance and
remediating previously or currently owned or operated properties will be material, there can be no guarantee that such costs will
not result in material expenditures.
Additionally,
in the course of our routine oil and natural gas operations, surface spills and leaks, including casing leaks, of oil or other
materials occur, and we incur costs for waste handling and environmental compliance. Moreover, we are able to control directly
the operations of only those wells for which we act as the operator. Management believes that we are in substantial compliance
with applicable environmental laws and regulations.
In
response to liabilities associated with these activities, accruals are established when reasonable estimates are possible. Such
accruals would primarily include estimated costs associated with remediation. We have used discounting to present value in determining
our accrued liabilities for environmental remediation or well closure, but no material claims for possible recovery from third
party insurers or other parties related to environmental costs have been recognized in our financial statements. We adjust the
accruals when new remediation responsibilities are discovered and probable costs become estimable, or when current remediation
estimates must be adjusted to reflect new information.
We
do not anticipate being required in the near future to expend amounts that are material in relation to our total capital expenditures
program by reason of environmental laws and regulations, but inasmuch as such laws and regulations are frequently changed, we
are unable to predict the ultimate cost of compliance. More stringent laws and regulations protecting the environment may be adopted
in the future and we may incur material expenses in connection with environmental laws and regulations in the future.
Occupational
Health and Safety.
We are also subject to laws and regulations concerning occupational safety and health. Due to
the continued changes in these laws and regulations, and the judicial construction of many of them, we are unable to predict with
any reasonable degree of certainty our future costs of complying with these laws and regulations. We consider the cost of safety
and health compliance a necessary and manageable part of our business. We have been able to plan for and comply with new initiatives
without materially altering our operating strategies.
Hydraulic
Fracturing.
Vast quantities of natural gas, natural gas liquids and oil deposits exist in deep shale and other unconventional
formations. It is customary in our industry to recover these resources through the use of hydraulic fracturing, combined with
horizontal drilling. Hydraulic fracturing is the process of creating or expanding cracks, or fractures, in deep underground formations
using water, sand and other additives pumped under high pressure into the formation. As with the rest of the industry, we use
hydraulic fracturing as a means to increase the productivity of almost every well that we drill and complete. These formations
are generally geologically separated and isolated from fresh ground water supplies by thousands of feet of impermeable rock layers.
We follow applicable legal requirements for groundwater protection in our operations that are subject to supervision by state
and federal regulators (including the Bureau of Land Management (BLM) on federal acreage). Furthermore, our well construction
practices require the installation of multiple layers of protective steel casing surrounded by cement that are specifically designed
and installed to protect freshwater aquifers by preventing the migration of fracturing fluids into aquifers.
Injection
rates and pressures are required to be monitored in real time at the surface during our hydraulic fracturing operations. Pressure
is required to be monitored on both the injection string and the immediate annulus to the injection string. Hydraulic fracturing
operations are required to be shut down if an abrupt change occurs to the injection pressure or annular pressure. These aspects
of hydraulic fracturing operations are designed to prevent a pathway for the fracturing fluid to contact any aquifers during the
hydraulic fracturing operations.
Hydraulic
fracture stimulation requires the use of water. We use fresh water or recycled produced water in our fracturing treatments in
accordance with applicable water management plans and laws. Hydraulic fracturing is typically regulated by state oil and gas commissions.
Some states have adopted, and other states are considering adopting, regulations that impose disclosure requirements on hydraulic
fracturing operations. Some states, such as Texas, mandate disclosure of chemical additives used in hydraulic fracturing. The
EPA also has commenced a study of the potential impacts of hydraulic fracturing activities on drinking water resources, with a
progress report released in late 2012 and a final draft report was released for public comment and peer review in June 2015. In
addition, the BLM published a revised draft of proposed rules that would impose new requirements on hydraulic fracturing operations
conducted on federal and tribal lands, including the disclosure of chemical additives used in hydraulic fracturing operations.
EPA’s guidance, the EPA’s pending study, BLM’s proposed rules, and other analyses by federal and state agencies
to assess the impacts of hydraulic fracturing could each spur further action toward federal and/or state legislation and regulation
of hydraulic fracturing activities.
Restrictions
on hydraulic fracturing could make it prohibitive to conduct our operations, and also reduce the amount of oil, natural gas liquids
and natural gas that we are ultimately able to produce in commercial quantities from our properties.
The
Endangered Species Act.
The Endangered Species Act (ESA) restricts activities that may affect areas that contain endangered
or threatened species or their habitats. While some of our assets and lease acreage may be located in areas that are designated
as habitats for endangered or threatened species, we believe that we are in substantial compliance with the ESA. However, the
designation of previously unidentified endangered or threatened species in areas where we intend to conduct construction activity
could materially limit or delay our plans.
Global
Warming and Climate Change.
Various state governments and regional organizations are considering enacting new legislation
and promulgating new regulations governing or restricting the emission of greenhouse gases from stationary sources such as our
equipment and operations. Legislative and regulatory proposals for restricting greenhouse gas emissions or otherwise addressing
climate change could require us to incur additional operating costs and could adversely affect demand for the natural gas and
oil that we sell. The potential increase in our operating costs could include new or increased costs to obtain permits, operate
and maintain our equipment and facilities, install new emission controls on our equipment and facilities, acquire allowances to
authorize our greenhouse gas emissions, pay taxes related to our greenhouse gas emissions and administer and manage a greenhouse
gas emissions program.
Taxation.
Our operations, as is the case in the petroleum industry generally, are significantly affected by federal tax laws. Federal,
as well as state, tax laws have many provisions applicable to corporations which could affect our future tax liabilities.
Commitments
and Contingencies.
We are liable for future restoration and abandonment costs associated with our oil and gas properties.
These costs include future site restoration, post closure and other environmental exit costs. The costs of future restoration
and well abandonment have not been determined in detail. State regulations require operators to post bonds that assure that well
sites will be properly plugged and abandoned. We currently operate only in Texas, which requires a security bond based on the
number of wells we operate. Management views this as a necessary requirement for operations and does not believe that these costs
will have a material adverse effect on our financial position as a result of this requirement.
Available
Information
Our
website address is http://www.lucasenergy.com. The information on, or that may be accessed through, our website is not incorporated
by reference into this report and should not be considered a part of this report. You can access our filings of Annual Reports
on Form 10-K, Quarterly Reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports as soon as reasonably
practicable after such reports have been filed with the United States Securities and Exchange Commission (SEC). In addition, you
can access our proxy statements, our Code of Business Conduct and Ethics, Nominating and Corporate Governance Committee Charter,
Audit Committee Charter, and Compensation Committee Charter on our website http://www.lucasenergy.com, at “Investors”
– “SEC Filings” – “All SEC Filings” and “Governance” - “Policies”.
Our
fiscal year ends on the last day of March of each year. We refer to the years ended March 31, 2016 and 2015 as our 2016 and 2015 fiscal years, respectively.
ITEM
1A. RISK FACTORS.
Our
business and operations are subject to many risks. The risks described below may not be the only risks we face, as our business
and operations may also be subject to risks that we do not yet know of, or that we currently believe are immaterial. If any of
the events or circumstances described below actually occurs, our business, financial condition, results of operations or cash
flow could be materially and adversely affected and the trading price of our common stock could decline. The following risk factors
should be read in conjunction with the other information contained herein, including the financial statements and the related
notes. Unless the context requires otherwise, “we,” “us” and “our” refer to Lucas Energy,
Inc. and its subsidiary. In addition, please read “Cautionary Note Regarding Forward-Looking Statements” in this filing,
where we describe additional uncertainties associated with our business and the forward-looking statements included or incorporated
by reference in this filing.
Our
securities should only be purchased by persons who can afford to lose their entire investment in us. You should carefully consider
the following risk factors and other information in this filing before deciding to become a holder of our securities. If any of
the following risks actually occur, our business and financial results could be negatively affected to a significant extent.
Risks
Relating to the Pending Acquisition
In
the event the Asset Purchase Agreement closes, it will cause immediate and substantial dilution to existing stockholders and will
result in a change of control of the Company.
Pursuant
to the Asset Purchase Agreement and in consideration for the Assets, we agreed to assume $31.35 million of commercial bank debt;
issue 552,000 shares of to-be-designated Series B Preferred Stock to one of the Sellers, which is under common control with the
Seller Representative (as described and defined below under “Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations” – “Asset Purchase Agreement”), with a total liquidation value of
$13.8 million; issue 13,009,664 shares of common stock to certain of the Sellers; and pay $4,975,000 in cash to certain of the
Sellers. The Series B Preferred Stock will have a liquidation preference of $25 per share. The Series B Preferred Stock will be
convertible into common stock at a rate of approximately 7.14:1 (issuable into an aggregate of 3,942,857 shares of common stock
if fully converted), at the option of the holder thereof, and will also be subject to certain automatic conversion provisions.
Each outstanding share of Series B Preferred Stock will be entitled to one vote per share on all stockholder matters. As such,
in the event the contemplated Acquisition closes, the issuance of the common stock consideration and Series B Preferred Stock
will result in immediate and substantial dilution to the interests of our then stockholders and result in a change of control
of the Company.
Additionally,
pursuant to the Asset Purchase Agreement, the Sellers will have the right to appoint three members to our Board of Directors,
and it is anticipated that one of their director nominees will be Richard N. Azar II. Mr. Azar, the principal Seller and manager
of the properties, who is planned to be appointed as Executive Chairman following the closing. Mr. Azar is a founding partner
of the Seller Representative, and for over 20 years has been instrumental in developing the Hunton resource play in Central Oklahoma
through his direction of the Seller Representative, ownership in Altex Resources, Inc., and various other successful oil and gas
ventures. Mr. Azar will also be receiving a significant amount of the shares of common stock issuable upon closing of the Acquisition
and all of the Series B Preferred Stock issuable at closing, either personally or through entities which he controls. By the six
month anniversary of the closing of the Asset Purchase Agreement, one of the three current members of our Board of Directors will
be required to resign in order that we will have five members of our Board of Directors, including three appointed by the Sellers,
on such date.
In
the event the Asset Purchase Agreement closes, we will be required to assume significant amounts of debt and our operation and
management of the Assets may not be able to generate sufficient cash flows to meet our debt service obligations, which could reduce
our financial flexibility, increase interest expenses and adversely impact our operations.
As
described above, one of the requirements of the closing of the Asset Purchase Agreement is that we assume $31.35 million of commercial
bank debt. Our ability to make payments on such indebtedness will depend on our ability to generate cash from the Assets. The
Assets may not generate sufficient cash flow from operations to enable us to repay this indebtedness and to fund other liquidity
needs, including capital expenditure requirements. Such indebtedness could affect our operations in several ways, including the
following:
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a
significant portion of our cash flows could be required to be used to service such indebtedness;
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a
high level of debt could increase our vulnerability to general adverse economic and industry
conditions;
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any
covenants contained in the agreements governing such outstanding indebtedness could limit
our ability to borrow additional funds, dispose of assets, pay dividends and make certain
investments;
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a
high level of debt may place us at a competitive disadvantage compared to our competitors
that are less leveraged and, therefore, our competitors may be able to take advantage
of opportunities that our indebtedness may prevent us from pursuing; and
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debt
covenants to which we may agree may affect our flexibility in planning for, and reacting
to, changes in the economy and in our industry.
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The
indebtedness to be incurred by us in connection with the Acquisition will bear interest at variable rates, and therefore if interest
rates increase, our debt service requirements will increase. In such case, we may need to refinance or restructure all or a portion
of our indebtedness on or before maturity. We may not be able to refinance any of our indebtedness, including the assumed indebtedness,
on commercially reasonable terms, or at all.
A
high level of indebtedness increases the risk that we may default on our debt obligations. We may not be able to generate sufficient
cash flows to pay the principal or interest on our debt. If we cannot service or refinance our indebtedness, we may have to take
actions such as selling significant assets, seeking additional equity financing (which will result in additional dilution to stockholders)
or reducing or delaying capital expenditures, any of which could have a material adverse effect on our operations and financial
condition. If we do not have sufficient funds and are otherwise unable to arrange financing, our assets may be foreclosed upon
which could have a material adverse effect on our business, financial condition and results of operations.
The
Asset Purchase Agreement limits our ability to pursue alternatives to the acquisition.
The
Asset Purchase Agreement contains provisions that could adversely impact competing proposals to acquire us and for us to acquire
properties. These provisions include the prohibition on us generally from soliciting any acquisition proposal or offer for a competing
transaction. These provisions, might discourage a third party that might have an interest in acquiring all or a significant part
of our company from considering or proposing an acquisition, even if that party were prepared to pay consideration with a higher
value than the current proposed acquisition consideration.
Failure
to complete the Acquisition could negatively impact our stock price and future business and financial results.
If
the Acquisition is not completed, our ongoing business may be adversely affected and we would be subject to a number of risks,
including the following:
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we
will not realize the benefits expected from the Acquisition, including a potentially
enhanced competitive and financial position, expansion of assets and therefore opportunities,
and will instead be subject to all the risks we currently face as an independent company;
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we
may experience negative reactions from the financial markets and our partners and employees;
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we
may have to repay the Debenture (as described and defined below under “Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations”
– “Financing”), and we may not receive the remaining $14.5 million
in funding under our April 2016 private placement;
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the
Asset Purchase Agreement places certain restrictions on the conduct of our business prior
to the completion of the Acquisition or the termination of the Asset Purchase Agreement.
Such restrictions may prevent us from making certain acquisitions, taking certain other
specified actions or otherwise pursuing business opportunities during the pendency of
the Acquisition; and
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matters
relating to the Acquisition (including integration planning) may require substantial
commitments of time and resources by our management, which would otherwise have been
devoted to other opportunities that may have been beneficial to us as an independent
company.
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We
will be subject to business uncertainties and contractual restrictions while the Acquisition is pending.
Uncertainty
about the effect of the Acquisition on employees and partners may have an adverse effect on us. These uncertainties may impair
our ability to attract, retain and motivate key personnel until the Acquisition is completed or terminated, and could cause partners
and others that deal with us to seek to change existing business relationships, cease doing business with us or cause potential
new partners to delay doing business with us until the Acquisition has been successfully completed. Retention of certain employees
may be challenging during the pendency of the Acquisition, as certain employees may experience uncertainty about their future
roles or compensation structure. If key employees depart because of issues relating to the uncertainty and difficulty of integration
or a desire not to remain with the business, our business following the Acquisition could be negatively impacted. In addition,
the Asset Purchase Agreement restricts us from making certain acquisitions and taking other specified actions until the Acquisition
is completed. These restrictions may prevent us from pursuing attractive business opportunities that may arise prior to the completion
of the Acquisition.
The
total number of shares to be issued by us as consideration to the Sellers in the Acquisition, and the resulting dilution that
our current stockholders will experience because of it, will be significant.
Under
the terms of the Asset Purchase Agreement, we have agreed to issue to the Sellers, in the aggregate, 13,009,664 shares of our
common stock and 552,000 shares of to-be-designated Series B Preferred Stock at the closing of the Acquisition. Although following
the Acquisition, shares held by our current stockholders will each represent a piece of a larger company, our issuance of the
securities in the Acquisition to the Sellers at closing will result in significant dilution to our current stockholders in terms
of their ownership percentages. After the closing of the Acquisition, we estimate that the outstanding shares held by our current
stockholders will represent only 11.0% of our outstanding shares of common stock.
The
shares of Series B Preferred Stock issuable upon closing of the Acquisition will be convertible into shares of common stock and,
when and if converted, will result in additional dilution to our current stockholders.
Each
share of to-be-designated Series B Preferred Stock will be convertible, at the option of the holder, into that number of fully-paid,
nonassessable shares of common stock determined by dividing the Original Issue Price for the Series B Preferred Stock ($25.00,
as may be adjusted for recapitalizations) by the Conversion Price ($3.50, as may be adjusted for recapitalizations). Each share
of Series B Preferred Stock will automatically convert into shares of common stock under certain conditions set forth in the Certificate
of Designations of the Series B Preferred Stock. Assuming the conversion of all such shares as of the closing of the Acquisition,
this would result in the issuance of approximately 3,942,857 shares of common stock, which is equivalent to approximately 21.2%
of our common stock that will be outstanding as of immediately after the closing of the Acquisition.
Concentration
of share ownership by our largest stockholders may prevent other stockholders from influencing significant corporate decisions.
If
the Acquisition is completed, certain Sellers will own significant portions of our stock. For example, RAD2 Minerals, Ltd will
beneficially own approximately 37.2% of our outstanding shares of common stock, Coyle Manna Management LLC will beneficially own
approximately 12.2% of our outstanding shares of common stock, and collectively, the Sellers will beneficially own approximately
91.3% of our outstanding shares of common stock. As a result, certain Sellers, and the persons and entities that control such
Sellers, will have the ability to exert significant influence over matters requiring approval by our stockholders, including the
election and removal of directors, and on the outcome of corporate actions, including a change of control of the Company, a business
combination involving the Company, the incurrence of indebtedness, the issuance of equity securities and the payment of dividends
on our stock. This concentration of ownership could be disadvantageous to other stockholders with differing interests from such
persons.
The
Sellers will have significant control over our Board of Directors following the Acquisition.
Following
the Acquisition, the Sellers will have the right to appoint three members to our Board of Directors (Board), and it is anticipated
that one of their director nominees will be Richard N. Azar II. Upon such appointments, the Sellers will have significant control
over our Board and the decisions made by our Board.
Servicing
debt could limit funds available for other purposes.
Following
the Acquisition, we will use cash from operations to pay the principal and interest on our consolidated debt. These payments limit
funds available for other purposes, including expansion of our operations through acquisitions and funding future capital expenditures.
The
Acquisition may go forward even if the Assets experience a material adverse change.
Although
we have the right to not consummate the Acquisition if the Assets suffer certain material adverse changes in financial condition
prior to the closing (subject to certain exceptions), we may elect to proceed with the Acquisition despite such a material adverse
change, and can do so without approval of our stockholders. If the Assets suffer a material adverse change, but we still complete
the Acquisition, neither we nor our stockholders will have the benefit, if any, of the condition waived.
Completion
of the Acquisition is subject to a number of conditions and if these conditions are not satisfied or waived, the Acquisition will
not be completed.
The
Acquisition is subject to customary closing conditions, including (1) approval by our stockholders of the issuance of the shares
of common stock and Series B Preferred Stock in connection with the Acquisition, (2) receipt by us of the $4.975 million required
to be paid to the Sellers at closing, which we plan to raise from the Sellers’ debt holders from whom we are required to
assume the $31.35 million in debt; (3) receipt of required regulatory approvals, (4) the absence of any law or order prohibiting
the consummation of the Acquisition, and (5) approval of the NYSE MKT of the continued listing of our common stock on the NYSE
MKT prior to and following the closing. Each party’s obligation to complete the Acquisition is also subject to certain additional
customary conditions, including (a) subject to certain exceptions, the accuracy of the representations and warranties of the other
parties, and (b) performance in all material respects by the other parties of its obligations under the Asset Purchase Agreement.
Failure to fulfill any of such closing conditions could prevent us from completing the Acquisition and have a material adverse
effect on the Company.
The
Asset Purchase Agreement also includes customary termination provisions for both the Company and the Sellers and, if the Asset
Purchase Agreement is terminated prior to closing, such termination could have a material adverse effect on the Company.
The
Asset Purchase Agreement includes customary termination provisions for both us and the Sellers, which include, subject to the
terms of the Asset Purchase Agreement and in certain circumstances rights to cure or other prerequisites, that the Asset Purchase
Agreement can be terminated by us, if (i) any issues arise in connection with our due diligence on the Assets which in aggregate
would constitute a material adverse effect on such Assets (as described in the Asset Purchase Agreement) and such issues cannot
be reasonably cured by the parties; (ii) our stockholders fail to approve the issuance of the securities issuable in connection
with the Acquisition at a meeting called for such purpose; (iii) we fail to obtain all required consents; (iv) we fail to raise
the cash necessary to acquire the Assets; (v) the Sellers fail to provide all required closing deliverables; or (vi) the Sellers
breach any representation or warranty in the Asset Purchase Agreement, subject to the right to cure. The termination rights of
the Sellers include a termination by the Sellers if (i) any issues arise in connection with the Seller’s due diligence of
us which in aggregate would constitute a material adverse effect (as described in the Asset Purchase Agreement) and such issues
cannot be reasonably cured by the parties; (ii) we have more than 1.8 million shares of common stock outstanding at closing, or
the Sellers would own less than 80% of each class of our outstanding shares, on a fully-diluted basis, at closing; (iii) our stockholders
fail to approve the items required to be approved for closing; (iv) we fail to maintain our listing on the NYSE MKT prior to and
following closing; (v) we fail to assume the $31.35 million in debt required to be assumed at closing; (vi) we fail to provide
all required closing deliverables; (vii) we breach any representation or warranty in the Asset Purchase Agreement, subject to
the right to cure; or (viii) our Board withdraws its recommendation for the stockholders to approve the issuance of the securities
issuable in the Acquisition because we have been presented with a superior acquisition proposal. The Asset Purchase Agreement
can also be terminated by either party with five days prior written notice if the Acquisition has not been completed by September
30, 2016, provided that such failure is not the result of the breach of the agreement by the terminating party. As a result of
the above, the Asset Purchase Agreement may be terminated by us or the Sellers prior to closing.
Termination
of the Asset Purchase Agreement could negatively impact us.
In
the event the Asset Purchase Agreement is terminated, our business may have been adversely impacted by our failure to pursue other
beneficial opportunities due to the focus of management on the Acquisition, and the market price of our common stock might decline
to the extent that the current market price reflects a market assumption that the Acquisition will be completed. If the Asset
Purchase Agreement is terminated and our Board of Directors seeks another acquisition or business combination, our stockholders
cannot be certain that we will be able to find a party willing to offer equivalent or more attractive consideration than the consideration
provided for by the acquisition.
Misrepresentations
made to us by the Sellers regarding the Assets could cause us to incur substantial financial obligations and harm our business.
If
we were to discover that there were misrepresentations made to us by the Sellers or their representatives regarding the Assets,
we would explore all possible legal remedies to compensate us for any loss, including our rights to indemnification under the
Asset Purchase Agreement. However, there is no assurance that legal remedies would be available or collectible. If such unknown
liabilities exist and we are not fully indemnified for any loss that we incur as a result thereof, we could incur substantial
financial obligations, which could materially adversely affect our financial condition and harm our business.
If
we are not able to integrate the Assets into our operations in a timely manner, the anticipated benefits of the Acquisition may
not be realized in a timely fashion, or at all, and our existing businesses may be materially adversely affected.
The
success of the Acquisition will depend, in part, on our ability to realize the growth opportunities and synergies of combining
the Assets with ours and our ability to effectively utilize the additional resources we will have following the Acquisition. The
integration of the Assets may involve unforeseen difficulties. These difficulties could disrupt our ongoing business, distract
our management and employees and increase our expenses, which could have a material adverse effect on our business, financial
condition and operating results.
The
Acquisition will result in significant costs to us, whether or not it is completed, which could result in a reduction in our income
and cash flows.
We
will be required to pay our costs related to the Acquisition even if the Acquisition is not completed, such as amounts payable
to legal and financial advisors and independent accountants, and such costs will be significant. All of these costs will be incurred
whether or not the Acquisition is completed.
Because
the valuation of the Assets is based in part on certain financial projections about future results, and projections are subject
to inherent risks and uncertainties, the Sellers may receive Acquisition consideration that is greater than the fair market value
of the Assets.
The
Sellers provided financial projections to us in connection with the determination of the consideration to be paid for the Assets,
and we, our Board and our financial advisor relied in part on the Sellers’ projections for purposes of valuing the Assets
and agreeing on the purchase price set forth in the Asset Purchase Agreement. Our valuation is not necessarily indicative of the
actual value of the Assets. Accordingly, if actual financial results in the future are lower than the projections we relied upon,
the Acquisition consideration may be greater than the fair market value of the Assets.
The
financial projections we relied upon may not be accurate and may not be met in the future because the projections reflect numerous
estimates and assumptions with respect to industry performance, general business, economic, regulatory, market and financial conditions
and other matters, all of which are difficult to predict and many of which are beyond the Sellers’ and our control. As a
result, actual results may differ materially from these projections. It is expected that there will be differences between actual
and projected results because the projections cover multiple years and such information by its nature becomes less reliable with
each successive year.
If
the benefits of the Acquisition do not meet the expectations of the marketplace, or financial or industry analysts, the market
price of our common stock may decline.
The
market price of our common stock may decline as a result of the Acquisition if the Assets do not perform as expected, or we do
not otherwise achieve the perceived benefits of the Acquisition as rapidly as, or to the extent, anticipated by the marketplace,
or financial or industry analysts. Accordingly, investors may experience a loss as a result of a decreasing stock price and we
may not be able to raise future capital, if necessary, in the equity markets.
Transaction-related
accounting impairment and amortization charges may delay and reduce our profitability.
Under
generally accepted accounting principles, the Assets and assumed liabilities of the Sellers will be recorded on our books post-Acquisition
at their fair values at the date the Acquisition is completed. Any excess of the value of the consideration paid by us at the
date the Acquisition is completed over the fair value of the identifiable tangible and intangible assets of the Sellers will be
treated as excess of purchase price over the fair value of net assets acquired. Under current accounting standards, to the extent
applicable, intangible assets, other than goodwill, will be amortized to expense over their estimated useful lives, which will
affect our post-Acquisition profitability over several years beginning in the period in which the Acquisition is completed. The
Assets will be tested at a minimum on an annual basis for impairment, which may result in additional accounting impairment charges.
Any
weakness in internal control over financial reporting or disclosure controls and procedures could result in a loss of investor
confidence in our financial reports and lead to a stock price decline.
We
are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002 and
report the results in our annual report on Form 10-K, including this Annual Report on Form 10-K. We are also required to maintain
effective disclosure controls and procedures. After the Acquisition, our internal controls and our disclosure controls and procedures
will need to expand to encompass activities related to the Assets. If material weaknesses arise as a result and they are not remedied,
we will be unable to assert that our internal controls are effective. Any failure to have effective internal control over financial
reporting or disclosure controls and procedures covering the combined business post-Acquisition could cause investors to lose
confidence in the accuracy and completeness of our financial reports, limit our ability to raise financing or lead to regulatory
sanctions, any of which could result in a material adverse effect on our business or decline in the market price of our common
stock post-Acquisition.
The
loss of key executives could adversely affect our operations up to and following the closing of the Acquisition.
The
success of the Acquisition will be dependent upon the continued service of a relatively small group of our key executives. Following
the closing of the Acquisition, we expect that our existing executives will remain with us and Mr. Azar, the principal Seller,
is planned to be appointed as Executive Chairman of our Board. The unexpected loss of the services of one or more of these executives
or members of our Board could adversely affect our ability to manage the business going forward and to manage our operations following
the closing of the Acquisition.
Risks
Relating to Our Operations and Industry
We
require financing to execute our business plan and fund capital program requirements.
Our
anticipated cash flow from operations, possible proceeds from sales of properties and funding provided by leveraging our capital
structure, may not be sufficient to meet our working capital and operating needs for approximately the next twelve months. Additionally,
in order to continue growth and to fund our business and expansion plans, we will require additional financing. Moving forward,
we hope to pursue third party capital in the form of debt (subordinated to International Bank of Commerce, or IBC), equity or
some combination of the two for certain funding requirements. We may be unsuccessful in obtaining additional financing on attractive
terms, if at all. We currently require approximately $2.0 million of additional funding within the next few months related to
the closing and finance costs associated with the transactions contemplated by and requirements set forth in the Asset Purchase
Agreement, Stock Purchase Agreement and Securities Purchase Agreement, and additional funding of approximately $0.5 million for
additional drilling and workover activities on existing properties.
Due
to our need for immediate funding, in the event we do not receive the full amount of the proceeds expected under the Securities
Purchase Agreement and Stock Purchase Agreement (as described and defined below under “Item 7. Management’s Discussion
and Analysis of Financial Condition and Results of Operations” – “Financing”) entered into in April 2016
due to the failure to satisfy any of the conditions to receive such proceeds, we may be forced to raise capital through the sale
of debt (subordinated to IBC) or equity in the near term. In order to issue additional securities, we must, subject to certain
exceptions, obtain the consent of the investor in our April 2016 financing. If we are unable to obtain the consent of this investor
in connection with future financings, we may be unable to raise additional capital on acceptable terms, or at all. If external
financing sources are not available in a timely manner or at all, or are inadequate to fund our operations, it could materially
harm our financial condition and results of operation. Additionally, we may not have the time or resources available to seek stockholder
approval (if required pursuant to applicable NYSE MKT rules and requirements) for such transactions which may result in the issuance
of more than 20% of our outstanding common stock. As such, we may instead rely on an exemption from the NYSE MKT stockholder approval
rules which allows an NYSE MKT listed company an exemption from such rules when a delay in securing stockholder approval would
seriously jeopardize the financial viability of the company. Consequently, our stockholders may not be offered the ability to
approve transactions we may undertake in the future, including those transactions which would ordinarily require stockholder approval
under applicable NYSE MKT rules and regulations, and/or those transactions which would result in substantial dilution to existing
stockholders.
We
require significant additional financing to continue as a going concern and pay outstanding liabilities and our lack of available
funding raises questions regarding our ability to continue as a going concern.
Due
to the nature of oil and gas interests, i.e., that rates of production generally decline over time as oil and gas reserves are
depleted, if we are unable to drill additional wells and develop our proved undeveloped reserves (PUDs), either because we are
unable to raise sufficient funding for such development activities, or otherwise, or in the event we are unable to acquire additional
operating properties; we believe that our revenues will continue to decline over time. Furthermore, in the event we are unable
to raise additional funding in the future, we will not be able to participate with Earthstone Energy, Inc. in the drilling of
planned additional wells, will not be able to complete other drilling and/or workover activities, and may not be able to make
required payments on our outstanding liabilities, including amounts owed on the Letter Loan Agreement with Louise H. Rogers (as
amended and modified to date, the “Rogers Loan”). Therefore, in the event we do not raise additional funding in the
future we will be forced to scale back our business plan, sell or liquidate assets to satisfy outstanding debts and/or take other
steps which may include seeking bankruptcy protection.
These
conditions raise substantial doubt about our ability to continue as a going concern for the next twelve months. The accompanying
financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America
on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course
of business. Accordingly, the financial statements do not include any adjustments relating to the recoverability of assets and
classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The financial
statements included herein also include a going concern footnote from our auditors.
Additionally,
due to our need for immediate funding, in the event we do not receive the full amount of the proceeds expected under the Securities
Purchase Agreement and Stock Purchase Agreement entered into in April 2016 due to the failure to satisfy any of the conditions
to receive such proceeds, we may be forced to raise capital through the sale of debt (subordinated to IBC) or equity in the near
term. In order to issue additional securities, we must, subject to certain exceptions, obtain the consent of the investor in our
April 2016 financing. If we are unable to obtain the consent of this investor in connection with future financings, we may be
unable to raise additional capital on acceptable terms, or at all. If external financing sources are not available in a timely
manner or at all, or are inadequate to fund our operations, it could materially harm our financial condition and results of operation.
We may not have the time or resources available to seek stockholder approval (if required pursuant to applicable NYSE MKT rules
and requirements) for such transactions which may result in the issuance of more than 20% of our outstanding common stock. As
such, we may instead rely on an exemption from the NYSE MKT stockholder approval rules which allows an NYSE MKT listed company
an exemption from such rules when a delay in securing stockholder approval would seriously jeopardize the financial viability
of the company. Consequently, our stockholders may not be offered the ability to approve transactions we may undertake in the
future, including those transactions which would ordinarily require stockholder approval under applicable NYSE MKT rules and regulations,
and/or those transactions which would result in substantial dilution to existing stockholders.
In
the event we are unable to raise funding in the future or complete a business combination or similar transaction in the near term,
we will not be able to pay our liabilities. In the event we are unable to raise adequate funding in the future for our operations
and to pay our outstanding debt obligations or in the event we fail to enter into a business combination or similar transaction,
we would be forced to liquidate our assets (or our creditors may undertake a foreclosure of such assets in order to satisfy amounts
we owe to such creditors) or may be forced to seek bankruptcy protection, which could result in the value of our outstanding securities
declining in value or becoming worthless.
We
are subject to production declines and loss of revenue due to shut-in wells.
The
majority of our production revenues come from a small number of producing wells. In the event those wells are required to be shut-in
(as they were for various periods in the past), our production and revenue could be adversely effected. Our wells are shut-in
from time-to-time for maintenance, workovers, upgrades and other matters outside of our control, including repairs, adverse weather
(including hurricanes, flooding and tropical storms), inability to dispose of produced water or other regulatory and market conditions.
Any significant period where our wells, and especially our top producing wells, are shut-in, would have a material adverse effect
on our results of production, revenues and net income or loss for the applicable period.
Many
of our leases are in areas that have been partially depleted or drained by offset wells.
Many
of our leases are in areas that have been partially depleted or drained by offset drilling. Interference from offset drilling
may inhibit our ability to find or recover commercial quantities of oil and/or may result in an acceleration in the decline in
production of our wells, which may in turn have an adverse effect on our recovered barrels of oil and consequently our results
of operations.
Crude
oil and natural gas prices are highly volatile in general and low prices will negatively affect our financial results.
Our
revenues, operating results, profitability, cash flow, future rate of growth and ability to borrow funds or obtain additional
capital, as well as the carrying value of our oil and natural gas properties, are substantially dependent upon prevailing prices
of crude oil and natural gas. Lower crude oil and natural gas prices also may reduce the amount of crude oil and natural gas that
we can produce economically. Historically, the markets for crude oil and natural gas have been very volatile, and such markets
are likely to continue to be volatile in the future. Prices for oil and natural gas fluctuate widely in response to a variety
of factors beyond our control, such as:
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overall
U.S. and global economic conditions;
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weather
conditions and natural disasters;
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seasonal
variations in oil and natural gas prices;
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price
and availability of alternative fuels;
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technological
advances affecting oil and natural gas production and consumption;
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consumer
demand;
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domestic
and foreign supply of oil and natural gas;
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variations
in levels of production;
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regional
price differentials and quality differentials of oil and natural gas; price and quantity
of foreign imports of oil, NGLs and natural gas;
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the
completion of large domestic or international exploration and production projects;
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restrictions
on exportation of our oil and natural gas;
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the
availability of refining capacity;
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the
impact of energy conservation efforts;
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political
conditions in or affecting other oil producing and natural gas producing countries, including
the current conflicts in the Middle East and conditions in South America and Russia;
and
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domestic
and foreign governmental regulations, actions and taxes.
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Further,
oil and natural gas prices do not necessarily fluctuate in direct relation to each other. Our revenue, profitability, and cash
flow depend upon the prices of supply and demand for oil and natural gas, and a drop in prices can significantly affect our financial
results and impede our growth. In particular, declines in commodity prices may:
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negatively
impact the value of our reserves, because declines in oil and natural gas prices would
reduce the value and amount of oil and natural gas that we can produce economically;
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reduce
the amount of cash flow available for capital expenditures, repayment of indebtedness,
and other corporate purposes; and
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limit
our ability to borrow money or raise additional capital.
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We
may have difficulty managing growth in our business, which could have a material adverse effect on our business, financial condition
and results of operations and our ability to execute our business plan in a timely fashion.
Because
of our small size, growth in accordance with our business plans, if achieved, will place a significant strain on our financial,
technical, operational and management resources. If we expand our activities, development and production, and increase the number
of projects we are evaluating or in which we participate, there will be additional demands on our financial, technical and management
resources. The failure to continue to upgrade our technical, administrative, operating and financial control systems or the occurrence
of unexpected expansion difficulties, including the inability to recruit and retain experienced managers, geoscientists, petroleum
engineers and landmen could have a material adverse effect on our business, financial condition and results of operations and
our ability to execute our business plan in a timely fashion.
We
face intense competition.
We
are in direct competition for properties with numerous oil and natural gas companies, drilling and income programs and partnerships
exploring various areas of Texas and will face competition for properties in Oklahoma in the event the Acquisition closes. Many
competitors are large, well-known energy companies, although no single entity dominates the industry. Many of our competitors
possess greater financial and personnel resources enabling them to identify and acquire more economically desirable energy producing
properties and drilling prospects than us. Additionally, there is competition from other fuel choices to supply the energy needs
of consumers and industry. Management believes that a viable marketplace exists for smaller producers of natural gas and crude
oil.
Our
competitors may use superior technology and data resources that we may be unable to afford or that would require a costly investment
by us in order to compete with them more effectively.
Our
industry is subject to rapid and significant advancements in technology, including the introduction of new products and services
using new technologies and databases. As our competitors use or develop new technologies, we may be placed at a competitive disadvantage,
and competitive pressures may force us to implement new technologies at a substantial cost. In addition, many of our competitors
will have greater financial, technical and personnel resources that allow them to enjoy technological advantages and may in the
future allow them to implement new technologies before we can. We cannot be certain that we will be able to implement technologies
on a timely basis or at a cost that is acceptable to us. One or more of the technologies that we will use or that we may implement
in the future may become obsolete, and we may be adversely affected.
Our
wholly-owned subsidiary currently owes significant funds under an outstanding promissory note, the repayment of which is secured
by a first priority security interest in substantially all of our subsidiary’s assets.
Effective
on August 13, 2013, we entered into the Rogers Loan, as described in greater detail under, “Note 6 – Notes Payable”
to our consolidated financial statements included in “Part II” - “Item 8. Financial Statements and Supplementary
Data”, below. The maturity date of the Rogers Loan is currently October 31, 2016. We have also (i) transferred all of our
oil and gas interests and equipment existing as of December 16, 2015 (the “CATI Properties”) to our wholly-owned Texas
subsidiary, CATI; (ii) clarified that following the transfer, Louis H. Rogers (“Rogers”) has no right to foreclose
upon us (at the Nevada corporate parent level) upon the occurrence of an event of default under the Rogers Loan, and that instead
Rogers can only take action against CATI and the CATI Properties; and (iii) required Rogers to release all UCC and other security
filings on us (provided that Rogers is allowed to file the same filings on CATI and its assets). Finally, we have entered into
an Assignment, Novation, and Assumption Agreement (the “Assignment Agreement”). Pursuant to the Assignment Agreement,
we assigned our obligations under the Rogers Loan and related loan documents, to CATI, as if CATI had originally been a party
thereto, CATI agreed to assume such obligations and to take whatever actions requested by Rogers in order for Rogers to secure
the amounts owed under the Rogers Note, and Rogers agreed to release us (at the parent company level) from any obligations under
the Rogers Loan and related loan documents, other than under the amendment above. Notwithstanding the above, we do not have sufficient
funds to repay the Rogers Loan. In the event of the default in the payment when due of the amounts owed under the Rogers Loan,
as amended, Rogers may seek to secure her interest pursuant to the aforementioned security rights in CATI and the CATI Properties.
If CATI is in default of the Rogers Loan, Rogers can take certain actions under the Rogers Loan, including demanding immediate
repayment of all amounts outstanding or initiating foreclosure proceedings against CATI and the CATI Properties. As the Rogers
Loan is secured by substantially all of the CATI Properties, Rogers (or where applicable, her agent) can foreclose on the CATI
Properties which would cause us to significantly curtail or cease operations. Because our ownership interest in CATI currently
constitutes significantly all of our assets, a foreclosure on the CATI Properties could cause the value of our securities to decline
or become worthless. Additionally, as a result of the above, CATI may be forced to seek bankruptcy protection.
The
future occurrence or continuance of an event of default under the Rogers Loan or the acceleration of amounts owed thereunder could
have a material adverse effect on us and our financial condition.
The
Rogers Loan and note issued in connection therewith include standard and customary events of default. Upon the occurrence of an
event of default, Rogers may declare the entire unpaid balance (as well as any interest, fees and expenses) immediately due and
payable. Funding to repay such amounts, if required by Rogers, may not be available timely, on favorable terms, if at all, and
if Rogers were to require immediate repayment of the amounts owed, it would likely have a material adverse effect on our results
of operations, financial condition and the value of our common stock.
We
may not timely receive funds under the April 2016 Securities Purchase Agreement and Stock Purchase Agreement and/or may not receive
such funds at all.
Pursuant
to our April 2016 Securities Purchase Agreement and Stock Purchase Agreement, we may not receive up to $14.5 million in proceeds
if the Acquisition does not close, we do not receive approval of our stockholders for NYSE MKT purposes, certain equity conditions
are not met, or there is not an effective registration statement covering the common stock underlying the securities issued or
to be issued to the investor. In the event that we do not timely receive funds under the April 2016 Securities Purchase Agreement
and Stock Purchase Agreement, and/or we do not receive such funds at all, it will have a material adverse effect on our ability
to satisfy our liabilities and could force us to curtail our operations or seek bankruptcy protection, which could result in the
value of our securities declining in value or becoming worthless.
We
have various outstanding Convertible Promissory Notes which are convertible into shares of our common stock at a discount to our
current market price.
To
date, we have issued or agreed to issue $3,000,000 in Convertible Promissory Notes (as described and defined below under “Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” – “Financing”).
The Convertible Promissory Notes are due and payable on various dates between October 1, 2016 and April 26, 2017. The Convertible
Promissory Notes accrue interest at the rate of 6% per annum (15% upon the occurrence of an event of default), and allow the holders
thereof the right to convert the principal and interest due thereunder into our common stock at a conversion price of $1.50 per
share, provided that any conversion is subject to us first receiving approval for the issuance of shares of our common stock under
the Convertible Promissory Notes under applicable NYSE MKT rules and regulations (“NYSE Approval”). Each conversion
is also subject to a per holder 9.99% ownership limitation upon conversion. We have the right to prepay the Convertible Promissory
Notes. The Convertible Promissory Notes include customary events of default for facilities of similar nature and size. Upon the
conversion of the Convertible Promissory Notes (which are each limited to 19.9% of our outstanding shares of common stock on the
date each transaction was entered into, prior to shareholder approval for such issuances), the notes will be convertible into
a significant number of shares of our common stock at $1.50 per share or $3.25 per share, as applicable, which is a discount to
the current trading price of our common stock. As a result, any conversion of the Convertible Promissory Notes and sale of shares
of common stock issuable in connection with the conversion thereof will likely cause the value of our common stock, if any, to
decline in value, as described in greater detail under the Risk Factors below.
The
issuance and sale of common stock upon conversion of the Convertible Promissory Notes, the Debenture and the other convertible
securities to be issued, may depress the market price of our common stock.
If
there are sequential conversions of the Convertible Promissory Notes, the Debenture (as described and defined below under “Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” – “Financing”)
and the other convertible securities to be issued, and sales of such converted shares take place, the price of our common stock
may decline. The shares of common stock issuable upon conversion of these securities may be sold without restriction after the
applicable holding period under Rule 144 has elapsed. In addition, we have agreed to file resale registration statements for the
shares of common stock issuable upon conversion of the Debenture and related warrant, Series C Preferred Stock and related warrant,
and certain of the Convertible Promissory Notes and related warrants subject to certain conditions, which will make those shares
freely tradable when the registration statements become effective. As a result, the sale of these shares may adversely affect
the market price of our common stock.
In
addition, the common stock issuable upon conversion of these convertible securities may represent overhang that may also adversely
affect the market price of our common stock. Overhang occurs when there is a greater supply of a company’s stock in the
market than there is demand for that stock. When this happens the price of the company’s stock will decrease, and any additional
shares which shareholders attempt to sell in the market will only further decrease the share price. The Convertible Promissory
Notes are currently convertible into shares of our common stock at a discount to the current market price of our common stock
as described above, and such discount to market provides the holders with the ability to sell their common stock at or below market
and still make a profit. In the event of such overhang, the note holders will have an incentive to sell their common stock as
quickly as possible. If the share volume of our common stock cannot absorb the discounted shares, then the value of our common
stock will likely decrease.
The
issuance of common stock upon conversion of the Convertible Notes and other convertible securities will cause immediate and substantial
dilution.
The
issuance of common stock upon conversion of the Convertible Notes and other convertible securities will result in immediate and
substantial dilution to the interests of other stockholders.
Restrictions
on drilling activities intended to protect certain species of wildlife may adversely affect our ability to conduct drilling activities
in some of the areas where we operate.
Oil
and natural gas operations in our operating areas can be adversely affected by seasonal or permanent restrictions on drilling
activities designed to protect various wildlife. Seasonal restrictions may limit our ability to operate in protected areas and
can intensify competition for drilling rigs, oilfield equipment, services, supplies and qualified personnel, which may lead to
periodic shortages when drilling is allowed. These constraints and the resulting shortages or high costs could delay our operations
and materially increase our operating and capital costs. Permanent restrictions imposed to protect endangered species could prohibit
drilling in certain areas or require the implementation of expensive mitigation measures. Specifically, applicable laws protecting
endangered species prohibit the harming of endangered or threatened species, provide for habitat protection, and impose stringent
penalties for noncompliance. The designation of previously unprotected species as threatened or endangered in areas where we operate
could cause us to incur increased costs arising from species protection measures or could result in limitations, delays, or prohibitions
on our exploration and production activities that could have an adverse impact on our ability to develop and produce our reserves.
The
derivatives legislation adopted by Congress, and implementation of that legislation by federal agencies, could have an adverse
impact on our ability to hedge risks associated with our business.
On
July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Dodd-Frank Act,
which, among other things, sets forth the new framework for regulating certain derivative products including the commodity hedges
of the type that we may elect to use, but many aspects of this law are subject to further rulemaking and will take effect over
several years. As a result, it is difficult to anticipate the overall impact of the Dodd-Frank Act on our ability or willingness
to enter into and maintain such commodity hedges and the terms of such hedges. There is a possibility that the Dodd-Frank Act
could have a substantial and adverse impact on our ability to enter into and maintain these commodity hedges. In particular, the
Dodd-Frank Act could result in the implementation of position limits and additional regulatory requirements on derivative arrangements,
which could include new margin, reporting and clearing requirements. In addition, this legislation could have a substantial impact
on our counterparties and may increase the cost of our derivative arrangements in the future. If these types of commodity hedges
become unavailable or uneconomic, our commodity price risk could increase, which would increase the volatility of revenues and
may decrease the amount of credit available to us. Any limitations or changes in our use of derivative arrangements could also
materially affect our future ability to conduct acquisitions.
If
we do not hedge our exposure to reductions in oil and natural gas prices, we may be subject to significant reductions in prices.
Alternatively, we may use oil and natural gas price hedging contracts, which involve credit risk and may limit future revenues
from price increases and result in significant fluctuations in our profitability.
In
the event that we choose not to hedge our exposure to reductions in oil and natural gas prices by purchasing futures and by using
other hedging strategies, we may be subject to significant reduction in prices which could have a material negative impact on
our profitability. Alternatively, we may elect to use hedging transactions with respect to a portion of our oil and natural gas
production to achieve more predictable cash flow and to reduce our exposure to price fluctuations. While the use of hedging transactions
limits the downside risk of price declines, their use also may limit future revenues from price increases. Hedging transactions
also involve the risk that the counterparty may be unable to satisfy its obligations.
Our
operations are substantially dependent on the availability of water. Restrictions on our ability to obtain water may have an adverse
effect on our financial condition, results of operations and cash flows.
Water
is an essential component of deep shale oil and natural gas production during both the drilling and hydraulic fracturing, or fracking
processes. Our operations in West Texas and future operations in other areas could be adversely impacted if we are unable to locate
sufficient amounts of water, or dispose of or recycle water used in our exploration and production operations. Currently, the
quantity of water required in certain completion operations, such as hydraulic fracturing, and changing regulations governing
usage may lead to water constraints and supply concerns (particularly in some parts of the country). As a result, future availability
of water from certain sources used in the past may be limited. Moreover, the imposition of new environmental initiatives and conditions
could include restrictions on our ability to conduct certain operations such as hydraulic fracturing or disposal of waste, including,
but not limited to, produced water, drilling fluids and other wastes associated with the exploration, development or production
of oil and natural gas. The federal Clean Water Act, or CWA and analogous state laws impose restrictions and strict controls regarding
the discharge of pollutants, including produced waters and other oil and natural gas waste, into navigable waters or other regulated
federal and state waters. Permits or other approvals must be obtained to discharge pollutants to regulated waters and to conduct
construction activities in such waters and wetlands. Uncertainty regarding regulatory jurisdiction over wetlands and other regulated
waters has, and will continue to, complicate and increase the cost of obtaining such permits or other approvals. The CWA and analogous
state laws provide for civil, criminal and administrative penalties for any unauthorized discharges of pollutants and unauthorized
discharges of reportable quantities of oil and other hazardous substances. Many state discharge regulations, and the Federal National
Pollutant Discharge Elimination System General permits issued by the EPA, prohibit the discharge of produced water and sand, drilling
fluids, drill cuttings and certain other substances related to the oil and natural gas industry into coastal waters. While generally
exempt under federal programs, many state agencies have also adopted regulations requiring certain oil and natural gas exploration
and production facilities to obtain permits for storm water discharges. In October 2011, the EPA announced its intention to develop
federal pretreatment standards for wastewater discharges associated with hydraulic fracturing activities. If adopted, the pretreatment
rules will require coalbed methane and shale gas operations to pretreat wastewater before transferring it to treatment facilities
Some states have banned the treatment of fracturing wastewater at publicly owned treatment facilities. There has been recent nationwide
concern over earthquakes associated with Class II underground injection control wells, a predominant storage method for crude
oil and gas wastewater. It is likely that new rules and regulations will be developed to address these concerns, possibly eliminating
access to Class II wells in certain locations, and increasing the cost of disposal in others. Finally, the EPA study noted above
has focused and will continue to focus on various stages of water use in hydraulic fracturing operations. It is possible that,
following the conclusion of the EPA’s study, the agency will move to more strictly regulate the use of water in hydraulic
fracturing operations. While we cannot predict the impact that these changes may have on our business at this time, they may be
material to our business, financial condition, and operations. Compliance with environmental regulations and permit requirements
governing the withdrawal, storage and use of surface water or groundwater necessary for hydraulic fracturing of wells or the disposal
or recycling of water will increase our operating costs and may cause delays, interruptions or termination of our operations,
the extent of which cannot be predicted. In addition, our inability to meet our water supply needs to conduct our completion operations
may impact our business, and any such future laws and regulations could negatively affect our financial condition, results of
operations and cash flows.
If
we acquire crude oil and natural gas properties in the future, our failure to fully identify existing and potential problems,
to accurately estimate reserves, production rates or costs, or to effectively integrate the acquired properties into our operations
could materially and adversely affect our business, financial condition and results of operations.
From
time to time, we seek to acquire crude oil and natural gas properties. Although we perform reviews of properties to be acquired
in a manner that we believe is duly diligent and consistent with industry practices, reviews of records and properties may not
necessarily reveal existing or potential problems, and may not permit us to become sufficiently familiar with the properties in
order to fully assess their deficiencies and potential. Even when problems with a property are identified, we may assume environmental
and other risks and liabilities in connection with acquired properties pursuant to the acquisition agreements. Moreover, there
are numerous uncertainties inherent in estimating quantities of crude oil and natural gas reserves (as discussed further below),
actual future production rates and associated costs with respect to acquired properties. Actual reserves, production rates and
costs may vary substantially from those assumed in our estimates. We may be unable to locate or make suitable acquisitions on
acceptable terms and future acquisitions may not be effectively and profitably integrated. Acquisitions involve risks that could
divert management resources and/or result in the possible loss of key employees and customers of the acquired operations. For
the reasons above, among others, an acquisition may have a material and adverse effect on our business and results of operations,
particularly during the periods in which the operations of the acquired properties are being integrated into our ongoing operations
or if we are unable to effectively integrate the acquired properties into our ongoing operations.
If
we make any acquisitions or enter into any business combinations in the future, they may disrupt or have a negative impact on
our business.
If
we make acquisitions or enter into any business combinations in the future, funding permitting, we could have difficulty integrating
the acquired companies’ assets, personnel and operations with our own. Additionally, acquisitions, mergers or business combinations
we may enter into in the future could result in a change of control of the Company, and a change in the Board of Directors or
officers of the Company. In addition, the key personnel of the acquired business may not be willing to work for us. We cannot
predict the effect expansion may have on our core business. Regardless of whether we are successful in making an acquisition or
completing a business combination, the negotiations could disrupt our ongoing business, distract our management and employees
and increase our expenses. In addition to the risks described above, acquisitions and business combinations are accompanied by
a number of inherent risks, including, without limitation, the following:
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the
difficulty of integrating acquired companies, concepts and operations;
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the
potential disruption of the ongoing businesses and distraction of our management and
the management of acquired companies;
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difficulties
in maintaining uniform standards, controls, procedures and policies;
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the
potential impairment of relationships with employees and partners as a result of any
integration of new management personnel;
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the
potential inability to manage an increased number of locations and employees;
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our
ability to successfully manage the companies and/or concepts acquired;
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the
failure to realize efficiencies, synergies and cost savings; or
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the
effect of any government regulations which relate to the business acquired.
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Our
business could be severely impaired if and to the extent that we are unable to succeed in addressing any of these risks or other
problems encountered in connection with an acquisition or business combination, many of which cannot be presently identified.
These risks and problems could disrupt our ongoing business, distract our management and employees, increase our expenses and
adversely affect our results of operations.
Any
acquisition or business combination transaction we enter into in the future could cause substantial dilution to existing stockholders,
result in one party having majority or significant control over the Company or result in a change in business focus of the Company.
We
depend significantly upon the continued involvement of our present management.
We
depend to a significant degree upon the involvement of our management, specifically, our Chief Executive Officer and director,
Anthony C. Schnur, who is in charge of our strategic planning and operations. Our performance and success are dependent to a large
extent on the efforts and continued employment of Mr. Schnur. We do not believe that Mr. Schnur could be quickly replaced with
personnel of equal experience and capabilities, and his successor(s) may not be as effective. If Mr. Schnur or any of our other
key personnel resign or become unable to continue in their present roles and if they are not adequately replaced, our business
operations could be adversely affected.
We
have an active Board of Directors that meets several times throughout the year and is intimately involved in our business and
the determination of our operational strategies. Members of our Board of Directors work closely with management to identify potential
prospects, acquisitions and areas for further development. If any of our directors resign or become unable to continue in their
present role, it may be difficult to find replacements with the same knowledge and experience and as a result, our operations
may be adversely affected.
Certain
of our undeveloped leasehold assets are subject to leases that will expire over the next several years unless production is established
on units containing the acreage.
Leases
on natural gas and oil properties typically have a term of three to five years, after which they expire unless, prior to expiration,
a well is drilled and production of hydrocarbons in paying quantities is established. If our leases expire and we are unable to
renew the leases, we will lose our right to develop the related properties. Although we seek to actively manage our undeveloped
properties, our drilling plans for these areas are subject to change based upon various factors, including drilling results, natural
gas and oil prices, the availability and cost of capital, drilling and production costs, availability of drilling services and
equipment, gathering system and pipeline transportation constraints and regulatory approvals.
Our
business is subject to extensive regulation.
As
many of our activities are subject to federal, state and local regulation, and as these rules are subject to constant change or
amendment, our operations may be adversely affected by new or different government regulations, laws or court decisions applicable
to our operations.
Government
regulation and liability for environmental matters may adversely affect our business and results of operations.
Crude
oil and natural gas operations are subject to extensive federal, state and local government regulations, which may be changed
from time to time. Matters subject to regulation include discharge permits for drilling operations, drilling bonds, reports concerning
operations, the spacing of wells, unitization and 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 crude oil and natural gas wells below
actual production capacity in order to conserve supplies of crude oil and natural gas. There are federal, state and local laws
and regulations primarily relating to protection of human health and the environment applicable to the development, production,
handling, storage, transportation and disposal of crude oil and natural gas, byproducts thereof and other substances and materials
produced or used in connection with crude oil and natural gas operations. In addition, we may inherit liability for environmental
damages caused by previous owners of property we purchase or lease. As a result, we may incur substantial liabilities to third
parties or governmental entities. The implementation of new, or the modification of existing, laws or regulations could have a
material adverse effect on us.
Future
increases in our tax obligations; either due to increases in taxes on energy products, energy service companies and exploration
activities or reductions in currently available federal income tax deductions with respect to oil and natural gas exploration
and development, may adversely affect our results of operations and increase our operating expenses.
Federal,
state and local governments have jurisdiction in areas where we operate and impose taxes on the oil and natural gas products we
sell. There are constant discussions by federal, state and local officials concerning a variety of energy tax proposals, some
of which, if passed, would add or increase taxes on energy products, service companies and exploration activities. Additionally,
the current administration has proposed legislation which would make significant changes to federal tax laws, including the elimination
of certain key United States federal income tax incentives currently available to oil and natural gas exploration and production
companies. These proposed changes include, but are not limited to: (1) the repeal of the percentage depletion allowance for oil
and natural gas properties, (2) the elimination of current deductions for intangible drilling and development costs, (3) the elimination
of the deduction for certain domestic production activities, and (4) an extension of the amortization period for certain geological
and geophysical expenditures. It is unclear whether any such changes will be enacted into law or how soon any such changes could
become effective in the event they were enacted into law. The passage of any legislation as a result of these proposals or any
other changes in U.S. federal income tax laws could impact or increase the taxes that we are required to pay and consequently
adversely affect our results of operations and/or increase our operating expenses.
The
crude oil and natural gas reserves we report in our SEC filings are estimates and may prove to be inaccurate.
There
are numerous uncertainties inherent in estimating crude oil and natural gas reserves and their estimated values. The reserves
we report in our filings with the SEC now and in the future will only be estimates and such estimates may prove to be inaccurate
because of these uncertainties. Reservoir engineering is a subjective and inexact process of estimating underground accumulations
of crude oil and natural gas that cannot be measured in an exact manner. Estimates of economically recoverable crude oil and natural
gas reserves depend upon a number of variable factors, such as historical production from the area compared with production from
other producing areas and assumptions concerning effects of regulations by governmental agencies, future crude oil and natural
gas prices, future operating costs, severance and excise taxes, development costs and work-over and remedial costs. Some or all
of these assumptions may in fact vary considerably from actual results. For these reasons, estimates of the economically recoverable
quantities of crude oil and natural gas attributable to any particular group of properties, classifications of such reserves based
on risk of recovery, and estimates of the future net cash flows expected therefrom prepared by different engineers or by the same
engineers but at different times may vary substantially. Accordingly, reserve estimates may be subject to downward or upward adjustment.
Actual production, revenue and expenditures with respect to our reserves will likely vary from estimates, and such variances may
be material.
Additionally,
“probable” and “possible reserve estimates” are considered unproved reserves and as such, the SEC views
such estimates to be inherently unreliable, may be misunderstood or seen as misleading to investors that are not “experts”
in the oil or natural gas industry. Unless you have such expertise, you should not place undue reliance on these estimates. Except
as required by applicable law, we undertake no duty to update this information and do not intend to update this information.
The
calculated present value of future net revenues from our proved reserves will not necessarily be the same as the current market
value of our estimated oil and natural gas reserves.
You
should not assume that the present value of future net cash flows as included in our public filings is the current market value
of our estimated proved oil and natural gas reserves. We generally base the estimated discounted future net cash flows from proved
reserves on current costs held constant over time without escalation and on commodity prices using an unweighted arithmetic average
of first-day-of-the-month index prices, appropriately adjusted, for the 12-month period immediately preceding the date of the
estimate. Actual future prices and costs may be materially higher or lower than the prices and costs used for these estimates
and will be affected by factors such as:
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actual
prices we receive for oil and natural gas;
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actual
cost and timing of development and production expenditures;
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the
amount and timing of actual production; and
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changes
in governmental regulations or taxation.
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In
addition, the 10% discount factor that is required to be used to calculate discounted future net revenues for reporting purposes
under GAAP is not necessarily the most appropriate discount factor based on the cost of capital in effect from time to time and
risks associated with our business and the oil and natural gas industry in general.
Crude
oil and natural gas development, re-completion of wells from one reservoir to another reservoir, restoring wells to production
and exploration, drilling and completing new wells are speculative activities and involve numerous risks and substantial and uncertain
costs.
Our
growth will be materially dependent upon the success of our future development program. Even considering our business philosophy
to avoid wildcat wells, drilling for crude oil and natural gas and reworking existing wells involves numerous risks, including
the risk that no commercially productive crude oil or natural gas reservoirs will be encountered. The cost of exploration, drilling,
completing and operating wells is substantial and uncertain, and drilling operations may be curtailed, delayed or cancelled as
a result of a variety of factors beyond our control, including: unexpected drilling conditions; pressure or irregularities in
formations; equipment failures or accidents; inability to obtain leases on economic terms, where applicable; adverse weather conditions
and natural disasters; compliance with governmental requirements; and shortages or delays in the availability of drilling rigs
or crews and the delivery of equipment. Furthermore, we cannot provide investors with any assurance that we will be able to obtain
rights to additional producing properties in the future and/or that any properties we obtain rights to will contain commercially
exploitable quantities of oil and/or gas.
Drilling
or reworking is a highly speculative activity. Even when fully and correctly utilized, modern well completion techniques such
as hydraulic fracturing and horizontal drilling do not guarantee that we will find crude oil and/or natural gas in our wells.
Hydraulic fracturing involves pumping a fluid with or without particulates into a formation at high pressure, thereby creating
fractures in the rock and leaving the particulates in the fractures to ensure that the fractures remain open, thereby potentially
increasing the ability of the reservoir to produce oil or natural gas. Horizontal drilling involves drilling horizontally out
from an existing vertical well bore, thereby potentially increasing the area and reach of the well bore that is in contact with
the reservoir. Our future drilling activities may not be successful and, if unsuccessful, such failure would have an adverse effect
on our future results of operations and financial condition. Our overall drilling success rate and/or our drilling success rate
for activities within a particular geographic area may decline in the future. We may identify and develop prospects through a
number of methods, some of which do not include lateral drilling or hydraulic fracturing, and some of which may be unproven. The
drilling and results for these prospects may be particularly uncertain. Our drilling schedule may vary from our capital budget.
The final determination with respect to the drilling of any scheduled or budgeted prospects will be dependent on a number of factors,
including, but not limited to: the results of previous development efforts and the acquisition, review and analysis of data; the
availability of sufficient capital resources to us and the other participants, if any, for the drilling of the prospects; the
approval of the prospects by other participants, if any, after additional data has been compiled; economic and industry conditions
at the time of drilling, including prevailing and anticipated prices for crude oil and natural gas and the availability of drilling
rigs and crews; our financial resources and results; the availability of leases and permits on reasonable terms for the prospects;
and the success of our drilling technology.
These
projects may not be successfully developed and the wells discussed, if drilled, may not encounter reservoirs of commercially productive
crude oil or natural gas. There are numerous uncertainties in estimating quantities of proved reserves, including many factors
beyond our control. If we are unable to find commercially exploitable quantities of oil and natural gas in any properties we may
acquire in the future, and/or we are unable to commercially extract such quantities we may find in any properties we may acquire
in the future, the value of our securities may decline in value.
Recent
commodity price declines have resulted in impairment of our oil and gas properties, and future natural gas and oil price declines
may result in additional write-downs of the carrying amount of our assets, which could materially and adversely affect our results
of operations.
The
value of our assets depends on prices of natural gas and oil. Declines in these prices as well as increases in development costs,
changes in well performance, delays in asset development or deterioration of drilling results may result in our having to make
material downward adjustments to our estimated proved reserves, and could result in an impairment charge and a corresponding write-down
of the carrying amount of our oil and natural gas properties. For example, in March 2016, we recorded an impairment of approximately
$21.4 million associated with oil and gas properties in certain non-core fields in south Texas. The impairment of these fields
was due to a significant decline in commodity prices during the 2016 fiscal year.
We
evaluate our oil and gas properties for impairment using the full cost method whereby the carrying value of property and equipment
is compared to the “estimated present value” of its proved reserves discounted at a 10-percent interest rate of future
net revenues, based on current economic and operating conditions at the end of the period, plus the cost of properties not being
amortized, plus the lower of cost or fair market value of unproved properties included in costs being amortized, less the income
tax effects related to book and tax basis differences. In the event that commodity prices decline further, there could be a significant
revision in the future.
Because
of the inherent dangers involved in oil and gas exploration, there is a risk that we may incur liability or damages as we conduct
our business operations, which could force us to expend a substantial amount of money in connection with litigation and/or a settlement.
The
oil and natural gas business involves a variety of operating hazards and risks such as well blowouts, pipe failures, casing collapse,
explosions, uncontrollable flows of oil, natural gas or well fluids, fires, spills, pollution, releases of toxic gas and other
environmental hazards and risks. These hazards and risks could result in substantial losses to us from, among other things, injury
or loss of life, severe damage to or destruction of property, natural resources and equipment, pollution or other environmental
damage, cleanup responsibilities, regulatory investigation and penalties and suspension of operations. In addition, we may be
liable for environmental damages caused by previous owners of property purchased and leased by us in the future. As a result,
substantial liabilities to third parties or governmental entities may be incurred, the payment of which could reduce or eliminate
the funds available for the purchase of properties and/or property interests, exploration, development or acquisitions or result
in the loss of our properties and/or force us to expend substantial monies in connection with litigation or settlements. As such,
our current insurance or the insurance that we obtain in the future may not be adequate to cover any losses or liabilities. We
cannot predict the availability of insurance or the availability of insurance at premium levels that justify our purchase. The
occurrence of a significant event not fully insured or indemnified against could materially and adversely affect our financial
condition and operations. We may elect to self-insure if management believes that the cost of insurance, although available, is
excessive relative to the risks presented. In addition, pollution and environmental risks generally are not fully insurable. The
occurrence of an event not fully covered by insurance could have a material adverse effect on our financial condition and results
of operations, which could lead to any investment in us declining in value or becoming worthless.
Unless
we replace our oil and natural gas reserves, our reserves and production will decline, which would adversely affect our business,
financial condition and results of operations.
The
rate of production from our oil and natural gas properties will decline as our reserves are depleted. Our future oil and natural
gas reserves and production and, therefore, our income and cash flow, are highly dependent on our success in (a) efficiently developing
and exploiting our current reserves on properties owned by us or by other persons or entities and (b) economically finding or
acquiring additional oil and natural gas properties. In the future, we may have difficulty acquiring new properties. During periods
of low oil and/or natural gas prices, it will become more difficult to raise the capital necessary to finance expansion activities.
If we are unable to replace our production, our reserves will decrease, and our business, financial condition and results of operations
would be adversely affected.
The
unavailability or high cost of drilling rigs, completion equipment and services, supplies and personnel, including hydraulic fracturing
equipment and personnel, could adversely affect our ability to establish and execute exploration and development plans within
budget and on a timely basis, which could have a material adverse effect on our business, financial condition and results of operations.
Shortages
or the high cost of drilling rigs, completion equipment and services, supplies or personnel could delay or adversely affect our
operations. When drilling activity in the United States increases, associated costs typically also increase, including those costs
related to drilling rigs, equipment, supplies and personnel and the services and products of other vendors to the industry. These
costs may increase, and necessary equipment and services may become unavailable to us at economical prices. Should this increase
in costs occur, we may delay drilling activities, which may limit our ability to establish and replace reserves, or we may incur
these higher costs, which may negatively affect our business, financial condition and results of operations.
We
incur certain costs to comply with government regulations, particularly regulations relating to environmental protection and safety,
and could incur even greater costs in the future.
Our
exploration, production and marketing operations are regulated extensively at the federal, state and local levels and are subject
to interruption or termination by governmental and regulatory authorities based on environmental or other considerations. Moreover,
we have incurred and will continue to incur costs in our efforts to comply with the requirements of environmental, safety and
other regulations. Further, the regulatory environment in the oil and natural gas industry could change in ways that we cannot
predict and that might substantially increase our costs of compliance and, in turn, materially and adversely affect our business,
results of operations and financial condition.
Specifically,
as an owner or lessee and operator of crude oil and natural gas properties, we are subject to various federal, state, local and
foreign regulations relating to the discharge of materials into, and the protection of, the environment. These regulations may,
among other things, impose liability on us for the cost of pollution cleanup resulting from operations, subject us to liability
for pollution damages and require suspension or cessation of operations in affected areas. Moreover, we are subject to the United
States (U.S.) Environmental Protection Agency’s (U.S. EPA) rule requiring annual reporting of greenhouse gas (GHG) emissions.
Changes in, or additions to, these regulations could lead to increased operating and compliance costs and, in turn, materially
and adversely affect our business, results of operations and financial condition.
We
are aware of the increasing focus of local, state, national and international regulatory bodies on GHG emissions and climate change
issues. In addition to the U.S. EPA’s rule requiring annual reporting of GHG emissions, we are also aware of legislation
proposed by U.S. lawmakers to reduce GHG emissions.
Additionally,
there have been various proposals to regulate hydraulic fracturing at the federal level, including possible regulations limiting
the ability to dispose of produced waters. Currently, the regulation of hydraulic fracturing is primarily conducted at the state
level through permitting and other compliance requirements. Any new federal regulations that may be imposed on hydraulic fracturing
could result in additional permitting and disclosure requirements (such as the reporting and public disclosure of the chemical
additives used in the fracturing process) and in additional operating restrictions. In addition to the possible federal regulation
of hydraulic fracturing, some states and local governments have considered imposing various conditions and restrictions on drilling
and completion operations, including requirements regarding casing and cementing of wells, testing of nearby water wells, restrictions
on the access to and usage of water and restrictions on the type of chemical additives that may be used in hydraulic fracturing
operations. Such federal and state permitting and disclosure requirements and operating restrictions and conditions could lead
to operational delays and increased operating and compliance costs and, moreover, could delay or effectively prevent the development
of crude oil and natural gas from formations which would not be economically viable without the use of hydraulic fracturing.
We
will continue to monitor and assess any new policies, legislation, regulations and treaties in the areas where we operate to determine
the impact on our operations and take appropriate actions, where necessary. We are unable to predict the timing, scope and effect
of any currently proposed or future laws, regulations or treaties, but the direct and indirect costs of such laws, regulations
and treaties (if enacted) could materially and adversely affect our business, results of operations and financial condition.
Federal
and state legislation and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional
operating restrictions or delays.
Hydraulic
fracturing is a common practice that is used to stimulate production of hydrocarbons from tight formations. The process involves
the injection of water, sand and chemicals under pressure into rock formations to fracture the surrounding rock and stimulate
production. There has been increasing public controversy regarding hydraulic fracturing with regard to the transportation and
use of fracturing fluids, impacts on drinking water supplies, use of waters, and the potential for impacts to surface water, groundwater,
air quality and the environment generally. A number of lawsuits and enforcement actions have been initiated implicating hydraulic
fracturing practices. Additional legislation or regulation could make it more difficult to perform hydraulic fracturing, cause
operational delays, increase our operating costs or make it easier for third parties opposing the hydraulic fracturing process
to initiate legal proceedings. New legislation or regulations in the future could have the effect of prohibiting the use of hydraulic
fracturing, which would prevent us from completing our wells as planned and would have a material adverse effect on production
from our wells. If these legislative and regulatory initiatives cause a material delay or decrease in our drilling or hydraulic
fracturing activities, our business and profitability could be materially impacted.
Possible
regulation related to global warming and climate change could have an adverse effect on our operations and demand for oil and
gas.
Studies
over recent years have indicated that emissions of certain gases may be contributing to warming of the Earth’s atmosphere.
In response to these studies, governments have begun adopting domestic and international climate change regulations that require
reporting and reductions of the emission of greenhouse gases. Methane, a primary component of natural gas, and carbon dioxide,
a by-product of the burning of oil, natural gas and refined petroleum products, are considered greenhouse gases. In the United
States, at the state level, many states, either individually or through multi-state regional initiatives, have begun implementing
legal measures to reduce emissions of greenhouse gases, primarily through the planned development of emission inventories or regional
greenhouse gas cap and trade programs or have begun considering adopting greenhouse gas regulatory programs. At the federal level,
Congress has considered legislation that could establish a cap and trade system for restricting greenhouse gas emissions in the
United States. The ultimate outcome of this federal legislative initiative remains uncertain. In addition to pending climate legislation,
the EPA has issued greenhouse gas monitoring and reporting regulations. Beyond measuring and reporting, the EPA issued an “Endangerment
Finding” under section 202(a) of the Clean Air Act, concluding that greenhouse gas pollution threatens the public health
and welfare of current and future generations. The finding served as a first step to issuing regulations that require permits
for and reductions in greenhouse gas emissions for certain facilities. Moreover, the EPA has begun regulating greenhouse gas emission
from certain facilities pursuant to the Prevention of Significant Deterioration and Title V provisions of the Clean Air Act. In
the courts, several decisions have been issued that may increase the risk of claims being filed by government entities and private
parties against companies that have significant greenhouse gas emissions. Such cases may seek to challenge air emissions permits
that greenhouse gas emitters apply for and seek to force emitters to reduce their emissions or seek damages for alleged climate
change impacts to the environment, people, and property. Any existing or future laws or regulations that restrict or reduce emissions
of greenhouse gases could require us to incur increased operating and compliance costs. In addition, such laws and regulations
may adversely affect demand for the fossil fuels we produce, including by increasing the cost of combusting fossil fuels and by
creating incentives for the use of alternative fuels and energy.
The
lack of availability or high cost of drilling rigs, equipment, supplies, insurance, personnel and oilfield services could adversely
affect our ability to execute our exploration and development plans on a timely basis and within our budget.
Our
industry is cyclical and, from time to time, there is a shortage of drilling rigs, equipment, supplies or qualified personnel.
During these periods, the costs and delivery times of rigs, equipment and supplies tend to increase, in some cases substantially.
In addition, the demand for, and wage rates of, qualified drilling rig crews rise as the number of active rigs in service increases
within a geographic area. If increasing levels of exploration and production result in response to strong prices of oil and natural
gas, the demand for oilfield services will likely rise, and the costs of these services will likely increase, while the quality
of these services may suffer. The future lack of availability or high cost of drilling rigs, as well as any future lack of availability
or high costs of other equipment, supplies, insurance or qualified personnel, in the areas in which we operate could materially
and adversely affect our business and results of operations.
Our
officers and directors have limited liability, and we are required in certain instances to indemnify our officers and directors
for breaches of their fiduciary duties.
We
have adopted provisions in our Articles of Incorporation and Bylaws which limit the liability of our officers and directors and
provide for indemnification by us of our officers and directors to the full extent permitted by Nevada corporate law. Our articles
generally provide that our officers and directors shall have no personal liability to us or our stockholders for monetary damages
for breaches of their fiduciary duties as directors, except for breaches of their duties of loyalty, acts or omissions not in
good faith or which involve intentional misconduct or knowing violation of law, acts involving unlawful payment of dividends or
unlawful stock purchases or redemptions, or any transaction from which a director derives an improper personal benefit. Such provisions
substantially limit our stockholders’ ability to hold officers and directors liable for breaches of fiduciary duty, and
may require us to indemnify our officers and directors.
We
currently have outstanding indebtedness and we may incur additional indebtedness which could reduce our financial flexibility,
increase interest expense and adversely impact our operations and our unit costs.
We
currently have outstanding indebtedness and in the future, we may incur significant amounts of additional indebtedness in order
to make acquisitions or to develop our properties (including, but not limited to in connection with the Acquisition as described
above). Our level of indebtedness could affect our operations in several ways, including the following:
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a
significant portion of our cash flows could be used to service our indebtedness;
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a
high level of debt would increase our vulnerability to general adverse economic and industry
conditions;
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any
covenants contained in the agreements governing our outstanding indebtedness could limit
our ability to borrow additional funds,
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dispose
of assets, pay dividends and make certain investments;
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a
high level of debt may place us at a competitive disadvantage compared to our competitors
that are less leveraged and, therefore, may be able to take advantage of opportunities
that our indebtedness may prevent us from pursuing; and
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debt
covenants to which we may agree may affect our flexibility in planning for, and reacting
to, changes in the economy and in our industry.
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A
high level of indebtedness increases the risk that we may default on our debt obligations. We may not be able to generate sufficient
cash flows to pay the principal or interest on our debt, and future working capital, borrowings or equity financing may not be
available to pay or refinance such debt. If we do not have sufficient funds and are otherwise unable to arrange financing, we
may have to sell significant assets or have a portion of our assets foreclosed upon which could have a material adverse effect
on our business, financial condition and results of operations.
Our
CATI Properties are located in the Austin Chalk and Eagle Ford trends, making us vulnerable to risks associated with operating
in one major geographic area.
Our
CATI Properties are located in the Austin Chalk and Eagle Ford trends south, and southeast of San Antonio, Texas. As a result,
we may be disproportionately exposed to the impact of delays or interruptions of production from wells caused by transportation
capacity constraints, curtailment of production, availability of equipment, facilities, personnel or services, significant governmental
regulation, natural disasters, adverse weather conditions, or interruption of transportation of oil or natural gas produced from
the wells in this area. In addition, the effect of fluctuations on supply and demand may become more pronounced within specific
geographic oil and gas producing areas such as the ones we operate in, which may cause these conditions to occur with greater
frequency or magnify the effect of these conditions. Due to the concentrated nature of our portfolio of CATI Properties, a number
of our CATI Properties could experience any of the same conditions at the same time, resulting in a relatively greater impact
on our results of operations than they might have on other companies that have a more diversified portfolio of properties. Such
delays or interruptions could have a material adverse effect on our financial condition and results of operations.
Servicing
our debt requires a significant amount of cash, which we may not have available when payments are due.
Our
ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness, will depend upon
our future operating performance, which is subject to general economic and competitive conditions and to financial, business and
other factors, many of which we cannot control. In the future, we may incur additional indebtedness in order to make future acquisitions
or to develop our properties, including under our current liabilities. If we do not have sufficient funds on hand to pay our debt,
we may be required to seek a waiver or amendment from our lenders, refinance our indebtedness, sell assets or sell additional
securities. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at the time.
We may not be able obtain such financing or complete such transactions on terms acceptable to us, or at all. In addition, we may
not be able to consummate an asset sale to raise capital or sell assets at prices that we believe are fair, and proceeds that
we do receive may not be adequate to meet any debt service obligations then due. Our failure to generate sufficient funds to pay
our debts or to undertake any of these actions successfully could result in a default on our debt obligations, which would materially
adversely affect our business, results of operations and financial condition.
Future
acquired properties may not be worth what we pay due to uncertainties in evaluating recoverable reserves and other expected benefits,
as well as potential liabilities.
Successful
property acquisitions require an assessment of a number of factors beyond our control. These factors include estimates of recoverable
reserves, exploration potential, future natural gas and oil prices, operating costs, production taxes and potential environmental
and other liabilities. These assessments are complex and inherently imprecise. Our review of the properties we acquire may not
reveal all existing or potential problems. In addition, our review may not allow us to fully assess the potential deficiencies
of the properties. We do not inspect every well, and even when we inspect a well we may not discover structural, subsurface, or
environmental problems that may exist or arise. There may be threatened or contemplated claims against the assets or businesses
we acquire related to environmental, title, regulatory, tax, contract, litigation or other matters of which we are unaware, which
could materially and adversely affect our production, revenues and results of operations. We may not be entitled to contractual
indemnification for pre-closing liabilities, including environmental liabilities, and our contractual indemnification may not
be effective. At times, we acquire interests in properties on an “as is” basis with limited representations and warranties
and limited remedies for breaches of such representations and warranties. In addition, significant acquisitions can change the
nature of our operations and business if the acquired properties have substantially different operating and geological characteristics
or are in different geographic locations than our existing properties.
We
have limited control over activities in properties we do not operate, which could reduce our production and revenues, affect the
timing and amounts of capital requirements and potentially result in a dilution of our respective ownership interest in the event
we are unable to make any required capital contributions.
We
do not operate all of the properties in which we have an interest. As a result, we may have a limited ability to exercise influence
over normal operating procedures, expenditures or future development of underlying properties and their associated costs. For
all of the properties that are operated by others, we are dependent on their decision-making with respect to day-to-day operations
over which we have little control. The failure of an operator of wells in which we have an interest to adequately perform operations,
or an operator’s breach of applicable agreements, could reduce production and revenues we receive from that well. The success
and timing of our drilling and development activities on properties operated by others depend upon a number of factors outside
of our control, including the timing and amount of capital expenditures, the available expertise and financial resources, the
inclusion of other participants and the use of technology. Since we do not own the majority interest in many of the wells we do
not operate, we may not be in a position to remove the operator in the event of poor performance.
The
employment agreement of our Chief Executive Officer includes certain provisions which may prevent or delay a change of control.
Effective
November 1, 2012, we entered into an Employment Agreement with Anthony C. Schnur, our Chief Executive Officer and Interim Chief
Financial Officer, which agreement was amended and restated effective December 12, 2012. The agreement had a term of two years,
expiring on October 31, 2014, provided that the agreement is automatically extended for additional one year terms, unless either
party provides notice of their intent not to renew within the 30 day period prior to any automatic renewal date and because neither
party has provided notice, the agreement has been automatically extended until October 31, 2016. The Company agreed to pay Mr.
Schnur a base annual salary of $310,000 during the term of the agreement, of which $290,000 is payable in cash and $20,000 is
payable in shares of the Company’s common stock. In the event the agreement is terminated by the Company for a reason other
than cause (as described in the agreement) or by Mr. Schnur for good reason (as described in the agreement), Mr. Schnur is due
in the form of a lump sum payment, the product of the base salary and bonus he was paid under the agreement for the prior 12 month
period, provided that if such termination occurs six months before or 24 months following the occurrence of a Change of Control
(as described in the agreement), Mr. Schnur is due 200% of the amount described above upon such termination. The requirement to
pay severance fees under the Employment Agreement may prevent or delay a change of control of the Company.
Risks
Relating To An Investment In Our Securities
If
we are unable to maintain compliance with NYSE MKT continued listing standards, our common stock may be delisted from the NYSE
MKT equities market, which would likely cause the liquidity and market price of our common stock to decline.
Our
common stock currently is listed on the NYSE MKT. The NYSE MKT will consider suspending dealings in, or delisting, securities
of an issuer that does not meet its continued listing standards. If we cannot meet the NYSE MKT continued listing requirements,
the NYSE MKT may delist our common stock, which could have an adverse impact on us and the liquidity and market price of our stock.
We
may be unable to comply with NYSE MKT continued listing standards. Our business has been and may continue to be affected by worldwide
macroeconomic factors, which include uncertainties in the credit and capital markets. External factors that affect our stock price,
such as liquidity requirements of our investors, as well as our performance, could impact our market capitalization, revenue and
operating results, which, in turn, could affect our ability to comply with the NYSE MKT’s listing standards. The NYSE MKT
has the ability to suspend trading in our common stock or remove our common stock from listing on the NYSE MKT if in the opinion
of the exchange: (a) the financial condition and/or operating results of the Company appear to be unsatisfactory; or (b) it appears
that the extent of public distribution or the aggregate market value of our common stock has become so reduced as to make further
dealings on the exchange inadvisable; or (c) we have sold or otherwise disposed of our principal operating assets, or have ceased
to be an operating company; or (d) we have failed to comply with our listing agreements with the exchange; or (e) any other event
shall occur or any condition shall exist which makes further dealings on the exchange unwarranted.
If
we are unable to maintain compliance with the NYSE MKT criteria for continued listing, our common stock would be subject to delisting.
A delisting of our common stock could negatively impact us by, among other things, reducing the liquidity and market price of
our common stock and reducing the number of investors willing to hold or acquire our common stock, which could negatively impact
our ability to raise equity financing. In addition, delisting from the NYSE MKT might negatively impact our reputation and, as
a consequence, our business. Additionally, if we were delisted from the NYSE MKT and are not able to list our common stock on
another national exchange we will no longer be eligible to use Form S-3 registration statements and will instead be required to
file a Form S-1 registration statement for any primary or secondary offerings of our common stock, which would delay our ability
to raise funds in the future, may limit the type of offerings of common stock we could undertake, and would increase the expenses
of any offering, as, among other things, registration statements on Form S-1 are subject to SEC review and comments whereas take
downs pursuant to a previously filed Form S-3 are not.
If
we are delisted from the NYSE MKT, your ability to sell your shares of our common stock would also be limited by the penny stock
restrictions, which could further limit the marketability of your shares.
If
our common stock is delisted from the NYSE MKT, it would come within the definition of “penny stock” as defined in
the Exchange Act and would be covered by Rule 15g-9 of the Exchange Act. That Rule imposes additional sales practice requirements
on broker-dealers who sell securities to persons other than established customers and accredited investors. For transactions covered
by Rule 15g-9, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser’s
written agreement to the transaction prior to the sale. Consequently, Rule 15g-9, if it were to become applicable, would affect
the ability or willingness of broker-dealers to sell our securities, and accordingly would affect the ability of stockholders
to sell their securities in the public market. These additional procedures could also limit our ability to raise additional capital
in the future.
We
do not intend to pay cash dividends to our stockholders.
We
currently anticipate that we will retain all future earnings, if any, to finance the growth and development of our business. We
do not intend to pay cash dividends in the foreseeable future. Any payment of cash dividends will depend upon our financial condition,
capital requirements, earnings and other factors deemed relevant by our Board of Directors. As a result, only appreciation of
the price of our common stock, which may not occur, will provide a return to our stockholders.
We
currently have an illiquid and volatile market for our common stock, and the market for our common stock is and may remain illiquid
and volatile in the future.
We
currently have a highly sporadic, illiquid and volatile market for our common stock, which market is anticipated to remain sporadic,
illiquid and volatile in the future. Factors that could affect our stock price or result in fluctuations in the market price or
trading volume of our common stock include:
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our
actual or anticipated operating and financial performance and drilling locations, including
reserve estimates;
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quarterly
variations in the rate of growth of our financial indicators, such as net income/loss
per share, net income/loss and cash flows, or those of companies that are perceived to
be similar to us;
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changes
in revenue, cash flows or earnings estimates or publication of reports by equity research
analysts;
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speculation
in the press or investment community;
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public
reaction to our press releases, announcements and filings with the SEC;
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sales
of our common stock by us or other stockholders, or the perception that such sales may
occur;
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the
amount of our freely tradable common stock available in the public marketplace;
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general
financial market conditions and oil and natural gas industry market conditions, including
fluctuations in commodity prices;
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the
realization of any of the risk factors that we are subject to;
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the
recruitment or departure of key personnel;
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commencement
of, or involvement in, litigation;
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the
prices of oil and natural gas;
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the
success of our exploration and development operations, and the marketing of any oil and
natural gas we produce;
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changes
in market valuations of companies similar to ours; and
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domestic
and international economic, legal and regulatory factors unrelated to our performance.
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Our
common stock is listed on the NYSE MKT under the symbol “LEI.” Our stock price may be impacted by factors that are
unrelated or disproportionate to our operating performance. The stock markets in general have experienced extreme volatility that
has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect
the trading price of our common stock. Additionally, general economic, political and market conditions, such as recessions, interest
rates or international currency fluctuations may adversely affect the market price of our common stock. Due to the limited volume
of our shares which trade, we believe that our stock prices (bid, ask and closing prices) may not be related to our actual value,
and not reflect the actual value of our common stock. You should exercise caution before making an investment in us.
Additionally,
as a result of the illiquidity of our common stock, investors may not be interested in owning our common stock because of the
inability to acquire or sell a substantial block of our common stock at one time. Such illiquidity could have an adverse effect
on the market price of our common stock. In addition, a stockholder may not be able to borrow funds using our common stock as
collateral because lenders may be unwilling to accept the pledge of securities having such a limited market. An active trading
market for our common stock may not develop or, if one develops, may not be sustained.
A
prolonged decline in the market price of our common stock could affect our ability to obtain additional financing which would
adversely affect our operations.
Historically,
we have relied on equity and debt financing as primary sources of financing. A prolonged decline in the market price of our common
stock or a reduction in our accessibility to the global markets may result in our inability to secure additional financing which
would have an adverse effect on our operations.
If
the holders of our outstanding convertible securities and warrants sell a large number of shares all at once or in blocks after
converting such convertible securities and exercising such warrants, or the holders of our registered shares sell a large number
of shares, the trading value of our shares could decline in value.
As
of the date of this prospectus, we have Series B Warrants outstanding to purchase an aggregate of 100,422 shares of common stock
which have an exercise price of $71.50 per share; outstanding warrants to purchase 41,300 shares of common stock sold in April
2012, which have an exercise price of $57.50 per share; outstanding warrants to purchase 13,000 shares of our common stock at
an exercise price of $37.50 per share, which were issued in connection with our April and May 2013 loan agreements; outstanding
warrants to purchase 11,195 shares of our common stock at an exercise price of $0.01 per share, which were issued in connection
with our August 2013 Rogers Loan; outstanding warrants to purchase 66,668 shares of our common stock at a current exercise price
of $9.95 per share, which were issued in connection with our April 2014 offering; outstanding convertible promissory notes convertible
into 966,667 shares of our common stock at $1.50 per share; an outstanding Debenture convertible into 163,077 shares of our common
stock at a conversion price of $3.25 per share; and outstanding warrants to purchase 1,384,616 shares of our common stock at an
exercise price of $3.25 per share, which were issued in connection with the sale of the Debenture. The trading price of our common
stock has fluctuated significantly during the last 52 weeks.
We
have 1,739,397 shares of common stock issued and outstanding as of the date of this filing and will have 15,139,351 shares of
common stock issued and outstanding if the Acquisition closes. As a result, the exercise of outstanding warrants, or conversion
of outstanding convertible promissory notes or Debenture, and the subsequent resale of such shares of common stock (which shares
of common stock issuable upon exercise of the Series B Warrants, the warrants sold in our April and September 2012 offerings and
the warrants sold in our April 2014 offering, will be eligible for immediate resale, and which shares of common stock issuable
upon conversion of the convertible promissory notes and Debenture and exercise of the warrants issued in April, May and August
2013, will be eligible for immediate resale subject to the terms and conditions of Rule 144) may cause dilution to existing stockholders
and cause the market price of our securities to decline in value. Additionally, the common stock issuable upon exercise of the
warrants or conversion of the convertible promissory notes or Debenture may represent overhang that may also adversely affect
the market price of our common stock. Overhang occurs when there is a greater supply of a Company’s stock in the market
than there is demand for that stock. When this happens the price of the Company’s stock will decrease, and any additional
shares which stockholders attempt to sell in the market will only further decrease the share price. Finally, the offer or sale
of large numbers of shares of common stock in the future, including those shares previously registered in our registration statements
and prospectus supplements, and/or in connection with future registration statements or prospectus supplements may cause the market
price of our securities to decline in value.
The
warrants sold in our April 2014 offering and the warrants issuable pursuant to our March 2016 Note Purchase Agreement have anti-dilution
rights which could cause their exercise price to be reduced.
The
warrants sold in our April 2014 offering include anti-dilution rights, which provide that if at any time the warrants are outstanding,
we issue or are deemed to have issued (which includes shares issuable upon exercise of warrants and options and conversion of
convertible securities) for consideration less than the then current exercise price of the warrants, the exercise price of such
warrants is automatically reduced (a) to the lowest price per share of consideration provided or deemed to have been provided
for such securities, not to be deemed less than $0.01 per share, during the one year period following the closing date of the
offering (April 21, 2014), which date has passed without any required adjustments; and thereafter (b) to the product of (x) the
exercise price then in effect, and (y) a fraction, the numerator of which is the number of shares of common stock outstanding
immediately prior to such issuance plus the number of shares of common stock which the aggregate consideration received by us
would purchase at the exercise price in effect immediately prior to such issuance, and the denominator of which is the number
of shares of common stock outstanding immediately prior to such issuance plus the number of such additional shares of common stock
issued. Notwithstanding the above, no adjustment of the exercise price is required in connection with any issuances or deemed
issuance of shares of common stock (1) to our officers, directors, consultants or employees pursuant to stock option or stock
purchase plans or agreements on terms approved by our Board of Directors, subject to adjustment for all subdivisions and combinations;
and (2) in connection with the re-negotiation, modification, extension or re-pricing of debt of the Company outstanding on the
closing date, subject to the prior written approval of the holders of the warrants. Additionally, in the event we acquire ownership
of another entity or a significant amount of assets from another person or entity by way of an asset purchase agreement, merger
(pursuant to which we are the surviving entity and our common stock is not converted or exchanged), business combination or share
exchange pursuant to which shares of our common stock or convertible securities (including options or warrants) are issued or
granted by us as partial or sole consideration to the counterparty or counterparties in such transaction or series of transactions
(a “Company Combination”), then and in such event, the exercise price of the warrants is automatically reduced, to
the average of the highest bid and lowest asked prices of our common stock averaged over the thirty (30) business days after the
closing of the Company Combination if such exercise price as adjusted is less than the exercise price in effect on the date such
Company Combination Price is determined.
The
warrants issuable pursuant to our March 2016 Note Purchase Agreement include anti-dilution rights, for the first 12 months following
the issuance date of such warrants, which automatically reduce the exercise price of the warrants to any lower priced security
sold, granted or issued by us during such anti-dilution period, subject to certain exceptions, including officer and director
grants and the transactions contemplated by the Acquisition.
We
may be forced to expend significant resources and pay significant costs and expenses associated with outstanding registration
rights.
In
connection with our entry into the April 2014 Securities Purchase Agreement, we provided the investors in the offering registration
rights pursuant to a Registration Rights Agreement. Pursuant to the Registration Rights Agreement, the purchasers in the April
2014 Securities Purchase Agreement have demand and piggy-back registration rights. We also agreed to register certain securities
in connection with the April 2016 Stock Purchase Agreement and Securities Purchase Agreement. We also have agreed to register
for resale the shares of common stock issuable in connection with the Acquisition. We will have to expend significant resources
and pay significant costs and expenses, including filing fees, legal fees and accounting fees, in connection with such registration
statements.
Nevada
law and our Articles of Incorporation authorize us to issue shares of stock which shares may cause substantial dilution to our
existing stockholders.
We
have authorized capital stock consisting of 100,000,000 shares of common stock, $0.001 par value per share and 10,000,000 shares
of preferred stock, $0.001 par value per share. As of the date of this filing, we have 1,739,397 shares of common stock outstanding
and we will have 15,139,351 shares of common stock outstanding if the Acquisition closes, but does not take into account the 552,000
shares of Series B Preferred Stock issuable in connection with the Acquisition, each convertible into approximately 7.14 shares
of our common stock or the Series C Preferred Stock we have agreed to sell upon the closing of the Acquisition and subject to
certain conditions (as described and defined below under “Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations” – “Financing”). As a result, our Board of Directors has the ability
to issue a large number of additional shares of common stock without stockholder approval, subject to the requirements of the
NYSE MKT (which generally require stockholder approval for any transactions which would result in the issuance of more than 20%
of our then outstanding shares of common stock or voting rights representing over 20% of our then outstanding shares of stock),
which if issued could cause substantial dilution to our then stockholders. Shares of additional preferred stock may also be issued
by our Board of Directors without stockholder approval, with voting powers and such preferences and relative, participating, optional
or other special rights and powers as determined by our Board of Directors, which may be greater than the shares of common stock
currently outstanding. As a result, shares of preferred stock may be issued by our Board of Directors which cause the holders
to have majority voting power over our shares, provide the holders of the preferred stock the right to convert the shares of preferred
stock they hold into shares of our common stock, which may cause substantial dilution to our then common stock stockholders and/or
have other rights and preferences greater than those of our common stock stockholders. Investors should keep in mind that the
Board of Directors has the authority to issue additional shares of common stock and preferred stock, which could cause substantial
dilution to our existing stockholders. Additionally, the dilutive effect of any preferred stock which we may issue may be exacerbated
given the fact that such preferred stock may have super voting rights and/or other rights or preferences which could provide the
preferred stockholders with substantial voting control over us subsequent to the date of this prospectus and/or give those holders
the power to prevent or cause a change in control. As a result, the issuance of shares of common stock and/or Preferred Stock
may cause the value of our securities to decrease and/or become worthless.
Stockholders
may be diluted significantly through our efforts to obtain financing and/or satisfy obligations through the issuance of additional
shares of our common stock.
Wherever
possible, our Board of Directors will attempt to use non-cash consideration to satisfy obligations. In many instances, we believe
that the non-cash consideration will consist of shares of our common stock. Subject to certain consent rights of the investor
in our April 2016 financing, our Board of Directors has authority, without action or vote of the stockholders, to issue all or
part of the authorized but unissued shares of common stock (subject to NYSE MKT rules which limit among other things, the number
of shares we can issue without stockholder approval to no more than 20% of our outstanding shares of common stock). These actions
will result in dilution of the ownership interests of existing stockholders, and that dilution may be material.
If
persons engage in short sales of our common stock, including sales of shares to be issued upon exercise of our outstanding warrants,
the price of our common stock may decline.
Selling
short is a technique used by a stockholder to take advantage of an anticipated decline in the price of a security. In addition,
holders of options and warrants will sometimes sell short knowing they can, in effect, cover through the exercise of an option
or warrant, thus locking in a profit. A significant number of short sales or a large volume of other sales within a relatively
short period of time can create downward pressure on the market price of a security. Further sales of common stock issued upon
exercise of our outstanding warrants could cause even greater declines in the price of our common stock due to the number of additional
shares available in the market upon such exercise, which could encourage short sales that could further undermine the value of
our common stock. You could, therefore, experience a decline in the value of your investment as a result of short sales of our
common stock.
The
market price for our common stock may be volatile, and our stockholders may not be able to sell our stock at a favorable price
or at all.
Many
factors could cause the market price of our common stock to rise and fall, including: actual or anticipated variations in our
quarterly results of operations; changes in market valuations of companies in our industry; changes in expectations of future
financial performance; fluctuations in stock market prices and volumes; issuances of dilutive common stock or other securities
in the future; the addition or departure of key personnel; announcements by us or our competitors of acquisitions, investments
or strategic alliances; and the increase or decline in the price of oil and natural gas.
Substantial
sales of our common stock, or the perception that such sales might occur, could depress the market price of our common stock.
We
cannot predict whether future issuances of our common stock or resales in the open market will decrease the market price of our
common stock. The impact of any such issuances or resales of our common stock on our market price may be increased as a result
of the fact that our common stock is thinly, or infrequently, traded. The exercise of any options that we have or that we may
grant to directors, executive officers and other employees in the future, the issuance of common stock in connection with acquisitions
and other issuances of our common stock (including shares previously registered in our registration statements and prospectus
supplements, and/or in connection with future registration statements or prospectus supplements) could have an adverse effect
on the market price of our common stock. In addition, future issuances of our common stock may be dilutive to existing stockholders.
Any sales of substantial amounts of our common stock in the public market, or the perception that such sales might occur, could
lower the market price of our common stock.
We
face potential liability in the event we do not satisfy the current public information requirements of Rule 144(c) of the Securities
Act of 1933, as amended, prior to the date the Series B Warrants and shares of common stock issuable upon exercise thereof have
been sold by the holders thereof or have expired.
Pursuant
to an agreement entered into with the Series B Warrant holders, we agreed that if at any time prior to the date that all of the
Series B Warrants and any shares of common stock issuable upon exercise of such warrants are sold by the holders thereof, we fail
to satisfy the current public information requirement of Rule 144(c) of the Securities Act of 1933, as amended (a “Public
Information Failure”), as partial relief for the damages to any holder of warrants, we would pay the holders, based on their
pro rata ownership of non-exercised and non-expired warrants on the first day of a Public Information Failure, an aggregate of
$80,000 for the first thirty calendar days that there is a Public Information Failure (pro-rated for a period of less than thirty
days) and an amount in cash equal to one and one-half percent (1.5%) of the aggregate Black Scholes Value (as defined in the warrants)
of such holder’s non-exercised and non-expired warrants on the sixty-first (61st) calendar day after the Public Information
Failure (covering the 31st to 60th calendar days) and on every thirtieth day (pro-rated for periods totaling less than thirty
days) thereafter until the earlier of (i) the date such Public Information Failure is cured; (ii) such time that such public information
is no longer required pursuant to Rule 144; and (iii) the expiration date of the warrants. Additionally, upon the occurrence of
any Public Information Failure during the 12 months prior to the expiration of any warrant, the expiration date of such warrant
will be automatically extended for one day for each day that a Public Information Failure occurs and is continuing. As such, in
the event of the occurrence of a Public Information Failure, we will face liability and penalties.
We
incur significant costs as a result of operating as a fully reporting publicly traded company and our management is required to
devote substantial time to compliance initiatives.
We
incur significant legal, accounting and other expenses in connection with our status as a fully reporting public company. Specifically,
we are required to prepare and file annual, quarterly and current reports, proxy statements and other information with the SEC.
Additionally, our officers, directors and significant stockholders are required to file Form 3, 4 and 5’s and Schedule 13D/G’s
with the SEC disclosing their ownership of the Company and changes in such ownership. Furthermore, the Sarbanes-Oxley Act of 2002
(the “Sarbanes-Oxley Act”) and rules subsequently implemented by the SEC have imposed various new requirements on
public companies, including requiring changes in corporate governance practices. In addition, the Sarbanes-Oxley Act requires,
among other things, that we maintain effective internal controls for financial reporting and disclosure of controls and procedures.
The costs and expenses of compliance with SEC rules and our filing obligations with the SEC, or our identification of deficiencies
in our internal controls over financial reporting that are deemed to be material weaknesses, could materially adversely affect
our results of operations or cause the market price of our stock to decline in value.
Securities
analyst coverage or lack of coverage may have a negative impact on our common stock’s market price.
The
trading market for our common stock will depend, in part, on the research and reports that securities or industry analysts publish
about us or our business. We do not have any control over these analysts. If securities or industry analysts stop their coverage
of us or additional securities and industry analysts fail to cover us in the future, the trading price for our common stock would
be negatively impacted. If any analyst or analysts who cover us downgrade our common stock, changes their opinion of our shares
or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If any analyst or analysts
cease coverage of us or fail to publish reports on us regularly, demand for our common stock could decrease and we could lose
visibility in the financial markets, which could cause our stock price and trading volume to decline.
Due
to the fact that our common stock is listed on the NYSE MKT, we are subject to financial and other reporting and corporate governance
requirements which increase our cost and expenses.
We
are currently required to file annual and quarterly information and other reports with the SEC that are specified in Sections
13 and 15(d) of the Exchange Act. Additionally, due to the fact that our common stock is listed on the NYSE MKT, we are also subject
to the requirements to maintain independent directors, comply with other corporate governance requirements and are required to
pay annual listing and stock issuance fees. These obligations require a commitment of additional resources including, but not
limited, to additional expenses, and may result in the diversion of our senior management’s time and attention from our
day-to-day operations. These obligations increase our expenses and may make it more complicated or time consuming for us to undertake
certain corporate actions due to the fact that we may require the approval of the NYSE MKT for such transactions and/or NYSE MKT
rules may require us to obtain stockholder approval for such transactions.
You
may experience future dilution as a result of future equity offerings or other equity issuances.
We
may in the future issue additional shares of our common stock or other securities convertible into or exchangeable for our common
stock.