NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – BASIS OF PRESENTATION
The
accompanying consolidated financial statements of PEDEVCO CORP.
(“PEDEVCO” or the “Company”), have been
prepared in accordance with generally accepted accounting
principles in the United States of America (“GAAP”) and
the rules of the Securities and Exchange Commission
(“SEC”) and should be read in conjunction with the
audited financial statements and notes thereto contained in
PEDEVCO’s latest Annual Report filed with the SEC on Form
10-K. In the opinion of management, all adjustments, consisting of
normal recurring adjustments, necessary for a fair presentation of
the financial position and the results of operations for the
interim periods presented have been reflected herein. The results
of operations for interim periods are not necessarily indicative of
the results to be expected for the full year. Notes to the
financial statements that would substantially duplicate disclosures
contained in the audited financial statements for the most recent
fiscal year, as reported in the Annual Report on Form 10-K for the
year ended December 31, 2017, filed with the SEC on March 29, 2018,
have been omitted.
The
Company’s consolidated financial statements include the
accounts of the Company, its wholly-owned subsidiaries and
subsidiaries in which the Company has a controlling financial
interest. All significant inter-company accounts and transactions
have been eliminated in consolidation.
The Company's future financial condition and liquidity will be
impacted by, among other factors, the success of our
drilling program, the number of
commercially viable oil and natural gas discoveries made and the
quantities of oil and natural gas discovered, the speed with which
we can bring such discoveries to production, and the actual cost of
exploration, appraisal and development of our
prospects.
The Company’s strategy is to be the operator, directly or
through its subsidiaries and joint ventures, in the majority of its
acreage so the Company can dictate the pace of development of such
acreage, in order to execute its business plan. The majority
of the Company’s capital expenditure budget through 2019 will
be focused on the development of its Permian Basin Asset, with a
secondary focus on development of its D-J Basin Asset (each, as
defined below). The Permian Basin Asset development plan calls for
the deployment of an estimated $45 million to $50 million in
capital in order to drill and complete four initial horizontal
wells in phase one of the Company’s development plan over the
next 3 to 6 months, followed by phase two which contemplates the
drilling and completion of up to an additional 12 horizontal wells
through 2019, subject to, and based upon, the results from phase
one, and in each case, available funding. The D-J Basin Asset
development plan is currently under evaluation for both the
Company’s operated and non-operated acreage, and is projected
to require $5 million to $10 million in capital through 2019. Due
to the held-by-production nature of the Company’s Permian
Basin Asset, the Company believes capital can be allocated to the
DJ Basin Asset if needed. The Company’s combined Permian
Basin Asset and D-J Basin Asset development plan calls for a
combined total 2018-2019 capital budget of $50 million to $60
million, of which $7 million was raised in October 2018 in a
convertible promissory note offering. The Company expects that it
will have sufficient cash available to meet its needs over the
foreseeable future, which cash the Company anticipates being
available from (i) the Company’s projected cash flow from
operations, (ii) existing cash on hand, (
iii) potential loans (which may be
convertible) made available from the Company’s senior lender,
SK Energy LLC (“SK Energy”), which is owned and
controlled by Dr. Simon Kukes, the Company’s Chief Executive
Officer and director, which funds may not be available on favorable
terms, if at all, and (iv) additional funding verbally committed by
SK Energy for the full funding of the Company through 2019, to the
extent funding on attractive terms is unavailable to the Company
through outside sources, and subject to terms to be mutually agreed
upon by the Company and SK Energy. In addition, the Company may
seek additional funding through asset sales, farm-out arrangements,
lines of credit, or public or private debt or equity financings to
fund additional 2018-2019 capital expenditures and/or repay or
refinance a portion or all of the Company’s outstanding debt.
If market conditions are not conducive to raising additional
funds, the Company may choose to extend the drilling program
and associated capital expenditures further into
2020.
NOTE 2 – DESCRIPTION OF BUSINESS
PEDEVCO
is
an oil and gas company focused on
the development, acquisition and production of oil and natural
gas
assets where the latest in modern drilling and
completion techniques and technologies have yet to be applied. In
particular, the Company focuses on legacy proven properties where
there is a long production history, well defined geology and
existing infrastructure that can be leveraged when applying modern
field management technologies. The Company’s current
properties are located in the San Andres formation of the Permian
Basin situated in West Texas and eastern New Mexico (the
“Permian Basin”) and in
the Denver-Julesberg Basin (“D-J Basin”) in
Colorado. The Company holds its Permian Basin acres located
in Chavez and Roosevelt Counties, New Mexico, through its
wholly-owned operating subsidiary, Pacific Energy Development Corp.
(“PEDCO”), which asset the Company refers to as its
“Permian Basin Asset,” and it holds its D-J Basin acres
located in Weld and Morgan Counties, Colorado, through its
wholly-owned operating subsidiary, Red Hawk Petroleum, LLC
(“Red Hawk”), which asset the Company refers to as its
“D-J Basin Asset.”
The Company believes that horizontal development and exploitation
of conventional assets in the Permian Basin and development of the
Wattenberg and Wattenberg Extension in the D-J Basin represent
among the most economic oil and natural gas plays in the U.S.
Moving forward, the Company plans to optimize its existing assets
and opportunistically seek additional acreage proximate to its
currently held core acreage, as well as other attractive onshore
U.S. oil and gas assets that fit the Company’s acquisition
criteria, that Company management believes can be developed using
its technical and operating expertise, and be accretive to
shareholder value.
NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Basis of Presentation and Principles of Consolidation.
The consolidated financial statements herein have been prepared in
accordance with GAAP and include the accounts of the Company and
those of its wholly and partially-owned subsidiaries as follows:
(i) Blast AFJ, Inc., a Delaware corporation; (ii)
PEDCO, a Nevada corporation; (iii) Pacific Energy
& Rare Earth Limited, a Hong Kong company (dissolved on August
11, 2017); (iv) Blackhawk Energy Limited, a British Virgin Islands
company (dissolved in May 2018); (v) Red Hawk Petroleum, LLC, a
Nevada limited liability company; (vi) White Hawk Energy, LLC, a
Delaware limited liability company, formed on January 4, 2016 in
connection with the contemplated reorganization transaction with
GOM Holdings, LLC (“GOM”), which reorganization
transaction has since been terminated (dissolved in March 2018);
(vii)
Ridgeway Arizona Oil Corp., an
Arizona corporation (“RAOC”), acquired by PEDCO
effective September 1, 2018 in connection with the Company’s
acquisition of the Permian Basin Asset; (viii) EOR Operating
Company, a Texas corporation (“EOR”) acquired by PEDCO
effective September 1, 2018 in connection with the Company’s
acquisition of the Permian Basin Asset; and (ix) Condor Energy
Technology LLC, a Nevada limited liability company
(“Condor”), acquired by Red Hawk on August 1, 2018 in
connection with the Company’s acquisition of part of its D-J
Basin Asset
. All significant intercompany accounts and
transactions have been eliminated.
Use of Estimates in Financial Statement
Preparation.
The preparation of financial statements in
conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, as well as certain financial
statement disclosures. While management believes that the estimates
and assumptions used in the preparation of the financial statements
are appropriate, actual results could differ from these estimates.
Significant estimates generally include those with respect to the
amount of recoverable oil and gas reserves, the fair value of
financial instruments, oil and gas depletion, asset retirement
obligations, and stock-based compensation.
Cash and Cash Equivalents.
The Company considers all
highly liquid investments with original maturities of three months
or less to be cash equivalents. As of September 30, 2018, and
December 31, 2017, cash equivalents consisted of money market funds
and cash on deposit. As of September 30, 2018, the Company also had
restricted cash of $2,316,000. This amount is on deposit to secure
plugging and abandonment bonds with the State of New Mexico
(related to the acquisition of the New Mexico properties on
September 1, 2018). This restricted cash is shown as part of cash
on the balance sheet as of September 30, 2018.
In
November 2016, the Financial Accounting Standards Board
(“FASB”) issued an Accounting Standards Update
(“ASU”) amending the presentation of restricted cash
within the consolidated statements of cash flows. The new guidance
requires that restricted cash be added to cash and cash equivalents
on the consolidated statements of cash flows. The Company adopted
this ASU on January 1, 2018 on a retrospective basis with no impact
to the consolidated statements of cash flows for the nine months
ended September 30, 2018.
As of
September 30, 2018 and December 31, 2017, the Company had
restricted cash of $2,316,000 and $-0-, respectively, related to a
deposit to secure plugging and abandonment bonds with the State of
New Mexico.
The
following is a summary of cash and cash equivalents and restricted
cash at September 30, 2018 and December 31, 2017 (in
thousands):
|
|
|
Cash
|
460
|
917
|
Restricted cash
– current
|
2,316
|
-
|
Cash, cash
equivalents and restricted cash
|
2,776
|
917
|
Concentrations of Credit Risk.
Financial instruments
which potentially subject the Company to concentrations of credit
risk include cash deposits placed with financial institutions. The
Company maintains its cash in bank accounts which, at times, may
exceed federally insured limits as guaranteed by the Federal
Deposit Insurance Corporation (“FDIC”). At September
30, 2018, approximately $2,317,000 of the Company’s cash
balances were uninsured. The Company has not experienced any losses
on such accounts.
Sales
to one customer comprised 53% of the Company’s total oil
and gas revenues for the nine months ended September 30, 2018.
Sales to one customer comprised 52% of the Company’s total
oil and gas revenues for the nine months ended September 30, 2017.
The Company believes that, in the event that its primary customers
are unable or unwilling to continue to purchase the Company’s
production, there are a substantial number of alternative buyers
for its production at comparable prices.
Accounts Receivable.
Accounts receivable typically
consist of oil and gas receivables. The Company has classified
these as short-term assets in the balance sheet because the Company
expects repayment or recovery within the next 12 months. The
Company evaluates these accounts receivable for collectability
considering the results of operations of these related entities
and, when necessary, records allowances for expected unrecoverable
amounts. To date, no allowances have been recorded. Included in
accounts receivable – oil and gas is $50,000 related to
receivables from joint interest owners.
Bad Debt Expense.
The Company’s ability to collect
outstanding receivables is critical to its operating performance
and cash flows. Accounts receivable are stated at an amount
management expects to collect from outstanding balances. The
Company extends credit in the normal course of business. The
Company regularly reviews outstanding receivables and when the
Company determines that a party may not be able to make required
payments, a charge to bad debt expense in the period of
determination is made. Though the Company’s bad debts have
not historically been significant, the Company could experience
increased bad debt expense should a financial downturn
occur.
Equipment.
Equipment is stated at cost less accumulated
depreciation and amortization. Maintenance and repairs are charged
to expense as incurred. Renewals and betterments which extend the
life or improve existing equipment are capitalized. Upon
disposition or retirement of equipment, the cost and related
accumulated depreciation are removed and any resulting gain or loss
is reflected in operations. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets,
which are 3 to 10 years.
Oil and Gas Properties, Successful Efforts Method.
The
successful efforts method of accounting is used for oil and gas
exploration and production activities. Under this method, all costs
for development wells, support equipment and facilities, and proved
mineral interests in oil and gas properties are capitalized.
Geological and geophysical costs are expensed when incurred. Costs
of exploratory wells are capitalized as exploration and evaluation
assets pending determination of whether the wells find proved oil
and gas reserves. Proved oil and gas reserves are the estimated
quantities of crude oil and natural gas which geological and
engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing
economic and operating conditions, (i.e., prices and costs as of
the date the estimate is made). Prices include consideration of
changes in existing prices provided only by contractual
arrangements, but not on escalations based upon future
conditions.
Exploratory
wells in areas not requiring major capital expenditures are
evaluated for economic viability within one year of completion of
drilling. The related well costs are expensed as dry holes if it is
determined that such economic viability is not attained. Otherwise,
the related well costs are reclassified to oil and gas properties
and subject to impairment review. For exploratory wells that are
found to have economically viable reserves in areas where major
capital expenditure will be required before production can
commence, the related well costs remain capitalized only if
additional drilling is under way or firmly planned. Otherwise the
related well costs are expensed as dry holes.
Exploration
and evaluation expenditures incurred subsequent to the acquisition
of an exploration asset in a business combination are accounted for
in accordance with the policy outlined above.
Depreciation,
depletion and amortization of capitalized oil and gas properties is
calculated on a field by field basis using the unit of production
method. Lease acquisition costs are amortized over the total
estimated proved developed and undeveloped reserves and all other
capitalized costs are amortized over proved developed
reserves.
Impairment of Long-Lived Assets.
The Company reviews
the carrying value of its long-lived assets annually or whenever
events or changes in circumstances indicate that the historical
cost-carrying value of an asset may no longer be appropriate. The
Company assesses recoverability of the carrying value of the asset
by estimating the future net undiscounted cash flows expected to
result from the asset, including eventual disposition. If the
future net undiscounted cash flows are less than the carrying value
of the asset, an impairment loss is recorded equal to the
difference between the asset’s carrying value and estimated
fair value.
Asset Retirement Obligations.
If a reasonable estimate
of the fair value of an obligation to perform site reclamation,
dismantle facilities or plug and abandon wells can be made, the
Company will record a liability (an asset retirement obligation or
“ARO”) on its consolidated balance sheet and capitalize
the present value of the asset retirement cost in oil and gas
properties in the period in which the retirement obligation is
incurred. In general, the amount of an ARO and the costs
capitalized will be equal to the estimated future cost to satisfy
the abandonment obligation assuming the normal operation of the
asset, using current prices that are escalated by an assumed
inflation factor up to the estimated settlement date, which is then
discounted back to the date that the abandonment obligation was
incurred using an assumed cost of funds for the Company. After
recording these amounts, the ARO will be accreted to its future
estimated value using the same assumed cost of funds and the
capitalized costs are depreciated on a unit-of-production basis
over the estimated proved developed reserves. Both the accretion
and the depreciation will be included in depreciation, depletion
and amortization expense on our consolidated statements of
operations.
The
following table describes changes in our asset retirement
obligations during the nine months ended September 30, 2018
and 2017 (in thousands):
|
|
|
Asset retirement
obligations at January 1
|
$
477
|
$
246
|
Accretion
expense
|
84
|
134
|
Obligations
incurred for acquisition
|
2,061
|
-
|
Changes in
estimates
|
13
|
97
|
Asset retirement
obligations at September 30
|
$
2,635
|
$
477
|
Revenue Recognition.
ASU 2014-09,
“Revenue from Contracts with Customers
(Topic 606)”
, supersedes the revenue recognition
requirements and industry-specific guidance under
Revenue Recognition (Topic 605)
. Topic
606 requires an entity to recognize revenue when it transfers
promised goods or services to customers in an amount that reflects
the consideration the entity expects to be entitled to in exchange
for those goods or services. The Company adopted Topic 606 on
January 1, 2018, using the modified retrospective method applied to
contracts that were not completed as of January 1, 2018. Under the
modified retrospective method, prior period financial positions and
results will not be adjusted. The cumulative effect adjustment
recognized in the opening balances included no significant changes
as a result of this adoption. While the Company does not expect
2018 net earnings to be materially impacted by revenue recognition
timing changes, Topic 606 requires certain changes to the
presentation of revenues and related expenses beginning January 1,
2018. Refer to Note 4 – Revenue from Contracts with Customers
for additional information.
The
Company’s revenue is comprised entirely of revenue from
exploration and production activities. The Company’s oil is
sold primarily to marketers, gatherers, and refiners. Natural gas
is sold primarily to interstate and intrastate natural-gas
pipelines, direct end-users, industrial users, local distribution
companies, and natural-gas marketers. NGLs are sold primarily to
direct end-users, refiners, and marketers. Payment is generally
received from the customer in the month following
delivery.
Contracts
with customers have varying terms, including month-to-month
contracts, and contracts with a finite term. The Company recognizes
sales revenues for oil, natural gas, and NGLs based on the amount
of each product sold to a customer when control transfers to the
customer. Generally, control transfers at the time of delivery to
the customer at a pipeline interconnect, the tailgate of a
processing facility, or as a tanker lifting is completed. Revenue
is measured based on the contract price, which may be index-based
or fixed, and may include adjustments for market differentials and
downstream costs incurred by the customer, including gathering,
transportation, and fuel costs.
Revenues
are recognized for the sale of the Company’s net share of
production volumes. Sales on behalf of other working interest
owners and royalty interest owners are not recognized as
revenues.
Income Taxes.
The Company utilizes the asset and
liability method in accounting for income taxes. Under this method,
deferred tax assets and liabilities are recognized for operating
loss and tax credit carry-forwards and for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable
income in the year in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
the results of operations in the period that includes the enactment
date. A valuation allowance is recorded to reduce the carrying
amounts of deferred tax assets unless it is more likely than not
that the value of such assets will be realized.
Stock-Based Compensation.
The Company utilizes the
Black-Scholes option pricing model to estimate the fair value of
employee stock option awards at the date of grant, which requires
the input of highly subjective assumptions, including expected
volatility and expected life. Changes in these inputs and
assumptions can materially affect the measure of estimated fair
value of our share-based compensation. These assumptions are
subjective and generally require significant analysis and judgment
to develop. When estimating fair value, some of the assumptions
will be based on, or determined from, external data and other
assumptions may be derived from our historical experience with
stock-based payment arrangements. The appropriate weight to place
on historical experience is a matter of judgment, based on relevant
facts and circumstances.
The
Company estimates volatility by considering the historical stock
volatility. The Company has opted to use the simplified method for
estimating expected term, which is generally equal to the midpoint
between the vesting period and the contractual term.
Earnings (Loss) per Common Share.
Basic earnings (loss) per
share (“EPS”) is computed by dividing net income (loss)
available to common shareholders (numerator) by the weighted
average number of shares outstanding (denominator) during the
period. Diluted EPS give effect to all dilutive potential common
shares outstanding during the period using the treasury stock
method and convertible preferred stock using the if-converted
method. In computing diluted EPS, the average stock price for the
period is used to determine the number of shares assumed to be
purchased from the exercise of stock options and/or warrants.
Diluted EPS excluded all dilutive potential shares if their effect
is anti-dilutive. For the nine months ended September 30, 2018, the
dilutive potential common shares outstanding during the period
included only a portion of the potentially issuable shares of
common stock related to options and warrants as the majority of
outstanding options and warrants were anti-dilutive. The payment of
the Bridge Notes occurred before September 30, 2018, so they were
not included.
Basic
net loss per share is based on the weighted average number of
common and common-equivalent shares outstanding. The Company
incurred a net loss for the nine months ended September 30, 2017,
and therefore, basic and diluted loss per share for the period
ending September 30, 2017 is the same as all potential common
equivalent shares would be anti-dilutive. The Company excluded
473,727 potentially issuable shares of common stock related to
options, 1,248,045 potentially issuable shares of common stock
related to warrants and 147,695 potentially issuable shares of
common stock related to the conversion of Bridge Notes due to their
anti-dilutive effect for the nine months ended September 30, 2017.
Potential common shares includable in the computation of
fully-diluted per share results are not presented in the
consolidated financial statements for the nine-month period ended
September 30, 2017 as their effect would be
anti-dilutive.
See
further discussion of diluted earnings (loss) per common share in
Note 10.
Fair Value of Financial Instruments.
The Company follows
Fair Value Measurement
(“ASC 820”), which clarifies fair value as an exit
price, establishes a hierarchal disclosure framework for measuring
fair value, and requires extended disclosures about fair value
measurements. The provisions of ASC 820 apply to all financial
assets and liabilities measured at fair value.
As
defined in ASC 820, fair value, clarified as an exit price,
represents the amount that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between
market participants. As a result, fair value is a market-based
approach that should be determined based on assumptions that market
participants would use in pricing an asset or a
liability.
As a
basis for considering these assumptions, ASC 820 defines a
three-tier value hierarchy that prioritizes the inputs used in the
valuation methodologies in measuring fair value.
Level
1
– Quoted
prices in active markets for identical assets or
liabilities.
Level
2
– Inputs
other than Level 1 that are observable, either directly or
indirectly, such as quoted prices for similar assets or
liabilities, quoted prices in markets that are not active, or other
inputs that are observable or can be corroborated by observable
market data for substantially the full term of the assets or
liabilities.
Level
3
–
Unobservable inputs that are supported by little or no market
activity and that are significant to the fair value of the assets
or liabilities.
The
fair value hierarchy also requires an entity to maximize the use of
observable inputs and minimize the use of unobservable inputs when
measuring fair value.
Recently Issued Accounting Pronouncements.
In February
2016, the Financial Accounting Standards Board (“FASB”)
Accounting Standards Update (“ASU”) 2016-02, a new
lease standard requiring lessees to recognize lease assets and
lease liabilities for most leases classified as operating leases
under previous U.S. GAAP. The guidance is effective for fiscal
years beginning after December 15, 2018, with early adoption
permitted. The Company will be required to use a modified
retrospective approach for leases that exist or are entered into
after the beginning of the earliest comparative period in the
financial statements. The Company has evaluated the adoption of the
standard and, due to there being only one operating lease currently
in place, there will be minimal impact of the standard on its
consolidated financial statements.
In
April 2016, the FASB issued ASU No. 2016-09, “
Compensation – Stock
Compensation
” (Topic 718). The FASB issued this update
to improve the accounting for employee share-based payments and
affect all organizations that issue share-based payment awards to
their employees. Several aspects of the accounting for share-based
payment award transactions are simplified, including: (a) income
tax consequences; (b) classification of awards as either equity or
liabilities; and (c) classification on the statement of cash flows.
The updated guidance is effective for annual periods beginning
after December 15, 2016, including interim periods within those
fiscal years. Early adoption of the update is permitted.
The Company adopted the standard as of January 1, 2017.
There was no impact of the standard on its consolidated financial
statements.
In
August 2016, the FASB issued ASU 2016-15,
“Statement of Cash Flows (Topic 230):
Classification of Certain Cash Receipts and Cash
Payments”
(“ASU 2016-15”). ASU 2016-15
will make eight targeted changes to how cash receipts and cash
payments are presented and classified in the statement of cash
flows. ASU 2016-15 is effective for fiscal years beginning after
December 15, 2017. The new standard requires adoption
on a retrospective basis unless it is impracticable to apply, in
which case it would be required to apply the amendments
prospectively as of the earliest date practicable.
There was no impact of the standard on its consolidated
financial statements.
In
November 2016, the FASB issued ASU 2016-18,
“Statement of Cash Flows (Topic
230)”
, requiring that the statement of cash flows
explain the change in the total cash, cash equivalents, and amounts
generally described as restricted cash or restricted cash
equivalents. This guidance is effective for fiscal years, and
interim reporting periods therein, beginning after December 15,
2017, with early adoption permitted. The provisions of this
guidance are to be applied using a retrospective approach which
requires application of the guidance for all periods presented.
There was no impact of the standard on its consolidated financial
statements.
In September 2016, the FASB issued ASU
2016-13,
Financial Instruments-Credit
Losses
. ASU 2016-13 was issued
to provide more decision-useful information about the expected
credit losses on financial instruments and changes the loss
impairment methodology. ASU 2016-13 is effective for reporting
periods beginning after December 15, 2019 using a modified
retrospective adoption method. A prospective transition approach is
required for debt securities for which an other-than-temporary
impairment had been recognized before the effective date. The
Company is currently assessing the impact this accounting standard
will have on its financial statements and related
disclosures.
In
August 2018, the FASB issued ASU 2018-13, “Fair Value
Measurement (Topic 820): Disclosure Framework—Changes to the
Disclosure Requirements for Fair Value Measurement”. The
amendments in this update is to improve the effectiveness of
disclosures in the notes to the financial statements by
facilitating clear communication of the information required by
GAAP that is most important to users of each entity’s
financial statements. The amendments in this update
apply to all entities that are required, under existing GAAP, to
make disclosures about recurring or nonrecurring fair value
measurements. The amendments in this update are effective for all
entities for fiscal years beginning after December 15, 2019, and
interim periods within those fiscal years. The Company does not
expect that this guidance will have a material impact on its
consolidated financial statements.
In July
2018, the FASB issued ASU 2018-11, “Leases (Topic 842):
Target Improvements”. The amendments in this
update also clarify which Topic (Topic 842 or Topic
606) applies for the combined component. Specifically, if the
non-lease component or components associated with the lease
component are the predominant component of the combined component,
an entity should account for the combined component in accordance
with Topic 606. Otherwise, the entity should account for the
combined component as an operating lease in accordance with Topic
842. An entity that elects the lessor practical expedient also
should provide certain disclosures. The Company is currently
evaluating the adoption of this guidance and does not expect that
this guidance will have a material impact on its consolidated
financial statements. The Company has not adopted this
standard and will do so when specified by the
FASB.
In July
2018, the FASB issued ASU 2018-10, “Codification Improvements
to Topic 842, Leases”. The amendments in this
update affect narrow aspects of the guidance issued in
the amendments in update 2016-02 as described in the
table below. The amendments in this update related to
transition do not include amendments from proposed Accounting
Standards Update, Leases (Topic 842): Targeted Improvements,
specific to a new and optional transition method to adopt the new
lease requirements in Update 2016-02. That additional transition
method will be issued as part of a forthcoming and separate
update that will result in additional amendments to
transition paragraphs included in this Update to conform with the
additional transition method. The Company is currently evaluating
the adoption of this guidance and does not expect that this
guidance will have a material impact on its consolidated financial
statements. The Company has not adopted this Standard and will do
so when specified by the FASB.
In June
2018, the FASB issued ASU 2018-07, “Compensation—Stock
Compensation (Topic 718): Improvements to Nonemployee Share-Based
Payment Accounting”. The amendments in this update maintain
or improve the usefulness of the information provided to the users
of financial statements while reducing cost and complexity in
financial reporting. The areas for simplification in this
update involve several aspects of the accounting for
nonemployee share-based payment transactions resulting from
expanding the scope of Topic 718, to include share-based payment
transactions for acquiring goods and services from nonemployees.
Some of the areas for simplification apply only to nonpublic
entities. The amendments in this update are effective for all
entities for fiscal years beginning after December 15, 2018, and
interim periods within those fiscal years. The Company does not
expect that this guidance will have a material impact on its
consolidated financial statements.
The
Company does not expect the adoption of any recently issued
accounting pronouncements to have a significant impact on its
financial position, results of operations, or cash
flows.
Subsequent Events.
The Company has evaluated all
transactions through the date the consolidated financial statements
were issued for subsequent event disclosure
consideration.
NOTE 4 – REVENUE FROM CONTRACTS WITH CUSTOMERS
Change in Accounting Policy.
The Company adopted ASU
2014-09,
“Revenue from
Contracts with Customers (Topic 606)”
, on January 1,
2018, using the modified retrospective method applied to contracts
that were not completed as of January 1, 2018. Refer to Note 3
– Summary of Significant Accounting Policies for additional
information.
Exploration and Production.
There were no significant
changes to the timing or valuation of revenue recognized for sales
of production from exploration and production
activities.
Disaggregation of Revenue from Contracts with Customers.
The
following table disaggregates revenue by significant product type
for the three and nine months ended September 30, 2018 (in
thousands):
|
Three Months
Ended
September 30,
2018
|
Nine Months
Ended
September 30,
2018
|
|
|
|
Oil
sales
|
$
1,173
|
2,552
|
Natural gas
sales
|
50
|
144
|
Natural gas liquids
sales
|
36
|
105
|
Total revenue from
customers
|
$
1,259
|
2,801
|
There
were no significant contract liabilities or transaction price
allocations to any remaining performance obligations as of December
31, 2017 or September 30, 2018.
NOTE 5 – OIL AND GAS PROPERTIES
The
following table summarizes the Company’s oil and gas
activities by classification for the nine months ended September
30, 2018 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Oil and gas
properties, subject to amortization
|
$
68,306
|
$
20,017
|
$
-
|
$
-
|
$
88,323
|
Oil and gas
properties, not subject to amortization
|
-
|
-
|
-
|
-
|
-
|
Asset retirement
costs
|
260
|
2,074
|
-
|
-
|
2,334
|
Accumulated
depreciation, depletion and impairment
|
(33,644
)
|
(2,136
)
|
-
|
-
|
(35,780
)
|
Total oil and gas
assets
|
$
34,922
|
$
19,955
|
$
-
|
$
-
|
$
54,877
|
The
depletion recorded for production on proved properties for the
three and nine months ended September 30, 2018 and 2017, amounted
to $885,000 compared to $1,304,000, and $2,136,000 compared to
$2,824,000, respectively.
For the
three and nine months ended September 30, 2018, the Company has
incurred $29,000 in drilling costs, in addition to amounts incurred
for the participation (non-operated working interest) in the
drilling of two wells in the DJ Basin ($295,000), the acquisition
of Condor ($693,000 as detailed below) and the acquisition of the
New Mexico assets ($19,000,000 as detailed below).
Acquisition of New Mexico Properties
On August 1, 2018, the Company entered into a Purchase and Sale
Agreement with Milnesand Minerals Inc., Chaveroo Minerals Inc.,
Ridgeway Arizona Oil Corp. (“RAOC”), and EOR Operating
Company (“EOR”) (collectively the
“Seller”)(the “Purchase Agreement”). The
transaction closed on August 31, 2018, and the effective date of
the acquisition was September 1, 2018. Pursuant to the Purchase
Agreement, the Company acquired certain oil and gas assets
described in greater detail below (the “Assets”) from
the Seller in consideration for $18,500,000 (of which $500,000 was
held back to provide for potential indemnification of the Company
under the Purchase Agreement and Stock Purchase Agreement
(described below), with one-half ($250,000) to be released to
Seller 90 days after closing and the balance ($250,000) to be
released 180 days after closing (provided that if a court of
competent jurisdiction determines that any part of the amount
withheld by the Company subsequent to 180 days after closing was in
fact due to the Seller, the Company is required to pay the Seller
200%, instead of 100%, of the amount so retained).
The Assets represent approximately 23,000 net leasehold acres,
current operated production, and all the Seller’s leases and
related rights, oil and gas and other wells, equipment, easements,
contract rights, and production (effective as of the effective
date) as described in the Purchase Agreement. The Assets are
located in the San Andres play in the Permian Basin situated in
West Texas and Eastern New Mexico, with all acreage and production
100% operated, and substantially all acreage held by production
(“HBP”).
Also on August 31, 2018, the Company closed the transactions under
the August 1, 2018 Stock Purchase Agreement with Hunter Oil
Production Corp. (“Hunter Oil”), and acquired all the
stock of RAOC and EOR (the “Acquired Companies”) for
net cash paid of $500,000 (an aggregate purchase price of
$2,816,000, less $2,316,000 in restricted
cash which the Acquired Companies are required to maintain as of
the closing date). The Stock Purchase Agreement contains customary
representations and warranties of the parties, post-closing
adjustments, and indemnification requirements requiring Hunter Oil
to indemnify us for certain items.
The following table summarizes the allocation of the purchase price
to the net assets acquired (in thousands):
Purchase
price at September 1, 2018
|
|
Cash
paid
|
$
20,816
|
|
500
|
|
$
21,316
|
|
|
Fair
value of net assets acquired at September 1, 2018
|
|
Restricted
cash for bonds
|
$
2,316
|
Oil
and gas properties, subject to amortization
|
21,012
|
Total
assets
|
23,328
|
|
|
Asset
retirement obligations
|
2,012
|
Total
liabilities
|
2,012
|
Net
assets acquired
|
$
21,316
|
The following table presents the Company’s supplemental
consolidated pro forma total revenues, lease operating costs, net
income (loss) and net income (loss) per common share as if the
acquisition of the New Mexico assets had occurred on January 1,
2018 (in thousands except for share and per share
amounts):
|
For the Nine Months Ended
September 30, 2018
|
|
|
|
|
Revenue
|
$
2,801
|
$
1,222
|
$
4,023
|
Lease
operating costs
|
$
(1,665
)
|
$
(931
)
|
$
(2,596
)
|
Net
income (loss)
|
$
59,323
|
$
(1,481
)
|
$
57,842
|
Net
income (loss) per common share (diluted)
|
$
5.97
|
$
(0.15
)
|
$
5.82
|
(1)
|
Amounts are based on Company estimates.
|
Acquisition of Condor Properties from MIE Jurassic Energy
Corporation
On August 1, 2018, the Company entered into a Membership Interest
Purchase Agreement (the “Membership Purchase
Agreement”) with MIE Jurassic Energy Corporation
(“MIEJ”) to acquire 100% of the outstanding membership
interests of Condor from MIEJ in exchange for cash paid of
$537,000. Condor owns approximately 2,340 net leasehold acres, 100%
HBP, located in Weld and Morgan Counties, Colorado, with four
operated, producing wells.
The following table summarizes the allocation of the purchase price
to the net assets acquired (in thousands):
Purchase
price at August 1, 2018
|
|
|
$
537
|
|
|
Fair
value of net assets acquired at August 1, 2018
|
|
Cash
|
$
2
|
Accounts
receivable – oil and gas
|
59
|
Other
current assets
|
39
|
Oil
and gas properties, subject to amortization
|
742
|
Bonds
|
105
|
Total
assets
|
947
|
|
|
Current
liabilities
|
361
|
Asset
retirement obligations
|
49
|
Total
liabilities
|
410
|
Final
Purchase price
|
$
537
|
NOTE 6 – ACCOUNTS RECEIVABLE
On
November 19, 2015, the Company entered into a Letter Agreement with
certain parties including
Dome
Energy AB and a subsidiary thereto (together, “Dome
Energy”)
, pursuant to which Dome Energy agreed to
acquire the Company’s interests in eight wells and fully fund
the Company’s proportionate share of all the corresponding
working interest owner expenses with respect to these eight wells.
The Company assigned its interests in these wells to Dome Energy
effective November 18, 2015, and Dome Energy assumed all amounts
owed for the drilling and completion costs corresponding to these
interests acquired from the Company. As part of this transaction,
Dome Energy also agreed to pay an additional $250,000 to the
Company in the event a prior anticipated merger with Dome Energy
(which transaction was subsequently abandoned by the parties) was
not consummated. In connection with the assignment of these well
interests, Dome Energy issued a contingent promissory note to the
Company, dated November 19, 2015 (the “Dome Promissory
Note”), with a principal amount of $250,000, which was due to
mature on December 29, 2015, upon the termination of the
anticipated merger with Dome Energy.
On
March 24, 2015, Red Hawk and Dome Energy entered into a Service
Agreement, pursuant to which Red Hawk agreed to provide certain
human resource and accounting services to Dome Energy, of which
$156,000 remained due and payable by Dome Energy to Red Hawk as of
December 31, 2015. On March 29, 2016, the Company entered into a
Settlement Agreement with Dome Energy and certain of its affiliated
entities, pursuant to which the Company and Dome Energy agreed to
terminate and cancel the Service Agreement and settle a number of
outstanding matters, with Dome Energy agreeing to pay to Red Hawk
$50,000 on May 2, 2016, in full satisfaction of the amounts due
under the Service Agreement, with all remaining amounts owed
forgiven by Red Hawk. As of December 31, 2015, the receivable due
from Dome Energy totaled $406,000. During the year ended December
31, 2016, the net receivable created by the Dome Promissory Note
was reduced to $25,000 by (i) the collection of the $250,000 as
described above, (ii) forgiveness by the Company of $106,000 due
from Dome Energy pursuant to the Settlement Agreement, and (iii)
the recording of an allowance of $25,000 as a doubtful account
(which was recognized as bad debt expense in selling, general and
administrative expense on the Company’s income statement). As
of December 31, 2016, the $50,000 was still due from Dome to
Red Hawk as a part of the Settlement Agreement. The Company
recorded an allowance for doubtful accounts as of December 31, 2016
of $25,000 related to this outstanding amount, as $25,000 of the
$50,000 was collected in early 2017. During the three months ended
March 31, 2017, the net receivable created by the Dome
Promissory Note was equal to $25,000 due to (i) the collection of
the $25,000 in January 2017, and (ii) the reversal of the allowance
of $25,000 as a doubtful account (and credited to bad debt expense
in selling, general and administrative expense on the
Company’s income statement) due to the collection in April
2017 of the final $25,000 that had been due (the Company had no
allowance for doubtful accounts as of March 31, 2017). As of
December 31, 2017 and September 30, 2018, the net receivable
created by the Dome Promissory Note was $-0-.
NOTE 7 – OTHER CURRENT ASSETS
On
September 11, 2013, the Company entered into a Shares Subscription
Agreement (“SSA”) to acquire an approximate 51%
ownership in Asia Sixth Energy Resources Limited (“Asia
Sixth”), which held an approximate 60% ownership interest in
Aral Petroleum Capital Limited Partnership (“Aral”), a
Kazakhstan entity. In August 2014 the SSA was restructured (the
“Aral Restructuring”), in connection with which the
Company received a promissory note in the principal amount of $10.0
million from Asia Sixth (the “A6 Promissory Note”),
which was to be converted into a 10.0% interest in Caspian Energy,
Inc. (“Caspian Energy”), an Ontario, Canada company
listed on the NEX board of the TSX Venture Exchange, upon the
consummation of the Aral Restructuring. The Aral Restructuring was
consummated on May 20, 2015, upon which date the A6 Promissory Note
was converted into 23,182,880 shares of common stock of Caspian
Energy.
In
February 2015, the Company expanded its D-J Basin position through
the acquisition of acreage from Golden Globe Energy (US), LLC
(“GGE”) (the “GGE Acquisition” and the
“GGE Acquired Assets”). In connection with the GGE
Acquisition, on February 23, 2015, the Company provided GGE an
option to acquire its interest in Caspian Energy for $100,000
payable upon exercise of the option (which expires on the same date
as the RJC Subordinated Note, as defined below) recorded in prepaid
expenses and other current assets. As a result, the carrying value
of the 23,182,880 shares of common stock of Caspian Energy which
were issued upon conversion of the A6 Promissory Note at December
31, 2015 was $100,000. The $100,000 option is classified as part of
other current assets as of September 30, 2018 and December 31,
2017.
NOTE 8 – NOTES PAYABLE
Debt Restructuring
On June
26, 2018, the Company borrowed $7.7 million from SK Energy LLC,
which is 100% owned and controlled by Dr. Simon Kukes, the
Company’s Chief Executive Officer and director, under a
Promissory Note dated June 25, 2018, in the amount of $7.7 million
(the “SK Energy Note”), the terms of which are
discussed below.
Also on
June 25, 2018, the Company entered into Debt Repayment Agreements
(the “Repayment Agreements”, each described in greater
detail below) with (i) the holders of our outstanding Tranche A
Secured Promissory Notes (“Tranche A Notes”) and
Tranche B Secured Promissory Notes (“Tranche B Notes”),
which the Company entered into pursuant to the terms of the May 12,
2016 Amended and Restated Note Purchase Agreement, (ii) RJ Credit
LLC (“RJC”), which held a subordinated promissory note
issued by the Company pursuant to that certain Note and Security
Agreement, dated April 10, 2014, as amended (the “RJC
Subordinated Note”), and (iii) MIE Jurassic Energy
Corporation, which held a subordinated promissory note issued by
the Company pursuant to that certain Amended and Restated Secured
Subordinated Promissory Note, dated February 18, 2015, as amended
(the “MIEJ Note”, and together with the “Tranche
B Notes,” the “Junior Notes”), pursuant to which,
on June 26, 2018, the Company retired all of the then outstanding
Tranche A Notes, in the aggregate amount of approximately
$7,260,000 in exchange for cash paid of $3,800,000 and all of the
then outstanding Junior Notes, in the aggregate amount of
approximately $70,299,000, in exchange for an aggregate amount of
cash paid of $3,876,000.
As part
of the same transactions, and as required conditions to closing the
sale of the SK Energy Note, SK Energy entered into a Stock Purchase
Agreement with GGE, the holder of the Company’s then
outstanding 66,625 shares of Series A Convertible Preferred Stock
(convertible pursuant to their terms into 6,662,500 shares of the
Company’s common stock – approximately 47.6% of the
Company’s then outstanding shares post-conversion), pursuant
to which, SK Energy purchased, for $100,000, all of the Series A
Convertible Preferred Stock (the “Stock Purchase
Agreement”).
Additionally,
on June 25, 2018, the Company entered into a Debt Repayment
Agreement (the “Bridge Note Repayment Agreement”) with
all of the holders of its convertible subordinated promissory notes
issued pursuant to the Second Amendment to Secured Promissory
Notes, dated March 7, 2014, originally issued on March 22, 2013
(the “Bridge Notes”), pursuant to which all the
holders, holding in aggregate $475,000 of outstanding principal
amount under the Bridge Notes, agreed to the payment and full
satisfaction of all outstanding amounts (including accrued interest
and additional payment-in-kind) for 25% of the principal amounts
owed thereunder, or an aggregate amount of cash paid of
$119,000.
The
result of the above transactions was a net reduction of liabilities
of approximately $70,728,000 that were removed from the
Company’s balance sheet as of June 25, 2018. For the nine
months ended September 30, 2018, a gain on the settlement of all of
these debts in the amount of $70,309,000 was recorded ($70,631,000,
net of the expense related to the issuance of warrants to certain
of the Tranche A Note holders with an estimated fair value of
$322,000 based on the Black-Scholes option pricing model). See the
table below for a summary (amounts in thousands).
Debt and accrued
interest retired as part of debt restructuring
|
$
78,331
|
New debt recorded
under troubled debt restructuring
|
(7,700
)
|
Expense for
issuance of warrants
|
(322
)
|
Net gain on
troubled debt restructuring
|
$
70,309
|
The
three-year promissory note of $7.7 million in principal with an 8%
annual interest rate was recorded at $7,700,000 (and shown on the
balance sheet as Note Payable – Related Party), net of debt
discount from the issuance of 600,000 shares of common stock (as
described below) with a fair value of $185,000 based on the market
price at the issuance date. The Company accounted for the debt
reduction as a troubled debt restructuring as the debt balance,
which the Company did not currently have the funds to repay, was
now to be classified as current due to the principal and
accumulated interest being due in May 2019. It is probable that the
Company would have been in payment default in the foreseeable
future without this restructuring modification. As indicated in
previous SEC financial filings, the Company had indicated that
there was doubt before the restructuring as to whether the Company
would be able to continue to operate as a going concern. In
recognition of this, the creditors granted a concession on the debt
balance that was paid and considered payment in full on June 25,
2018. The warrants were issued as an inducement for the previous
creditors to cancel a significant portion of the debt and were an
integral part of this troubled debt restructuring and therefore
were included as a reduction to the gain recognized on the
restructuring.
SK Energy Note Terms
The SK
Energy Note accrues interest monthly at 8% per annum, payable
quarterly (beginning October 15, 2018), in either cash or shares of
common stock (at the option of the Company), or, with the consent
of SK Energy, such interest may be accrued and capitalized.
Additionally, in the event that the Company is prohibited from
paying the interest payments due on the SK Energy Note in cash
pursuant to the terms of its senior debt and/or the requirement
that the Company obtain shareholder approval for the issuance of
shares of common stock in lieu of interest due under the SK Energy
Note due to the Share Cap (described and defined below), such
interest will continue to accrue until such time as the Company can
either pay such accrued interest in cash or stock.
If
interest on the SK Energy Note is paid in common stock, SK Energy
will be due that number of shares of common stock as equals the
amount due divided by the average of the closing sales prices of
the Company’s common stock for the ten trading days
immediately preceding the last day of the calendar quarter prior to
the applicable payment date, rounded up to the nearest whole share
of common stock (the “Interest Shares”). The SK Energy
Note is due and payable on June 25, 2021, but may be prepaid at any
time, without penalty. Other than in connection with the Interest
Shares, the principal amount of the SK Energy Note is not
convertible into common stock of the Company. The SK Energy Note
contains standard and customary events of default, and, upon the
occurrence of an event of default, the amount owed under the SK
Energy Note accrues interest at 10% per annum.
As
additional consideration for SK Energy agreeing to the terms of the
SK Energy Note, the Company agreed to issue SK Energy 600,000
shares of common stock (the “Loan Shares”), with a fair
value of $185,000 based on the market price on the date of issuance
that was accounted for as a debt discount and is being amortized
over the term of the note. The SK Energy Note includes a share
issuance limitation preventing the Company from issuing Interest
Shares thereunder, if such issuance, together with the number of
Loan Shares, plus such number of Interest Shares issued previously,
as of the date of such new issuance, totals more than 19.99% of the
Company’s outstanding shares of common stock as of June 25,
2018 (i.e., 1,455,023 shares) (the “Share
Cap”).
Repayment Agreement Terms
As
described above, pursuant to the Repayment Agreements, the holders
of the Company’s outstanding Tranche A Notes and Junior Notes
retired all of the then outstanding Tranche A Notes, in the
aggregate amount of $7,260,000, in exchange for an aggregate of
$3,800,000 of cash and all of the then outstanding Junior Notes, in
the aggregate amount of $70,299,000, in exchange for an aggregate
of $3,876,000 of cash. The note holders also agreed to forgive all
amounts owed under the terms of the Tranche A Notes and Junior
Notes, as applicable, other than the amounts paid. The Tranche A
Note Repayment Agreement was entered into by and between the
Company and each of the then holders of the Company’s Tranche
A Notes, BBLN-PEDCO Corp., BHLN-PEDCO Corp. and PBLA ULICO 2017
(collectively, the “Tranche A Noteholders”). The
Tranche B Note Repayment Agreement was entered into by and between
the Company and each of the then holders of the Company’s
Tranche B Notes, Senior Health Insurance Company of Pennsylvania,
Bankers Conseco Life Insurance Company, Washington National
Insurance Company, Principal Growth Strategies, LLC, Cadle Rock IV,
LLC, and RJ Credit LLC, and holders of the RJC Subordinated Note
held by RJ Credit LLC and the MIEJ Note held by MIE Jurassic Energy
Corporation (collectively, the “Junior Noteholders”).
Pursuant to the terms of the Repayment Agreement relating to the
Tranche B Notes, in addition to the cash consideration due to the
Tranche B Noteholders, as described above, the Company agreed to
grant to certain of the Junior Noteholders their pro rata share of
warrants to purchase an aggregate of 1,448,472 shares of common
stock of the Company (the “Tranche B Warrants”). The
Tranche B Warrants have a term of three years, an exercise price
equal to $0.328 per share, and the estimated fair value of $322,000
was based on the Black-Scholes option pricing model.
Amendment to Series A Convertible Preferred Stock Designation;
Rights of Shareholders
In
connection with the Stock Purchase Agreement, and immediately
following the closing of the acquisition described in the Stock
Purchase Agreement (discussed above), the Company and SK Energy, as
the then holder of all of the then outstanding shares of Series A
Convertible Preferred Stock, agreed to the filing of an Amendment
to the Amended and Restated Certificate of Designations of PEDEVCO
Corp. Establishing the Designations, Preferences, Limitations and
Relative Rights of Its Series A Convertible Preferred Stock (the
“Preferred Amendment”), which amended the designation
of our Series A Convertible Preferred Stock (the
“Designation”) to remove the beneficial ownership
restriction contained therein, which prevented any holder of Series
A Convertible Preferred Stock from converting such Series A
Convertible Preferred Stock into shares of common stock of the
Company if such conversion would result in the holder thereof
holding more than 9.9% of the Company’s then outstanding
common stock.
The
Company filed the Preferred Amendment with the Secretary of State
of Texas on June 26, 2018.
As a
result of the Stock Purchase Agreement (i.e., the sale of the
Series A Convertible Preferred Stock to a party other than GGE),
automatic termination, pursuant to the terms of the Designation, of
the right of GGE, upon notice to the Company, voting the Series A
Convertible Preferred Stock separately as a single class, to
appoint designees to fill up to two (2) seats on our Board of
Directors, one of which must be an independent director as defined
by applicable rules was triggered. As such, effective upon the
closing of the Stock Purchase Agreement, the Company’s common
stockholders have the right to appoint all members of our Board of
Directors via plurality vote.
Note Purchase Agreement and Sale of Secured Promissory
Notes
On
March 7, 2014, the Company entered into a $50 million financing
facility (the “Notes Purchase Agreement”) between the
Company, BRe BCLIC Primary, BRe BCLIC Sub, BRe WNIC 2013 LTC
Primary, BRe WNIC 2013 LTC Sub, and RJC, as investors
(collectively, the “Investors”), and BAM Administrative
Services LLC, as agent for the Investors (the “Agent”).
The Company issued the Investors Secured Promissory Notes in the
aggregate principal amount of $34.5 million (the “Initial
Notes”). On March 19, 2015, BRe WNIC 2013 LTC Primary
transferred a portion of its Initial Note to HEARTLAND Bank, and
effective April 1, 2015, BRe BCLIC Primary transferred its Initial
Note to Senior Health Insurance Company of Pennsylvania
(“SHIP”), with each of HEARTLAND Bank and SHIP becoming
an “Investor” for purposes of the discussion below.
Effective March 9, 2018, CadleRock IV, LLC acquired all of
HEARTLAND’s interests in the Senior Notes, becoming an
“Investor” for purposes of the discussion
below.
2016 Senior Note Restructuring
On May
12, 2016 (the “Closing Date”), the Company entered into
an Amended and Restated Note Purchase Agreement (the “Amended
NPA”), with existing lenders SHIP, BRe BCLIC Sub, BRe WINIC
2013 LTC Primary, BRe WNIC 2013 LTC Sub, Heartland Bank (assigned
to CadleRock IV, LLC in March 2018), and RJC, and new lenders
BHLN-Pedco Corp. (“BHLN”) and BBLN-Pedco Corp.
(“BBLN,” and together with BHLN and RJC, the
“Tranche A Investors”) (the investors in the Tranche B
Notes (defined below) and the Tranche A Investors, collectively,
the “Lenders”), and the Agent, as agent for the
Lenders. The Amended NPA amended and restated the Senior Notes held
by the Investors, and the Company issued new Senior Secured
Promissory Notes to each of the Investors (collectively, the
“Tranche B Notes”) in a transaction that qualified as a
troubled debt restructuring. RJC is also a party to the RJC
Subordinated Note (discussed below under Notes Payable -
Subordinated Note Payable Assumed).
Subsequently,
certain of the Lenders transferred some or all of the principal
outstanding under the New Senior Notes (as defined below) held by
them and the term Lenders as used herein refers to the current
holders of the New Senior Notes, as applicable.
The
Amended NPA created and issued to the Tranche A Investors new
“Tranche A Notes,” in substantially the same form and
with similar terms as the Tranche B Notes, except as discussed
below, consisting of a term loan issuable in tranches with a
maximum aggregate principal amount of $25,960,000, with borrowed
funds accruing interest at 15% per annum, and maturing on May 11,
2019 (the “Tranche A Maturity Date”) (the
“Tranche A Notes,” and together with the Tranche B
Notes, the “New Senior Notes”).
On June
25, 2018, the Company entered into Debt Repayment Agreements (the
“Repayment Agreements”, each described in greater
detail above), pursuant to which, the holders of our outstanding
Tranche A Notes and Junior Notes retired all of the then
outstanding Tranche A Notes, in the aggregate amount of $7,260,000,
in exchange for an aggregate of $3,800,000 of cash and all of the
then outstanding Junior Notes, in the aggregate amount of
$70,299,000, in exchange for an aggregate of $3,876,000 in cash.
The note holders also agreed to forgive all amounts owed under the
terms of the Tranche A Notes and Junior Notes, as applicable, other
than the amounts paid.
The
amount of interest deferred under the Tranche A and Tranche B Notes
as of June 25, 2018 and December 31, 2017 equaled $4,125,000 and
$3,195,000, respectively, and was previously accounted for on the
balance sheet under long-term accrued expenses and accrued expenses
- related party.
All
debt discount amounts were amortized using the effective interest
rate method. The total amount of the remaining debt discount
reflected on the accompanying balance sheet as of September 30,
2018 was $-0-. As of June 25, 2018 and December 31, 2017, the
remaining unamortized debt discount was $2,359,000 and $3,751,000,
respectively. Amortization of debt discount and total interest
expense for the notes (New Senior Notes – Tranche A and
Tranche B Notes and the Junior Notes) was $1,391,000 and
$4,732,000, respectively, for the nine months ended
September 30, 2018 and $2,434,000 and $5,025,000,
respectively, for the nine months ended September 30,
2017.
Bridge Note Financing
On June
25, 2018, the Company entered into a Debt Repayment Agreement (the
“Bridge Note Repayment Agreement”) with all of the
holders of its convertible subordinated promissory notes issued
pursuant to that certain Second Amendment to Secured Promissory
Notes, dated March 7, 2014, originally issued on March 22, 2013
(the “Bridge Notes”), which notes had an aggregate
principal balance of $475,000, plus accrued interest of $258,000
and additional payment-in-kind (“PIK”) of $48,000, as
of June 25, 2018, pursuant to which all the holders agreed to the
payment and full satisfaction of all outstanding amounts (including
accrued interest and additional payment-in-kind) for 25% of the
principal amounts owed thereunder, or an aggregate of
$119,000.
The
unamortized debt premium on the Convertible Bridge Notes as of June
25, 2018 and December 31, 2017, was $113,000. The gain recorded in
June 2018 on the settlement of the bridge note debt
was $775,000 and $-0-, respectively.
The
interest expense related to these notes for the three and nine
months ended September 30, 2018 and 2017 was $-0- compared to
$15,000, and $27,000 compared to $43,000,
respectively.
MIE Jurassic Energy Corporation
On
February 14, 2013, PEDCO entered into a Secured Subordinated
Promissory Note with MIEJ (as amended from time to
time, the “MIEJ Note”).
In
February 2015, the Company and PEDCO entered into a Settlement
Agreement with MIEJ and issued a new promissory note in the amount
of $4.925 million to MIEJ (the “NEW MIEJ Note”). The
Settlement Agreement related to the February 2015 disposition of
the Company’s interest in Condor Energy Technology, LLC, a
joint venture previously owned 20% by the Company and 80% by MIEJ.
As of June 25, 2018, the principal amount outstanding under the
MIEJ Note was $4,925,000 with accrued interest of
$1,718,000.
As
described above, on June 25, 2018, the Company entered into
Repayment Agreements, with various parties, including MIEJ,
pursuant to which the Company retired all of the then outstanding
MIEJ debt in exchange for an aggregate of $320,000 in cash. As
described above, pursuant to the Repayment Agreements, the note
holders also agreed to forgive all amounts owed under the terms of
the Junior Notes, as applicable, other than the amounts paid. The
gain recorded in the three and six months ending June 30, 2018 on
the settlement of the MIEJ debt was $6,323,000.
The
interest expense related to this note for the three and nine months
ended September 30, 2018 and 2017 was $-0-compared to $123,000 and
$241,000 compared to $369,000, respectively, with the total
cumulative interest equal to $1,718,000 through June 25, 2018 and
September 30, 2018.
Subordinated Note Payable Assumed
In
2015, the Company assumed approximately $8.35 million of
subordinated note payable from GGE in the acquisition of the GGE
Acquired Assets (the “RJC Subordinated Note”). The
amount outstanding on the RJC Subordinated Note as of June 25, 2018
and December 31, 2017 was $12,173,000 and $11,483,000,
respectively. The lender under the RJC Subordinated Note is RJC,
which is one of the lenders under the Senior Notes and is an
affiliate of GGE.
As
described above, on June 25, 2018, the Company entered into
Repayment Agreements with various parties, including RJ Credit LLC,
pursuant to which, on June 26, 2018, the Company retired all of the
then outstanding Junior Notes, in exchange for an aggregate of
$3,876,000 in cash.
As
described above, pursuant to the Repayment Agreements, the note
holders also agreed to forgive all amounts owed under the terms of
the Junior Notes, as applicable, other than the amounts paid.
The
interest expense related to this note for the three and six months
ended June 30, 2018 and 2017 was $342,000 compared to $322,000, and
$690,000 compared to $630,000, respectively.
New Interest on Existing SK Energy Note
As
described in greater detail above under “Note 8 – Notes
Payable – Debt Restructuring”, on June 26, 2018, the
Company borrowed $7.7 million from SK Energy under the SK Energy
Note.
The SK
Energy Note accrues interest monthly at 8% per annum, payable
quarterly (beginning October 15, 2018), in either cash or shares of
common stock (at the option of the Company), or, with the consent
of SK Energy, such interest may be accrued and capitalized. The SK
Energy Note is due and payable on June 25, 2021, but may be prepaid
at any time, without penalty. Other than in connection with the
Interest Shares, the principal amount of the SK Energy Note is not
convertible into common stock of the Company.
The
amount of interest deferred under the SK Energy Note as of
September 30, 2018 and December 31, 2017 equaled $167,000 and $-0-,
respectively, and is accounted for on the balance sheet under
short-term accrued expenses - related party. As described below in
Note 14, on October 25, 2018, we converted $167,000 of
accrued interest on the SK Energy Note into 75,118 shares of common
stock.
All
debt discount amounts were amortized using the effective interest
rate method. The total amount of the remaining debt discount
reflected on the accompanying balance sheet as of September 30,
2018 and December 31, 2017 was $173,000 and $-0-, respectively.
Amortization of debt discount and total interest expense for the SK
Energy Note was $12,000 and $167,000, respectively, for the three
and nine months ended September 30, 2018 and $-0- and $-0-,
respectively, for the three and nine months ended September 30,
2017.
Issuance of New Debt
On
August 1, 2018, the Company received total proceeds of $23,600,000
from the sale of multiple Convertible Promissory Notes (the
“Convertible Notes”). A total of $22,000,000 in
Convertible Notes were purchased by SK Energy; $200,000 in
Convertible Notes were purchased by an executive officer of SK
Energy; $500,000 in Convertible Notes were purchased by a trust
affiliated with John J. Scelfo, a director of the Company; $500,000
in Convertible Notes were purchased by an entity affiliated with
Ivar Siem, our director, and J. Douglas Schick, President of the
Company;
$200,000 in Convertible Notes
was purchased by H. Douglas Evans
(who became a Director and
related party on September 27, 2018)
;
and $200,000 in Convertible Notes were
purchased by an unaffiliated party. The $23,600,000 is accounted
for on the balance sheet as $23,200,000 of subordinated notes
payable – related party and $400,000 as subordinated notes,
as these notes are subordinated to the original SK Energy Note
issued in June 2018.
The
Convertible Notes accrue interest monthly at 8.5% per annum, which
interest is payable on the maturity date unless otherwise converted
into our common stock as described below. The accrued interest
expense related to these notes for the three and nine months ended
September 30, 2018 was $316,000, and $-0- for the three and nine
month ended September 30, 2017. The accrued interest is accounted
for on the balance sheet as of September 30, 2018 as $310,000 of
accrued interest – related party and $6,000 of accrued
interest.
The
Convertible Notes and all accrued interest thereon are convertible
into shares of our common stock, from time to time after August 29,
2018, at the option of the holders thereof, at a conversion price
equal to the greater of (x) $0.10 above the greater of the book
value of the Company’s common stock and the closing sales
price of the Company’s common stock on the date the
Convertible Notes were entered into (the “Book/Market
Price”) (which was $2.03 per share); (y) $1.63 per share; and
(z) the VWAP Price, defined as the volume weighted average price
(calculated by aggregate trading value on each trading day) of the
Company’s common stock for 20 trading days.
The
conversion of the SK Energy Convertible Note is subject to a 49.9%
conversion limitation (for so long as SK Energy or any of its
affiliates holds such note), which prevents the conversion of any
portion thereof into common stock of the Company if such conversion
would result in SK Energy beneficially owning (as such term is
defined in the Securities Exchange Act of 1934, as amended)
(“Beneficially Owning”) more than 49.9% of the
Company’s outstanding shares of common stock.
The
conversion of the other Convertible Notes is subject to a 4.99%
conversion limitation, at any time such note is Beneficially Owned
by any party other than (i) SK Energy or any of its affiliates
(which is subject to the separate conversion limitation described
above); (ii) any officer of the Company; (iii) any director of the
Company; or (iv) any person which at the time of obtaining
Beneficial Ownership of the Convertible Note beneficially owns more
than 9.99% of the Company’s outstanding common stock or
voting stock (collectively (ii) through (iv), “Borrower
Affiliates ”). The Convertible Notes are not subject to a
conversion limitation at any time they are owned or held by
Borrower Affiliates.
The
Convertible Notes are due and payable on August 1, 2021, but may be
prepaid at any time, without penalty. The Convertible Notes contain
standard and customary events of default and upon the occurrence of
an event of default the amount owed under the Convertible Notes
accrues interest at 10% per annum.
The
terms of the Convertible Notes may be amended or waived and such
amendment or waiver shall be applicable to all of the Convertible
Notes with the written consent of Convertible Note holders holding
at least a majority in interest of the then aggregate dollar value
of Convertible Notes outstanding.
NOTE 9 – COMMITMENTS AND CONTINGENCIES
Office Lease
In June
2018, the Company entered into a third lease addendum to the
original lease agreement signed in July 2012, the first lease
addendum signed in May 2016, and the second lease addendum signed
in July 2017, as amended, which extends the term of the lease by an
additional year, now ending in July 2019, for office space located
in Danville, California. The total current obligation for the
remainder of this lease extension through July 2019 is
$48,000.
In June
2018, the Company assumed the lease for its corporate office space
located in Houston, Texas from American Resources, Inc., an entity
owned and controlled by Ivar Siem, a director of the Company, and
J. Douglas Schick, the Company’s President. The term of the
lease ends on August 31, 2019, and the obligation for the remainder
of this lease is $122,000.
Leasehold Drilling Commitments
The
Company’s oil and gas leasehold acreage is subject to
expiration of leases if the Company does not drill and hold such
acreage by production or otherwise exercises options to extend such
leases, if available, in exchange for payment of additional cash
consideration. In the D-J Basin Asset, 7 net acres are due to
expire during the three months remaining in 2018 (1,354 net acres
did expire during the nine months ended September 30, 2018), 125
net acres expire in 2019, and 329 net acres expire thereafter (net
to our direct ownership interest only). In the Permian Basin (the
assets acquired on September 1, 2018), no net acres are due to
expire during the three months remaining in 2018 (no net acres
expired during the nine months ended September 30, 2018), no net
acres expire in 2019, and 2,886 net acres expire thereafter (net to
our direct ownership interest only). The Company plans to hold
significantly all of this acreage through a program of drilling and
completing producing wells. If the Company is not able to drill and
complete a well before lease expiration, the Company may seek to
extend leases where able. As of September 30, 2018, the
Company had fully impaired its unproved leasehold costs based on
management’s revised re-leasing program.
Other Commitments
Although
the Company may, from time to time, be involved in litigation and
claims arising out of its operations in the normal course of
business, the Company is not currently a party to any material
legal proceeding. In addition, the Company is not aware of any
material legal or governmental proceedings against it, or
contemplated to be brought against it.
As part
of its regular operations, the Company may become party to various
pending or threatened claims, lawsuits and administrative
proceedings seeking damages or other remedies concerning its
commercial operations, products, employees and other
matters.
Although
the Company provides no assurance about the outcome of these or any
other pending legal and administrative proceedings and the effect
such outcomes may have on the Company, the Company believes that
any ultimate liability resulting from the outcome of such
proceedings, to the extent not otherwise provided for or covered by
insurance, will not have a material adverse effect on the
Company’s financial condition or results of
operations.
NOTE 10 – SHAREHOLDERS’ EQUITY (DEFICIT)
PREFERRED STOCK
At
September 30, 2018, the Company was authorized to issue 100,000,000
shares of preferred stock with a par value of $0.001 per share, of
which 25,000,000 shares have been designated “Series A”
preferred stock.
On
February 23, 2015, the Company issued 66,625 Series A Convertible
Preferred Stock shares to GGE as part of the consideration paid for
the GGE Acquired Assets. The grant date fair value of the
Series A Convertible Preferred Stock was $28,402,000, based on a
calculation using a binomial lattice option pricing
model.
As part
of the required conditions to closing the sale of the SK Energy
Note as described further in Note 8, SK Energy entered into a Stock
Purchase Agreement with GGE, pursuant to which, SK Energy
purchased, for $100,000, all of the Series A Convertible Preferred
Stock.
In
connection with the Stock Purchase Agreement, and immediately
following the closing of the acquisition described in the Stock
Purchase Agreement, the Company and SK Energy, as the then holder
of all of the outstanding shares of Series A Convertible Preferred
Stock, agreed to the filing of an Amendment to the Amended and
Restated Certificate of Designations of PEDEVCO Corp. Establishing
the Designations, Preferences, Limitations and Relative Rights of
Its Series A Convertible Preferred Stock (the “Preferred
Amendment”), which amended the designation of our Series A
Convertible Preferred Stock (the “Designation”) to
remove the beneficial ownership restriction contained therein,
which prevented any holder of Series A Convertible Preferred Stock
from converting such Series A Convertible Preferred Stock into
shares of common stock of the Company if such conversion would
result in the holder thereof holding more than 9.9% of the
Company’s then outstanding common stock. The Company filed
the Preferred Amendment with the Secretary of State of Texas on
June 26, 2018.
The
transactions affected pursuant to the Stock Purchase Agreement
(i.e., the sale of the Series A Convertible Preferred Stock to a
party other than GGE), triggered the automatic termination,
pursuant to the terms of the Designation, of the right of GGE, upon
notice to us, voting the Series A Convertible Preferred Stock
separately as a single class, to appoint designees to fill up to
two (2) seats on our Board of Directors, one of which must be an
independent director as defined by applicable rules. As such,
effective upon the closing of the Stock Purchase Agreement, our
common stockholders have the right to appoint all members of our
Board of Directors via plurality vote.
On July
3, 2018, SK Energy converted all of its 66,625 outstanding shares
of Series A Convertible Preferred Stock into 6,662,500 shares of
the Company’s common stock.
As of
September 30, 2018 and December 31, 2017, there were -0- and 66,625
shares of the Company’s Series A Convertible Preferred Stock
outstanding, respectively.
COMMON STOCK
At
September 30, 2018, the Company was authorized to issue 200,000,000
shares of its common stock with a par value of $0.001 per
share.
During
the nine months ended September 30 30, 2018, the Company issued
shares of common stock and restricted common stock as follows:
600,000 shares of common stock issued to SK Energy
with a fair value of $185,000 based on the market price on the date
of issuance, 80,000 shares of restricted stock were issued to the
CEO with a fair value of $27,000 based on the market price on the
date of issuance, and 30,848 shares were issued to employees for
the cashless exercise of options.
The
80,000 shares of restricted stock were issued i
n
consideration for Mr. Ingriselli rejoining the Company as its
President and Chief Executive Officer in May 2018, with 60,000
shares vesting on December 1, 2018 and 20,000 of the shares vesting
on March 1, 2019, subject to his continued service as an employee
or consultant of the Company on such vesting dates.
In
addition, during the nine months ended September 30, 2018, SK
Energy converted all of its 66,625 outstanding shares of Series A
Convertible Preferred Stock into 6,662,500 shares of the
Company’s common stock.
Also,
restricted stock awards were granted to Messrs. Frank C. Ingriselli
(then President) and Clark R. Moore (Executive Vice President,
General Counsel and Secretary) of 60,000 and 50,000 shares,
respectively, under the Company’s Amended and Restated 2012
Equity Incentive Plan during the nine months ended September
30, 2018. The restricted stock awards vest as follows: 100%
on the six (6) month anniversary of the grant date. These shares
have a total fair value of $164,000 based on the market price on
the issuance date. Subsequent restricted stock awards were granted
to one employee and two Directors for a total 90,000 shares, under
the Company’s Amended and Restated 2012 Equity Incentive
Plan. The grants for a total of 40,000 of the restricted stock
awards vest as follows: 100% on the one year anniversary of the
grant date. These shares have a total fair value of $88,000 based
on the market price on the issuance date. The grant for 50,000
shares of restricted stock vest as follows: 50% on the one year
anniversary of the grant date and 50% on the second year
anniversary of the grant date. These shares have a total fair value
of $109,000 based on the market price on the issuance date. In each
case above the restricted shares are subject to the recipient of
the shares being an employee of or consultant to the Company on
such vesting date, and subject to the terms and conditions of a
Restricted Shares Grant Agreement, as applicable, entered into by
and between the Company and the recipient. In addition, 65,017
shares were issued to an employee for the cashless exercise of
options, and 192,208 shares were issued for the cashless exercise
of warrants.
As of
September 30, 2018, there were 15,109,327 shares of common stock
outstanding.
Stock-based
compensation expense recorded related to the vesting of restricted
stock for the three and nine months ended September 30, 2018 and
2017 was $161,000 compared to $73,000, and $475,000 compared to
$535,000, respectively. The remaining unamortized stock-based
compensation expense at September 30, 2018 related to restricted
stock was $321,000.
The
calculation of earnings (loss) per share for the three
and nine months ended September 30, 2018 and 2017 were as follows
(amounts in thousands, except share and per share
data):
|
For the Three
Months
Ended
September 30,
|
For the Nine
Months
Ended September
30,
|
Numerator:
|
|
|
|
|
Net income
(loss)
|
$
(2,733
)
|
$
(4,605
)
|
$
59,323
|
$
(13,091
)
|
|
|
|
|
|
Effect of common
stock equivalents
|
-
|
-
|
-
|
-
|
Net income (loss)
adjusted for common stock equivalents
|
$
(2,733
)
|
$
(4,605
)
|
$
59,323
|
$
(13,091
)
|
|
|
|
|
|
Denominator:
|
|
|
|
|
Weighted average
– basic
|
14,747,952
|
6,074,294
|
9,822,007
|
5,753,827
|
|
|
|
|
|
Earnings (loss) per
share – basic
|
(0.19
)
|
(0.76
)
|
6.04
|
(2.28
)
|
|
|
|
|
|
Dilutive effect of
common stock equivalents:
|
|
|
|
|
Options
|
269,392
|
-
|
120,576
|
-
|
Preferred
Stock
|
-
|
-
|
-
|
-
|
|
|
|
|
|
Denominator:
|
|
|
|
|
Weighted average
shares – diluted
|
15,017,344
|
6,074,294
|
9,942,583
|
5,753,827
|
|
|
|
|
|
Earnings per share
– diluted
|
(0.18
)
|
(0.76
)
|
5.97
|
(2.28
)
|
NOTE 11 – STOCK OPTIONS AND WARRANTS
Blast 2003 Stock Option Plan and 2009 Stock Incentive
Plan
Prior
to June 2005, the Company was known as Blast Energy Services, Inc.
(“Blast”). Under Blast’s 2003 Stock Option Plan
and 2009 Stock Incentive Plan, options to acquire 298 and 343
shares of common stock were granted and remained outstanding and
exercisable as of September 30, 2018 and December 31, 2017,
respectively. No new options were issued under these plans in 2018
or 2017.
2012 Incentive Plan
On July
27, 2012, the shareholders of the Company approved the 2012 Equity
Incentive Plan (the “2012 Incentive Plan”), which was
previously approved by the Board of Directors on June 27, 2012, and
authorizes the issuance of various forms of stock-based awards,
including incentive or non-qualified options, restricted stock
awards, performance shares and other securities as described in
greater detail in the 2012 Incentive Plan, to the Company’s
employees, officers, directors and consultants. The 2012 Incentive
Plan was amended on June 27, 2014, October 7, 2015 and December 28,
2016, December 28, 2017 and September 27, 2018 to increase by
500,000, 300,000, 500,000, 1,500,000, and 3,000,000 (to 6,000,000
currently), respectively, the number of shares of common stock
reserved for issuance under the 2012 Incentive Plan.
A total
of 6,000,000 shares of common stock are eligible to be issued under
the 2012 Incentive Plan as of September 30, 2018 and December
31, 2017, of which 2,576,130 shares have been issued as restricted
stock, 718,250 shares are subject to issuance upon exercise of
issued and outstanding options, and 2,705,620 shares remain
available for future issuance as of September 30,
2018.
PEDCO 2012 Equity Incentive Plan
As a
result of the July 27, 2012 merger by and between the Company,
Blast Acquisition Corp., a wholly-owned Nevada subsidiary of the
Company (“MergerCo”), and Pacific Energy Development
Corp., a privately-held Nevada corporation (“PEDCO”)
pursuant to which MergerCo was merged with and into PEDCO, with
PEDCO continuing as the surviving entity and becoming a
wholly-owned subsidiary of the Company, in a transaction structured
to qualify as a tax-free reorganization (the “Merger”),
the Company assumed the PEDCO 2012 Equity Incentive Plan (the
“PEDCO Incentive Plan”), which was adopted by PEDCO on
February 9, 2012. The PEDCO Incentive Plan authorized PEDCO to
issue an aggregate of 100,000 shares of common stock in the form of
restricted shares, incentive stock options, non-qualified stock
options, share appreciation rights, performance shares, and
performance units under the PEDCO Incentive Plan. As of September
30, 2018 and December 31, 2017, options to purchase an aggregate of
31,015 shares of the Company’s common stock and 66,625 shares
of the Company’s restricted common stock have been granted
under this plan (all of which were granted by PEDCO prior to the
closing of the merger with the Company, with such grants being
assumed by the Company and remaining subject to the PEDCO Incentive
Plan following the consummation of the merger). The Company does
not plan to grant any additional awards under the PEDCO Incentive
Plan.
Options
The
Company granted options to purchase 220,000 shares of common stock
during the nine-month period ended September 30, 2018.
During
the three and nine months ended September 30, 2018 and 2017, the
Company recognized stock option expense of $56,000 compared to
$7,000 and $91,000 compared to $62,000, respectively. The remaining
amount of unamortized stock options expense at September 30, 2018,
was $373,000.
The
intrinsic value of outstanding options and exercisable
options at September 30, 2018 was $321,000 and $174,000,
respectively.
The
intrinsic value of outstanding options and exercisable
options at December 31, 2017 was $-0- and $-0-,
respectively.
Option
activity during the nine months ended September 30, 2018
was:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at
January 1, 2018
|
743,727
|
$
3.45
|
3.8
|
Granted
|
220,000
|
2.19
|
-
|
Exercised
|
(120,000
)
|
0.44
|
-
|
Forfeited and
cancelled
|
(3,495
)
|
45.67
|
-
|
|
|
|
|
Outstanding at
September 30, 2018
|
840,232
|
$
3.46
|
3.4
|
|
|
|
|
Exercisable at
September 30, 2018
|
545,232
|
$
4.41
|
2.7
|
Warrants
During
the nine months ended September 30, 2018, the Company granted
warrants to certain of the Junior Noteholders to purchase an
aggregate of 1,448,472 shares of common stock. These warrants have
a term of three years, an exercise price of $0.322, and the
estimated fair value of $322,000 was based on the Black-Scholes
option pricing model. These warrants were all granted during the
three months ended June 30, 2018.
During
the nine months ended September 30, 2018 and 2017, the Company
recognized warrant expense (included in the net gain for the debt
restructuring) of $322,000 and $-0-. This warrant expense was all
incurred during the three months ended June 30, 2018. The remaining
amount of unrecognized warrant expense at September 30, 2018 was
$-0-.
During
the nine months ended September 30, 2018, 192,208 shares were
issued for the exercise of warrants (in exchange for cash received
of $64,000), 165,017 warrants expired and 1,105,935
were cancelled and re-purchased at a total price of
$1,095,000.
The
intrinsic value of outstanding as well as exercisable warrants at
September 30, 2018 and December 31, 2017 was $284,000 and $-0-,
respectively.
Warrant
activity during the nine months ended September 30, 2018
was:
|
|
Weighted
Average
Exercise
Price
|
Weighted
Average
Remaining
Contract
Term
(#
years)
|
Outstanding at
January 1, 2018
|
1,231,373
|
$
7.44
|
1.4
|
Granted
|
1,448,472
|
0.32
|
-
|
Exercised
|
(192,208
)
|
0.32
|
-
|
Forfeited and
cancelled
|
(1,270,952
)
|
1.44
|
-
|
|
|
|
|
Outstanding at
September 30, 2018
|
1,216,685
|
$
6.36
|
1.0
|
|
|
|
|
Exercisable at
September 30, 2018
|
1,216,685
|
$
6.36
|
1.0
|
NOTE 12 – RELATED PARTY TRANSACTIONS
See
Note 8 above for further discussion of the debt restructuring on
June 25, 2018, the Promissory Note dated June 25, 2018 with SK
Energy in the amount of $7.7 million, and the Debt Repayment
Agreements with various previous debt holders including the
previous debt held by GGE, which was retired effective on June 25,
2018. As part of these transactions, SK Energy entered into a Stock
Purchase Agreement with GGE, the holder of the Company’s then
outstanding 66,625 shares of Series A Convertible Preferred Stock
(convertible pursuant to their terms into 6,662,500 shares of the
Company’s common stock – approximately 47.6% of the
Company’s then outstanding shares post-conversion), pursuant
to which on June 25, 2018, SK Energy purchased, for $100,000, all
of the Series A Convertible Preferred Stock.
As a
result of the transactions discussed above and the Notes above, as
of September 30, 2018, SK Energy is now a related party while
GGE is no longer a related party as of September 30, 2018. This is
based on the 66,625 shares of the Company’s Series
A Convertible Preferred Stock owned by SK Energy as of June 30,
2018, which were subsequently converted into shares of the
Company’s common stock on a 100:1 basis, and the termination,
effective June 25, 2018, of GGE’s right to appoint up to
two representatives to the Company’s Board of
Directors.
The
following table reflects the related party amounts for GGE included
in the December 31, 2017 balance sheet and the related party
amounts for SK Energy, Directors and Officers included in the
September 30, 2018 balance sheet (in thousands):
|
|
|
Short-term accrued
expenses
|
167
|
-
|
Long-term accrued
expenses
|
$
310
|
$
1,733
|
Long-term secured
notes payable, net of discount of $-0- and $1,148,
respectively
|
-
|
15,930
|
Long-term secured
notes payable – subordinated
|
-
|
11,483
|
Long-term notes
payable – subordinated
|
23,200
|
-
|
Long-term notes
payable, net of discount of $173 and $-0-,
respectively
|
7,527
|
-
|
Total related party
liabilities
|
$
31,204
|
$
29,146
|
NOTE 13 – INCOME TAXES
Due to
the Company’s cumulative net losses, there was no provision
for income taxes for the nine months ended September 30, 2018 and
2017.
On
December 22, 2017, new federal tax reform legislation was enacted
in the United States (the “2017 Tax Act”), resulting in
significant changes from previous tax law. The 2017 Tax Act reduces
the federal corporate income tax rate to 21% from 34% effective
January 1, 2018. The rate change, along with certain immaterial
changes in tax basis resulting from the 2017 Tax Act, resulted in a
reduction of the Company’s deferred tax assets of $18,589,000
and a corresponding reduction in the valuation allowance as of
December 31, 2017. The following table reconciles the U.S. federal
statutory income tax rate in effect for the nine months ended
September 30, 2018 and 2017 and the Company’s effective tax
rate (amounts in thousands):
|
Nine Months
Ended
September 30,
2018
|
Nine Months
Ended
September 30,
2017
|
|
|
|
U.S. federal
statutory income tax
|
$
12,458
|
$
(4,451
)
|
State and local
income tax, net of benefits
|
3,939
|
(606
)
|
Amortization of
debt discount
|
385
|
940
|
Gain on debt
restructuring
|
(19,433
)
|
-
|
Officer life
insurance and D&O insurance
|
24
|
23
|
Stock-based
compensation
|
157
|
230
|
Tax rate changes
and other
|
-
|
-
|
Change in valuation
allowance for deferred income tax assets
|
2,470
|
3,864
|
Effective income
tax rate
|
$
-
|
$
-
|
Deferred
income tax assets as of September 30, 2018 and December 31, 2017
are as follows (in thousands):
Deferred
Tax Assets
|
|
|
Difference in
depreciation, depletion, and capitalization methods – oil and
natural gas properties
|
$
4,198
|
$
3,649
|
Net operating loss
– federal taxes
|
31,782
|
30,322
|
Net operating loss
– state taxes
|
5,859
|
5,398
|
Total deferred tax
asset
|
41,839
|
39,369
|
|
|
|
Less valuation
allowance
|
(41,839
)
|
(39,369
)
|
Total deferred tax
assets
|
$
-
|
$
-
|
In
assessing the realization of deferred tax assets, management
considers whether it is more likely than not that some portion or
all of deferred assets will not be realized. The ultimate
realization of the deferred tax assets is dependent upon the
generation of future taxable income during the periods in which
those temporary differences become deductible.
Based
on the available objective evidence, management believes it is more
likely than not that the net deferred tax assets will not be fully
realizable. Accordingly, management has applied a full valuation
allowance against its net deferred tax assets at September 30,
2018. The net change in the total valuation allowance from December
31, 2017 to September 30, 2018, was an increase of
$2,470,000.
The
Company’s policy is to recognize interest and penalties
accrued on any unrecognized tax benefits as a component of income
tax expense. As of September 30, 2018, the Company did not have any
significant uncertain tax positions or unrecognized tax benefits.
The Company did not have associated accrued interest or penalties,
nor were there any interest expense or penalties recognized during
the period from February 9, 2011 (Inception) through September 30,
2018.
As of
September 30, 2018, the Company had net operating loss
carryforwards (“NOLs”) of approximately $101,420,000,
plus $49,922,000 subject to limitations, for federal and state tax
purposes. If not utilized, these losses will begin to expire
beginning in 2033 and 2023, respectively, for both federal and
state purposes.
Utilization
of NOL and tax credit carryforwards may be subject to a substantial
annual limitation due to ownership change limitations that may have
occurred or that could occur in the future, as required by the
Internal Revenue Code (the “Code”), as amended, as well
as similar state provisions. In general, an “ownership
change” as defined by the Code results from a transaction or
series of transactions over a three-year period resulting in an
ownership change of more than 50% of the outstanding stock of a
company by certain stockholders or public groups.
The
Company currently has tax returns open for examination by the
Internal Revenue Service for all years
since 2010.
NOTE 14
– SUBSEQUENT
EVENTS
On October 25, 2018, the Company borrowed an
additional $7.0 million from SK Energy, through the issuance of a
convertible promissory note in the amount of $7.0 million (the
“October 2018 Convertible Note”)
.
The October 2018 Convertible Note accrues interest
monthly at 8.5% per annum, which is payable on the maturity date,
unless otherwise converted into shares of the Company’s
common stock as described below. The October 2018 Convertible Note
and all accrued interest thereon are convertible into shares of the
Company’s common stock, at the option of the holder thereof,
at a conversion price equal to $1.79 per share. Further, the
conversion of the October 2018 Convertible Note is subject to a
49.9% conversion limitation which prevents the conversion of any
portion thereof into common stock of the Company if such conversion
would result in SK Energy or any of its affiliates beneficially
owning more than 49.9% of the Company’s outstanding shares of
common stock. The October 2018 Convertible Note is due and payable
on October 25, 2021, but may be prepaid at any time without
penalty.
Also on
October 25, 2018, the Company and SK Energy agreed to convert an
aggregate of $167,000 of interest accrued under the SK Energy Note
(see Note 8) from its effective date through September 30, 2018
into 75,118 shares of the Company’s common stock, based on a
conversion price equal to $2.18,
pursuant to the conversion terms of the SK Energy
Note
.