ITEM
1. FINANCIAL STATEMENTS
TORCHLIGHT
ENERGY RESOURCES, INC.
|
CONSOLIDATED
BALANCE SHEETS (Unaudited)
|
The
accompanying notes are an integral part of these unaudited interim consolidated financial statements.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
CONSOLIDATED
STATEMENTS OF OPERATIONS (Unaudited)
|
The
accompanying notes are an integral part of these unaudited interim consolidated financial statements.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)
|
The
accompanying notes are an integral part of these unaudited interim consolidated financial statements.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
CONSOLIDATED
STATEMENT OF STOCKHOLDERS EQUITY (Unaudited)
|
The
accompanying notes are an integral part of these unaudited interim consolidated financial statements.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
Torchlight
Energy Resources, Inc. was incorporated in October 2007 under the laws of the State of Nevada as Pole Perfect Studios, Inc. (PPS).
From its incorporation to November 2010, the company was primarily engaged in business start-up activities.
We
are engaged in the acquisition, exploitation and/or development of oil and natural gas properties in the United States. We operate
our business through our subsidiaries Torchlight Energy Inc., Torchlight Energy Operating, LLC, Hudspeth Oil Corporation, Torchlight
Hazel LLC, and Warwink Properties LLC.
At
June 30, 2020, the Company had not yet achieved profitable operations. We had a net loss of $6,993,115 for the six months ended
June 30, 2020 and had accumulated losses of $106,146,816 since our inception. We expect to incur further losses in the development
of our business. The Company had a working capital deficit as of June 30, 2020 of $14,748,949. These conditions raise substantial
doubt about the Companys ability to continue as a going concern.
The
Companys ability to continue as a going concern is dependent on its ability to generate future profitable operations and/or
to obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when
they come due. Managements plan to address the Companys ability to continue as a going concern includes: (1) obtaining
debt or equity funding from private placement, institutional, or public sources; (2) obtain loans from financial institutions,
where possible, or (3) participating in joint venture transactions with third parties. Although management believes that it will
be able to obtain the necessary funding to allow the Company to remain a going concern through the methods discussed above, there
can be no assurances that such methods will prove successful.
These
consolidated financial statements have been prepared assuming that the Company will continue as a going concern and therefore,
the financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification
of assets or the amount and classifications of liabilities that may result from the outcome of this uncertainty.
|
3.
|
SIGNIFICANT
ACCOUNTING POLICIES
|
The
Company maintains its accounts on the accrual method of accounting in accordance with accounting principles generally accepted
in the United States of America. Accounting principles followed and the methods of applying those principles, which materially
affect the determination of financial position, results of operations and cash flows are summarized below:
Use
of estimates – The preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and certain assumptions that affect the amounts reported
in these consolidated financial statements and accompanying notes. Actual results could differ from these estimates.
Basis
of presentation – The financial statements are presented on a consolidated basis and include all of the accounts
of Torchlight Energy Resources Inc. and its wholly owned subsidiaries, Torchlight Energy, Inc., Torchlight Energy Operating, LLC,
Hudspeth Oil Corporation, Torchlight Hazel LLC, and Warwink Properties LLC. All significant intercompany balances and transactions
have been eliminated.
These
interim financial statements are unaudited and have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission (SEC) regarding interim financial reporting. Certain disclosures have been condensed or omitted
from these financial statements. Accordingly, they do not include all the information and notes required by accounting principles
generally accepted in the United States of America (GAAP) for complete consolidated financial statements, and should
be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form
10-K for the year ended December 31, 2019.
In
the opinion of management, the accompanying unaudited financial condensed consolidated financial statements include all adjustments,
consisting of normal recurring adjustments, necessary to fairly present the financial position as of, and the results of operations
for, all periods presented. In preparing the accompanying financial statements, management has made certain estimates and assumptions
that affect reported amounts in the condensed financial statements and disclosures of contingencies. Actual results may differ
from those estimates. The results for interim periods are not necessarily indicative of annual results. Certain reclassifications
have been made to the prior periods consolidated financial statements and related footnotes to conform them to the current
period presentation.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
3.
|
SIGNIFICANT
ACCOUNTING POLICIES - continued
|
Risks
and uncertainties – The Companys operations are subject to significant risks and uncertainties, including
financial, operational, technological, and other risks associated with operating an emerging business, including the potential
risk of business failure.
Concentration
of risks – At times the Companys cash balances are in excess of amounts guaranteed by the Federal Deposit
Insurance Corporation. The Companys cash is placed with a highly rated financial institution, and the Company regularly
monitors the credit worthiness of the financial institutions with which it does business.
Fair
value of financial instruments – Financial instruments consist of cash, receivables, payables and promissory notes,
if any. The estimated fair values of cash, receivables, and payables approximate the carrying amount due to the relatively short
maturity of these instruments. The carrying amounts of any promissory notes approximate their fair value giving affect for the
term of the note and the effective interest rates.
For
assets and liabilities that require re-measurement to fair value the Company categorizes them in a three-level fair value hierarchy
as follows:
|
●
|
Level
1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
|
|
●
|
Level
2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or
liability, either directly or indirectly through market corroboration.
|
|
●
|
Level
3 inputs are unobservable inputs based on managements own assumptions used to measure assets and liabilities at fair value.
|
A
financial asset or liabilitys classification within the hierarchy is determined based on the lowest level input that is
significant to the fair value measurement.
Cash
and cash equivalents - Cash and cash equivalents include certain investments in highly liquid instruments with original
maturities of three months or less.
Accounts
receivable – Accounts receivable consist of uncollateralized oil and natural gas revenues due under normal trade
terms, as well as amounts due from working interest owners of oil and gas properties for their share of expenses paid on their
behalf by the Company. Management reviews receivables periodically and reduces the carrying amount by a valuation allowance that
reflects managements best estimate of the amount that may not be collectible. As of June 30, 2020 and December 31, 2019,
no valuation allowance was considered necessary.
Oil
and gas properties – The Company uses the full cost method of accounting for exploration and development activities
as defined by the Securities and Exchange Commission (SEC). Under this method of accounting, the costs of unsuccessful,
as well as successful, exploration and development activities are capitalized as properties and equipment. This includes any internal
costs that are directly related to property acquisition, exploration and development activities but does not include any costs
related to production, general corporate overhead or similar activities.
Oil
and gas properties include costs that are excluded from costs being depleted or amortized. Oil and natural gas property costs
excluded represent investments in unevaluated properties and include non-producing leasehold, geological, and geophysical costs
associated with leasehold or drilling interests and exploration drilling costs. The Company allocates a portion of its acquisition
costs to unevaluated properties based on relative value. Costs are transferred to the full cost pool as the properties are evaluated
over the life of the reservoir. Unevaluated properties are reviewed for impairment at least quarterly and are determined through
an evaluation considering, among other factors, seismic data, requirements to relinquish acreage, drilling results, remaining
time in the commitment period, remaining capital plan, and political, economic, and market conditions.
Gains
and losses on the sale of oil and gas properties are not generally reflected in income unless the gain or loss would significantly
alter the relationship between capitalized costs and proved reserves. Sales of less than 100% of the Companys interest
in the oil and gas property are treated as a reduction of the capital cost of the field, with no gain or loss recognized, as long
as doing so does not significantly affect the unit-of-production depletion rate. Costs of retired equipment, net of salvage value,
are usually charged to accumulated depreciation.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
3.
|
SIGNIFICANT
ACCOUNTING POLICIES - continued
|
Capitalized
interest – The Company capitalizes interest on unevaluated properties during the periods in which they are excluded
from costs being depleted or amortized. During the six months ended June 30, 2020 and 2019, the Company capitalized $1,182,445
and $1,362,244, respectively, of interest on unevaluated properties.
Depreciation,
depletion, and amortization – The depreciable base for oil and natural gas properties includes the sum of all capitalized
costs net of accumulated depreciation, depletion, and amortization (DD&A), estimated future development costs
and asset retirement costs not included in oil and natural gas properties, less costs excluded from amortization. The depreciable
base of oil and natural gas properties is amortized on a unit-of-production method.
Ceiling
test – Future production volumes from oil and gas properties are a significant factor in determining the full cost
ceiling limitation of capitalized costs. Under the full cost method of accounting, the Company is required to periodically perform
a ceiling test that determines a limit on the book value of oil and gas properties. If the net capitalized cost
of proved oil and gas properties, net of related deferred income taxes, plus the cost of unproved oil and gas properties, exceeds
the present value of estimated future net cash flows discounted at 10 percent, net of related realizable tax affects, plus the
cost of unproved oil and gas properties, the excess is charged to expense and reflected as additional accumulated DD&A. The
Company recorded an impairment expense of $2,108,301 and $474,357 for the six months ended June 30, 2020 and 2019, respectively,
to recognize the adjustment required by the ceiling test.
The
ceiling test calculation uses a commodity price assumption which is based on the unweighted arithmetic average of the price on
the first day of each month for each month within the prior 12 month period and excludes future cash outflows related to estimated
abandonment costs.
The
determination of oil and gas reserves is a subjective process, and the accuracy of any reserve estimate depends on the quality
of available data and the application of engineering and geological interpretation and judgment. Estimates of economically recoverable
reserves and future net cash flows depend on a number of variable factors and assumptions that are difficult to predict and may
vary considerably from actual results. In particular, reserve estimates for wells with limited or no production history are less
reliable than those based on actual production. Subsequent re-evaluation of reserves and cost estimates related to future development
of proved oil and gas reserves could result in significant revisions to proved reserves. Other issues, such as changes in regulatory
requirements, technological advances, and other factors which are difficult to predict could also affect estimates of proved reserves
in the future.
Asset
retirement obligations – The fair value of a liability for an assets retirement obligation (ARO)
is recognized in the period in which it is incurred if a reasonable estimate of fair value can be made, with the corresponding
charge capitalized as part of the carrying amount of the related long-lived asset. The liability is accreted to its then-present
value each subsequent period, and the capitalized cost is depleted over the useful life of the related asset. Abandonment costs
incurred are recorded as a reduction of the ARO liability.
Inherent
in the fair value calculation of an ARO are numerous assumptions and judgments including the ultimate settlement amounts, inflation
factors, credit adjusted discount rates, timing of settlement, and changes in the legal, regulatory, environmental, and political
environments. To the extent future revisions to these assumptions impact the fair value of the existing ARO liability, a corresponding
adjustment is made to the oil and gas property balance. Settlements greater than or less than amounts accrued as ARO are recorded
as a gain or loss upon settlement.
Income
taxes – Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating loss carry forwards. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date. A valuation allowance is established to reduce deferred tax assets if
it is more likely than not that the related tax benefits will not be realized.
Authoritative
guidance for uncertainty in income taxes requires that the Company recognize the financial statement benefit of a tax position
only after determining that the relevant tax authority would more likely than not sustain the position following an examination.
Management has reviewed the Companys tax positions and determined there were no uncertain tax positions requiring recognition
in the consolidated financial statements. Company tax returns remain subject to Federal and State tax examinations. Generally,
the applicable statutes of limitation are three to four years from their respective filings.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
3.
|
SIGNIFICANT
ACCOUNTING POLICIES - continued
|
Estimated
interest and penalties related to potential underpayment on any unrecognized tax benefits are classified as a component of tax
expense in the statements of operation. The Company has not recorded any interest or penalties associated with unrecognized tax
benefits for any periods covered by these financial statements.
Share-based
compensation – Compensation cost for equity awards is based on the fair value of the equity instrument on the date
of grant and is recognized over the period during which an employee is required to provide service in exchange for the award.
The
Company accounts for stock option awards using the calculated value method. The expected term was derived using the simplified
method provided in Securities and Exchange Commission release Staff Accounting Bulletin No. 110, which averages an awards weighted
average vesting period and contractual term for plain vanilla share options.
The
Company accounts for any forfeitures of options when they occur. Previously recognized compensation cost for an award is reversed
in the period that the award is forfeited.
The
Company also issues equity awards to non-employees. The fair value of these option awards is estimated when the award recipient
completes the contracted professional services. The Company recognizes expense for the estimated total value of the awards during
the period from their issuance until performance completion.
The
Company values warrant and option awards using the Black-Scholes option pricing model.
Revenue
recognition
The
Companys revenue is typically generated from contracts to sell natural gas, crude oil or NGLs produced from interests in
oil and gas properties owned by the Company. Contracts for the sale of natural gas and crude oil are evidenced by (1) base contracts
for the sale and purchase of natural gas or crude oil, which document the general terms and conditions for the sale, and (2) transaction
confirmations, which document the terms of each specific sale. The transaction confirmations specify a delivery point which represents
the point at which control of the product is transferred to the customer. These contracts frequently meet the definition of a
derivative under ASC 815, and are accounted for as derivatives unless the Company elects to treat them as normal sales as permitted
under that guidance. The Company elects to treat contracts to sell oil and gas production as normal sales, which are then accounted
for as contracts with customers. The Company has determined that these contracts represent multiple performance obligations which
are satisfied when control of the commodity transfers to the customer, typically through the delivery of the specified commodity
to a designated delivery point.
Revenues
from oil and gas sales are detailed as follows:
Revenue
is measured based on consideration specified in the contract with the customer, and excludes any amounts collected on behalf of
third parties. The Company recognizes revenue in the amount that reflects the consideration it expects to be entitled to in exchange
for transferring control of those goods to the customer. Amounts allocated in the Companys price contracts are based on
the standalone selling price of those products in the context of long-term contracts. Payment is generally received one or two
months after the sale has occurred.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
3.
|
SIGNIFICANT
ACCOUNTING POLICIES - continued
|
Gain
or loss on derivative instruments is outside the scope of ASC 606 and is not considered revenue from contracts with customers
subject to ASC 606. The Company may in the future use financial or physical contracts accounted for as derivatives as economic
hedges to manage price risk associated with normal sales, or in limited cases may use them for contracts the Company intends to
physically settle but do not meet all of the criteria to be treated as normal sales.
Producer
Gas Imbalances. The Company applies the sales method of accounting for natural gas revenue. Under this method, revenues are
recognized based on the actual volume of natural gas sold to purchasers.
Basic
and diluted earnings (loss) per share – Basic earnings (loss) per common share is computed by dividing net
income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period.
Diluted earnings (loss) per common share is computed in the same way as basic earnings (loss) per common share except that the
denominator is increased to include the number of additional common shares that would be outstanding if all potential common shares
had been issued and if the additional common shares were dilutive. The calculation of diluted earnings per share excludes 11,025,186
shares issuable upon the exercise of outstanding warrants and options because their effect would be anti-dilutive.
Environmental
laws and regulations – The Company is subject to extensive federal, state, and local environmental laws and regulations.
Environmental expenditures are expensed or capitalized depending on their future economic benefit. The Company believes that it
is in compliance with existing laws and regulations. The Company accrued no liability as of June 30, 2020 and December 31, 2019.
Recent
adopted accounting pronouncements – In February 2016 the FASB, issued ASU, 2016-02, Leases. The ASU requires companies
to recognize on the balance sheet the assets and liabilities for the rights and obligations created by leased assets. ASU 2016-02
was effective for the Company in the first quarter of 2019. The Company adopted the change which did not have a material impact
on its consolidated financial statements.
Other
recently issued or adopted accounting pronouncements are not expected to have, or did not have, a material impact on the Companys
financial position or results from operations.
Subsequent
events – The Company evaluated subsequent events through August 10, 2020, the date of issuance of these financial
statements. Subsequent events are disclosed in Note 11.
The
following table presents the capitalized costs for oil & gas properties of the Company as of June 30, 2020 and December 31,
2019:
Unevaluated
costs as of June 30, 2020 include cumulative costs on developing projects including the Orogrande, Hazel, and Winkler projects
in West Texas.
The
Company periodically adjusts for the separation of evaluated versus unevaluated costs within its full cost pool to recognize the
value impairment related to the expiration of, or changes in market value, of unevaluated leases. The impact of reclassifications
as they become necessary is to increase the basis for calculation of future periods depletion, depreciation and amortization
which effectively recognizes the impairment on the consolidated statement of operations over future periods. Reclassified costs
also become evaluated costs for purposes of ceiling tests and which may cause recognition of increased impairment expense in future
periods. The cumulative unevaluated costs which have been reclassified within our full cost pool totals $5,881,635 as of June 30, 2020.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
4.
|
OIL
& GAS PROPERTIES - continued
|
Due
to the volatility of commodity prices, should oil and natural gas prices decline in the future, it is possible that a further
write-down could occur. Proved reserves are estimated quantities of crude oil, natural gas, and natural gas liquids, which geological
and engineering data demonstrate with reasonable certainty to be recoverable from known reservoirs under existing economic and
operating conditions. The independent engineering estimates include only those amounts considered to be proved reserves and do
not include additional amounts which may result from new discoveries in the future, or from application of secondary and tertiary
recovery processes where facilities are not in place or for which transportation and/or marketing contracts are not in place.
Estimated reserves to be developed through secondary or tertiary recovery processes are classified as unevaluated properties.
Current
Projects
We
are an energy company engaged in the acquisition, exploration, exploitation and/or development of oil and natural gas properties
in the United States. We are primarily focused on the acquisition of early stage projects, the development and delineation of
these projects, and then the monetization of those assets once these activities are completed.
Since
2010, our primary focus has been the development of interests in oil and gas projects we hold in the Permian Basin in West Texas.
We also hold minor interests in certain other oil and gas projects in Central Oklahoma that we are in the process of divesting.
As
of June 30, 2020, we had interests in four oil and gas projects: the Orogrande Project in Hudspeth County, Texas, the Hazel Project
in Sterling, Tom Green, and Irion Counties, Texas, the Winkler Project in Winkler County, Texas and the wells in Central Oklahoma.
Orogrande
Project, West Texas
On
August 7, 2014, we entered into a Purchase Agreement with Hudspeth Oil Corporation (Hudspeth), McCabe Petroleum
Corporation (MPC), and Gregory McCabe, our Chairman. Mr. McCabe was the sole owner of both Hudspeth and MPC. Under
the terms and conditions of the Purchase Agreement, we purchased 100% of the capital stock of Hudspeth which held certain oil
and gas assets, including a 100% working interest in approximately 172,000 predominately contiguous acres in the Orogrande Basin
in West Texas. Mr. McCabe has, at his option, a 10% working interest back-in after payout and a reversionary interest if drilling
obligations are not met, all under the terms and conditions of a participation and development agreement among Hudspeth, MPC and
Mr. McCabe. Mr. McCabe also holds a 4.5% overriding royalty interest in the Orogrande acreage,- which he obtained prior to, and
was not a part of the August 2014 transaction. As of June 30, 2020, leases covering approximately 134,000 acres remain in effect.
We
believe all drilling obligations through June 30, 2020 have been met.
On
September 23, 2015, Hudspeth entered into a Farmout Agreement with Pandora Energy, LP (Pandora), Founders Oil &
Gas, LLC (Founders), and for the limited purposes set forth therein, MPC and Mr. McCabe, for the entire Orogrande
Project in Hudspeth County, Texas. The Farmout Agreement provided that Hudspeth and Pandora (collectively referred to as Farmor)
would assign to Founders an undivided 50% of the leasehold interest and a 37.5% net revenue interest in the oil and gas leases
and mineral interests in the Orogrande Project, which interests, except for any interests retained by Founders, would be reassigned
to Farmor by Founders if Founders did not spend a minimum of $45.0 million on actual drilling operations on the Orogrande Project
by September 23, 2017. Under a joint operating agreement also entered into on September 23, 2015, Founders was designated as operator
of the leases.
Effective
March 27, 2017 the property became subject to a DDU Agreement which allows for all 192 existing leases covering approximately
134,000 net acres leased from University Lands to be combined into one drilling and development unit for development purposes.
The term of the DDU Agreement expires on December 31, 2023, and the time to drill on the drilling and development unit continues
through December 2023. The DDU Agreement also grants the right to extend the DDU Agreement through December 2028 if compliance
with the DDU Agreement is met and the extension fee associated with the additional time is paid.
Our
drilling obligations include four wells in year 2020 and five wells per year in years 2021, 2022 and 2023. We have received a
waiver of the requirement to develop four wells in 2020. The drilling obligations are minimum yearly requirements and may be exceeded
if acceleration is desired.
During
2017, we assumed operational control from Founders Oil and Gas Operating LLC on the Orogrande Project. We were joined by Wolfbone
Investments, LLC, (Wolfbone), a company owned by Mr. McCabe. We, along with Hudspeth, Wolfbone and, for the limited
purposes set forth therein, Pandora, entered into an Assignment of Farmout Agreement with Founders, (the Assignment of
Farmout Agreement), pursuant to which we and Wolfbone will share the remaining commitments under the Farmout Agreement.
All original provisions of our carried interest were to remain in place including reimbursement to us on each wellbore. Founders
was to remain a 9.5% working interest owner in the Orogrande Project for the $9.5 million it had spent as of the date of the Assignment
of Farmout Agreement, and such interests were to be carried until $40.5 million is spent by Wolfbone and us, with each contributing
50% of such capital spend, under the existing agreement.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
4.
|
OIL
& GAS PROPERTIES - continued
|
Our
working interest in the Orogrande Project thereby increased by 20.25% to a total of 67.75% and Wolfbone then owned 20.25%.
On
July 25, 2018, we and Hudspeth entered into a Settlement & Purchase Agreement (the Settlement Agreement) with
Founders (and Founders Oil & Gas Operating, LLC), Wolfbone and MPC, which agreement provides for Founders assigning all of
its working interest in the oil and gas leases of the Orogrande Project to Hudspeth and Wolfbone equally. Future well capital
spending obligations remained the same 50% contribution from Hudspeth and 50% from Wolfbone until such time as the $40.5 million
to be spent on the project. The Company estimates that there is still approximately $9.0 million remaining to be spent on the
project until such time as the capital expenditures revert back to the percentages of the working interest owners.
After
the assignment by Founders, Hudspeths working interest increased to 72.5%.
The
Company has drilled eight test wells in the Orogrande in order to stay in compliance with University Lands D&D Unit Agreement,
as well as, to test for potential shallow pay zones and deeper pay zones that may be present on structural plays. Development
of the wells continued into the six months ended June 30, 2020 to further capture and document the scientific base in support
of demonstrating the production potential of the property. The Company is currently marketing the project for an outright sale
or farm in partner. This marketing process has been long and arduous as the overall market is quite soft. Due to the size and
scope of the project, we are dealing with very large companies that have multitudes of people reviewing our material, which in
itself is extensive. During the marketing process, the Company and Wolfbone will endeavor to complete the University Maverick
A24 #1 as a potential producer in the Atoka formation. Should a farm out partner or sale not occur, the Company and Wolfbone will
continue to drill additional wells in the play in order to fulfill the obligations under the DDU Agreement
Rich
Masterson, our consulting geologist, is credited with originating the Orogrande Project in Hudspeth County in the Orogrande Basin.
With Mr. Mastersons assistance and based on all the science we have gathered to date, we have identified multiple unconventional
and conventional target pay zones with depths between 3,000 and 8,000 with primary pay, described as the Penn formation,
located at depths of 5,300 to 5,900. Based on our geologic analysis to date, this basin has stacked pay with zones including
the Wolfcamp, Penn, Barnett, Woodford, Atoka and more. These potential zones are prospective for oil and gas with a GOR of 1100
expected based on our gathered scientific information and analysis from independent third parties.
On
March 9, 2020, holders of notes payable by the Company entered into a Conversion Agreement under which the noteholders elected
to convert principal of $6,000,000 and approximately $1,331,000 of accrued interest on the notes, in accordance with their terms,
into an aggregate 6% working interest (of all such holders) in the Orogrande Project.
The
Orogrande Project ownership as of June 30, 2020 is detailed as follows:
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
4.
|
OIL
& GAS PROPERTIES - continued
|
Hazel
Project in the Midland Basin in West Texas
Effective
April 4, 2016, TEI acquired from MPC a 66.66% working interest in approximately 12,000 acres in the Midland Basin. A back-in after
payout of a 25% working interest was retained by MPC and another unrelated working interest owner.
In
October 2016, the holders of all of our then-outstanding shares of Series C Preferred Stock (which were issued in July 2016) elected
to convert into a total 33.33% working interest in our Hazel Project, reducing our ownership from 66.66% to a 33.33% working interest.
The
Company has drilled six test wells on the Hazel Project to capture and document the scientific base in support of demonstrating
the production potential of the property.
Acquisition
of Additional Interests in Hazel Project
On
January 30, 2017, we entered into and closed an Agreement and Plan of Reorganization and a Plan of Merger with an entity which
was wholly-owned by Mr. McCabe, which resulted in the acquisition of approximately 40.66% working interest in the 12,000 gross
acres, 9,600 net acres, in the Hazel Project.
Also
on January 30, 2017, TEI entered into and closed a Purchase and Sale Agreement with Wolfbone. Under the agreement, TEI acquired
certain of Wolfbones Hazel Project assets, including its interest in the Flying B Ranch #1 well and the 40 acre unit surrounding
the well.
Upon
the closing of the transactions, our working interest in the Hazel Project increased by 40.66% to a total ownership of 74%.
Effective
June 1, 2017, we acquired an additional 6% working interest from unrelated working interest owners increasing our working interest
in the Hazel project to 80%, and an overall net revenue interest of 74-75%.
Mr.
Masterson, who assisted with development in our Orogrande project, is also credited with originating the Hazel Project in the
Midland Basin.
We
were required to drill one well every six months to hold the entire 12,000 acre block for eighteen months until to November 22,
2018, and thereafter two wells every six months. During 2019 and the six months ended June 30, 2020 modifications were completed
to mineral owner leases as described below.
Lease
Modifications
In
May 2019 we entered into agreements with two of the three mineral owners on the northern section of the leases to keep the entire
acreage block as one lease with a one year extension. We issued each of them 50,000 shares of our common stock as consideration
for this extension. As of June 30, 2020 we have structured the extension agreement retroactively with the third mineral owner
for cash consideration. Due to this extension, our obligation for 2019 reduced to one obligation well. We finished that obligation
well targeting a shallow zone that showed oil potential. For the remainder of 2020 the Company must drill one well in June and
two wells by the December 31, 2020. Development of the June well was initiated during June, 2020.
In
April 2018, we announced that we have commenced a process that could result in the monetization of the Hazel Project. We believe
the development activity at the Hazel Project, coupled with nearby activities of other oil and gas operators, suggests that this
project has achieved a level of value worth monetizing. We anticipate that the liquidity that would be provided from selling the
Hazel Project could be redeployed into the Orogrande Project. While this process is underway, we will take all necessary steps
to maintain the leasehold as required. As of this filing, we continue to maintain the leases in good standing and continue to
market the acreage in an effort to focus on the Orogrande Project.
The
marketing process is ongoing for the Hazel project. We continue to encounter, as does the entire industry, a soft market for acquisitions
and divestitures transactions. We will continue to look to sell the property or joint venture the property via farm in or a drillco
transaction.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
4.
|
OIL
& GAS PROPERTIES - continued
|
Winkler
Project, Winkler County, Texas
On
December 1, 2017, an Agreement and Plan of Reorganization was entered into with MPC and Warwink Properties, LLC (Warwink
Properties) to acquire certain assets, including a 10.71875% working interest in approximately 640 acres in Winkler County,
Texas. Also on December 1, 2017, MPC closed its transaction with MECO IV, LLC ( MECO), for the purchase and sale
of certain assets. Warwink Properties received a carry from MECO (through the tanks) of up to $1,179,076 in the next well drilled
on the Winkler County leases.
Also
on December 1, 2017, the transactions contemplated by the Purchase Agreement that TEI entered into with MPC closed. Under the
Purchase Agreement TEI acquired beneficial ownership of certain of MPCs assets, including acreage and wellbores located
in Ward County, Texas (the Ward County Assets).
Addition
to the Winkler Project
As
of May 7, 2018 our Winkler project in the Delaware Basin had begun the drilling phase of the first Winkler Project well, the UL
21 War-Wink 47 #2H. Additional acreage was leased by our operating partner under the Area of Mutual Interest Agreement (AMI) and
we exercised its right to participate for its 12.5% in the additional 1,080 gross acres. Our carried interest in the first well
was applied to this new well and allowed MECO to drill and produce potential revenues sooner than originally planned. The primary
leasehold is a 320-acre block and allows for 5,000-foot lateral wells to be drilled. The first well was completed and began production
in October, 2018 and is producing currently.
The
operator has informed us that there will be no planned additional wells in the acreage in 2020. All acreage is presently held
by production.
In
December 2018, the Company began to take measures on its own to market the Winkler Project in an effort to focus on the Orogrande.
This process is ongoing.
Hunton
Play, Central Oklahoma
Presently,
we are producing from one well in the Viking Area of Mutual Interest and one well in Prairie Grove.
Assessment
for Assets Held for Sale Classification
With
respect to marketing oil and natural gas properties, the Company has evaluated the properties being marketed to determine whether
any should be reclassified as held-for-sale at June 30, 2020. The held-for-sale criteria include: management commits to a plan
to sell; the asset is available for immediate sale; an active program to locate a buyer exists; the sale of the asset is probable
and expected to be completed within one year; the asset is being actively marketed for sale; and it is unlikely that significant
changes to the plan will be made. If each of these criteria is met, the property would be reclassified as held-for-sale on the
Companys consolidated balance sheets and measured at the lower of their carrying amount or estimated fair value less costs
to sell. Fair values are estimated using accepted valuation techniques, such as a discounted cash flow model, valuations performed
by third parties, earnings multiples, or indicative bids, when available. Management considers historical experience and all available
information at the time the estimates are made; however, the fair value that is ultimately realized upon the sale of the assets
to be divested may differ from the estimated fair values reflected in the consolidated financial statements. If each of these
criteria is met, DD&A expense would not be recorded on assets to be divested once they are classified as held for sale. Based
on managements assessment, certain criteria have not been met and no assets are classified as held for sale as of June 30,
2020.
|
5.
|
RELATED
PARTY PAYABLES
|
As
of June 30, 2020 and December 31, 2019, related party payables of $45,000, and accrued payroll was $1,086,176 and $996,176, respectively,
consisting of accrued and unpaid compensation due to our executive officers.
|
6.
|
COMMITMENTS
AND CONTINGENCIES
|
Leases
The
Company is a subtenant on a month to month basis for the occupancy of its office premises.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
6.
|
COMMITMENTS
AND CONTINGENCIES - continued
|
Legal
Matters
On
January 31, 2020, Torchlight Energy Resources, Inc. and its wholly owned subsidiaries Torchlight Energy, Inc. and Torchlight Energy
Operating, LLC were served with a lawsuit brought by Goldstone Holding Company, LLC (Goldstone Holding Company, LLC v. Torchlight
Energy, Inc., et al., in the 160th Judicial District Court of Dallas County, Texas). On February 24, 2020, Torchlight Energy
Resources, Inc., Torchlight Energy, Inc., and Torchlight Energy Operating, LLC timely filed their answer, affirmative defenses,
and requests for disclosure. The suit, which seeks monetary relief over $1 million, makes unspecified allegations of misrepresentations
involving a November 2015 participation agreement and a 2016 amendment to the participation agreement. The Company has denied
the allegations and has asserted several affirmative defenses including but not limited to, that the suit is barred by the applicable
statute of limitations, that the claims have been released, and that the claims are barred because of contractual disclaimers
between sophisticated parties.
On
April 30, 2020, our wholly owned subsidiary, Hudspeth Oil Corporation, filed suit against Datalog LWT, Inc. d/b/a Cordax
Evaluation Technologies. The suit seeks the recovery of approximately $1.4 million in costs incurred as a result of a tool
failure during drilling activities on the University Founders A25 #2 well that is located in the Orogrande Field.
Working interest owner Wolfbone Investments, LLC, a company owned by our Chairman Gregory Mccabe, is a co-plaintiff in that
action. After the suit was filed, Cordax filed a mineral lien in the amount of $104,500.01 against the Orogrande Field and
has sued the operator and counterclaimed against Hudpspeth for breach of contract, seeking the same amount as the lien.
We are contesting the lien in good faith. The suit, Hudspeth Oil Corporation and Wolfbone Investments, LLC v.
Datalog LWT, Inc. d/b/a Cordax Evaluation Technologies, was filed in the 189th Judicial District Court of
Harris County, Texas.
Environmental
Matters
The
Company is subject to contingencies as a result of environmental laws and regulations. Present and future environmental laws and
regulations applicable to the Companys operations could require substantial capital expenditures or could adversely affect
its operations in other ways that cannot be predicted at this time. As of June 30, 2020 and December 31, 2019, no amounts had
been recorded because no specific liability has been identified that is reasonably probable of requiring the Company to fund any
future material amounts.
Common
Stock
On
January 10, 2020, the Company sold 600,000 shares of common stock for cash at $0.60 per share for total proceeds of $360,000 in
a private placement.
On
January 16, 2020, the Company announced the closing of its underwritten public offering of 3,285,715 shares of its common stock
at a public offering price of $0.70 per share, for total proceeds of $1,997,118 after deducting underwriting discounts and other
offering expenses payable by the Company.
In
May 2020, the Company issued 680,376 shares of common stock in satisfaction of the payment in kind valued at $314,107 due on April
10, 2020 under the terms of the promissory notes held by the Straz Foundation and the Straz Trust.
In
May 2020, we issued 1,630,434 restricted shares of common stock to an investor for the purchase price of $750,000. The investor,
Maverick Oil & Gas Corporation, is the operator for our Orogrande Project. Our subsidiary Hudspeth Oil Corporation owed the
investor in excess of $750,000 on unpaid balances and cost overruns on work performed on the Orogrande Project, which amount is
due and payable now. The investor agreed to a future credit of $750,000 in the balance of accounts receivable owed to it by Hudspeth
Oil as consideration for the purchase of the common stock. Under the terms of the sale, we provided registration rights to the
investor.
On
May 20, 2020, the Company announced the closing of its underwritten public offering of 3,450,000 shares of its common stock at
a public offering price of $0.34 per share, for total proceeds of $886,622 after deducting underwriting discounts and other offering
expenses payable by the Company. In connection with the offering the Company issued 172,500 warrants valued at $36,225 using the
Black Scholes method.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
7.
|
STOCKHOLDERS
EQUITY - continued
|
On
June 16, 2020, the Company announced the closing of its registered direct offering of 7,894,737 shares of its common stock at
a public offering price of $0.38 per share, for total proceeds of $2,783,691 after deducting underwriting discounts and other
offering expenses payable by the Company. In connection with the offering the Company issued 3,157,895 warrants. The warrants
were exercised on July 9, 2020 under the cashless provisions in the agreement resulting in the Company issuing 3,157,895 shares
of common stock for which no cash was received. Of the total consideration received from the offering, $854,887 was allocated
to the warrants using the pro rata percentage of the number of warrants to the total shares ultimately issued under the offering
terms.
During
the six months ended June 30, 2020, the Company issued 267,857 shares of common stock with a fair value of $146,250 as compensation
for services.
During
the six months ended June 30, 2020, the Company issued 40,000 shares of common stock to a vendor with a fair value of $26,000
for delay in payment on outstanding account payable.
During
the six months ended June 30, 2020, the Company issued 40,000 shares of common stock to note holders as compensation for extension
of the maturity date of the notes. The fair value of the shares was $16,000.
During
the six months ended June 30, 2020, the Company issued 257,143 shares of common stock to a vendor with a fair value of $90,000
in payment of an outstanding account payable.
During
the six months ended June 30, 2020, the Company issued 100,000 shares of common stock to the former CEO of the Company with a
fair value of $45,000 in payment of an accrued liability from prior years.
Warrants
and Options
During
the six months ended June 30, 2020, the Company issued 215,000 warrants with total fair value of $98,900 as compensation for services
and recorded expense of $39,000 related to options issued in prior periods.
During
the six months ended June 30, 2020, the Company issued 750,000 warrants valued at $382,500 in connection with the conversion of
convertible notes payable into working interest in the Companys Orogrande Project.
During
the six months ended June 30, 2020, the Company issued 600,000 warrants in connection with the sale of 600,000 shares of common
stock valued at $360,000 in a private placement.
During
the six months ended June 30, 2020, the Company issued 172,500 warrants valued at $36,225 in connection with the offering of common
stock on May 20, 2020 as referred to above.
In
connection with the registered direct offering closed June 16, 2020, as referred above, the Company issued 3,157,895 warrants.
The warrants were exercised on July 9, 2020 under the cashless provisions in the agreement resulting in the Company issuing 3,157,895
shares of common stock for which no cash was received. Of the total consideration received from the offering of $854,887 was allocated
to the warrants using the pro rata percentage of the number of warrants to the total shares ultimately issued under the offering
terms.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
7.
|
STOCKHOLDERS
EQUITY - continued
|
A
summary of warrants outstanding as of June 30, 2020 by exercise price and year of expiration is presented below:
On
June 11, 2020, 4,500,000 stock options previously granted to officers of the Company in 2015 expired. Reference subsequent events
in Note 11 regarding the issuance of stock options at July 15, 2020, the date of the renewal of Employment Agreements which had
also expired in June, 2020.
A
summary of stock options outstanding as of June 30, 2020 by exercise price and year of expiration is presented below:
At
June 30, 2020, the Company had reserved 11,025,186 common shares for future exercise of warrants and options.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
|
7.
|
STOCKHOLDERS
EQUITY - continued
|
Warrants
and options granted were valued using the Black-Scholes Option Pricing Model. The assumptions used in calculating the fair value
of the warrants and options issued were as follows:
The
Company recorded no income tax provision at June 30, 2020 and December 31, 2019 because of losses incurred.
The
Company estimates its annual effective income tax rate in recording its quarterly provision for income taxes in the various jurisdictions
in which it operates. Statutory tax rate changes and other significant or unusual items are recognized as discrete items in the
quarter in which they occur. The Company recorded no income tax expense for the six months ended June 30, 2020 because the Company
expects to incur a tax loss in the current year. Similarly, no income tax expense was recognized for the six months ended June
30, 2019.
The
Company had a net deferred tax asset related to federal net operating loss carryforwards of $70,899,608 and $66,984,025 at June
30, 2020 and December 31, 2019, respectively. The federal net operating loss carryforward will begin to expire in 2033. Realization
of the deferred tax asset is dependent, in part, on generating sufficient taxable income prior to expiration of the loss carryforwards.
The Company has placed a 100% valuation allowance against the net deferred tax asset because future realization of these assets
is not assured.
Promissory
Notes Issued in 2017
On
April 10, 2017, we sold two 12% unsecured promissory notes with a total of $8,000,000 in principal amount to David A. Straz, Jr.
Foundation (the Straz Foundation) and the David A. Straz, Jr. Irrevocable Trust DTD 11/11/1986 (the Straz
Trust) in a private transaction. Interest only is due and payable on the notes each month at the rate of 12% per annum,
with a balloon payment of the outstanding principal due and payable at maturity on April 10, 2020. The holders of the notes will
also receive annual payments of common stock at the rate of 2.5% of principal amount outstanding, based on a volume-weighted average
price. Both notes were sold at an original issue discount of 94.25% and accordingly, we received total proceeds of $7,540,000
from the investors. We used the proceeds for working capital and general corporate purposes, which includes, without limitation,
drilling capital, lease acquisition capital and repayment of prior debt.
These
12% promissory notes allow for early redemption. The notes also contain certain covenants under which we have agreed that, except
for financing arrangements with established commercial banking or financial institutions and other debts and liabilities incurred
in the normal course of business, we will not issue any other notes or debt offerings which have a maturity date prior to the
payment in full of the 12% notes, unless consented to by the holders.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
9.
|
PROMISSORY
NOTES - continued
|
The
effective interest rate is 16.15%.
On
April 24, 2017, we used $2,509,500 of the proceeds from this financing to redeem and repay a portion of the outstanding 12% Series
B Convertible Unsecured Promissory Notes. Separately, $1,000,000 of the principal amount of the Series B Notes plus accrued interest
was converted into 1,007,890 shares of common stock and $64,297 was rolled into the new debt financing.
On
February 20, 2020, the Company extended the maturity on $4 million of the 12% unsecured promissory notes previously due in April,
2020. The maturity date of the subject promissory note has been extended for one year, from April 10, 2020 to April 10, 2021.
As
part of the terms of this extension agreement, the Company paid the noteholder a fee of $80,000 on February 20, 2020. The promissory
note was originally issued in April 2017, and provides for monthly payments of interest only at the rate of 12% per annum, with
a balloon payment of the outstanding principal due and payable at maturity.
Promissory
Notes Issued in 2018
On
February 6, 2018, we sold to the Straz Trust in a private transaction a 12% unsecured promissory note with a principal amount
of $4,500,000. Interest only was due and payable on the note each month at the rate of 12% per annum, with a balloon payment of
the outstanding principal due and payable at maturity on April 10, 2020. The holder of the note will also receive annual payments
of common stock at the rate of 2.5% of principal amount outstanding, based on a volume-weighted average price. We sold the note
at an original issue discount of 96.27% and accordingly, we received total proceeds of $4,332,150 from the investor. We used the
proceeds for working capital and general corporate purposes, which includes, without limitation, drilling capital, lease acquisition
capital and repayment of prior debt.
This
12% promissory note allows for early redemption, provided that if we redeem before February 6, 2019, we must pay the holder all
unpaid interest and common stock payments on the portion of the note redeemed that would have been earned through February 6,
2019. The note also contains certain covenants under which we have agreed that, except for financing arrangements with established
commercial banking or financial institutions and other debts and liabilities incurred in the normal course of business, we will
not issue any other notes or debt offerings which have a maturity date prior to the payment in full of the 12% note, unless consented
to by the holder.
The
effective interest rate is 15.88%.
Extension
of Promissory Notes
On
April 24, 2020, the Company entered into a Note Amendment Agreement with each of the Straz Foundation, as a lender , the Straz
Trust , as a lender and collateral agent , and The Northern Trust Company and Christopher M. Straz, as co-trustees of the Straz
Trust. Under the Note Amendment Agreement, the parties agreed to amend and restate the two promissory notes issued to the Straz
Trust on April 10, 2017 and February 6, 2018 that have total principal outstanding of $8,500,000, along with the promissory note
issued to the Straz Foundation on April 10, 2017 which had an outstanding principal amount of $4,000,000. Under the Note Amendment
Agreement, the maturity dates of the two promissory notes held by the Straz Trust and the Note held by the Foundation were extended
to April 10, 2021. We had previously extended the maturity date of the promissory note held by the Straz Foundation to April 10,
2021.
Under
the Note Amendment Agreements, we and our subsidiaries provided a first priority lien on certain collateral in favor of the collateral
agent for the benefit of the lenders. The collateral includes all assets and property held by Hudspeth Oil Corporation and Torchlight
Hazel, LLC, which includes without limitation our working interest in certain oil and gas leases in Hudspeth County, Texas, known
as the Orogrande Project and our working interest in certain oil and gas leases in the Midland Basin in West Texas,
known as the Hazel Project. Further, these subsidiaries, along with Torchlight Energy, Inc., provided guaranty with
respect to payment of the three promissory notes. The Note Amendment Agreements also provide that (a) upon any disposition of
less than 100% of Borrowers right, title and interest in and to the Orogrande Project or the Hazel Project, we must prepay
an amount equal to 75% of the proceeds thereof (up to the outstanding amount due under the notes), unless such disposition results
in us owning less than a 45% working interest (on an 8/8ths basis) in the Orogrande Project or the Hazel Project, in which case
the prepayment amount is to be equal to 100% of such proceeds (up to the outstanding amount due under the notes); and (b) upon
any disposition of 100% of our right, title and interest in and to the Orogrande Project or the Hazel Project, we must prepay
an amount equal to 100% of the proceeds thereof (up to the outstanding amount due under the notes).
Additionally,
the promissory notes, as amended, now provide conversion rights whereby the lenders will have the right, at each such lenders
option, to convert any portion of principal and interest into shares of common stock of Torchlight Energy Resources, Inc. at a
conversion price of $1.50 per share.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
9.
|
PROMISSORY
NOTES - continued
|
The
Note Amendment Agreements (as further amended) provided that no later than May 25, 2020, we were obligated to pay: (a) to the
lenders all past due interest that has accrued on the existing promissory notes, and (b) to the Straz Trust a fee of $170,000,
which payments were made. Further, the agreements have certain negative covenants regarding related party transactions, dividends, stock
repurchases, grants of liens on other assets, and payment of accrued executive compensation. There are also typical affirmative
covenants regarding legal compliance and payment of taxes. The agreements also provide certain notice and disclosure requirements,
including notice of material events, such as defaults under other obligations and litigation. The $170,000 extension fee was paid
on May 22 and the interest payments were made on June 17, 2020 within the terms of a forbearance agreement which provided an extension
of the due date of the interest payments.
All
other terms and conditions of the three original promissory notes remain substantially unchanged, including without limitation,
monthly payments of interest only at the rate of 12% per annum, with a balloon payment of the outstanding principal due and payable
at maturity, and annual payments of common stock at the rate of 2.5% of the principal amount outstanding, based on a volume-weighted
average price.
In
May 2020 and April 2019, respectively, the holders of the notes described above received 680,376 and 202,316 shares of common
stock as a payment in kind representing the annual payments of common stock due at the rate of 2.5% of principal amount outstanding
as of April 10 based on a volume-weighted average price calculation.
The
12% promissory note transactions through June 30, 2020 are summarized as follows:
The
12% unsecured notes payable at December 31, 2019 included $64,297 due to a holder unrelated to the Straz entities. As of June
30, 2020 the amount payable to that holder remains unsecured. The note was due on April 10, 2020. The holder agreed to convert
the note and accrued interest into common stock. On July 14, 2020 198,926 shares were issued valued at $65,646.
Convertible
Notes Issued in October, 2018
On
October 17, 2018, we sold to certain investors in a private transaction 16% Series C Unsecured Convertible Promissory Notes with
a total principal amount of $6,000,000. Interest and principal were due and payable on the notes in one balloon payment at maturity
on April 17, 2020. The notes were convertible, at the election of the holders, into an aggregate 6% working interest in certain
oil and gas leases in Hudspeth County, Texas, known as our Orogrande Project. After an analysis of the transaction
and a review of applicable accounting pronouncements, management concluded that the notes issued on October 17, 2018 which contain
a conversion right for holders to convert into a working interest in the Orogrande Project of the Company, meet a specific scope
exception to the provisions requiring derivative accounting.
The
notes allow us to redeem them early only upon the event of a fundamental transaction, such as a merger or sale of substantially
all our assets. The notes provide that the noteholders may accelerate and declare any and all of the obligations under the notes
to be immediately due and payable in the event of default, such as nonpayment, failure to perform required conversions, failure
to perform any covenant or agreement under the notes, an insolvency event, or certain defaults or judgments. As part of the sale
of the of the notes, the noteholders required that McCabe Petroleum Corporation, a Texas corporation owned by our Chairman Gregory
McCabe (MPC), provide them a put option whereby they have the right to have MPC purchase from them any unpaid principal
amount due on the notes. Additionally, if there is a fundamental transaction, Mr. McCabe will be required to pay a fee to each
noteholder that elects not to convert or require MPC to purchase the principal amount under the note, which fee will be equal
to such noteholders pro-rata share of a total fee amount of $1,500,000.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
9.
|
PROMISSORY
NOTES - continued
|
We
received total proceeds of $6,000,000 from the sale of the notes, of which $3,000,000 was used to pay back the promissory note
issued to MPC on December 1, 2017, which note was due on December 31, 2020. We used the remaining proceeds for working capital
and general corporate purposes, which includes, without limitation, drilling and lease acquisition capital.
Prior
to entering into the above transactions, our Board of Directors formed a special committee composed of independent directors to
analyze and authorize the transactions on behalf of Torchlight Energy Resources, Inc. and determine whether the transactions are
fair to the company. In this role, the special committee engaged an independent financial consulting firm which rendered a fairness
opinion deeming that the transactions were fair to the company, from a financial point of view, and contained terms no less favorable
to the company than those that could be obtained in arms length transactions.
On
March 9, 2020, each of the noteholders entered into a Conversion Agreement with us and our subsidiary Hudspeth Oil Corporation
(Hudspeth), under which the noteholders elected to convert the notes, in accordance with their terms, into an aggregate
6% working interest (of all such holders) in certain oil and gas leases in Hudspeth County, Texas, known as our Orogrande
Project. Principal of $6,000,000 and approximately $1,331,000 of accrued interest were converted at March 9, 2020.
The
Conversion Agreements also provided additional consideration to the noteholders including a limited carry, a top-off obligation
of us and Hudspeth, and warrants to purchase a total of 750,000 restricted shares of our common stock, which warrants will have
a term of five years and an exercise price of $0.70 per share. The limited carry provides that for the remainder of the 2020 calendar
year, Hudspeth will pay all costs and expenses attributable to the assigned working interests, except where prohibited by law
or regulation. The top-off obligation provides that, subject to the terms and conditions of the Conversion Agreements, if (a)
we sell our entire working interest in the Orogrande Project, (b) as part of such sale, the holders entire working interests
are sold, and (c) the gross proceeds received by all the holders in such transaction are equal to less than $9,000,000; then we
must pay the holders an amount equal to $9,000,000, (i) less gross proceeds the holders received in the transaction, (ii) less
the amount of the carry the holders received under the Conversion Agreements, and (iii) less any gross proceeds the holders received
in any farmouts occurring prior to the transaction.
The
transaction was treated as an extinguishment of debt. The fair value of the working interest transferred in the conversion of
the debt was $8,778,000 and the value of warrants issued to the holders was $382,500. The Company recognized a loss on extinguishment
of debt in the amount of $1,829,651 during the six months ended June 30, 2020.
Convertible
Notes Issued in First Quarter 2019
On
February 11, 2019 the Company raised a total of $2,000,000 from investors through the sale of two 14% Series D Unsecured Convertible
Promissory Notes. Principal was payable in a lump sum at maturity on May 11, 2020 with payments of interest payable monthly at
the rate of 14% per annum. Holders of the notes have the right to convert principal and interest at any time into common stock
at a conversion price of $1.08 per share. The Company has the right to redeem the notes at any time, provided that the redemption
amount must include all interest that would have been earned through maturity. The Company evaluated the notes for beneficial
conversion features and derivative accounting criteria and concluded that derivative accounting treatment is not applicable.
On
April 21, 2020, Torchlight Energy Resources, Inc. entered into agreements to amend the two 14% Series D Unsecured Convertible
Promissory Notes that were originally issued on February 11, 2019. Under the amendment agreements, (a) the maturity dates were
extended from May 11, 2020 to November 11, 2021, (b) the conversion price under which the noteholders may convert into our common
stock was changed from $1.08 to $0.43, and (c) the noteholders were provided the right, at each noteholders election, to
convert their notes into either (i) a working interest in the Orogrande Project at the rate of one acre per $1,100 of principal
and unpaid interest converted, or (ii) a working interest in the Hazel Project at the rate of one acre per $1,300 of principal
and unpaid interest converted; provided, that the noteholders right to convert into either such working interest is subject
to approval of the collateral agent of the Note Amendment Agreement with the Straz parties.
Under
the note amendments, the noteholders agreed to forebear demand or collection on all interest payments due and payable under the
Note, including any past due interest payments, for 20 days after the execution of the Note Amendment Agreement. Further, we agreed
to (a) issue each holder 20,000 restricted shares of common stock immediately and (b) pay each holder a fee of $10,000, at the
same time as the payment of past due interest is paid. The past due interest and fee was paid.
These
two promissory notes will continue to provide for monthly payments of interest only at the rate of 14% per annum, with a balloon
payment of the outstanding principal due and payable at maturity. Since the extension of the notes was completed before the date
of filing this report, the debt is presented on the balance sheet as noncurrent debt.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
9.
|
PROMISSORY
NOTES - continued
|
Convertible
Notes Issued in Third Quarter 2019
In
July 2019, the Company issued 8% Unsecured Convertible Promissory notes in the amount of $2,010,000 together with warrants to
purchase our common stock. Principal and 8% interest are due at maturity on May 21, 2021. The principal and accrued interest on
the notes are convertible into shares of common stock at $1.10 per common share at any time after the original issue date. Along
with the notes, the three year warrants equal to 20% of the number of shares of common stock issuable upon the conversion of the
notes were issued to note holders. The warrants are exercisable at $1.35 per share.
Warrants
issued along with the notes meet the requirements of the scope exemptions in ASC 815-10-15-74 and are thus classified as equity
upon issuance. The Company determined the fair value of the warrants using the Black Scholes pricing formula and is recognized
as a discount on the carrying amount of the notes and is credited to additional paid in capital. The fair value of the warrants
at the issuance date was determined to be $240,455.
A
beneficial conversion feature (BCF) of a convertible note is normally characterized as the convertible portion feature
that provides a rate of conversion that is below market value or in the money when issued. The BCF related to the
issuance of the notes was recorded at the issuance date. The BCF was measured using the intrinsic value method and is shown as
a discount to the carrying amount of the convertible note and is credited to additional paid in capital. The intrinsic value of
the BCF at the issuance date of the notes was determined to be $1,145,546.
The
allocated fair values of the BCF and the warrants was recorded as a debt discount from the face amount of the notes and such discount
is being accreted over the expected term of the notes and is charged to interest expense. The Company recognized interest expense
of $269,061 from the amortization of debt discount from notes for the six months ended June 30, 2020.
The
Company evaluated the July 2019 notes for derivative accounting criteria and concluded that derivative accounting treatment was
not applicable.
Convertible
Notes Issued in Fourth Quarter 2019
Effective
October 31, 2019, the Company issued 10% Unsecured Convertible Promissory notes in the amount of $540,000. Principal and interest
are due at maturity on December 3, 2020. The principal and accrued interest on the notes are convertible into shares of common
stock at $0.75 per common share at any time after the original issue date. The notes are convertible, at the election of the holders,
into an aggregate 0.367% working interest in our Orogrande Project.
The
Company evaluated the October 2019 notes for BCF and derivative accounting criteria and concluded that there was no BCF or derivative
accounting treatment applicable.
Paycheck
Protection Program Loan
In
response to the COVID-19 pandemic, the U.S. Small Business Administration (the SBA) made available low-interest
rate loans to qualified small businesses, including under its Paycheck Protection Program (the PPP). On April 10,
2020, in order to supplement its cash balance, the Company submitted an application for a loan (SBA loan) in the
amount of $77,477. On May 1, 2020, Companys SBA loan application was approved and the Company received the loan proceeds.
The SBA loan has an interest rate of 0.98% and matures in April 2022.
Section
1106 of the CARES Act provides for forgiveness of up to the full principal amount of qualifying loans guaranteed under the PPP.
The PPP and loan forgiveness are intended to provide economic relief to small businesses, such as the Company, that are adversely
impacted under the COVID-19 Emergency Declaration issued by President Trump on March 13, 2020. The Company will apply for loan
forgiveness when the SBA site for that purpose is available.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
10.
|
ASSET
RETIREMENT OBLIGATIONS
|
The
following is a reconciliation of the asset retirement obligations liability through June 30, 2020:
At-the-Market
Equity Offering Program
On
July 20, 2020, Torchlight Energy Resources, Inc. (the Company) entered into a Sales Agreement (the Sales
Agreement) with Roth Capital Partners, LLC (the Agent) to conduct an at-the-market equity offering
program pursuant to which the Company may issue and sell, from time to time at its sole discretion, shares of its common stock,
par value $0.001 per share, having an aggregate offering price of up to $7,000,000 (the Shares), through or to the
Agent, as the Companys sales agent. Subject to the terms and conditions of the Sales Agreement, the Agent will use its
commercially reasonable efforts to sell the Shares from time to time, based upon the Companys instructions. The Company
has no obligation to sell any of the Shares, and may, at any time, suspend the sale of the Shares under the Sales Agreement upon
proper notice to the other party. The Sales Agreement will terminate upon the issuance and sale of all of the Shares through or
to the Agent, unless earlier terminated in accordance with its terms.
The
Company has provided the Agent with customary indemnification rights, and the Agent will be entitled to an aggregate fixed commission
of 3.0% of the gross proceeds from Shares sold through the Agent under the Sales Agreement. Sales of the Shares under the Sales
Agreement will be made in transactions that are deemed to be at-the-market offerings as defined in Rule 415 under
the Securities Act of 1933, as amended, including sales made by means of ordinary brokers transactions, including on The
Nasdaq Capital Market, at market prices or as otherwise agreed to with the Agent. The Shares have been registered under the Securities
Act of 1933, as amended, pursuant to the Registration Statement on Form S-3 (No. 333 220181) filed by the Company with the Securities
and Exchange Commission (the SEC) on August 25, 2017, and declared effective on September 28, 2017 (the Registration
Statement). A base prospectus relating to certain securities of the Company, including the Shares, was included with the
Registration Statement. On July 20, 2020, the Company filed a prospectus supplement with the SEC relating to the offering of the
Shares pursuant to the Sales Agreement.
Since
July 20, 2020 and through August 6, 2020, the Company sold a total of 453,002 shares of common stock under at-the-market equity
offering program for aggregate gross proceeds of approximately $155,081.
Executive
Employment Agreements and Stock Options
On
July 15, 2020, we entered into new one-year employment agreements with John Brda, our President and Chief Executive Officer,
and Roger Wurtele, our Chief Financial Officer. Their previous employment agreements expired in June 2020. Under the new
agreements, Messrs. Brda and Wurtele will continue to receive their same annual salaries of $375,000 and $225,000, with 36%
and 20% of the salaries, respectively, continuing to accrue unpaid until such time as the Board of Directors believes there
is adequate cash for such payment, or as otherwise contemplated in the employment agreement. Each individual will be eligible
for a bonus at the Compensation Committees discretion. Each agreement provides that if there is a change of
control in the company (as defined in the agreement), the employee will be paid in one lump sum any amounts owed to the
employee under the agreement that are accrued and unpaid plus his salary that would be earned through the end of the term of
the agreement. Each employment agreement has a covenant not to compete and provides for expense reimbursement, four weeks of
vacation and certain other benefits.
TORCHLIGHT
ENERGY RESOURCES, INC.
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
11.
|
SUBSEQUENT
EVENTS - continued
|
Additionally,
as part of their employment compensation, the Compensation Committee granted Mr. Brda an option to purchase a total of up to 2,250,000
shares of common stock, including up to 375,000 shares at an exercise price of $0.50 per share and up to 1,875,000 shares at an
exercise price of $1.00 per share, and granted Mr. Wurtele an option to purchase a total of up to 750,000 shares of common stock,
including up to 375,000 shares at an exercise price of $0.50 per share and up to 375,000 shares at an exercise price of $1.00
per share. The options were granted under our Amended and Restated 2015 Stock Option Plan. The options of both executives will
vest upon either (a) the closing of a change of control occurring prior to July 15, 2021, or (b) the company entering into a letter
of intent with a third party prior to July 15, 2021 that contemplates a change of control, and the change of control transaction
closes with that third party (or an affiliate(s) of that third party) at a date not later than July 15, 2022; subject, however,
to acceleration and earlier vesting of all of the options in the event of (i) the termination of employment by the employee for
good reason under his employment agreement or (ii) a determination of the Compensation Committee, at its discretion.
In the event of the death or disability of the employee prior to vesting or if the company terminates the employees employment
for reasons other than for cause under the employment agreement prior to vesting, the option will still vest upon
the occurrence of the events described under clauses (a) or (b) above. The options, to the extent such options have not been exercised,
will terminate and become null and void on July 15, 2025, if and only if the options vest as described above, or on July 15, 2021,
if the options do not vest as described above, subject to the occurrence of the events contemplated under clause (b) above whereby
the options would not terminate until July 15, 2022.
Other
Equity Transactions
In
July 2020, as referenced in Notes 7 and 9 above, 198,926 shares of common stock were issued in connection with the conversion
of a note payable and 3,157,895 warrants were exercised on a cashless basis.