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 (“U.S. 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 U.S. 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 September 30, 2018, and operating results for
the three and nine months ended September 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 U.S. 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.
Correction
of Immaterial Errors
The
accompanying December 31, 2017, restated condensed consolidated balance sheet includes a correction related to the classification
and presentation of the Series A Convertible Preferred Stock (the “Preferred Stock”). The Preferred Stock had been
reported in stockholders’ equity from the date of issuance in February 2016. During the three months ended September 30,
2018, the Company determined that the Preferred Stock should not be included in stockholders’ equity, due to a redemption
feature outside the control of the Company, whereby the holders may require redemption in the event of a change in control. The
Company has corrected the presentation on the balance sheet to exclude the Preferred Stock from stockholders’ equity. The
correction of the error reclassified $2.0 million from stockholders’ equity into temporary equity but had no effect on previously
reported net income or earnings per share in any prior period.
Recently
Adopted Accounting Pronouncements
Revenue recognition
.
In May 2014, the Financial Accounting Standards Board (“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.
Financial Instruments.
In January 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-01 Financial
Instruments, Overall (Subtopic 825-10),
Recognition and Measurement of Financial Assets and Financial Liabilities
(“ASU
2016-01”)
.
The amendments in the ASU 2016-01 require equity investments, other than those accounted for under the
equity method or result in consolidation of an investee, to be measured at fair value with changes in fair value recognized in
income. The amendment is effective for public business entities with fiscal years beginning after December 31, 2017. The Company
adopted this standard on January 1, 2018, with a cumulative effect adjustment to retained earnings at December 31, 2017 of $903
thousand. The adjustment to retained earnings related to fair value changes of marketable securities that had been accumulated
previously in other comprehensive loss. Prospectively, unrealized gains and losses on marketable securities are recorded in earnings
under the caption in other income, changes in fair value of marketable securities. Prior period gains and losses are recorded
in other comprehensive loss; therefore, current year periods are not comparable to periods in the prior year.
Recently
Issued Accounting Pronouncements
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 update does not apply to
leases of mineral rights to explore for or use crude oil or natural gas. The Company is currently evaluating the impact of the
new guidance on its consolidated financial statements, however, based on its current operating leases and status as a non-operator,
it is not expected to have a material impact on its condensed and consolidated balance sheet or statement of operations.
Financial
instruments with characteristics of liabilities and equity.
In July 2017, the FASB has issued a two-part ASU 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 consolidated financial position, cash flows and results of operations.
Fair value measurement
.
In August 2018, the FASB issued ASU No. 2018-13,
Disclosure Framework
-
Changes to Disclosure Requirements for Fair
Value Measurement
(“ASU 2018-13”). ASU 2018-13 modifies the disclosure requirements on fair value measurements
in Topic 820 Fair Value Measurement. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, including interim
periods within those years. The Company is evaluating the impact the new guidance will have on its condensed and consolidated
financial statements and related disclosures.
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 nine months ended September 30, 2018.
The
following table presents our disaggregated revenue by major source and geographic area for the three and nine months ended September
30, 2018 and 2017 (in thousands):
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
Dakota
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
|
|
$
|
795
|
|
|
$
|
1,091
|
|
|
$
|
2,384
|
|
|
$
|
3,350
|
|
Natural
gas and liquids
|
|
|
65
|
|
|
|
111
|
|
|
|
240
|
|
|
|
290
|
|
Total
|
|
|
860
|
|
|
|
1,202
|
|
|
|
2,624
|
|
|
|
3,640
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Texas
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
|
|
|
325
|
|
|
|
220
|
|
|
|
1,258
|
|
|
|
791
|
|
Natural
gas and liquids
|
|
|
39
|
|
|
|
99
|
|
|
|
168
|
|
|
|
366
|
|
Total
|
|
|
364
|
|
|
|
319
|
|
|
|
1,426
|
|
|
|
1,157
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Louisiana
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Natural
gas and liquids
(1)
|
|
|
(2
|
)
|
|
|
17
|
|
|
|
300
|
|
|
|
479
|
|
Total
|
|
|
(2
|
)
|
|
|
17
|
|
|
|
300
|
|
|
|
479
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined
Total
|
|
$
|
1,222
|
|
|
$
|
1,538
|
|
|
$
|
4,350
|
|
|
$
|
5,276
|
|
|
(1)
|
Negative
production attributable to a combination of an over-accrual in June 2018, which was reversed
in July 2018 and maintenance-related downtime on a specific well in Louisiana.
|
3.
ASSETS AVAILABLE FOR SALE
During
the nine months ended September 30, 2018, the Company reclassified $0.7 million of assets reported as available for sale at December
31, 2017 to property and equipment, net. These assets are comprised of land parcels owned by Energy One in Riverton, Wyoming.
The Company has determined that the assets do not meet all the criteria for classification as available for sale because, although
the Company has a plan for disposing of the assets, it is not actively marketing them and does not consider it probable that the
assets will be sold within the next 12 months.
4.
LIQUIDITY
As
of September 30, 2018, the Company had cash and cash equivalents of $3.0 million and working capital of $3.6 million. During the
nine months ended September 30, 2018, the Company incurred a net loss of $1.0 million and used $0.9 million of cash in operating
activities.
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 accretive acquisition opportunities, and
(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. 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, which, are pari-passu to amounts borrowed under the Credit Facility and are secured by Energy One’s
oil and gas properties. 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 natural 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 commodity price 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 $37 thousand at September 30, 2018 and $161 thousand at December 31, 2017. Presented below is a summary of outstanding crude
oil and natural gas swaps as of September 30, 2018.
|
|
Begin
|
|
|
End
|
|
|
Quantity
(bbls/d)
|
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude
oil price swaps
|
|
|
10/1/18
|
|
|
|
12/31/18
|
|
|
|
100
|
|
|
$
|
68.50
|
|
|
|
Begin
|
|
|
End
|
|
|
Quantity
(mcf/d)
|
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural
gas price swaps
|
|
|
10/1/18
|
|
|
|
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 condensed consolidated statements of operations and comprehensive loss. For the nine
months ended September 30, 2018 and 2017, the Company’s unrealized gains from derivatives amounted to $124 thousand and
$29 thousand, respectively. Derivative contract settlements are included in the (loss) gain on commodity derivative contracts
in the condensed consolidated statement of operations. For the nine months ended September 30, 2018 and 2017, the Company’s
realized (loss) gain from derivatives amounted to $(349) thousand and $217 thousand, respectively. All derivative positions are
carried at their fair value and included in Commodity derivative contracts on the condensed consolidated balance sheets. The following
table summarizes the fair value of our open commodity derivatives as of September 30, 2018, and December 31, 2017 (in thousands).
Please see Note 14 for further disclosure.
|
|
September
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
|
|
$
|
4
|
|
|
$
|
(4
|
)
|
|
$
|
-
|
|
|
$
|
168
|
|
|
$
|
(168
|
)
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
value of oil and natural gas derivatives – Current Liabilities
|
|
|
(41
|
)
|
|
|
4
|
|
|
|
(37
|
)
|
|
|
(329
|
)
|
|
|
168
|
|
|
|
(161
|
)
|
6.
OIL AND GAS PRODUCING ACTIVITIES
Divestitures
On
October 3, 2017, the Company, Energy One and Statoil Oil and Gas LP (“Statoil”) entered into a purchase and sale agreement
(the “Purchase Agreement”), pursuant to which 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 September 30, 2018, the Company used a price of $59.78
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 nine months ended September 30, 2018 and 2017, the Company recorded no impairment charges.
7.
DEBT
On
December 27, 2017, the Company received shareholder approval for the exchange agreement (“Exchange Agreement”) by
and among the Company, Energy One 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 $4.5 million
of outstanding borrowings under the Company’s Credit Facility, for 5,819,270 newly-issued 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 September 30, 2018, APEG holds approximately
43% 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 which matures
in July 2019. As of September 30, 2018, outstanding borrowings under the Credit Facility amounted to $937 thousand. 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%.
Pursuant
to the terms of the Credit Facility, 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 Facility 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 Facility. As of
September 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 original term of the lease is 65 months;
extending until January 2023. At September 30, 2018, the future minimum rental commitments of the lease were $319 thousand. The
following table presents the future minimum rental commitments at September 30, 2018, by year (in thousands):
Year
|
|
Amount
|
|
2018
|
|
$
|
18
|
|
2019
|
|
|
72
|
|
2020
|
|
|
73
|
|
2021
|
|
|
74
|
|
2022
|
|
|
76
|
|
2023
|
|
|
6
|
|
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.
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.
On
February 12, 2016, the Company issued 50,000 shares of newly designated Series A Convertible Preferred Stock (the Preferred Stock”)
to Mt. Emmons Mining Company (“MEM”), a subsidiary of Freeport McMoRan. (the “Series A Purchase Agreement”)
The Preferred Stock was issued in connection with the disposition of the Company’s mining segment, whereby MEM acquired
property and replaced the Company as permittee and operator of a water treatment plant (the “Acquisition Agreement”).
The Preferred Stock was issued at $40 per share for an aggregate $2 million. The Preferred Stock liquidation preference, initially
$2 million, increases by quarterly dividends of 12.25% per annum (the “Adjusted Liquidation Preference”). 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.
At September 30, 2018, the aggregate number of shares of Common Stock issuable upon conversion is 793,349 shares, which is the
maximum number of shares issuable upon conversion.
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. The Preferred Stock does not vote with the Company’s Common Stock on an as-converted
basis on matters put before the Company’s shareholders. However, 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.
10.
SHAREHOLDERS’ EQUITY
At-the-Market
Offering
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 September 30, 2018, we issued 357,680 shares of common stock at an
average price of $1.52 per share for total proceeds of approximately $0.5 million. Since the beginning of the program in January
2018 through September 30, 2018, we have issued 1,288,537 shares of common stock at an average price of $1.41 for total net proceeds
after offering expenses of approximately $1.8 million, leaving $0.7 million available to be issued under the at-the-market offering
program.
Warrants
On
December 21, 2016, the Company completed a registered direct offering of 1,000,000 shares of common stock at a 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 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 $80 thousand 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 September 30, 2018, and December 31, 2017, the Company had a warrant
liability of $722 thousand and $1.2 million, respectively. As a result of common stock issuances made during the nine months ended
September 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 to directors, executive officers, employees and contractors of the Company under
its Amended and Restated 2012 Equity and Performance Incentive Plan (the “2012 Plan”). 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 nine months ended September 30, 2018 and 2017, no stock options were granted, exercised, forfeited and 69,225 options expired.
As of September 30, 2018, there was $58 thousand 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 September 30, 2018 and December 31, 2017:
|
|
September
30, 2018
|
|
|
December
31, 2017
|
|
|
|
Shares
|
|
|
Price
(1)
|
|
|
Shares
|
|
|
Price
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options outstanding
|
|
|
320,462
|
|
|
$
|
6.52
|
|
|
|
389,687
|
|
|
$
|
8.05
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options exercisable
|
|
|
210,462
|
|
|
$
|
9.32
|
|
|
|
274,132
|
|
|
$
|
10.79
|
|
|
(1)
|
Represents
the weighted average price.
|
The
following table summarizes information for stock options outstanding and exercisable at September 30, 2018:
Options
Outstanding
|
|
|
Options
Exercisable
|
|
|
|
|
Exercise
Price
|
|
|
|
|
|
|
|
|
Weighted
|
|
Number
|
|
|
Range
|
|
|
|
|
|
Remaining
|
|
|
Number
|
|
|
Average
|
|
of
Shares
|
|
|
Low
|
|
|
High
|
|
|
Weighted
Average
|
|
|
Contractual
Term
(years)
|
|
|
of
Shares
|
|
|
Exercise
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56,786
|
|
|
$
|
9.00
|
|
|
$
|
9.00
|
|
|
$
|
9.00
|
|
|
|
6.3
|
|
|
|
56,786
|
|
|
$
|
9.00
|
|
|
49,504
|
|
|
|
12.48
|
|
|
|
12.48
|
|
|
|
12.48
|
|
|
|
4.8
|
|
|
|
49,504
|
|
|
|
12.48
|
|
|
29,171
|
|
|
|
13.92
|
|
|
|
17.10
|
|
|
|
14.74
|
|
|
|
3.7
|
|
|
|
29,171
|
|
|
|
14.74
|
|
|
15,001
|
|
|
|
22.62
|
|
|
|
30.24
|
|
|
|
24.03
|
|
|
|
4.8
|
|
|
|
15,001
|
|
|
|
24.03
|
|
|
60,000
|
|
|
|
0.72
|
|
|
|
0.72
|
|
|
|
0.72
|
|
|
|
8.9
|
|
|
|
60,000
|
|
|
|
0.72
|
|
|
110,000
|
|
|
|
1.16
|
|
|
|
1.16
|
|
|
|
1.16
|
|
|
|
9.1
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
320,462
|
|
|
$
|
0.72
|
|
|
$
|
30.24
|
|
|
$
|
6.52
|
|
|
|
7.2
|
|
|
|
210,462
|
|
|
$
|
9.32
|
|
Common
Stock Grants
In May
2018, the Company granted 485,168 unrestricted shares of stock to Company employees and accordingly recorded $596 thousand of
stock-based compensation expense. For the nine months ended September 30, 2018 and 2017, total stock-based compensation expense
related to stock grants was $623 thousand and $289 thousand, respectively. As of September 30, 2018, there
was no unrecognized expense related to common stock grants.
11.
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 nine months ended September 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 September 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 three and nine-month periods ended September 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.
12.
EARNINGS (LOSS) PER SHARE
Basic
earnings (loss) per share is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding
for the period. Diluted earnings (loss) per share is similarly computed, except that the denominator includes the effect, using
the treasury stock method, of stock options, convertible preferred stock and warrants, if including such potential shares of common
stock is dilutive.
The
following table presents a reconciliation of the weighted-average diluted shares outstanding:
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares outstanding-basic
|
|
|
13,234,709
|
|
|
|
5,834,568
|
|
|
|
12,697,206
|
|
|
|
5,834,568
|
|
Dilutive effect
of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options
|
|
|
20,400
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Weighted
average common shares outstanding-diluted
|
|
|
13,255,109
|
|
|
|
5,834,568
|
|
|
|
12,967,206
|
|
|
|
5,834,568
|
|
We
reported net losses for the three months ended September 30, 2017 and for the nine-month periods ended September 30, 2018 and
2017. As a result, our basic and diluted weighted average shares outstanding were the same for those periods because the effect
of the common share equivalents was anti-dilutive.
The
following table presents the weighted-average common share equivalents excluded from the calculation of diluted earnings per share
due to their anti-dilutive effect:
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares equivalents excluded from diluted earnings per share due to their anti-dilutive effect:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options
|
|
|
300,062
|
|
|
|
390,525
|
|
|
|
320,462
|
|
|
|
390,525
|
|
Unvested
shares of 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
|
|
|
2,093,411
|
|
|
|
2,282,562
|
|
|
|
2,113,811
|
|
|
|
2,258,348
|
|
13.
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. For the nine months ended September 30, 2018 and 2017, approximately 80% and 73%, resprectively,
of the Company’s oil and gas revenue are associated with properties that are operated by three operators.
14.
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
or the Toronto 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 marketable securities is based on quoted market prices obtained from the Toronto Stock Exchange. 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 are recorded in other income (expense) on our consolidated statements of operations. 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 September 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 $1.02, average volatility rate of 90%, and a risk-free
interest rate of 2.90%. 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 $0.392 per share. As of September 30, 2018,
the fair value of the warrants was $722 thousand, or $0.72 per warrant, and was recorded as a liability on the accompanying condensed
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 September 30, 2018 and December 31, 2017 are as follows:
|
|
September
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
|
|
$
|
5
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
5
|
|
|
$
|
8
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
8
|
|
Anfield
Resources, Inc.
|
|
|
951
|
|
|
|
-
|
|
|
|
-
|
|
|
|
951
|
|
|
|
868
|
|
|
|
-
|
|
|
|
-
|
|
|
|
868
|
|
Total
|
|
$
|
956
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
956
|
|
|
$
|
876
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
876
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commodity
price risk derivatives
|
|
$
|
-
|
|
|
$
|
37
|
|
|
|
-
|
|
|
$
|
37
|
|
|
|
-
|
|
|
$
|
161
|
|
|
|
-
|
|
|
$
|
161
|
|
Outstanding
warrant liability
|
|
|
-
|
|
|
|
-
|
|
|
|
722
|
|
|
|
722
|
|
|
$
|
-
|
|
|
|
-
|
|
|
|
1,200
|
|
|
|
1,200
|
|
Total
|
|
$
|
-
|
|
|
$
|
37
|
|
|
$
|
722
|
|
|
$
|
759
|
|
|
|
|
|
|
$
|
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 September 30, 2018 and the year ended December 31, 2017.
Liabilities
|
|
|
|
|
|
|
Warrants
|
|
|
|
|
|
|
(Level
3)
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
Fair
value, beginning of period
|
|
$
|
1,200
|
|
|
$
|
1,030
|
|
|
|
|
|
|
|
|
|
|
Total
net losses included in:
|
|
|
|
|
|
|
|
|
Other
comprehensive loss
|
|
|
-
|
|
|
|
-
|
|
Fair
value adjustments included in net loss:
|
|
|
|
|
|
|
|
|
Net
fair value adjustment
|
|
|
(478
|
)
|
|
|
170
|
|
Fair value,
end of period
|
|
$
|
722
|
|
|
$
|
1,200
|
|
15.
SUBSEQUENT EVENTS
In
October 2018, the Company paid $0.9 million for its 30% working interest share in the drilling costs of the J. Beeler No. 1 well
in Zavala County, Texas. The Company funded its portion of the well with existing cash on hand. The J. Beeler No. 1 well was spud
on October 24, 2018 and is the second well to be drilled within the Company’s South Texas acreage position covering Dimmit
and Zavala Counties.