NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars
in Thousands, Except Per Share Amounts)
1.
|
ORGANIZATION,
OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
|
Organization
and Operations
U.S.
Energy Corp. (collectively with its subsidiaries referred to as the “Company” or “U.S. Energy”) was incorporated
in the State of Wyoming on January 26, 1966. The Company’s principal business activities are focused on the acquisition,
exploration and development of oil and gas properties in the United States.
Basis
of Presentation
The
accompanying unaudited condensed consolidated financial statements are presented in accordance with U.S. generally accepted accounting
principles (“GAAP”) and have been prepared by the Company pursuant to the rules and regulations of the Securities
and Exchange Commission (the “SEC”) regarding interim financial reporting. Accordingly, certain information and footnote
disclosures required by GAAP for complete financial statements have been condensed or omitted in accordance with such rules and
regulations. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for
a fair presentation of the consolidated financial statements have been included.
For
further information, please refer to the consolidated financial statements and footnotes thereto included in our Annual Report
on Form 10-K, 10-K/A for the year ended December 31, 2016 filed on April 17, 2017 and April 28, 2017. Our financial condition
as of September 30, 2017, and operating results for the nine months ended September 30, 2017 are not necessarily indicative of
the financial condition and results of operations that may be expected for any future interim period or for the year ending December
31, 2017.
Use
of Estimates
The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period. Significant estimates include oil and gas reserves
that are used in the calculation of depreciation, depletion, amortization and impairment of the carrying value of evaluated oil
and gas properties; production and commodity price estimates used to record accrued oil and gas sales receivable; valuation of
commodity derivative instruments; and the cost of future asset retirement obligations. The Company evaluates its estimates on
an on-going basis and bases its estimates on historical experience and on various other assumptions the Company believes to be
reasonable. Due to inherent uncertainties, including the future prices of oil and gas, these estimates could change in the near
term and such changes could be material.
Principles
of Consolidation
The
accompanying financial statements include the accounts of the Company and its wholly-owned subsidiary Energy One LLC (“Energy
One”). All inter-company balances and transactions have been eliminated in consolidation. Certain prior period amounts have
been reclassified to conform to the current period presentation of the accompanying financial statements.
Comprehensive
Income (Loss)
Comprehensive
income (loss) is used to refer to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss)
is comprised of revenues, expenses, gains, and losses that under GAAP are reported as separate components of shareholders’
equity instead of net income (loss).
Recent
Accounting Pronouncements
Revenue recognition.
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-09,
Revenue
from Contracts with Customers
(“ASU 2014-09”). The objective of ASU 2014-09 is greater consistency and comparability
across industries by using a five-step model to recognize revenue from customer contracts. ASU 2014-09 also contains some new
disclosure requirements under GAAP. In August 2015, the FASB issued Accounting Standards Update No. 2015-14,
Deferral
of the Effective Date
(“ASU 2015-14”). ASU 2015-14 defers the effective date of the new revenue standard
by one year, making it effective for annual reporting periods beginning after December 15, 2017, including interim periods within
that reporting period. In 2016, the FASB issued additional accounting standards updates to clarify the implementation guidance
of ASU 2014-09. The adoption of this guidance is not expected to impact the Company’s financial position or results of operations.
Financial
instruments.
In January 2016, the FASB issued Accounting Standards Update No. 2016-01,
Recognition and Measurement of Financial
Assets and Financial Liabilities
(“ASU 2016-01”), which requires that most equity instruments be measured at fair
value with subsequent changes in fair value recognized in net income. ASU 2016-01 also impacts financial liabilities under the
fair value option and the presentation and disclosure requirements for financial instruments. ASU 2016-01 does not apply to equity
method investments or investments in consolidated subsidiaries. ASU 2016-01 is effective for fiscal years beginning after December
15, 2017, including interim periods within those years. The Company is currently evaluating the effect that adopting this guidance
will have on its financial position, cash flows and results of operations.
Leases.
In
February 2016, the FASB issued Accounting Standards Update No. 2016-02,
Leases
(“ASU 2016-02”), which
requires a lessee to recognize lease payment obligations and a corresponding right-of-use asset to be measured at fair value on
the balance sheet. ASU 2016-02 also requires certain qualitative and quantitative disclosures about the amount, timing and uncertainty
of cash flows arising from leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim
periods within those years. The adoption of this guidance is not expected to impact the Company’s financial position or
results of operations.
Statement
of cash flows.
In August 2016, the FASB issued Accounting Standards Update No. 2016-15,
Statement of Cash Flows
(“ASU
2016-15”), which is intended to reduce diversity in practice in how certain transactions are classified in the statement
of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those
years. The adoption of this guidance will not impact the Company’s financial position or results of operations, but could
result in presentation changes on the Company’s statement of cash flows.
Business
combinations.
In January 2017, the FASB issued Accounting Standards Update No. 2017-01,
Clarifying the Definition of a
Business
(“ASU 2017-01”), which provides guidance to assist entities with evaluating whether transactions should
be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 requires entities to use a screen test to
determine when an integrated set of assets and activities is not a business or if the integrated set of assets and activities
needs to be further evaluated against the framework. ASU 2017-01 is effective for fiscal years beginning after December 15, 2017,
including interim periods within those years. The Company is currently evaluating the effect that adopting this guidance will
have on its financial position, cash flows and results of operations.
Stock-based
compensation.
In May 2017, the FASB issued Accounting Standards Update No. 2017-09,
Scope of Modification Accounting
(“ASU 2017-09”), which provides guidance about which changes to the terms or conditions of a share-based payment award
require an entity to apply modification accounting. The adoption of ASU 2017-09 will become effective for annual periods beginning
after December 15, 2017, and the Company is currently evaluating the impact that it will have on its financial position, cash
flows and results of operations.
As
of September 30, 2017, the Company has a working capital deficit of $0.8 million and an accumulated deficit of $124.6 million.
Additionally, the Company incurred a net loss of $0.4 million and $0.8 million for the three and nine months ended September 30,
2017, respectively.
On
May 2, 2017, the Amended and Restated Credit Agreement, dated July 30, 2010, between U.S. Energy Corp.’s wholly-owned subsidiary,
Energy One and Wells Fargo Bank N.A. was sold, assigned and transferred to APEG Energy II, L.P. (“APEG”) (the “Credit
Agreement”). APEG purchased and assumed all of Wells Fargo’s rights and obligations as the lender to Energy One under
the credit facility. Concurrently, U.S. Energy Corp., Energy One and APEG entered into a Limited Forbearance Agreement dated May
2, 2017. On June 28, 2017, U.S. Energy Corp., Energy One and APEG entered into a Fifth Amendment to the Credit Agreement providing
for, among other things, an extension of the maturity date to July 19, 2019, new financial coverage ratio covenants and a limited
release and waiver with respect to any historical Company non-compliance with any and all financial covenants by the Company.
As of September 30, 2017, the Company was in compliance with all financial covenants and fully conforming with all requirements
under its credit agreement. On October 5, 2017, U.S. Energy Corp. announced that the Company, the Company’s wholly owned
subsidiary Energy One LLC and APEG, entered into an exchange agreement (the “Exchange Agreement”), pursuant to which,
on the terms and subject to the conditions of the Exchange Agreement, APEG will exchange $4,463,380 of outstanding borrowings
under the Company’s Credit Facility, for 5,819,270 new shares of common stock of the Company. Please refer to Note 13 entitled
“Subsequent Events” for further information.
As
of September 30, 2017, the Company had cash and equivalents of $1.8 million. Management believes overhead and mining expense eliminations
have poised the Company to survive the continued low commodity price environment. However, there can be no assurance that the
Company will be able to complete future financings, dispositions or acquisitions on acceptable terms or at all. The significantly
lower oil price environment has substantially decreased our cash flows from operating activities. Sustained low oil prices could
significantly reduce or eliminate our planned capital expenditures. If production is not replaced through the acquisition or drilling
of new wells our production levels will lower due to the natural decline of production from existing wells.
Our
strategy is to continue to (1) maintain adequate liquidity and selectively participate in new drilling and completion activities,
subject to economic and industry conditions, (2) pursue acquisition and disposition opportunities, and (3) evaluate various avenues
to strengthen our balance sheet and improve our liquidity position. We expect to fund any near-term capital requirements and working
capital needs from existing cash on hand. Because production from existing oil and natural gas wells declines over time, further
reductions of capital expenditures used to drill and complete new oil and natural gas wells would likely result in lower levels
of oil and natural gas production in the future.
3.
|
COMMODITY
PRICE RISK DERIVATIVES
|
The
Company’s wholly-owned subsidiary Energy One has historically entered into crude oil derivative contracts (“economic
hedges”). The derivative contracts are priced based on West Texas Intermediate (“WTI”) quoted prices for crude
oil. The Company is a guarantor of Energy One’s obligations under the economic hedges. The objective of utilizing the economic
hedges is to reduce the effect of price changes on a portion of the Company’s future oil production, achieve more predictable
cash flows in an environment of volatile oil and gas prices and to manage the Company’s exposure to commodity price risk.
The use of these derivative instruments limits the downside risk of adverse price movements. However, there is a risk that such
use may limit the Company’s ability to benefit from favorable price movements. Energy One may, from time to time, add incremental
derivatives to hedge additional production, restructure existing derivative contracts or enter into new transactions to modify
the terms of current contracts in order to realize the current value of its existing positions. The Company does not engage in
speculative derivative activities or derivative trading activities, nor does it use derivatives with leveraged features. Presented
below is a summary of outstanding crude oil and natural gas swaps as of September 30, 2017.
|
|
Begin
|
|
|
End
|
|
|
Quantity
(bbls/d)
|
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude oil
price swaps
|
|
|
10/1/17
|
|
|
|
12/31/17
|
|
|
|
300
|
|
|
$
|
52.40
|
|
|
|
|
1/1/18
|
|
|
|
6/30/18
|
|
|
|
150
|
|
|
|
52.20
|
|
|
|
Begin
|
|
|
End
|
|
|
Quantity
(mcf/d)
|
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural
gas price swaps
|
|
|
1/1/18
|
|
|
|
12/31/18
|
|
|
|
500
|
|
|
|
3.01
|
|
Unrealized
gains and losses resulting from derivatives are recorded at fair value in the consolidated balance sheet. Changes in fair value
are included in the “change in unrealized gain (loss) on oil price risk derivatives” in the consolidated statements
of operations. For the nine months ended September 30, 2017 and 2016, the Company’s unrealized gains (losses) from derivatives
amounted to $0.03 and $(1.6) million, respectively. Derivative contract settlements are included in the “realized gain (loss)
on oil price risk derivatives” in the consolidated statement of operations. All derivative positions are carried at their
fair value on the condensed consolidated balance sheet and are included in “Commodity price risk derivatives.” For
the nine months ended September 30, 2017 and 2016, the Company’s realized gains from derivatives amounted to $0.2 and $1.4
million, respectively.
4.
|
CEILING
TEST FOR OIL AND GAS PROPERTIES
|
The
reserves used in the Company’s full cost ceiling test incorporate assumptions regarding pricing and discount rates in the
determination of present value. In the calculation of the ceiling test as of September 30, 2017, the Company used a price of $43.89
per barrel for oil and $2.92 per MMbtu for natural gas (as further adjusted for property specific gravity, quality, local markets
and distance from markets) to compute the future cash flows of the Company’s producing properties. These prices compare
to $42.75 per barrel for oil and $2.48 per MMbtu for natural gas used in the calculation of the Ceiling Test as of December 31,
2016. The Company used a discount factor of 10%.
For
the nine months ended September 30, 2017 and 2016, ceiling test impairment charges for the Company’s oil and gas properties
amounted to $0 and $9.6 million, respectively.
5.
|
DISCONTINUED
OPERATIONS AND PREFERRED STOCK ISSUANCE
|
Disposition
of Mining Segment
In
February 2006, the Company reacquired the Mt. Emmons molybdenum mining properties (the “Property”). In February 2016,
the Company’s Board of Directors decided to dispose of the Property rather than continuing the Company’s long-term
development strategy whereby the Company entered into the following agreements:
|
A.
|
The
Company entered into an Acquisition Agreement (the “Acquisition Agreement”) with Mt. Emmons Mining Company, a
subsidiary of Freeport-McMoRan Inc. (“MEM”), whereby MEM acquired the Property. The Company did not receive any
cash consideration for the disposition; the sole consideration for the transfer was that MEM assumed the Company’s obligations
to operate the Water Treatment Plant (“WTP”) and to pay the future mine holding costs for portions of the Property
that it desires to retain.
|
Under
U.S. GAAP, the disposal of a segment is reported as discontinued operations in the Company’s financial statements. Presented
below are the assets and liabilities associated with the Company’s mining segment as of September 30, 2017 and December
31, 2016:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Assets retained by
the Company:
|
|
|
|
|
|
|
|
|
Performance
bonds
|
|
$
|
114
|
|
|
$
|
114
|
|
|
|
|
|
|
|
|
|
|
Total
assets of discontinued operations
|
|
$
|
114
|
|
|
$
|
114
|
|
|
B.
|
Concurrent
with entry into the Acquisition Agreement and as additional consideration for MEM to accept transfer of the Property, the
Company entered into a Series A Convertible Preferred Stock Purchase Agreement (the “Series A Purchase Agreement”)
with MEM, whereby the Company issued 50,000 shares of newly designated Series A Convertible Preferred Stock (the “Preferred
Stock”) to MEM in exchange for (i) MEM accepting the transfer of the Property and replacing the Company as the permittee
and operator of the WTP, and (ii) the payment of approximately $1 to the Company. The Series A Purchase Agreement contains
customary representations and warranties on the part of the Company. As contemplated by the Acquisition Agreement and the
Series A Purchase Agreement and as approved by the Company’s Board of Directors, the Company filed with the Secretary
of State of the State of Wyoming Articles of Amendment containing a Certificate of Designations with respect to the Preferred
Stock (the “Certificate of Designations”). Pursuant to the Certificate of Designations, the Company designated
50,000 shares of its authorized preferred stock as Series A Convertible Preferred Stock. The Preferred Stock accrues dividends
at a rate of 12.25% per annum of the Adjusted Liquidation Preference (as defined below); such dividends are not payable in
cash but are accrued and compounded quarterly in arrears on the first business day of the succeeding calendar quarter. At
issuance, the aggregate fair value of the Preferred Stock was $2,000 based on the initial liquidation preference of $40 per
share. The “Adjusted Liquidation Preference” is initially $40 per share of Preferred Stock, with increases each
quarter by the accrued quarterly dividend. The Preferred Stock is senior to other classes or series of shares of the Company
with respect to dividend rights and rights upon liquidation. No dividend or distribution will be declared or paid on junior
stock, including the Company’s common stock, (1) unless approved by the holders of Preferred Stock and (2) unless and
until a like dividend has been declared and paid on the Preferred Stock on an as-converted basis.
|
At
the option of the holder, each share of Preferred Stock was initially convertible into approximately 13.33 shares of the Company’s
$0.01 par value common stock (the “Conversion Rate”) for an aggregate of 666,667 shares of common stock. The Conversion
Rate is subject to anti-dilution adjustments for stock splits, stock dividends, certain reorganization events, and to price-based
anti-dilution protections if the Company subsequently issues shares for less than 90% of fair value on the date of issuance. Each
share of Preferred Stock will be convertible into a number of shares of common stock equal to the ratio of the initial conversion
value to the conversion value as adjusted for accumulated dividends multiplied by the Conversion Rate. In no event will the aggregate
number of shares of common stock issued upon conversion be greater than approximately 793,000 shares. The Preferred Stock will
generally not vote with the Company’s common stock on an as-converted basis on matters put before the Company’s shareholders.
The holders of the Preferred Stock have the right to approve specified matters as set forth in the Certificate of Designations
and have the right to require the Company to repurchase the Preferred Stock in connection with a change of control. However, the
Company’s Board of Directors has the ability to prevent any change of control that could trigger a redemption obligation
related to the Preferred Stock.
During
the first quarter of 2016, the Company recorded the fair value of the Preferred Stock based on the initial liquidation preference
of $2,000. Since the cash consideration paid by MEM for the Preferred Stock was a nominal amount, the Company recorded a charge
to operations of approximately $2,000 associated with the issuance.
|
C.
|
Concurrent
with entry into the Acquisition Agreement and the Series A Purchase Agreement, the Company and MEM entered into an Investor
Rights Agreement, which provides MEM rights to certain information and Board observer rights. MEM has agreed that it, along
with its affiliates, will not acquire more than 16.86% of the Company’s issued and outstanding shares of Common Stock.
In addition, MEM has the right to demand registration of the shares of Common Stock issuable upon conversion of the Preferred
Stock under the Securities Act of 1933, as amended.
|
Combined
Results of Operations for Discontinued Operations
The
results of operations of the discontinued mining operations are presented separately in the accompanying financial statements.
Presented below are the components for the nine months ended September 30, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Issuance
of preferred stock to induce disposition
|
|
$
|
—
|
|
|
$
|
(1,999
|
)
|
|
|
|
|
|
|
|
|
|
Operating expenses
of mining segment:
|
|
|
|
|
|
|
|
|
Water
treatment plant
|
|
|
—
|
|
|
|
(256
|
)
|
Mine
property holding costs
|
|
|
—
|
|
|
|
(117
|
)
|
Professional
fees
|
|
|
—
|
|
|
|
(76
|
)
|
Total
results for discontinued operations
|
|
$
|
—
|
|
|
$
|
(2,448
|
)
|
Energy One, a wholly-owned subsidiary the
Company, has a credit facility with APEG Energy II, L.P. (“APEG”). As of September 30, 2017 and 2016, outstanding borrowings
under the credit facility amounted to $6.0 million. U.S. Energy Corp., Energy One and APEG entered into a Limited Forbearance Agreement
dated May 2, 2017. On June 28, 2017, U.S. Energy Corp., Energy One and APEG entered into a Fifth Amendment to the credit facility
providing for, among other things, an extension of the maturity date to July 19, 2019, new financial coverage ratio covenants and
a waiver with respect to any historical Company non-compliance with any and all financial covenants. As of September 30, 2017 and
2016, the borrowing base was $6.0 million. Borrowings under the credit facility are secured by Energy One’s oil and gas producing
properties and substantially all of the Company’s cash and equivalents. Each borrowing under the agreement has a term of
six months, but can be continued at the Company’s election through July 2019 if the Company remains in compliance with the
covenants under the credit facility. The interest rate on the credit facility is currently fixed at 8.75%. Please refer to Note
13 entitled “Subsequent Events” for further information.
Energy One is required to comply with customary affirmative covenants and with certain negative covenants.
The principal negative financial covenants do not permit (as the following terms are defined in the Fifth Amendment) (i) PDP Coverage
Ratio to be less than 1.2 to 1; and (ii) the current ratio to be less than 1.0 to 1.0. Please note that the liabilities carried
on the Company’s balance sheet under “Payable to major operator” and “Contingent ownership interests”
are excluded from any covenant calculations. As of September 30, 2017, the Company is in compliance with all credit facility covenants.
Additionally, the Credit Agreement prohibits or limits Energy One’s ability to incur additional debt, pay cash dividends
and other restricted payments, sell assets, enter into transactions with affiliates, and to merge or consolidate with another company.
The Company is a guarantor of Energy One’s obligations under the Credit Agreement.
7.
|
COMMITMENTS
AND CONTINGENCIES
|
From
time to time, the Company is party to certain legal actions and claims arising in the ordinary course of business. While the outcome
of these events cannot be predicted with certainty, management does not expect these matters to have a materially adverse effect
on the Company’s financial position or results of operations. Following is updated information related to currently pending
legal matters:
North
Dakota Properties.
On June 8, 2011, Brigham Oil & Gas, L.P. (“Brigham”), as the operator of the Williston
25-36 #1H Well, filed an action in the State of North Dakota, County of Williams, in District Court, Northwest Judicial District,
Case No. 53-11-CV-00495 to interplead to the court with respect to the undistributed suspended royalty funds from this well to
protect itself from potential litigation. Brigham became aware of an apparent dispute with respect to ownership of the mineral
interest between the ordinary high-water mark and the ordinary low water mark of the Missouri River. Brigham suspended payment
of certain royalty proceeds of production related to the minerals in and under this property pending resolution of the apparent
dispute. Brigham was subsequently sold to Statoil ASA (“Statoil”) who assumed Brigham’s rights and obligations
under this case. The Company owns a working interest, not royalty interest, in this well and no funds have been withheld.
On
January 28, 2013, the District Court Northwest Judicial District issued an Order for Partial Summary Judgment holding that the
State of North Dakota as part of its title to the beds of navigable waterways owns the minerals in the area between the ordinary
high and low watermarks on these waterways, and that this public title excludes ownership and any proprietary interest by riparian
landowners. This issue has been appealed to the North Dakota Supreme Court. The Company’s legal position is aligned with
Brigham, who will continue to provide legal counsel in this case for the benefit of all working interest owners.
The
Company is also a party to litigation that seeks to reform certain assignments of mineral interests it acquired from Brigham.
This matter involves the depth below the surface to which the assignments were effective. The plaintiff is seeking to reform the
agreement such that the Company’s assignment would be revised to be 12 feet closer to the surface. This dispute affects
one of the Company’s producing wells. The matter was settled on July 7, 2017 with the court ruling in favor Brigham and
therefore U.S. Energy will retain all interests in all subject leases.
Texas
Quiet Title Action – Willerson Lease.
In September 2013, the Company acquired from Chesapeake a 15% working interest
in approximately 4,244 gross mineral acres referred to as the Willerson lease. In January 2014, Willerson inquired if their lease
had terminated due to the failure to achieve production in paying quantities pursuant to the terms of the lease. The Company along
with Crimson and Liberty filed a declaratory judgment action in the District Court of Dimmit County in May 2014 seeking a determination
from the court that the lease remains valid and in effect. The lessors counterclaimed for breach of contract, trespass, and related
causes of action. In January 2016, the lessors filed a third-party petition alleging breach of contract, trespass, and related
causes of action against Chesapeake and EXCO Operating Company, LP. The matter has settled in 2017 with the Company’s portion
of such settlement being $75,000 plus related legal fees of $165,000 as reflected in the Company’s financial statements
under “Professional fees, insurance and other” as of September 30, 2017.
Arbitration
of Employment Claim.
A former employee has claimed that the Company owes up to $1.8 million under an Executive Severance and
Non-Compete agreement (the “Agreement”) due to a change of control and termination of employment without cause. The
Agreement requires that any disputes be submitted to binding arbitration and a request for arbitration was submitted by the parties
in March 2016. This matter was settled in May 2017 for $175,000 plus non-essential equipment of $15,000 as reflected in the Company’s
financial statements under “Rental and other income/(loss)” as of September 30, 2017.
Contingent
Ownership Interests.
As of September 30, 2017, the Company had recognized a contingent liability associated with uncertain
ownership interests of $1.6 million. This liability arises when the calculations of respective joint ownership interests by operators
differs from the Company’s calculations. These differences relate to a variety of matters, including allocation of non-consent
interests, complex payout calculations for individual and group wells and the timing of reversionary interests. Accordingly, these
matters are subject to legal interpretation and the related obligations are presented as a contingent liability in the accompanying
condensed consolidated balance sheet as of September 30, 2017. While the Company has classified this entire amount as a current
liability, most of these issues are expected to be resolved through arbitration, mediation or litigation. This matter was settled
on October 4, 2017. Please refer to Note 13 entitled “Subsequent Events” for further information.
Anfield
Gain Contingency.
In 2007, the Company sold all of its uranium assets for cash and stock of the purchaser, Uranium One Inc.
(“Uranium One”). The assets sold included a uranium mill in Utah and unpatented uranium claims in Wyoming, Colorado,
Arizona and Utah. Pursuant to the asset purchase agreement, the Company was entitled to additional consideration from Uranium
One up to $40,000 based on, among other things, the performance of the mill, and achievement of commercial production and royalties,
however no additional consideration has been received from Uranium One. In August 2014, the Company entered into an agreement
with Anfield Resources Inc. (“Anfield”) whereby if Anfield was successful in acquiring the property from Uranium One,
Anfield would be released from the future payment obligations stemming from the 2007 sale to Uranium One. On September 1, 2015,
Anfield acquired the property from Uranium One and is now obligated to provide the following consideration to the Company:
|
●
|
Issuance
of $2,500 in Anfield common shares to the Company. The Anfield shares are to be held in escrow and released in tranches over
a 36-month period. Pursuant to the agreement, if any of the share issuances result in the Company holding in excess of 20%
of the then issued and outstanding shares of Anfield (the “Threshold”), such shares in excess of the Threshold
would not be issued at that time, but deferred to the next scheduled share issuance. If, upon the final scheduled share issuance
the number of shares to be issued exceeds the Threshold, the value in excess of the Threshold is payable to the Company in
cash,
|
|
●
|
$2,500
payable in cash upon 18 months of continuous commercial production, and
|
|
●
|
$2,500
payable in cash upon 36 months of continuous commercial production.
|
The
first tranche of common shares resulted in the issuance of 7,436,505 shares of Anfield with a market value of $750,000 and such
shares were delivered to the Company in September 2015. The second tranche of shares resulted in the issuance of 3,937,652 additional
shares of Anfield with a market value of $750,000, and such shares were delivered to the Company in September 2016. Since the
trading volume in Anfield shares has increased, beginning primarily in the quarter ended June 30, 2016, the Company determined
a mark-to-market technique would be the most appropriate method to determine the fair value for Anfield shares. The primary factor
in using a mark-to-market valuation in determining the fair value of Anfield shares is justified because of the Company’s
belief that due to the increased liquidity in the stock, using current market prices for Anfield shares reflects the most accurate
fair value calculation. At September 30, 2017, we determined the fair value of the Anfield shares to be approximately $0.5 million.
Please refer to Note 13 entitled “Subsequent Events” for further information.
Preferred
Stock
The
Company’s articles of incorporation authorize the issuance of up to 100,000 shares of preferred stock, $0.01 par value.
Shares of preferred stock may be issued with such dividend, liquidation, voting and conversion features as may be determined by
the Board of Directors without shareholder approval. As discussed in Note 5, in February 2016 the Board of Directors approved
the designation of 50,000 shares of Series A Convertible Preferred Stock in connection with the disposition of the Company’s
mining segment.
Warrants
On
December 21, 2016, the Company completed a registered direct offering of 1.0 million shares of common stock at a net price of
$1.50 per share. Concurrently, the investors received warrants to purchase 1.0 million shares of Common Stock of the Company at
an exercise price of $2.05 per share, subject to adjustment, for a period of five years from closing. The total net proceeds received
by the Company was approximately $1.32 million. The fair value of the warrants upon issuance was $1.24 million, with the remaining
$0.08 million being attributed to common stock. The warrants contain a dilutive issuance and other liability provisions which
cause the warrants to be accounted for as a liability. Such warrant instruments are initially recorded as a liability and are
accounted for at fair value with changes in fair value reported in earnings.
Stock
Options
From
time to time, the Company grants stock options under its incentive plan covering shares of common stock to employees of the Company.
Stock options, when exercised, are settled through the payment of the exercise price in exchange for new shares of stock underlying
the option. These awards typically expire ten years from the grant date.
During
the nine months ended September 30, 2017, the Company granted its board of directors 60,000 options in aggregate at an exercise
price of $0.72 per share with a 10-year term. The shares were immediately vested and are included in the stock-based compensation
expense related to stock options for the nine months ended September 30, 2017 of $65,000 in comparison to $34,000 recorded for
the comparable period in 2016. Management used a Black-Scholes valuation model to assess the stock-based compensation expense
related to the options using the following input assumptions: 80% volatility rate, 2.34% risk free rate, and no associated dividend
payments. The Company had $15,000 of unrecognized compensation expense related to non-vested stock options to be recognized through
January 2018 as of September 30, 2017 and $80,000 of unrecognized compensation expense related to non-vested stock options as
of September 30, 2016.
As of September 30, 2017, the Company had 279,687
stock options outstanding with exercise prices ranging from $0.72 to $30.24 with a weighted average exercise price of $10.76 and
a remaining weighted-average period of 5.7 years. These shares include 274,132 shares which are exercisable as September 30, 2017
with a weighted average price of $10.79 per share.
Presented
below is information about stock options outstanding and exercisable as of September 30, 2017 and December 31, 2016:
|
|
September 30, 2017
|
|
|
December 31, 2016
|
|
|
|
Shares
|
|
|
Price
(1)
|
|
|
Shares
|
|
|
Price
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options outstanding
|
|
|
279,687
|
|
|
$
|
10.76
|
|
|
|
390,525
|
|
|
$
|
20.64
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options exercisable
|
|
|
274,132
|
|
|
$
|
10.79
|
|
|
|
376,084
|
|
|
$
|
20.97
|
|
|
(1)
|
Represents
the weighted average price.
|
The
following table summarizes information for stock options outstanding and exercisable at September 30, 2017:
Options Outstanding
|
|
|
Options Exercisable
|
|
Number
|
|
|
Exercise Price
|
|
|
Remaining
|
|
|
Number
|
|
|
Weighted
|
|
of
|
|
|
Range
|
|
|
Weighted
|
|
|
Contractual
|
|
|
of
|
|
|
Average
|
|
Shares
|
|
|
Low
|
|
|
High
|
|
|
Average
|
|
|
Term (years)
|
|
|
Shares
|
|
|
Exercise Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56,786
|
|
|
$
|
9.00
|
|
|
$
|
9.00
|
|
|
$
|
9.00
|
|
|
|
7.3
|
|
|
|
51,231
|
|
|
$
|
9.00
|
|
|
49,504
|
|
|
|
12.48
|
|
|
|
12.48
|
|
|
|
12.48
|
|
|
|
5.8
|
|
|
|
49,504
|
|
|
|
12.48
|
|
|
98,396
|
|
|
|
15.01
|
|
|
|
15.01
|
|
|
|
15.01
|
|
|
|
2.1
|
|
|
|
98,396
|
|
|
|
15.01
|
|
|
15,001
|
|
|
|
22.62
|
|
|
|
30.24
|
|
|
|
24.03
|
|
|
|
5.8
|
|
|
|
15,001
|
|
|
|
24.03
|
|
|
60,000
|
|
|
|
0.72
|
|
|
|
0.72
|
|
|
|
0.72
|
|
|
|
9.9
|
|
|
|
60,000
|
|
|
|
0.72
|
|
|
279,687
|
|
|
$
|
0.72
|
|
|
$
|
30.24
|
|
|
$
|
10.76
|
|
|
|
5.7
|
|
|
|
274,132
|
|
|
$
|
10.79
|
|
As
of September 30, 2017, 1,151,000 shares are available for future grants under the Company’s stock option plans.
Restricted
Stock Grants
In January 2015, the Board of Directors granted
340,711 shares of restricted stock under the 2012 Equity Plan to four officers of the Company. These shares originally vested annually
over a period of three years. However, during 2015 vesting was accelerated for three of the four officers in connection with severance
agreements for an aggregate of 240,711 shares. The remaining 100,000 shares vested for 33,333 shares in both January 2016 and January
2017 and the remaining shares will vest for 33,334 shares in January 2018. The fair market value of the 340,711 shares on the date
of grant was approximately $511,000. As of September 30, 2017, there was $12,671 of unrecognized expense related to unvested restricted
stock grants issued in January 2015, which will be recognized as stock-based compensation expense through January 2018.
On September 23, 2016, the Board of
Directors granted restricted stock to each member of the Board for 58,500 shares per Board member for an aggregate grant of
351,000 shares. In connection with the resignations of four members of the Company’s Board of Directors, the restricted
stock grants were amended and the members of the Board of Directors subsequently agreed to accept 33,332 fully-vested shares
each, in lieu of the 58,500 share grants for a total of 199,992 shares. The closing price of the Company’s common stock
on the grant date was $1.05, resulting in an aggregate compensation charge of $209,000. As of September 30, 2017, the Company
has accrued for the entire aggregate compensation charge over prior quarters and there was $0 of unrecognized expense related
to the September 23, 2016 grants. For the nine months ended September 30, 2017 and 2016, total stock-based compensation
expense related to restricted stock grants was $189,000 and $25,000 respectively.
For
Federal income tax purposes, as of December 31, 2016 the Company had net operating loss and percentage depletion carryovers of
approximately $74.7 million and $2.5 million, respectively. The net operating loss carryovers may be carried back two years and
forward twenty years from the year the net operating loss was generated. The net operating losses may be used to offset future
taxable income and expire in varying amounts through 2035. In addition, the Company has alternative minimum tax credit carry-forwards
of approximately $0.7 million which are available to offset future federal income taxes over an indefinite period. The Company
has established a valuation allowance for all deferred tax assets including the net operating loss and alternative minimum tax
credit carryforwards discussed above since the “more likely than not” realization criterion was not met as of September
30, 2017 and 2016. Accordingly, the Company did not recognize an income tax benefit for the nine months ended September 30, 2017
and 2016. Furthermore, the Company projects a net loss for the fiscal year ended December 31, 2017.
The
Company recognizes, measures, and discloses uncertain tax positions whereby tax positions must meet a “more-likely-than-not”
threshold to be recognized. As of September 30, 2017, gross unrecognized tax benefits are immaterial and there was no change in
such benefits during the three months ended September 30, 2017. The Company does not expect significant increase or decrease to
the uncertain tax positions within the next twelve months.
|
10.
|
EARNINGS
(LOSS) PER SHARE
|
Basic
earnings (loss) per share is computed based on the weighted average number of common shares outstanding. The calculation of diluted
earnings (loss) per share includes the potential dilutive impact of unvested restricted stock awards and contingently issuable
shares during the periods presented, unless their effect is anti-dilutive. For the three and nine months ended September 30, 2017
and 2016, common stock equivalents excluded from the calculation of weighted average shares because they were antidilutive are
as follows:
|
|
Three
Months Ended
September
30,
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017s
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options
|
|
|
279,687
|
|
|
|
390,525
(1)
|
|
|
|
279,687
|
|
|
|
390,525
(1)
|
|
Unvested
shares of restricted common stock
|
|
|
5,555
|
|
|
|
37,818
|
|
|
|
5,555
|
|
|
|
20,078
|
|
Outstanding
warrants
|
|
|
1,000,000
|
|
|
|
—
|
|
|
|
1,000,000
|
|
|
|
—
|
|
Series
A convertible preferred stock
|
|
|
793,000
|
|
|
|
699,004
|
|
|
|
768,473
|
|
|
|
581,535
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
2,078,242
|
|
|
|
1,127,347
|
|
|
|
2,053,715
|
|
|
|
992,138
|
|
|
(1)
|
Includes
weighted average number of shares for options and shares of restricted stock issued during
the period
|
|
11.
|
SIGNIFICANT
CONCENTRATIONS
|
The Company has exposure to credit risk in the event of nonpayment by the joint interest operators of the
Company’s oil and gas properties. Approximately 38% of the Company’s proved developed oil and gas reserve quantities
are associated with wells that are operated by a single operator (the “Major Operator”). As of September 30, 2017 and
December 31, 2016, the Company had a liability to the Major Operator of $2,442,176 and $2,710,000 respectively, for accrued operating
expenses and overpayments of net revenues when the Major Operator failed to recognize that the Company’s ownership interest
reverted after payout was achieved for certain wells during 2014 and 2015. Beginning in the second quarter of 2015, the Major Operator
began withholding the Company’s net revenues from all wells that it operates for the Company. Accordingly, the aggregate
balances are presented as current liabilities in the accompanying consolidated balance sheets. This matter was settled on October
4, 2017. Please refer to Note 13 entitled “Subsequent Events” for further information.
|
12.
|
FAIR
VALUE MEASUREMENTS
|
Fair
value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. In determining fair value, the Company uses various methods including market, income and
cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use
in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique.
These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes valuation
techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability
of the inputs used in the valuation techniques the Company is required to provide the following information according to the fair
value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values.
Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:
Level
1 - Quoted prices for identical assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.
Level
2 - Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active
markets, or other observable inputs that can be corroborated by observable market data. Level 2 also includes derivative contracts
whose value is determined using a pricing model with observable market inputs or can be derived principally from or corroborated
by observable market data.
Level
3 - Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing
models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair
value requires significant management judgment or estimation; also includes observable inputs for nonbinding single dealer quotes
not corroborated by observable market data.
The
Company has processes and controls in place to attempt to ensure that fair value is reasonably estimated. The Company performs
due diligence procedures over third-party pricing service providers in order to support their use in the valuation process. Where
market information is not available to support internal valuations, independent reviews of the valuations are performed and any
material exposures are evaluated through a management review process.
While
the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different
methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate
of fair value at the reporting date. The following is a description of the valuation methodologies used for complex financial
instruments measured at fair value:
Marketable
Equity Securities Valuation Methodologies
The
fair value of available for sale securities is based on quoted market prices obtained from independent pricing services. Accordingly,
the Company has classified these instruments as Level 1.
Warrant
Valuation Methodologies
The
warrants contain a dilutive issuance and other liability provisions which cause the warrants to be accounted for as a liability.
Such warrant instruments are initially recorded and valued as a level 3 liability and are accounted for at fair value with changes
in fair value reported in earnings.
The
Company estimated the value of the warrants issued with the Securities Purchase Agreement on December 31, 2016 to be $1,030,000,
or $1.03 per warrant, using the Monte Carlo model with the following assumptions: a term expiring June 21, 2022, exercise price
of $2.05, stock price of $1.28, average volatility rate of 90%, and a risk-free interest rate of 2.01%. The Company re-measured
the warrants as of September 30, 2017, using the same Monte Carlo model, using the following assumptions: a term expiring June
21, 2022, exercise price of $2.05, stock price of $0.77, average volatility rate of 90%, and a risk-free interest rate of 2.00%.
As of September 30, 2017, the fair value of the warrants was $580,000, or $0.58 per warrant, and was recorded as a liability on
the accompanying consolidated balance sheets. An increase in any of the variables would cause an increase in the fair value of
the warrants. Likewise, a decrease in any variable would cause a decrease in the value of the warrants.
Other
Financial Instruments
The
carrying amount of cash and equivalents, oil and gas sales receivable, other current assets, accounts payable and accrued expenses
approximate fair value because of the short-term nature of those instruments. The recorded amounts for the Senior Secured Revolving
Credit Facility discussed in Note 6 approximates the fair market value due to the variable nature of the interest rates, and the
fact that market interest rates have remained substantially the same since the latest amendment to the credit facility.
Recurring
Fair Value Measurements
Recurring
measurements of the fair value of assets and liabilities as of September 30, 2017 and December 31, 2016 are as follows:
|
|
September
30, 2017
|
|
|
December
31, 2016
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable
equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sutter
Gold Mining Company
|
|
$
|
7
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
7
|
|
|
$
|
16
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
16
|
|
Anfield
Resources, Inc.
|
|
|
457
|
|
|
|
—
|
|
|
|
—
|
|
|
|
457
|
|
|
|
930
|
|
|
|
—
|
|
|
|
—
|
|
|
|
930
|
|
Commodity
price risk derivatives
|
|
|
|
|
|
|
29
|
|
|
|
—
|
|
|
|
29
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Total
|
|
$
|
464
|
|
|
$
|
29
|
|
|
$
|
—
|
|
|
$
|
493
|
|
|
$
|
946
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
946
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
warrant liability
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
580
|
|
|
$
|
580
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,030
|
|
|
$
|
1,030
|
|
The
following table presents a reconciliation of changes in assets and liabilities measured at fair value on a recurring basis for
the period ended September 30, 2017 and the year ended December 31, 2016.
|
|
Assets
|
|
|
Liabilities
|
|
|
|
|
|
|
Marketable Securities and Derivatives
|
|
|
|
|
|
|
|
|
|
|
|
|
Sutter
|
|
|
|
Anfield
|
|
|
|
Derivatives
|
|
|
|
Warrants
|
|
|
|
|
|
|
|
|
(Level 1)
|
|
|
|
(Level 1)
|
|
|
|
(Level 2)
|
|
|
|
(Level 3)
|
|
|
|
Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value, December 31, 2016
|
|
$
|
16
|
|
|
$
|
930
|
|
|
$
|
—
|
|
|
|
1,030
|
|
|
$
|
1,976
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net losses included in:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss
|
|
|
(9
|
)
|
|
|
(473
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(482
|
)
|
Fair value adjustments included in net loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized gain on warrant fair value adjustment
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(450
|
)
|
|
|
(450
|
)
|
Crude oil price risk derivatives
|
|
|
—
|
|
|
|
—
|
|
|
|
29
|
|
|
|
—
|
|
|
|
29
|
|
Fair value, September 30, 2017
|
|
$
|
7
|
|
|
$
|
457
|
|
|
|
29
|
|
|
|
580
|
|
|
$
|
1,073
|
|
On
October 4, 2017, U.S. Energy Corp. (the “Company”), the Company’s wholly owned subsidiary Energy One LLC and
Statoil Oil and Gas LP (“Statoil”) entered into a purchase and sale agreement (the “Purchase Agreement”),
pursuant to which, on the terms, and subject to the conditions of the Purchase Agreement, the Company assigned, sold, and conveyed
certain non-operated assets in the Williston Basin, North Dakota in consideration for the elimination of $4.0 million in outstanding
liabilities and payment by Statoil to the Company of $2.0 million in cash. U.S. Energy has historically accounted for the eliminated
liabilities on the Company’s balance sheet under “Payable to major operator” and “Contingent ownership
interests.” The Purchase Agreement was unanimously approved by the board of directors of the Company and closed on October
5, 2017, with an effective date of August 1, 2017.
On
October 5, 2017, U.S. Energy Corp. announced that the Company, the Company’s wholly owned subsidiary Energy One LLC and
APEG Energy II, L.P., (“APEG”), an entity controlled by Angelus Private Equity Group, LLC entered into an exchange
agreement (the “Exchange Agreement”), pursuant to which, on the terms and subject to the conditions of the Exchange
Agreement, APEG will exchange $4,463,380 of outstanding borrowings under the Company’s Credit Facility, for 5,819,270 new
shares of common stock of the Company, par value $0.01 per share, representing an exchange price of $0.767 representing a 1.3%
premium over the 30-day volume weighted average price of the Company’s common stock on September 20, 2017 (the “Exchange
Shares”). Accrued, unpaid interest on the Credit Facility held by APEG will be paid in cash at the closing of the transaction.
Immediately following the close of the transaction, APEG will hold approximately 49.3% of the outstanding Common Stock of U.S.
Energy. The Company expects to close the Transaction in the fourth quarter of 2017. The Transaction is subject to certain customary
closing conditions, including approval by the Company’s shareholders of the Transaction.
On
November 6, 2017 U.S. Energy Corp. announced it has received scheduled proceeds from a previously announced August 2014 transaction
regarding the divestment of uranium mining assets in exchange for $2.5 million of stock in Anfield Resources Inc. Pursuant to
the agreement, payments for the divestiture were structured as three issuances of stock with the most recent and final $1.0 million
issuance consisting of 24,942,200 shares of Anfield. The recently received shares are restricted until March 2, 2018. U.S. Energy
now holds 36,316,357 shares of Anfield representing approximately 19.2% of the common stock outstanding.