1.
ORGANIZATION, OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Organization
and Operations
U.S.
Energy Corp. (collectively with its subsidiaries referred to as the “Company” or “U.S. Energy”) was incorporated
in the State of Wyoming on January 26, 1966. The Company’s principal business activities are focused on the acquisition,
exploration and development of oil and gas properties in the United States.
Basis
of Presentation
The
accompanying unaudited condensed consolidated financial statements are presented in accordance with U.S. generally accepted accounting
principles (“GAAP”) and have been prepared by the Company pursuant to the rules and regulations of the Securities
and Exchange Commission (the “SEC”) regarding interim financial reporting. Accordingly, certain information and footnote
disclosures required by GAAP for complete financial statements have been condensed or omitted in accordance with such rules and
regulations. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for
a fair presentation of the consolidated financial statements have been included.
For
further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form
10-K and 10K/A for the year ended December 31, 2017. Our financial condition as of June 30, 2018, and operating results for the
three and six months ended June 30, 2018 are not necessarily indicative of the financial condition and results of operations that
may be expected for any future interim period or for the year ending December 31, 2018.
Use
of Estimates
The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period. Significant estimates include oil and gas reserves
that are used in the calculation of depreciation, depletion, amortization and impairment of the carrying value of both evaluated
oil and gas properties as well as unevaluated properties; production and commodity price estimates used to record accrued oil
and gas sales receivable; valuation of commodity derivative instruments; and the cost of future asset retirement obligations.
The Company evaluates its estimates on an on-going basis and bases its estimates on historical experience and on various other
assumptions the Company believes to be reasonable. Due to inherent uncertainties, including the future prices of oil and gas,
these estimates could change in the near term and such changes could be material.
Principles
of Consolidation
The
accompanying financial statements include the accounts of the Company and its wholly-owned subsidiary Energy One LLC (“Energy
One”). All inter-company balances and transactions have been eliminated in consolidation.
Comprehensive
Income (Loss)
Comprehensive
income (loss) is used to refer to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss)
is comprised of revenues, expenses, gains, and losses that under GAAP are reported as separate components of shareholders’
equity instead of net income (loss). As of January 1, 2018 the company adopted ASU 2016-01 which requires equity investments (except
those accounted for under the equity method of accounting) to be measured at fair value with changes in fair market value recognized
in net income. Prior to January 1, 2018, the Company recorded all fair market value changes in marketable securities to shareholders’
equity. As of June 30, 2018, the Company recorded a loss in change in fair value of marketable securities of $0.1 million and
$0.1 million for the three and six months ended, respectively.
Recent
Accounting Pronouncements
Revenue
recognition
. In May 2014, the FASB issued a comprehensive new revenue recognition standard that supersedes the revenue recognition
requirements in Topic 605, Revenue Recognition, and industry-specific guidance in Subtopic 932-605, Extractive Activities-Oil
and Gas-Revenue Recognition. The core principle of the new guidance is that a company should recognize revenue to depict the transfer
of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled
in exchange for transferring those goods or services. The new standard also requires significantly expanded disclosure regarding
the qualitative and quantitative information of an entity’s nature, amount, timing and uncertainty of revenue and cash flows
arising from contracts with customers. The standard creates a five-step model that requires companies to exercise judgment when
considering the terms of a contract and all relevant facts and circumstances. The standard allows for several transition methods:
(a) a full retrospective adoption in which the standard is applied to all of the periods presented, or (b) a modified retrospective
adoption in which the standard is applied only to the most current period presented in the financial statements, including additional
disclosures of the standard’s application impact to individual financial statement line items. In March, April, May and
December 2016, the FASB issued new guidance in Topic 606, Revenue from Contracts with Customers, to address the following potential
implementation issues of the new revenue standard: (a) to clarify the implementation guidance on principal versus agent considerations,
(b) to clarify the identification of performance obligations and the licensing implementation guidance and (c) to address certain
issues in the guidance on assessing collectability, presentation of sales taxes, noncash consideration, and completed contracts
and contract modifications at transition. This standard is effective for annual reporting periods beginning after December 15,
2017, including interim periods within that reporting period. The Company follows the sales method of accounting for oil and natural
gas production, which is generally consistent with the revenue recognition provision of the new standard. The Company has completed
the process of evaluating the effect of the adoption and determined there were no changes required to our reported revenues as
a result of the adoption. The majority of our revenue arrangements generally consist of a single performance obligation to transfer
promised goods or services. Based on our evaluation process and review of our contracts with customers, the timing and amount
of revenue recognized based on the standard is consistent with our revenue recognition policy under previous guidance. The Company
adopted the new standard effective January 1, 2018, using the modified retrospective approach, and has expanded its financial
statement disclosures in order to comply with the standard. The Company implemented processes and controls to ensure new contracts
are reviewed for the appropriate accounting treatment and to generate the disclosures required under the new standard in the first
quarter of 2018. We have determined the adoption of the standard did not have a material impact on our results of operations,
cash flows, or financial position.
Leases.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The standard requires lessees to recognize the assets
and liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position
a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying
asset for the lease term. The new guidance is effective for annual and interim reporting periods beginning after December 15,
2018. The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach
with earlier application permitted as of the beginning of an interim or annual reporting period. The Company is currently evaluating
the impact of the new guidance on its financial statements, however, based on its current operating leases, it is not expected
to have a material impact.
Statement
of cash flows.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts
and Cash Payments. This guidance provides guidance of eight specific cash flow issues. This amendment is effective for periods
beginning after December 15, 2017, with early adoption permitted. The Company adopted this standard on January 1, 2018 and it
does not have a material impact on its financial statements and related disclosures.
Business
combinations.
In January 2017, the FASB issued Accounting Standards Update No. 2017-01,
Clarifying the Definition of a
Business
(“ASU 2017-01”), which provides guidance to assist entities with evaluating whether transactions should
be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 requires entities to use a screen test to
determine when an integrated set of assets and activities is not a business or if the integrated set of assets and activities
needs to be further evaluated against the framework. ASU 2017-01 is effective for fiscal years beginning after December 15, 2017,
including interim periods within those years. The Company adopted this standard on January 1, 2018 and it does not have a material
impact on its financial statements and related disclosures.
Hedging
activities
. On August 28, 2017, the FASB issued Accounting Standards Update (ASU) 2017-12, Derivatives and Hedging (Topic
815): Targeted Improvements to Accounting for Hedging Activities. The amendments in ASU 2017-12 apply to any entity that elects
to apply hedge accounting in accordance with U.S. generally accepted accounting principles (U.S. GAAP). The amendments in ASU
2017-12 take effect for public business entities for fiscal years, and interim periods within those fiscal years, beginning after
December 15, 2018. For all other entities, the amendments take effect for fiscal years beginning after December 15, 2019, and
interim periods beginning after December 15, 2020. Early adoption is permitted. The Company is currently evaluating the effect
that adopting this guidance will have on its financial position, cash flows and results of operations.
Financial
instruments with characteristics of liabilities and equity.
On July 13, 2017, the FASB has issued a two-part Accounting Standards
Update (AS), No. 2017-11, I. Accounting for Certain Financials Instruments with Down Round Features and II. Replacement of the
Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable
Noncontrolling Interest with a Scope Exception. The ASU is effective for public business entities for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the effect that adopting
this guidance will have on its financial position, cash flows and results of operations.
2.
REVENUE RECOGNITION
The
Company adopted ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
and the series of related accounting
standard updates that followed, on January 1, 2018, using the modified retrospective method of adoption. Adoption of the ASU did
not require an adjustment to the opening balance of equity and did not change the Company’s amount and timing of revenues.
The Company reports revenues utilizing information provided by the operator of the property following the same guidance. Adoption
of this guidance applied to all contracts at the date of initial application and all contracts reflect the non-operated nature
of the Company’s existing operations.
The
Company’s revenues are primarily derived from its interests in the sale of oil and natural gas production. The Company recognizes
revenue from its interests in the sales of oil and natural gas in the period that its performance obligations are satisfied. Performance
obligations are satisfied when the customer obtains control of product (as disclosed below), when the Company has no further obligations
to perform related to the sale, when the transaction price has been determined and when collectability is probable. The sales
of oil and natural gas are made under contracts which the third-party operators of the wells have negotiated with customers, which
typically include variable consideration that is based on pricing tied to local indices and volumes delivered in the current month.
The Company receives payment from the sale of oil and natural gas production from one to three months after delivery. At the end
of each month when the performance obligation is satisfied, the variable consideration can be reasonably estimated and amounts
due from customers are accrued in oil and gas sales receivable, net in the consolidated balance sheets. Variances between the
Company’s estimated revenue and actual payments are recorded in the month the payment is received, however, differences
have been and are insignificant. Accordingly, the variable consideration is not constrained.
The
Company does not disclose the value of unsatisfied performance obligations as it applies the practical exemption in accordance
with ASC 606 since the Company contracts are month to month and not in excess of one year. The exemption, as described in ASC
606-10-50-14(a), applies to variable consideration that is recognized as control of the product is transferred to the customer.
Since each unit of product represents a separate performance obligation, future volumes are wholly unsatisfied, and disclosure
of the transaction price allocated to remaining performance obligations is not required.
The
Company’s oil is typically sold at delivery points under contract terms that are common in our industry. The Company’s
natural gas produced is delivered by the well operators to various purchasers at agreed upon delivery points under a limited number
of contract types that are also common in our industry. However, under these contracts, the natural gas may be sold to a single
purchaser or may be sold to separate purchasers. Regardless of the contract type, the terms of these contracts compensate the
well operators for the value of the oil and natural gas at specified prices, and then the well operators will remit payment to
the Company for its share in the value of the oil and natural gas sold. There were no contract liabilities at the date of adoption
or for the six months ended June 30, 2018.
The
following table presents our disaggregated revenue by major source and geographic area for the six months ended June 30, 2018
and 2017 (in thousands):
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue (000’s):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North Dakota
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
|
|
|
784
|
|
|
|
1,325
|
|
|
|
1,589
|
|
|
|
2,259
|
|
Natural gas and liquids
|
|
|
82
|
|
|
|
123
|
|
|
|
172
|
|
|
|
180
|
|
Total
|
|
|
866
|
|
|
|
1,448
|
|
|
|
1,761
|
|
|
|
2,439
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Texas
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
|
|
|
508
|
|
|
|
266
|
|
|
|
933
|
|
|
|
571
|
|
Natural gas and
liquids
|
|
|
54
|
|
|
|
78
|
|
|
|
129
|
|
|
|
267
|
|
Total
|
|
|
562
|
|
|
|
344
|
|
|
|
1,062
|
|
|
|
838
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Louisiana
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Natural gas and liquids
|
|
|
145
|
|
|
|
200
|
|
|
|
305
|
|
|
|
462
|
|
Total
|
|
|
145
|
|
|
|
200
|
|
|
|
305
|
|
|
|
462
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined Total
|
|
|
1,573
|
|
|
|
1,992
|
|
|
|
3,128
|
|
|
|
3,739
|
|
3.
PROPERTIES AND EQUIPMENT
As
of June 30, 2018, the Company did not have any assets available for sale as compared to $0.7 million of assets available for sale
at December 31, 2017. The Company reclassified $0.7 million of “assets available for sale” on the consolidated balance
sheet to “property and equipment, net” as of June 30, 2018. These assets are comprised of land parcels owned by Energy
One in Riverton, Wyoming. Management believes that it is not probable that the assets will be sold within the next 12 months and
will continue to be held by the Company. The main drivers behind this belief are (1) the improved financial condition and liquidity
position of the Company caused by the completion of Company initiatives and improved global commodity prices, and (2) the rural
real estate market where the properties are located traditionally has unpredictable timelines in the completion of real estate
transactions.
4.
LIQUIDITY
As
of June 30, 2018, the Company has working capital of $3.9 million and an accumulated deficit of $127.5 million. Additionally,
the Company incurred a net loss of $1.2 million for the three months ended June 30, 2018, and $1.4 million for the six months
ended June 30, 2018.
As
of June 30, 2018, the Company had cash and cash equivalents of $2.8 million. Management believes that overhead reductions associated
with the Company’s divested mining operations combined with the reduction in the Company’s outstanding debt have poised
the Company to survive in the current commodity price environment. Our strategy is to continue to (1) maintain adequate liquidity
and selectively participate in new drilling and completion activities, subject to economic and industry conditions, (2) pursue
acquisition and disposition opportunities, (3) address the July 2019 maturity of our existing credit facility through either extending
the maturity of the existing credit facility or entering into a new credit facility with a new lender, and (4) evaluate various
avenues to strengthen our balance sheet and improve our liquidity position. We expect to fund any near-term capital requirements
and working capital needs from existing cash on hand. Because production from existing oil and natural gas wells declines over
time, further reductions of capital expenditures used to drill and complete new oil and natural gas wells would likely result
in lower levels of oil and natural gas production in the future.
5.
COMMODITY RISK DERIVATIVES
The
Company’s wholly-owned subsidiary Energy One has entered into commodity price derivative contracts (“economic hedges”)
with BP Energy, a third-party hedge counterparty. The derivative contracts are priced based on West Texas Intermediate (“WTI”)
quoted prices for crude oil and Henry Hub quoted prices for natural gas. The Company is a guarantor of Energy One’s obligations
under the economic hedges. The objective of utilizing the economic hedges is to reduce the effect of price changes on a portion
of the Company’s future oil production, achieve more predictable cash flows in an environment of volatile oil and gas prices
and to manage the Company’s exposure to commodity price risk. The use of these derivative instruments limits the downside
risk of adverse price movements. However, there is a risk that such use may limit the Company’s ability to benefit from
favorable price movements. Energy One may, from time to time, add incremental derivatives to hedge additional production, restructure
existing derivative contracts or enter into new transactions to modify the terms of current contracts in order to realize the
current value of its existing positions. The Company does not engage in speculative derivative activities or derivative trading
activities, nor does it use derivatives with leveraged features. The Company had a net liability from commodity risk derivatives
of $0.02 million at June 30, 2018 and $0.2 million at December 31, 2017. Presented below is a summary of outstanding crude oil
and natural gas swaps as of June 30, 2018.
|
|
Begin
|
|
End
|
|
Quantity (bbls/d)
|
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude oil price swaps
|
|
7/1/18
|
|
12/31/18
|
|
|
100
|
|
|
$
|
68.50
|
|
|
|
Begin
|
|
End
|
|
Quantity (mcf/d)
|
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural gas price swaps
|
|
7/1/18
|
|
12/31/18
|
|
|
500
|
|
|
$
|
3.01
|
|
Derivatives
are recorded at fair value in the consolidated balance sheets. Changes in fair value are included in the “(loss) gain on
commodity derivative contracts” in the consolidated statements of operations and comprehensive loss. For the six months
ended June 30, 2018 and 2017, the Company’s unrealized gains from derivatives amounted to $0.1 and $0.3 million, respectively.
Derivative contract settlements are included in the “(loss) gain on commodity derivative contracts” in the consolidated
statement of operations. For the six months ended June 30, 2018 and 2017, the Company’s realized (loss) gain from derivatives
amounted to $(0.3) million and $0.1 million, respectively. All derivative positions are carried at their fair value on the condensed
consolidated balance sheets and are included in “Commodity derivative contracts.” The following table summarizes the
fair value of our open commodity derivatives as of June 30, 2018, and December 31, 2017 (in thousands). Please see Note 13 for
further disclosure.
|
|
June 30, 2018
|
|
|
December 31, 2017
|
|
Fair Value of Oil and Natural Gas Derivatives (in thousands)
|
|
Gross Amount
|
|
|
Amount Offset
|
|
|
As Presented
|
|
|
Gross Amount
|
|
|
Amount Offset
|
|
|
As Presented
|
|
Fair value of oil and natural gas derivatives – Current Assets
|
|
$
|
25
|
|
|
$
|
(25
|
)
|
|
$
|
-
|
|
|
$
|
168
|
|
|
$
|
(168
|
)
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of oil and natural gas derivatives – Current Liabilities
|
|
|
(49
|
)
|
|
|
25
|
|
|
|
(24
|
)
|
|
|
(329
|
)
|
|
|
168
|
|
|
|
(161
|
)
|
6.
OIL AND GAS PRODUCING ACTIVITIES
Divestitures
On
October 3, 2017, U.S. Energy Corp. (the “Company”), the Company’s wholly owned subsidiary Energy One LLC and
Statoil Oil and Gas LP (“Statoil”) entered into a purchase and sale agreement (the “Purchase Agreement”),
pursuant to which, on the terms, and subject to the conditions of the Purchase Agreement, the Company assigned, sold, and conveyed
certain non-operated assets in the Williston Basin, North Dakota in consideration for the elimination of $4.0 million in outstanding
liabilities to StatOil and payment by Statoil to the Company of $2.0 million in cash. U.S. Energy has historically accounted for
the eliminated liabilities on the Company’s balance sheet under “Payable to major operator” and “Contingent
ownership interests.” The Purchase Agreement was unanimously approved by the board of directors of the Company and closed
on October 5, 2017, with an effective date of August 1, 2017.
Ceiling
Test and Impairment
The
reserves used in the Company’s full cost ceiling test incorporate assumptions regarding pricing and discount rates in the
determination of present value. In the calculation of the ceiling test as of June 30, 2018, the Company used a price of $53.86
per barrel of oil and $2.83 per MMbtu of natural gas (in each case adjusted for transportation, quality, and basis differentials
applicable to our properties on a weighted average basis) to compute the future cash flows of the Company’s producing properties.
These prices compare to $47.01 per barrel of oil and $2.98 per MMbtu of natural gas used in the calculation of the ceiling test
as of December 31, 2017. The discount factor used was 10%.
For
the three and six months ended June 30, 2018 and 2017, the Company recorded no impairment charges.
7.
DEBT
On
December 27, 2017, U.S. Energy Corp. received shareholder approval for the exchange agreement (“Exchange Agreement”)
by and among the Company, the Company’s wholly owned subsidiary Energy One LLC and APEG Energy II, L.P., (“APEG”),
an entity controlled by Angelus Private Equity Group, LLC pursuant to which, on the terms and subject to the conditions of the
Exchange Agreement, APEG exchanged $4,463,380 of outstanding borrowings under the Company’s Credit Facility, for 5,819,270
new shares of common stock of the Company, par value $0.01 per share, with an exchange price of $0.767 representing a 1.3% premium
over the 30-day volume weighted average price of the Company’s common stock on September 20, 2017 (the “Exchange Shares”).
Accrued, unpaid interest on the Credit Facility held by APEG was paid in cash at the closing of the transaction. As of June 30,
2018, APEG holds approximately 45% of the outstanding Common Stock of U.S. Energy.
Energy
One, a wholly-owned subsidiary of the Company, has a Credit Facility (the “Credit Facility”) with APEG Energy II,
L.P. (“APEG”) which matures in July 2019. As of June 30, 2018, outstanding borrowings under the Credit Facility amounted
to $0.9 million. Borrowings under the Credit Facility are secured by Energy One’s oil and gas producing properties. The
interest rate on the Credit Facility is currently fixed at 8.75%.
Energy
One is required to comply with customary affirmative covenants and with certain negative covenants. The principal negative financial
covenants do not permit (as the following terms are defined in the Fifth Amendment to the Credit Agreement) (i) Proved Developed
Producing Coverage Ratio to be less than 1.2 to 1; and (ii) the current ratio to be less than 1.0 to 1.0. Additionally, the Credit
Agreement prohibits or limits Energy One’s ability to incur additional debt, pay cash dividends and other restricted payments,
sell assets, enter into transactions with affiliates, and to merge or consolidate with another company. The Company is a guarantor
of Energy One’s obligations under the Credit Agreement. As of June 30, 2018, the Company was in compliance with all Credit
Facility covenants.
8.
COMMITMENTS AND CONTINGENCIES
Commitments
Lessee
Operating Leases.
In August 2017, the Company entered into a lease agreement for office space in Denver, Colorado. The future
minimum rental commitment under this sublease requires payments of $0.3 million.
Year
|
|
Cash Commitment
|
|
2018
|
|
$
|
42,024
|
|
2019
|
|
|
72,852
|
|
2020
|
|
|
73,125
|
|
2021
|
|
|
74,533
|
|
2022
|
|
|
75,942
|
|
2023
|
|
|
6,338
|
|
Contingencies
From
time to time, the Company is party to certain legal actions and claims arising in the ordinary course of business. While the outcome
of these events cannot be predicted with certainty, management does not expect these matters to have a materially adverse effect
on the Company’s financial position or results of operations.
9.
SHAREHOLDERS’ EQUITY
Preferred
Stock
The
Company’s articles of incorporation authorize the issuance of up to 100,000 shares of preferred stock, $0.01 par value.
Shares of preferred stock may be issued with such dividend, liquidation, voting and conversion features as may be determined by
the Board of Directors without shareholder approval. The Company is authorized to issue 50,000 shares of Series P preferred stock
in connection with a shareholder rights plan that expired in 2011. In February 2016 the Board of Directors approved the designation
of 50,000 shares of Series A Convertible Preferred Stock in connection with the disposition of the Company’s mining segment.
The
Series A Purchase Agreement contains customary representations and warranties on the part of the Company. As contemplated by the
Acquisition Agreement and the Series A Purchase Agreement and as approved by the Company’s Board of Directors, the Company
filed with the Secretary of State of the State of Wyoming Articles of Amendment containing a Certificate of Designations with
respect to the Preferred Stock (the “Certificate of Designations”). Pursuant to the Certificate of Designations, the
Company designated 50,000 shares of its authorized preferred stock as Series A Convertible Preferred Stock. The Preferred Stock
will accrue dividends at a rate of 12.25% per annum of the Adjusted Liquidation Preference (as defined); such dividends are not
payable in cash but are accrued and compounded quarterly in arrears. The “Adjusted Liquidation Preference” is initially
$40 per share of Preferred Stock for an aggregate of $2,000, with increases each quarter by the accrued quarterly dividend. The
Preferred Stock is senior to other classes or series of shares of the Company with respect to dividend rights and rights upon
liquidation. No dividend or distribution will be declared or paid on junior stock, including the Company’s common stock,
(1) unless approved by the holders of Preferred Stock and (2) unless and until a like dividend has been declared and paid on the
Preferred Stock on an as-converted basis.
At
the option of the holder, each share of Preferred Stock may initially be converted into 13.33 shares of the Company’s $0.01
par value Common Stock (the “Conversion Rate”) for an aggregate of 666,667 shares. The Conversion Rate is subject
to anti-dilution adjustments for stock splits, stock dividends and certain reorganization events and to price-based anti-dilution
protections. Each share of Preferred Stock will be convertible into a number of shares of Common Stock equal to the ratio of the
initial conversion value to the conversion value as adjusted for accumulated dividends multiplied by the Conversion Rate. In no
event will the aggregate number of shares of Common Stock issued upon conversion be greater than 793,349 shares. The Preferred
Stock will generally not vote with the Company’s Common Stock on an as-converted basis on matters put before the Company’s
shareholders. The holders of the Preferred Stock have the right to approve specified matters as set forth in the Certificate of
Designations and have the right to require the Company to repurchase the Preferred Stock in connection with a change of control.
Concurrent with entry into the Acquisition Agreement and the Series A Purchase Agreement, the Company and MEM entered into an
Investor Rights Agreement, which provides MEM rights to certain information and Board observer rights. MEM has agreed that it,
along with its affiliates, will not acquire more than 16.86% of the Company’s issued and outstanding shares of Common Stock.
In addition, MEM has the right to demand registration of the shares of Common Stock issuable upon conversion of the Preferred
Stock under the Securities Act of 1933, as amended.
Common
Stock
On
January 5, 2018, we entered into a common stock sales agreement with a financial institution pursuant to which we may offer and
sell, through the sales agent, common stock representing an aggregate offering price of up to $2.5 million through an at-the-market
continuous offering program. During the three months ended June 30, 2018, we issued an aggregate of 290,694 of common stock through
our continuous at-the-market offering program at an average price of $1.17 per share for total proceeds of approximately $0.3
million. Since the beginning of the program in January, 2018 we had issued, as of June 30, 2018, 930,857 shares of common
stock through our continuous at-the-market offering program at an average price of $1.37 for total net proceeds after offering
expenses of approximately $1.2 million.
Warrants
On
December 21, 2016, the Company completed a registered direct offering of 1,000,000 shares of common stock at a net gross price
of $1.50 per share. Concurrently, the investors received warrants to purchase 1,000,000 shares of Common Stock of the Company
at an exercise price of $2.05 per share, subject to adjustment, for a period of five years from closing. The total net proceeds
received by the Company were approximately $1.32 million. The fair value of the warrants upon issuance was $1.24 million, with
the remaining $0.08 million being attributed to common stock. The warrants contain a dilutive issuance and other liability provisions
which cause the warrants to be accounted for as a liability. Such warrant instruments are initially recorded as a liability and
are accounted for at fair value with changes in fair value reported in earnings. As of June 30, 2018, the Company had a warrant
liability of $1.0 million. As a result of common stock issuances made during the six months ended June 30, 2018, the warrant exercise
price was reduced from $2.05 to $1.13 per share pursuant to the original warrant agreement.
S
tock
Options
From
time to time, the Company grants stock options under its incentive plan covering shares of common stock to employees of the Company.
Stock options, when exercised, are settled through the payment of the exercise price in exchange for new shares of stock underlying
the option. These awards typically expire ten years from the grant date.
For
the six months ended June 30, 2018 and 2017, no stock options were granted, exercised, forfeited or expired. As of June 30, 2018,
there was $0.1 million of unrecognized expense related to unvested stock options that were previously granted, which will be recognized
as stock-based compensation expense through November 2019. Presented below is information about stock options outstanding and
exercisable as of June 30, 2018 and December 31, 2017:
|
|
June 30, 2018
|
|
|
December 31, 2017
|
|
|
|
Shares
|
|
|
Price
(1)
|
|
|
Shares
|
|
|
Price
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options outstanding
|
|
|
389,687
|
|
|
$
|
8.05
|
|
|
|
389,687
|
|
|
$
|
8.05
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options exercisable
|
|
|
279,687
|
|
|
$
|
10.76
|
|
|
|
274,132
|
|
|
$
|
10.79
|
|
|
(1)
|
Represents
the weighted average price.
|
The
following table summarizes information for stock options outstanding and exercisable at June 30, 2018:
Options Outstanding
|
|
|
Options Exercisable
|
|
Number
|
|
|
Exercise Price
|
|
|
Remaining
|
|
|
Number
|
|
|
Weighted
|
|
of
|
|
|
Range
|
|
|
Weighted
|
|
|
Contractual
|
|
|
of
|
|
|
Average
|
|
Shares
|
|
|
Low
|
|
|
High
|
|
|
Average
|
|
|
Term (years)
|
|
|
Shares
|
|
|
Exercise Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56,786
|
|
|
$
|
9.00
|
|
|
$
|
9.00
|
|
|
$
|
9.00
|
|
|
|
6.5
|
|
|
|
56,786
|
|
|
$
|
9.00
|
|
|
49,504
|
|
|
|
12.48
|
|
|
|
12.48
|
|
|
|
12.48
|
|
|
|
5.0
|
|
|
|
49,504
|
|
|
|
12.48
|
|
|
98,396
|
|
|
|
13.92
|
|
|
|
17.10
|
|
|
|
15.01
|
|
|
|
1.3
|
|
|
|
98,396
|
|
|
|
15.01
|
|
|
15,001
|
|
|
|
22.62
|
|
|
|
30.24
|
|
|
|
24.03
|
|
|
|
5.0
|
|
|
|
15,001
|
|
|
|
24.03
|
|
|
60,000
|
|
|
|
0.72
|
|
|
|
0.72
|
|
|
|
0.72
|
|
|
|
9.1
|
|
|
|
60,000
|
|
|
|
0.72
|
|
|
110,000
|
|
|
|
1.16
|
|
|
|
1.16
|
|
|
|
1.16
|
|
|
|
9.4
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
389,687
|
|
|
$
|
0.72
|
|
|
$
|
30.24
|
|
|
$
|
8.05
|
|
|
|
6.2
|
|
|
|
279,687
|
|
|
$
|
10.76
|
|
As
of June 30, 2018, 666,467 shares are available for future grants under the Company’s stock option plans.
Common
Stock Grants
In
May 2018, the Company granted 485,168 shares of stock to Company employees and accordingly recorded $0.6 million in stock-based
compensation expense. As the shares were immediately vested, the associated stock-based compensation expense was recorded immediately
upon grant. For the six months ended June 30, 2018, total stock-based compensation expense related to common stock grants was
$0.6 million. For the six months ended June 30, 2017, no stock-based compensation expenses was recorded. As of June 30, 2018,
there was no unrecognized expense related to any previous common stock grants.
10.
INCOME TAXES
The
Company has estimated the applicable effective tax rate expected for the full fiscal year. The Company’s effective tax rate
used to estimate income taxes on a current year-to-date basis for the six months ended June 30, 2018, and 2017, is 0% and 0%,
respectively.
On
December 27, 2017, as a result of a stock issuance (see Note 7) the gross deferred tax assets are subject to limitations under
I.R.C. Section 382. The Company still maintains a gross deferred tax asset position that is subject to a valuation allowance.
Deferred
tax assets (“DTAs”) are recognized for the expected future tax consequences of temporary differences between the financial
reporting and tax basis of assets and liabilities and for operating losses and tax credit carry forwards. We review our DTAs and
valuation allowance on a quarterly basis. As part of our review, we consider positive and negative evidence, including cumulative
results in recent years. Consistent with the position at December 31, 2017, the Company maintains a full valuation allowance recorded
against all DTAs. The Company therefore had no recorded DTAs as of June 30, 2018. We anticipate that we will continue to record
a valuation allowance against our DTAs until such time as we are able to determine that it is “more-likely-than-not”
that those DTAs will be realized.
The
Company recognizes, measures, and discloses uncertain tax positions whereby tax positions must meet a “more-likely-than-not”
threshold to be recognized. During the quarters ended June 30, 2018 and 2017, no adjustments were recognized for uncertain tax
positions.
The
Company does not expect to pay any federal or state income taxes for the fiscal year ended December 31, 2018.
11.
EARNINGS (LOSS) PER SHARE
Basic
earnings (loss) per share is computed based on the weighted average number of common shares outstanding. As the Company is in
a net loss position; for the three and six months ended June 30, 2018 and 2017, common stock equivalents excluded from the calculation
of weighted average shares because they were antidilutive are as follows:
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
|
389,687
|
|
|
|
390,525
|
(1)
|
|
|
389,687
|
|
|
|
390,525
|
(1)
|
Unvested shares of restricted common stock
|
|
|
-
|
|
|
|
100,000
|
|
|
|
-
|
|
|
|
100,000
|
|
Outstanding warrants
|
|
|
1,000,000
|
|
|
|
1,000,000
|
|
|
|
1,000,000
|
|
|
|
1,000,000
|
|
Series A convertible preferred stock
|
|
|
793,349
|
|
|
|
792,037
|
|
|
|
793,349
|
|
|
|
767,823
|
|
Total
|
|
|
2,183,036
|
|
|
|
2,282,562
|
|
|
|
2,183,036
|
|
|
|
2,258,348
|
|
12.
SIGNIFICANT CONCENTRATIONS
The
Company has exposure to credit risk in the event of nonpayment by the joint interest operators of the Company’s oil and
gas properties. Approximately 87% of the Company’s oil and gas revenue for the six months ended June 30, 2018 are associated
with properties that are operated by four operators: Operator A: 47%, Operator B: 17%, Operator C: 14%, and Operator D: 10%. Approximately
81% of the Company’s oil and gas revenue for the six months ended June 30, 2017 are associated with properties that are
operated by four operators: Operator A: 29%, Operator B: 11%, Operator C: 29%, and Operator D: 11%.
13.
FAIR VALUE MEASUREMENTS
Fair
value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. In determining fair value, the Company uses various methods including market, income and
cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use
in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique.
These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes valuation
techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability
of the inputs used in the valuation techniques the Company is required to provide the following information according to the fair
value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values.
Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following six categories:
Level
1 - Quoted prices for identical assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.
Level
2 - Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active
markets, or other observable inputs that can be corroborated by observable market data. Level 2 also includes derivative contracts
whose value is determined using a pricing model with observable market inputs or can be derived principally from or corroborated
by observable market data.
Level
3 - Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing
models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair
value requires significant management judgment or estimation; also includes observable inputs for nonbinding single dealer quotes
not corroborated by observable market data.
The
Company has processes and controls in place to attempt to ensure that fair value is reasonably estimated. The Company performs
due diligence procedures over third-party pricing service providers in order to support their use in the valuation process. Where
market information is not available to support internal valuations, independent reviews of the valuations are performed and any
material exposures are evaluated through a management review process.
While
the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different
methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate
of fair value at the reporting date. The following is a description of the valuation methodologies used for complex financial
instruments measured at fair value:
Marketable
Equity Securities Valuation Methodologies
The
fair value of available for sale securities is based on quoted market prices obtained from independent pricing services. Accordingly,
the Company has classified these instruments as Level 1.
Derivative
Assets and Liabilities
Derivative
assets and liabilities, at fair value, are included on our consolidated balance sheets as current or non-current assets or liabilities
based on the anticipated timing of cash settlements under the related contracts. Changes in the fair value of our commodity derivative
contracts, not designated as cash-flow hedges, are recorded in earnings as they occur and included in income (expense) on our
consolidated statements of operations and comprehensive loss. We estimate the fair values of swap contracts based on the present
value of the difference in exchange-quoted forward price curves and contractual settlement prices multiplied by notional quantities.
Accordingly, the Company has classified these instruments as Level 2.
Warrant
Valuation Methodologies
The
warrants contain a dilutive issuance and other liability provisions which cause the warrants to be accounted for as a liability.
Such warrant instruments are initially recorded and valued as a level 3 liability and are accounted for at fair value with changes
in fair value reported in earnings.
The
Company estimated the value of the warrants issued in connection with the closing of its registered direct offering on December
21, 2016 to be $1,030,000, or $1.03 per warrant, using the Monte Carlo model with the following assumptions: a term expiring June
21, 2022, exercise price of $2.05, stock price of $1.28, average volatility rate of 90%, and a risk-free interest rate of 2.01%.
The Company re-measured the warrants as of June 30, 2018, using the same Monte Carlo model, using the following assumptions: a
term expiring June 21, 2022, exercise price of $1.13, stock price of $1.32, average volatility rate of 95%, and a risk-free interest
rate of 2.68%. The “ratchet” anti-dilution provision in the warrants may result in the downward adjustment of the
exercise price of the warrants. If the Company issues common stock, options or common stock equivalents at a price less than the
exercise price of the warrants, subject to certain customary exceptions, the exercise price of the warrants is reduced to that
lower price, however in no event will the exercise price be reduced below $.392 per share. As of June 30, 2018, the fair value
of the warrants was $1,010,000, or $1.01 per warrant, and was recorded as a liability on the accompanying consolidated balance
sheets. An increase in any of the variables would cause an increase in the fair value of the warrants. Likewise, a decrease in
any variable would cause a decrease in the value of the warrants.
Other
Financial Instruments
The
carrying amount of cash and equivalents, oil and gas sales receivable, other current assets and liabilities approximate fair value
because of the short-term nature of those instruments.
Recurring
Fair Value Measurements
Recurring
measurements of the fair value of assets and liabilities as of June 30, 2018 and December 31, 2017 are as follows:
|
|
June 30, 2018
|
|
|
December 31, 2017
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sutter Gold Mining Company
|
|
$
|
10
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
10
|
|
|
$
|
8
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
8
|
|
Anfield Resources, Inc.
|
|
|
743
|
|
|
|
-
|
|
|
|
-
|
|
|
|
743
|
|
|
|
868
|
|
|
|
-
|
|
|
|
-
|
|
|
|
868
|
|
Total
|
|
$
|
753
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
753
|
|
|
$
|
878
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
876
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity price risk derivatives
|
|
$
|
-
|
|
|
$
|
24
|
|
|
|
-
|
|
|
$
|
24
|
|
|
|
-
|
|
|
$
|
161
|
|
|
|
-
|
|
|
$
|
161
|
|
Outstanding warrant liability
|
|
|
-
|
|
|
|
-
|
|
|
|
1,010
|
|
|
|
1,010
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
1,200
|
|
|
|
1,200
|
|
Total
|
|
$
|
-
|
|
|
$
|
24
|
|
|
$
|
1,010
|
|
|
$
|
1,034
|
|
|
|
|
|
|
$
|
161
|
|
|
$
|
1,200
|
|
|
$
|
1,361
|
|
The
following table presents a reconciliation of changes in liabilities measured at Level 3 fair value on a recurring basis for the
period ended June 30, 2018 and the year ended December 31, 2017.
Liabilities
|
|
|
|
|
|
|
Warrants
|
|
|
|
|
|
|
(Level 3)
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Fair value, as of December 31, 2017 and 2016
|
|
$
|
1,200
|
|
|
$
|
1,030
|
|
|
|
|
|
|
|
|
|
|
Total net losses included in:
|
|
|
|
|
|
|
|
|
Other comprehensive loss
|
|
|
-
|
|
|
|
-
|
|
Fair value adjustments included in net loss:
|
|
|
|
|
|
|
|
|
Net fair value adjustment
|
|
|
(190
|
)
|
|
|
170
|
|
Fair value, June 30, 2018, and December 31, 2017
|
|
$
|
1,010
|
|
|
$
|
1,200
|
|
14.
SUBSEQUENT EVENTS
On
June 27, 2018 the Company filed a shelf registration statement on Form S-3 registering up to $100 million in securities
as further described in the shelf registration statement.