ITEM
2
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MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Forward-Looking
Information
This
Form 10-Q quarterly report of Houston American Energy Corp. (the “Company”) for the three months ended March 31, 2017,
contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, which are intended to be covered by the safe harbors created thereby.
To the extent that there are statements that are not recitations of historical fact, such statements constitute forward-looking
statements that, by definition, involve risks and uncertainties. In any forward-looking statement, where we express an expectation
or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable
basis, but there can be no assurance that the statement of expectation or belief will be achieved or accomplished.
The
actual results or events may differ materially from those anticipated and as reflected in forward-looking statements included
herein. Factors that may cause actual results or events to differ from those anticipated in the forward-looking statements included
herein include the Risk Factors described in Item 1A herein and in our Form 10-K for the year ended December 31, 2016.
Readers
are cautioned not to place undue reliance on the forward-looking statements contained herein, which speak only as of the date
hereof. We believe the information contained in this Form 10-Q to be accurate as of the date hereof. Changes may occur after that
date, and we will not update that information except as required by law in the normal course of our public disclosure practices.
Additionally,
the following discussion regarding our financial condition and results of operations should be read in conjunction with the financial
statements and related notes contained in Item 1 of Part 1 of this Form 10-Q, as well as the Risk Factors in Item 1A and the financial
statements in Item 7 of Part II of our Form 10-K for the fiscal year ended December 31, 2016.
Critical
Accounting Policies
The
discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally accepted in the United States of America. We believe
certain critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial
statements. A description of our critical accounting policies is set forth in our Form 10-K for the year ended December 31, 2016.
As of, and for the three months ended, March 31, 2017, there have been no material changes or updates to our critical accounting
policies.
Unevaluated
Oil and Gas Properties
Unevaluated
oil and gas properties not subject to amortization, include the following at March 31, 2017:
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March 31, 2017
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Acquisition costs
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$
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1,136,358
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Development and evaluation costs
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2,153,916
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Total
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$
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3,290,274
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Of
the carrying value of unevaluated oil and gas prospects above, $2,295,235 was attributable to properties in the South American
country of Colombia and $995,039 was attributable to properties in the United States. We are maintaining our interest in these
properties.
Recent
Developments
Drilling
Activity
During
the quarter ended March 31, 2017, we drilled no wells. At March 31, 2017, no drilling operations were ongoing.
During
the quarter ended March 31, 2017, our capital investment expenditures totaled $997,985, principally relating to our acquisition,
for $986,000, of a 25% working interest (subject to a proportionate 5% back-in after payout) in two lease blocks covering approximately
717.25 acres in Reeves County, Texas. We subsequently entered into a pooling arrangement with respect to one block effectively
adding to our gross acreage position and reducing our working interest.
An
initial horizontal well on our Reeves County acreage was spud during the first week of May 2017. The well targets the Wolfcamp
A shale formation. Drilling of a second horizontal well, on the second Reeves County lease, is expected to commence shortly after
completion of drilling of the first well. Our share of drilling costs on the first well are estimated at $0.7 million.
In
Colombia, our operator has advised that they are continuing to carry on discussions with federal and local officials in order
to overcome opposition to their efforts to secure necessary permits to commence drilling operations on our Serrania concession.
Until a satisfactory resolution is reached allowing the issuance of necessary permits, substituting equivalent prospects or otherwise
compensating for the value of, and investments in, our Serrania concession, our operator has advised that they are deferring further
efforts to commence drilling on the Serrania concession.
Our
operator has also deferred commencement of work on the Los Picachos and Macaya concessions until satisfactory resolution of the
permitting issues on the Serrania concession.
Capital
Stock
In
January 2017, we issued 1,200 shares of 12% Series A Convertible Preferred Stock (the “Series A Preferred Stock”)
for aggregate gross proceeds of $1.2 million.
The
Series A Preferred Stock (i) accrues a cumulative dividend, commencing July 1, 2017, at 12% payable, if and when declared, quarterly;
(ii) is convertible at the option of the holder into shares of common stock at a conversion price of $0.20 per share, (iii) has
a liquidation preference of $1,000 per share plus accrued and unpaid dividends; and (iv) is redeemable at our option, commencing
on the second anniversary of the issue date, at a premium to issue price, which premium decreases from 12% to 0% following the
fifth anniversary of the issue date, plus accrued and unpaid dividends. Proceeds from the issuance of the Series A Preferred Stock
were used to acquire our interest in oil and gas properties in Reeves County, Texas and the balance, after offering expenses,
was added to working capital.
Subsequent
to quarter end, in May 2017, we received $909,600 from the sale of 909.6 Units (the “Units”), each Unit consisting
of one share of 12.0% Series B Convertible Preferred Stock (the “Series B Preferred Stock”) and a Warrant (the “Warrant”).
Proceeds from the sale of Units are expected to be used to fund our share of drilling costs on a first well on our Reeves County,
Texas acreage, estimated at $0.7 million, with proceeds in excess of such costs, after offering costs, to be added to working
capital.
The
Series B Preferred Stock (i) accrues a cumulative dividend at 12% payable, if and when declared, quarterly; (ii) is convertible
at the option of the holder into shares of common stock at a conversion price of $0.36 per share, (iii) has a liquidation preference
of $1,000 per share plus accrued and unpaid dividends; and (iv) is redeemable at our option, commencing on the second anniversary
of the issue date, at a premium to issue price, which premium decreases from 12% to 0% following the fifth anniversary of the
issue date, plus accrued and unpaid dividends.
The
Warrants are exercisable, for a period of 9 months to purchase an aggregate of 3,001,680 shares of common stock at $0.43 per share.
Employment
Arrangements
During
the quarter ended March 31, 2017, our compensation committee approved revised employment terms of John Boylan, our Chairman, CEO
and President, and we hired a Vice President – Business Development to assist in implementation of our growth plan.
The
principal terms of Mr. Boylan’s compensation, as revised during the quarter, include (i) an annual base salary of $250,000,
effective January 1, 2017, with $10,000 per month being payable on a current basis, and full salary and accrued unpaid salary
being payable at such time as the compensation committee determines that the Company has sufficient financial capability to pay
such amounts; (ii) annual bonuses as determined by the compensation committee; (iii) grant, pursuant to our Production Incentive
Compensation Plan, of a 1% interest in our revenues from all wells drilled on our Reeves County, Texas acreage; and (iv) grant
of a stock option to purchase 500,000 shares of common stock.
Subsequent
to quarter end, in May 2017, we terminated our newly hired Vice President – Business Development and options granted pursuant
to the terms of employment expired unvested and unexercised.
Results
of Operations
Oil
and Gas Revenues.
Total oil and gas revenues increased 19% to $57,633 in the three months ended March 31, 2017 compared to
$48,260 in the three months ended March 31, 2016. The increase in revenue was due to improved commodity pricing, including a 29%
increase in crude oil prices realized and a 46% increase in natural gas prices realized, partially offset by a decline in production
volumes.
The
following table sets forth the gross and net producing wells, net oil and gas production volumes and average hydrocarbon sales
prices for the quarters ended March 31, 2017 and 2016:
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Three Months Ended
March 31,
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2017
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2016
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Gross producing wells
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9
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9
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Net producing wells
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0.47
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0.47
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Net oil production (Bbl)
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876
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882
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Net gas production (Mcf)
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4,590
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6,579
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Average sales price – oil (per barrel)
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$
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47.91
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$
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37.25
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Average sales price – natural gas (per Mcf)
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$
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3.42
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$
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2.34
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The
decline in production reflects natural decline rates with no new production coming on line, partially offset by resumption of
production from a well that had been off line. The change in average sales prices realized reflects a partial recovery in global
commodity prices following a steep drop in prices beginning in late 2014 and continuing to mid-2016.
Oil
and gas sales revenues by region were as follows:
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Colombia
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U.S.
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Total
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2017 First Quarter
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Oil sales
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$
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—
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$
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41,959
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$
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41,959
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Gas sales
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$
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—
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$
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15,674
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$
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15,674
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2016 First Quarter
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Oil sales
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$
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—
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$
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32,852
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$
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32,852
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Gas sales
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$
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—
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$
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15,408
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$
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15,408
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Lease
Operating Expenses.
Lease operating expenses increased 123% to $23,154 during the three months ended March 31, 2017 from $10,388
during the three months ended March 31, 2016. The change in total lease operating expenses was attributable to the resumption
of production from a well that had been off line and increased salt water disposal fees. Lease operating expenses, by region were
as follows:
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Colombia
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U.S.
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Total
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2017 First Quarter
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$
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—
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$
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23,154
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$
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23,154
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2016 First Quarter
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$
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—
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$
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10,388
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$
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10,388
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Consistent
with our business model and operating history, we experience steep declines in lease operating expenses following strategic divestitures
and anticipate lease operating expenses to ramp up to levels consistent with regional costs as new wells are brought on line.
Depreciation
and Depletion Expense.
Depreciation and depletion expense was $17,696 and $25,013 for the three months ended March 31, 2017
and 2016, respectively. The change in depreciation and depletion was due to a lower depletion base and lower production rates.
General
and Administrative Expenses.
General and administrative expense increased by 46% to $519,297 during the three months ended
March 31, 2017 from $356,270 during the three months ended March 31, 2016. The increase in general and administrative expense
was primarily attributable to (i) an increase in the base salary of our principal officer effective January 1, 2017, including
deferred and accrued salary totaling $32,500 which will not be paid until our compensation committee determines that we have sufficient
financial capacity to pay the same, (ii) hiring of a non-executive officer in March 2017, (iii) increased legal, professional
and other costs associated with our efforts to finalize the acquisition of our Reeves County acreage, increase investor visibility,
maintain our exchange listing and secure funding to satisfy our financial commitments with respect to the Reeves County acreage,
(iv) increased stock compensation expense associated with 2017 option grants, and (v) increased insurance costs; all partially
offset by select salary reductions and timing related decreases in director fees.
Financial
Condition
Liquidity
and Capital Resources.
At March 31, 2017, we had a cash balance of $321,249 and working capital of $211,619, compared to a
cash balance of $481,172 and working capital of $423,795 at December 31, 2016. The change in cash and working capital during the
period was primarily attributable to the operating loss for the quarter.
Operating
activities used cash of $361,938 during the 2017 quarter as compared to $295,045 during the 2016 quarter. The change in operating
cash flow was primarily attributable to increased legal, professional and other costs associated with increased investor visibility
activities.
Investing
activities used $997,985 during the 2017 quarter compared to $40,603 used during the 2016 quarter. The increase in funds used
by investing activities during the 2017 quarter primarily reflects the acquisition of our Reeves County acreage ($986,000).
Financing
activities provided $1,200,000 during the 2017 quarter from the sale of Series A Preferred Stock compared to $90,079 used during
the 2016 quarter for the acquisition of treasury shares.
Long-Term
Liabilities
. At March 31, 2017, we had long-term liabilities of $28,002 as compared to $27,444 at December 31, 2016. Long-term
liabilities at March 31, 2017 and December 31, 2016 consisted of a reserve for plugging costs.
Capital
and Exploration Expenditures and Commitments.
Our principal capital and exploration expenditures relate to ongoing efforts
to acquire, drill and complete prospects. We expect that future capital and exploration expenditures will be funded principally
through funds on hand, including capital raised during the first quarter of 2017 from the sale of Series A Preferred Stock, from
funds received from the sale of additional securities, including our May 2017 sale of Units and, subject to our ability to fund
drilling and completion operations on our Reeves County acreage and the results of such operations, funds generated from operations
of wells anticipated to be brought on line during 2017.
During
the three months ended March 31, 2017, we invested $997,985, net, for the acquisition and development of oil and gas properties,
consisting of (1) cost of acquisition of U.S. properties $986,937, net, principally attributable to acreage acquired in Reeves
County, Texas, and (2) preparation and evaluation costs in Colombia of $11,048. Of the amount invested, we capitalized $992,093
to oil and gas properties not subject to amortization and reduced oil and gas properties subject to amortization by $1,108.
Our
estimated capital expenditure budget for the balance of 2017 is approximately $2.55 million and relates to planned drilling and
completion of two wells on our Reeves County acreage, including (1) drilling costs on an initial well of approximately $0.7 million,
(2) completion costs on an initial well of approximately $1.0 million, (3) drilling costs on a second well of approximately $0.35
million, and (4) completion costs on a second well of approximately $0.5 million. Our share of drilling and completion costs on
the second well, and other wells on that block, are estimated to be one-half of costs of the first well as a result of a pooling
arrangement covering the second block.
Capital
expenditure plans for 2017 may change depending on (1) our ability to fund our share of drilling and completion costs on the first
two wells on our Reeves County acreage, (2) the results of drillings on our Reeves County acreage, (3) the schedule of future
drilling operations on our Reeves County acreage, (4) the timing and ultimate resolution of permitting issues at Serrania, and
(5) based on field conditions and other factors beyond our control or the control of the operators of our prospects. Accordingly,
there can be no assurance as to the timing of these operations or the amount actually spent on such operations.
Our
current cash holdings, taking into account $909,600 raised from the sale of Units subsequent to March 31, 2017, are expected to
be adequate to fund our share of drilling costs on the first well on our Reeves County acreage but are not adequate to fund completion
costs of our initial well or drilling and completion operations of additional wells. While it is anticipated that favorable drilling
results on our first Reeves County well may result in the holders of Warrants exercising the same, which would provide as much
as $1.29 million of additional funding, there is no assurance as to if, and when, such Warrants will be exercised.
Absent
the exercise of Warrants, we will require additional capital to fully fund our share of completion costs on the initial Reeves
County well, our share of drilling and completion costs on any additional wells and to support operations over the balance of
2017. If, for any reason, we are unable to fully fund our drilling budget and fail to satisfy commitments reflected therein, we
may be subject to penalties or to the possible loss of some of our rights and interests in prospects with respect to which we
fail to satisfy funding commitments. We have no commitments to provide any additional financing should we require and seek such
financing and there is no guarantee that we will be able to secure additional financing on acceptable terms, or at all, to fully
fund our drilling budget and to support future operations, acquisitions and development activities.
Outlook;
Strategic Alternatives
Continued
low oil and natural gas prices during 2015 and 2016 and recurring delays in drilling of our Serrania prospect in Colombia had
a significant adverse impact on our business. Our financial statements include a “going concern” qualification reflecting
substantial doubt as to our ability to continue as a going concern. While we have no debt, we will continue to operate at a loss
absent substantial increases in production, pricing or both. Our present focus in addressing our recurring operating losses is
drilling two initial wells on our Reeves County acreage. If we are able to fund our share of drilling and completion costs and
if those wells experience success and production rates similar to recent wells in the vicinity, we anticipate that we will be
able to achieve profitability and positive cash flows once production from those wells commence. However, while we have secured
financing to fund our share of estimated drilling costs from the first planned well, we have not yet secured financing to fund
our share of estimated completion costs of that well or drilling and completion costs from the second planned well, although exercises
of outstanding Warrants could potentially provide such financing. We can provide no assurance as to our ultimate ability to fully
fund our share of estimated drilling and completion costs, as to the ultimate success of those wells or of the ultimate production
rates, if any, of those wells. If, for any reason, we are unable to finance our portion of drilling and completion costs on our
first two Reeves County wells, or if one or more of those wells is not successful or if production rates are less than anticipated,
we may continue to operate at a loss and may lack the financial resources to continue as a going concern and may be required to
divest certain assets or pursue other strategic alternatives to support operations.
Off-Balance
Sheet Arrangements
We
had no off-balance sheet arrangements or guarantees of third party obligations at March 31, 2017.
Inflation
We
believe that inflation has not had a significant impact on operations since inception.