Blueprint
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☑
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For the
quarterly period ended: September 30, 2018
☐
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For the
transition period from
to_____
Commission
file number: 001-35922
PEDEVCO CORP.
(Exact
name of registrant as specified in its charter)
Texas
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22-3755993
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(State
or other jurisdiction of incorporation or
organization)
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(IRS
Employer Identification No.)
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1250 Wood Branch Park Dr., Suite 400
Houston, Texas 77079
(Address
of Principal Executive Offices)
(855)
733-3826
(Registrant’s
Telephone Number, Including Area Code)
Indicate
by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes ☑
No ☐
Indicate
by check mark whether the registrant has submitted electronically
every Interactive Data File required to be submitted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during
the preceding 12 months (or for such shorter period that the
registrant was required to submit such files).
Yes ☑
No ☐
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated filer, a
smaller reporting company, or an emerging growth company. See the
definitions of “large accelerated
filer,”
“accelerated
filer,”
“smaller reporting
company,” and
“emerging growth
company” in Rule 12b-2 of
the Exchange Act.
Large accelerated filer ☐
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Accelerated filer ☐
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Non-accelerated filer ☐
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Smaller reporting company ☑
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Emerging growth company ☐
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If an emerging growth company, indicate by check mark if the
registrant has elected not to use the extended transition period
for complying with any new or revised financial accounting
standards provided pursuant to Section 13(a) of the Exchange
Act. ☐
Indicate
by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act. Yes ☐
No ☑
At November
12, 2018, there were 15,184,445 shares of
the Registrant’s common stock outstanding.
PEDEVCO CORP.
For the Three and Nine Months Ended September 30, 2018
INDEX
PART I – FINANCIAL INFORMATION
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Page
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Item
1.
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Financial
Statements
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F-1
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Consolidated
Balance Sheets as of September 30, 2018 and December 31, 2017
(Unaudited)
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F-1
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Consolidated
Statements of Operations for the Three and Nine Months Ended
September 30, 2018 and 2017 (Unaudited)
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F-2
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Consolidated
Statements of Cash Flows for the Nine Months Ended September 30,
2018 and 2017 (Unaudited)
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F-3
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Notes
to Unaudited Consolidated Financial Statements
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F-4
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Item
2.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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1
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Item
3.
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Quantitative
and Qualitative Disclosures About Market Risk
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13
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Item
4.
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Controls
and Procedures
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13
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PART II – OTHER INFORMATION
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14
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Item
1.
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Legal
Proceedings
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14
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Item
1A.
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Risk
Factors
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14
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Item
2.
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Unregistered
Sales of Equity Securities and Use of Proceeds
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20
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Item
3.
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Defaults
Upon Senior Securities
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21
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Item
4.
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Mine
Safety Disclosures
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21
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Item
5.
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Other
Information
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21
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Item
6.
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Exhibits
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21
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Signatures
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22
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PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PEDEVCO CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(amounts
in thousands, except share and per share data)
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Assets
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Current
assets:
|
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Cash
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$460
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$917
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Restricted
Cash
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2,316
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-
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Accounts receivable
– oil and gas
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813
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301
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Prepaid expenses
and other current assets
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237
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176
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Total current
assets
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3,826
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1,394
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Oil and gas
properties:
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Oil and gas
properties, subject to amortization, net
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54,877
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34,922
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Oil and gas
properties, not subject to amortization, net
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-
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-
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Total oil and gas
properties, net
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54,877
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34,922
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Other
assets
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190
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85
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Total
assets
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$58,893
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$36,401
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Liabilities
and Shareholders’ Equity (Deficit)
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Current
liabilities:
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Accounts
payable
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$507
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$101
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Accrued
expenses
|
997
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2,126
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Accrued expenses
– related party
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167
|
-
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Revenue
payable
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919
|
557
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Convertible notes
payable – Bridge Notes, net of premiums of $-0- and $113,
respectively
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-
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588
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Total current
liabilities
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2,590
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3,372
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Long-term
liabilities:
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Accrued
expenses
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6
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1,462
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Accrued expenses
– related party
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310
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1,733
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Notes payable
– Secured Promissory Notes, net of debt discount of $-0- and
$2,603, respectively
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-
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34,159
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Notes payable
– Secured Promissory Notes – related party, net of debt
discount of $-0- and $1,148, respectively
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-
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15,930
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Notes payable
– Secured Promissory Notes - Subordinated – related
party
|
-
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11,483
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Notes payable
– Subordinated
|
400
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-
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Notes payable
– Subordinated – related party
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23,200
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-
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Notes payable
– other
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-
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4,925
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Notes payable
– related party, net of debt discount of $173 and $-0-,
respectively
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7,527
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-
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Asset retirement
obligations
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2,635
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477
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Total
liabilities
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36,668
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73,541
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Commitments and
contingencies
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Shareholders’
equity (deficit):
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Series A
convertible preferred stock, $0.001 par value, 100,000,000 shares
authorized, -0- and 66,625 shares issued and outstanding,
respectively
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-
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-
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Common stock,
$0.001 par value, 200,000,000 shares authorized; 15,109,327 and
7,278,754 shares issued and outstanding, respectively
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15
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7
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Additional paid-in
capital
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100,988
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100,954
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Accumulated
deficit
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(78,778)
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(138,101)
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Total
shareholders’ equity (deficit)
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22,225
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(37,140)
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Total liabilities
and shareholders’ equity (deficit)
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$58,893
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$36,401
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See
accompanying notes to unaudited consolidated financial
statements.
PEDEVCO CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(amounts
in thousands, except share and per share data)
|
For the Three
Months
Ended
September 30,
|
For the Nine
Months
Ended September
30,
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Revenue:
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Oil and gas
sales
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$1,259
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$744
|
$2,801
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$2,290
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Operating
expenses:
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Lease operating
costs
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936
|
304
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1,665
|
1,031
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Exploration
expense
|
-
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-
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38
|
-
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Selling, general
and administrative expense
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1,622
|
511
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2,976
|
2,005
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Depreciation,
depletion, amortization and accretion
|
937
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1,299
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2,220
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2,852
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Total operating
expenses
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3,495
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2,114
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6,899
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5,888
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Loss on write-off
of cost method investment
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-
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(4)
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-
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(4)
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Operating income
(loss)
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(2,236)
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(1,374)
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(4,098)
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(3,602)
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Other income
(expense):
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Interest
expense
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(497)
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(3,231)
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(6,888)
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(9,489)
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Gain on debt
restructuring
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-
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-
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70,309
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-
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Total other income
(expense)
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(497)
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(3,231)
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63,421
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(9,489)
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Net income
(loss)
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$(2,733)
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$(4,605)
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$59,323
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$(13,091)
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Earnings (loss) per
common share:
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Basic
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$(0.19)
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$(0.76)
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$6.04
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$(2.28)
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Diluted
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$-
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$-
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$5.97
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$-
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Weighted average
number of common shares outstanding:
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Basic
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14,747,952
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6,074,294
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9,822,007
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5,753,827
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Diluted
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-
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-
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9,942,583
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-
|
See
accompanying notes to unaudited consolidated financial
statements.
PEDEVCO CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(amounts
in thousands)
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For the Nine
Months
Ended September
30,
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Cash Flows From
Operating Activities:
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Net income
(loss)
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$59,323
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$(13,091)
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Adjustments to
reconcile net income (loss) to net cash used in operating
activities:
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Stock-based
compensation expense
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566
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597
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Depreciation,
depletion and amortization
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2,220
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2,852
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Interest expense
deferred and capitalized in debt restructuring
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3,803
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5,200
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Gain on debt
restructuring
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(70,309)
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-
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Amortization of
debt discount
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1,403
|
2,434
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Changes in
operating assets and liabilities:
|
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Accounts
receivable
|
-
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25
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Accounts receivable
– oil and gas
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(512)
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(12)
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Prepaid expenses
and other current assets
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(61)
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(1)
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Accounts
payable
|
195
|
40
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Accrued
expenses
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1,829
|
905
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Accrued expenses
– related parties
|
477
|
790
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Revenue
payable
|
362
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39
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Net cash used in
operating activities
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(704)
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(218)
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Cash Flows From
Investing Activities:
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Cash paid for oil
and gas properties, net of restricted cash received of
$2,316
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(19,693)
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-
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Cash paid for
drilling costs
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(113)
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-
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Cash paid for oil
and gas security bonds
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(105)
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-
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Net cash used in
investing activities
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(19,911)
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-
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Cash Flows From
Financing Activities:
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Proceeds from notes
payable
|
400
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-
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Proceeds from notes
payable – related parties
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30,900
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-
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Repayment of notes
payable
|
(7,795)
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(30)
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Cash paid for
warrant repurchase
|
(1,095)
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-
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Proceeds from
warrant exercise for common stock
|
64
|
-
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Proceeds from
issuance of common stock, net of issuance costs
|
-
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530
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Net cash provided
by financing activities
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22,474
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500
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Net increase in
cash and restricted cash
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1,859
|
282
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Cash and
restricted cash at beginning of period
|
917
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659
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Cash and
restricted cash at end of period
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$2,776
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$942
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Supplemental
Disclosure of Cash Flow Information
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Cash paid
for:
|
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Interest
|
$-
|
$-
|
Income
taxes
|
$-
|
$-
|
|
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|
Noncash Investing
and Financing Activities:
|
|
|
Accrued oil and gas
development costs
|
$211
|
$-
|
Acquisition of
asset retirement obligations
|
$2,061
|
$-
|
Changes in
estimates of asset retirement costs
|
$13
|
$20
|
Common stock issued
as debt inducement
|
$185
|
$-
|
Conversion of
Series A preferred stock to common stock
|
$7
|
$-
|
See
accompanying notes to unaudited consolidated financial
statements.
PEDEVCO CORP.
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 in
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.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
Some of
the statements contained in this report discuss future
expectations, contain projections of results of operations or
financial condition, or state other “forward-looking”
information. The words “believe,”
“intend,”
“plan,”
“expect,”
“anticipate,”
“estimate,”
“project,”
“goal”
and similar expressions identify such a statement was made,
although not all forward-looking statements contain such
identifying words. These statements are subject to known and
unknown risks, uncertainties, and other factors that could cause
the actual results to differ materially from those contemplated by
the statements. The forward-looking information is based on various
factors and is derived using numerous assumptions. Factors that
might cause or contribute to such a discrepancy include, but are
not limited to, the risks discussed in this and our other SEC
filings. We do not promise to or take any responsibility to update
forward-looking information to reflect actual results or changes in
assumptions or other factors that could affect those statements
except as required by law. Future events and actual results could
differ materially from those expressed in, contemplated by, or
underlying such forward-looking statements.
Forward-looking
statements may include statements about our:
●
cash
flows and liquidity;
●
financial
strategy, budget, projections and operating results;
●
oil and
natural gas realized prices;
●
timing
and amount of future production of oil and natural
gas;
●
availability
of oil field labor;
●
the
amount, nature and timing of capital expenditures, including future
exploration and development costs;
●
availability
and terms of capital;
●
government
regulation and taxation of the oil and natural gas
industry;
●
marketing
of oil and natural gas;
●
exploitation
projects or property acquisitions;
●
costs
of exploiting and developing our properties and conducting other
operations;
●
general
economic conditions;
●
competition
in the oil and natural gas industry;
●
effectiveness
of our risk management activities;
●
environmental
liabilities;
●
counterparty
credit risk;
●
developments
in oil-producing and natural gas-producing countries;
●
future
operating results;
●
future
acquisition and debt transactions; and
●
estimated
future reserves and the present value of such reserves; and plans,
objectives, expectations and intentions contained in this Quarterly
Report that are not historical.
All
forward-looking statements speak only at the date of the filing of
this Quarterly Report. The reader should not place undue reliance
on these forward-looking statements. Although we believe that our
plans, intentions and expectations reflected in or suggested by the
forward-looking statements we make in this Quarterly Report are
reasonable, we provide no assurance that these plans, intentions or
expectations will be achieved. We disclose important factors that
could cause our actual results to differ materially from our
expectations under “Risk Factors” and
“Management’s
Discussion and Analysis of Financial Condition and Results of
Operations” and elsewhere in this Quarterly Report and
our Annual Report on Form 10-K filed with the SEC on March 29,
2018. These cautionary statements qualify all forward-looking
statements attributable to us or persons acting on our behalf. We
do not undertake any obligation to update or revise publicly any
forward-looking statements except as required by law, including the
securities laws of the United States and the rules and regulations
of the SEC.
The
following is management’s discussion and analysis of the
significant factors that affected the Company’s financial
position and results of operations during the periods included in
the accompanying unaudited consolidated financial statements. You
should read this in conjunction with the discussion under
“Item 7.
Management’s Discussion and Analysis of Financial Condition
and Results of Operations” and the audited
consolidated financial statements included in our Annual Report on
Form 10-K for the year ended December 31, 2017, and the
unaudited consolidated financial statements included in this
quarterly report.
Certain
abbreviations and oil and gas industry terms used throughout
this Quarterly Report are described and defined in greater detail
under “Glossary of
Oil And Natural Gas Terms” on page 28 of our
Annual Report on Form 10-K for the year ended December 31, 2017, as
filed with the Securities and Exchange Commission on March 29,
2018.
Certain
capitalized terms used below but not otherwise defined, are defined
in, and shall be read along with the meanings given to such terms
in, the notes to the unaudited financial statements of the Company
for the three and nine months ended September 30, 2018,
above.
Unless
the context requires otherwise, references to the
“Company,”
“we,”
“us,”
“our,”
“PEDEVCO” and
“PEDEVCO
Corp.” refer specifically to PEDEVCO Corp. and its
wholly and majority owned subsidiaries.
In
addition, unless the context otherwise requires and for the
purposes of this report only:
●
“Bbl”
refers to one stock tank barrel, or 42 U.S. gallons liquid volume,
used in this report in reference to crude oil or other liquid
hydrocarbons;
●
“Boe”
barrels of oil equivalent, determined using the ratio of one Bbl of
crude oil, condensate or natural gas liquids, to six Mcf of natural
gas;
●
“Mcf”
refers to a thousand cubic feet of natural gas;
●
“NGL”
refers to natural gas liquids;
●
“Exchange
Act” refers to the Securities Exchange Act of 1934, as
amended;
●
“SEC”
or the “Commission” refers to the
United States Securities and Exchange Commission; and
●
“Securities
Act” refers to the Securities Act of 1933, as
amended.
General Overview
We are 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, we focus 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. Our
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. As of September 30, 2018, we held approximately
23,441 net Permian Basin acres located in Chavez and Roosevelt
Counties, New Mexico, through our wholly-owned operating
subsidiary, Pacific Energy Development Corp.
(“PEDCO”),
which we refer to as our “Permian Basin
Asset,” and approximately
11,957 net D-J Basin acres located in Weld and Morgan Counties,
Colorado, through our wholly-owned operating subsidiary, Red Hawk
Petroleum, LLC (“Red
Hawk”), which asset we
refer to as our “D-J Basin
Asset.” As of September
30, 2018, we held interests in 337 gross (337 net) wells in our
Permian Basin Asset of which 60 are active producers and 16 are
active injectors, all of which are held by PEDCO and operated by
its wholly-owned operating subsidiaries, and interests in 68 gross (21.3 net)
wells in our D-J Basin Asset, of which
18 gross (16.2 net) wells are operated by Red Hawk and currently
producing, 28 gross (5.12 net) wells are non-operated, and 22 wells
have an after-payout interest.
We have
listed below the total production volumes and total
revenue net to the Company for the three and nine months ended
September 30, 2018 and 2017 attributable to our D-J Basin and
Permian Basin Assets.
|
Three Months
Ended
September 30,
2018
|
Three Months
Ended
September 30,
2017
|
Oil volume
(BBL)
|
18,870
|
13,657
|
Gas volume
(MCF)
|
25,858
|
29,810
|
NGL volume
(MCF)
|
14,551
|
113,886
|
Volume equivalent
(BOE) (1)
|
25,605
|
37,606
|
Revenue
(000’s)
|
$1,259
|
$744
|
|
Nine Months
Ended
September 30,
2018
|
Nine Months
Ended
September 30,
2017
|
Oil volume
(BBL)
|
41,132
|
39,879
|
Gas volume
(MCF)
|
62,273
|
84,989
|
NGL volume
(MCF)
|
34,850
|
153781
|
Volume equivalent
(BOE) (1)
|
57,319
|
79,674
|
Revenue
(000’s)
|
$2,801
|
$2,290
|
(1)
Assumes 6 Mcf of natural gas is equivalent to 1 barrel of
oil.
Restructuring and Management Change
Prior
to June 2018, the Company focused primarily on development of the
unconventional shale formations within the D-J Basin. The Company
attempted to organically develop and aggregate oil and gas
properties through the energy industry downturn in 2016, in the
process accumulating $73.4 million in debt as of June 25,
2018.
On June
26, 2018, the Company secured a strategic investment from SK Energy
LLC (“SK
Energy”), which is owned and controlled by Dr. Simon
Kukes, the Chief Executive Officer, and a director of the Company,
amounting to a $7.7 million convertible note investment (the
“June 2018
Convertible Note”), which proceeds were applied to the
repayment and full satisfaction of approximately $73.4 million in
Company debt (as described above in Note 8 to the consolidated
unaudited financial statements), and which transaction also
included the separate, individually negotiated, $100,000
acquisition by SK Energy, from a third party, of all the
outstanding shares of Company Series A Convertible Preferred Stock
(66,625 shares of preferred stock convertible into 47.6% of the
Company’s then-outstanding shares of common stock
post-conversion)(collectively referred to as the
“Restructuring”).
Shortly
after the Restructuring, the Company also reconstituted its Board
of Directors and senior management team, replacing the former Board
and senior management with seasoned oil and gas industry experts
(the “Management
Change”). Our management team is now headed by our
Chief Executive Officer, Dr. Simon Kukes, who was formerly the CEO
at Samara-Nafta, a Russian oil company partnering with Hess
Corporation, President and CEO of Tyumen Oil Company, and Chairman
of Yukos Oil. Joining Dr. Kukes is our new President, J. Douglas
Schick, who has over 20 years of experience in the oil and gas
industry, having co-founded American Resources, Inc., and formerly
serving in executive, management and operational planning, strategy
and finance roles at Highland Oil and Gas, Mariner Energy, Inc.,
The Houston Exploration Co., ConocoPhillips and Shell Oil
Company.
Our
Board of Directors is now headed by our Chairman, John J. Scelfo,
who brings nearly 40 years of experience in oil and gas management,
finance and accounting, and who served in numerous executive-level
capacities at Hess Corporation, including as Senior Vice President,
Finance and Corporate Development, Chief Financial Officer,
Worldwide Exploration & Production, and as a member of
Hess’ eight-member Executive Committee. In addition, our
Board includes Ivar Siem, who brings broad experience from both the
upstream and the service segments of the oil and gas industry,
including serving as Chairman of Blue Dolphin Energy Company
(OTCQX: BDCO), as Chairman and interim CEO of DI Industries/Grey
Wolf Drilling, as Chairman and CEO of Seateam Technology ASA, and
in various executive roles at multiple other E&P and oil field
service companies. Furthermore, our Board includes H. Douglas
Evans, who brings over 40
years of experience in executive management positions with Gulf
Interstate Engineering Company, one of the world's top pipeline
design and engineering firms, including as its current Chairman and
previously its President and Chief Executive Officer, and who is a
past President and current Board member of the International Pipe
Line and Offshore Contractors Association, current Chairman of its
Strategy Committee, and an active member of the Pipeline
Contractors Association.
The
result of the Restructuring and Management Change was a simplified
balance sheet, a significant reduction in indebtedness, and a new
management team and a Board of Directors with a new corporate and
enhanced operational focus.
Transformation
Following
the Restructuring, the newly installed management team immediately
engaged in the process of evaluating several acquisitions that
would enable a shift in our overall business strategy to focus on
assets with the following characteristics:
o
Long-lived,
conventional oil and gas properties
o
Tighter
conventional reservoirs with marginal vertical recovery, ideal for
horizontal development
o
Permeability and
rock properties significantly better than shale plays
o
Minimal to no
application of modern drilling and completion techniques and
technologies
o
Existing equipment,
facilities and available access to infrastructure
o
Large contiguous
acreage positions
In
connection therewith, the Company undertook the below transactions
in August 2018:
Acquisition of Permian Basin Assets
On
August 31, 2018, the Company closed the acquisition of the Permian
Basin Asset in New Mexico from Hunter Oil Company for a purchase
price of $21,316,000. The purchase price included $20,816,000 paid
in cash and $500,000 which is to be
held back to provide for potential indemnification of PEDCO, 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, The purchase price included $18,500,000 for all
production, associated assets and acreages, $500,000 for the
operating entities and associated inventory, and $2,316,000 of
restricted cash held in the operating companies for bonding with
the State of New Mexico. These properties had previously been
evaluated by the new management team and fit the Company’s
new corporate focus. Both the Milnesand and Chaveroo fields in the
Permian Basin Asset are legacy oil fields having produced to date
48 million barrels of oil equivalent from the San Andres formation,
via 40 acre vertical well spacing. The Company believes that by
applying horizontal drilling to the Permian Basin Asset,
downspacing to 20 acres can be achieved at a lower cost, with
significantly better recoveries than continued vertical
drilling.
The following table summarizes the allocation of the purchase price
to the net assets acquired (in thousands):
To
finance this acquisition, the Company sold $23.6 million of
convertible debt with a conversion price of $2.13 per share (the
“August 2018
Convertible Notes,” as described further below in
“Recent
Developments”). SK Energy purchased $22.0 million of
the convertible notes.
Acquisition of Additional D-J Basin Assets
The
Company also acquired additional D-J Basin Assets consisting of
four operated wells and 2,340 net acres held by production in the
D-J Basin which added to the Company’s then-current position.
This consolidation of ownership in existing acreage within the D-J
Basin provides for a more focused development plan related to these
assets.
Strategy
We believe 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. We plan to optimize our existing assets and
opportunistically seek additional acreage proximate to our
currently held core acreage, as well as other attractive onshore
U.S. oil and gas assets that fit our acquisition criteria, that
Company management believes can be developed using our technical
and operating expertise, and be accretive to shareholder
value.
Specifically,
we seek to increase shareholder value through the following
strategies:
●
Grow production, cash flow and reserves by
developing our operated drilling inventory and participating
opportunistically in non-operated projects. We believe our
extensive inventory of drilling locations in the Permian Basin and
select opportunities in the D-J Basin, combined with our operating
expertise, will enable us to continue to deliver accretive
production, cash flow and reserves. We have identified over 150
gross drilling locations across our Permian Basin acreage based on
20-acre spacing. We believe the location, concentration and scale
of our core leasehold positions, coupled with our technical
understanding of the reservoirs will allow us to efficiently
develop our core areas and to allocate capital to maximize the
value of our resource base.
●
Apply modern drilling and completion techniques
and technologies. We own and intend to own additional
properties that have been historically underdeveloped and
underexploited. We believe our competitive advantage and attention
to detail through innovation propels us to apply the latest
industry advances in horizontal drilling, completions design, frac
intensity and locally optimal frac fluids to fully develop our
properties.
●
Optimization of well density and
configuration. We own properties that are legacy
conventional oil fields characterized by widespread vertical
development and geological well control. We utilize the extensive
petrophysical and production data of such legacy properties to
confirm optimal well spacing and configuration using modern
reservoir evaluation methodologies.
●
Maintain a high degree of operational
control. We believe that by retaining high operational
control, we can efficiently manage the timing and amount of our
capital expenditures and operating costs, and thus key in on the
optimal drilling and completions strategies, which we believe will
generate higher recoveries and greater rates of return per
well.
●
Leverage extensive deal flow, technical and
operational experience to evaluate and execute accretive
acquisition opportunities. Our management and technical
teams have an extensive track record of forming and building oil
and gas businesses. We also have significant expertise in
successfully sourcing, evaluating and executing acquisition
opportunities. We believe our understanding of the geology,
geophysics and reservoir properties of potential acquisition
targets will allow us to identify and acquire highly prospective
acreage in order to grow our reserve base and maximize stockholder
value.
●
Preserve financial flexibility to pursue
organic and external growth opportunities. We intend to
maintain a disciplined financial profile that will provide us
flexibility across various commodity and market cycles. We intend
to leverage capital available from our strategic partners, and
access to the public equity markets, to continuously fund
development and operations.
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 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.
Recent Developments
August 2018 Convertible Notes
As described above in Note 8 to the consolidated financial
statements included herein, on August 1, 2018, we raised
$23,600,000 through the sale of $23,600,000 in Convertible
Promissory Notes (the “August 2018
Convertible Notes”). A
total of $22,000,000 in August 2018 Convertible Notes was purchased
by SK Energy; $200,000 in August 2018 Convertible Notes was
purchased by an executive officer of SK Energy; $500,000 in August
2018 Convertible Notes was purchased by a trust affiliated with
John J. Scelfo, a director of the Company; $500,000 in August 2018
Convertible Notes was purchased by an entity affiliated with Ivar
Siem, our director, and J. Douglas Schick, who was appointed as the
President of the Company on August 1, 2018; $200,000 in August 2018
Convertible Notes was purchased by H. Douglas Evans (who
became a Director and related party on September 27,
2018); and $200,000 in August 2018
Convertible Notes were purchased by an unaffiliated party. The
August 2018 Convertible Notes mature on August 1, 2021, may be
prepaid at any time without penalty, and accrue interest monthly at
8.5% per annum, which interest is payable on the maturity date
unless otherwise converted into our common stock. The August 2018
Convertible Notes and all accrued interest thereon are convertible
into shares of our common stock, from time to time at the option of
the holders thereof, at a conversion price equal to $2.13 per
share. Further, the conversion of the August 2018 Convertible Note
held by SK Energy 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.
Hunter Oil Purchase and Sale Agreement and Stock Purchase
Agreement
On August 31, 2018, we closed the transactions contemplated by (i)
a Purchase and Sale Agreement with Milnesand Minerals Inc., a
Delaware corporation, Chaveroo Minerals Inc., a Delaware
corporation, Ridgeway Arizona Oil Corp., an Arizona corporation
(“RAOC”),
and EOR Operating Company, a Texas corporation
(“EOR”)(collectively “Seller”),
and (ii) a Stock Purchase Agreement with Hunter Oil Production
Corp. (“Hunter
Oil”). Pursuant to these
agreements, we (through our wholly-owned subsidiary Pacific
Energy Development Corp. (“PEDCO”))
acquired (x) approximately 23,441 net leasehold acres, current
operated production, and all of Seller’s leases and related
rights, oil and gas and other wells, equipment, easements, contract
rights, and production (effective as of September 1, 2018) for
$18,500,000 (of which $500,000 is to be held back to provide for
potential indemnification of PEDCO, 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), and (y) all of the stock of
RAOC and EOR for net $500,000 (an aggregate purchase price of
$2,815,636, less $2,315,636 in restricted cash which EOR and RAOC
are required to maintain as of the closing date). These assets are
referred to by the Company as its “Permian Basin
Assets.”
Condor Acquisition
On August 1, 2018, Red Hawk Petroleum, LLC, our wholly-owned
subsidiary (“Red
Hawk”) entered into a
Membership Interest Purchase Agreement (the
“Membership Purchase
Agreement”) with MIE
Jurassic Energy Corporation (“MIEJ”).
Pursuant to the Membership Purchase Agreement, MIEJ sold Red Hawk
100% of the outstanding membership interests of Condor Energy
Technology LLC (“Condor”)
in consideration for $537,000. Condor owns approximately 2,340 net
leasehold acres, 100% held by production (HBP), located in Weld and
Morgan Counties, Colorado, with four operated producing wells.
Together with the Company’s other assets located in the D-J
Basin, these assets are referred to by the Company as its
“D-J Basin
Assets.”
Warrant Repurchase Agreements
On
August 31, 2018, we entered into warrant repurchase agreements with
certain of our former note holders holding warrants exercisable for
shares of the Company’s common stock at an exercise price of
$0.322 per share, which former note holders received such warrants
in connection with the June 2018 Restructuring described above.
Pursuant to the warrant repurchase agreements, effective September
17, 2018, we repurchased and cancelled warrants exercisable for an
aggregate of 1,105,935 shares of the Company’s common stock
in exchange for payment of an aggregate of $1,095,000 or $0.99 per
warrant share. The Company’s stock price closed at $2.04 per
share on the September 17, 2018, the effective date of the warrant
repurchase agreements.
October Convertible Note
On October 25, 2018, we 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 our common stock as described below. The October
2018 Convertible Note and all accrued interest thereon are
convertible into shares of our common stock, from time to time, 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.
Critical Accounting Policies
The
preparation of financial statements in conformity with generally
accepted accounting principles requires us to make judgments,
estimates and assumptions in the preparation of our consolidated
financial statements and accompanying notes. Actual results could
differ from those estimates. We believe there have been no
significant changes in our critical accounting policies as
discussed in our Annual Report on Form 10-K for the year
ended December 31, 2017.
Results of Operations and Financial Condition
All of
the numbers presented below are rounded numbers and should be
considered as approximate.
Comparison of the Three Months Ended September 30, 2018 with the
Three Months Ended September 30, 2017
Oil and Gas Revenue. For the three months ended
September 30, 2018, we generated a total of $1,259,000 in revenues
from the sale of oil and gas, compared to $744,000 for the three
months ended September 30, 2017. The increase of $515,000 was
primarily due to an increase in oil volume as additional oil and
gas properties were acquired during the three months ended
September 30, 2018, resulting in an increase in production from our
oil and gas assets.
Lease Operating Expenses. For the three months ended
September 30, 2018, lease operating expenses associated with our
oil and gas properties were $936,000, compared to $304,000 for
the three months ended September 30, 2017. The increase of $632,000
was primarily due to workover expenses and somewhat higher variable
lease operating expenses associated with the higher oil volume
resulting from the increased number of wells and increased oil
production.
Selling, General and Administrative Expenses. For the three
months ended September 30, 2018, selling, general and
administrative (“SG&A”) expenses were
$1,622,000, compared to $511,000 for the three months ended
September 30, 2017. The increase of $1,111,000 was primarily due to
increases in payroll, stock-based compensation expense, as well as
other cost increases in various areas as shown in the table below.
The increases are primarily due to the hiring of additional
personnel and expenses associated with two acquisitions. The
components of SG&A expenses for the three months ended
September 30, 2018 and 2017 are summarized below (amounts in
thousands):
|
For the Three
Months Ended
|
|
|
|
|
(in
thousands)
|
|
|
|
Payroll and related
costs
|
$758
|
$259
|
$499
|
Stock-based
compensation expense
|
217
|
80
|
137
|
Legal
fees
|
176
|
60
|
116
|
Accounting and
other professional fees
|
213
|
39
|
174
|
Insurance
|
70
|
27
|
43
|
Travel and
entertainment
|
66
|
7
|
59
|
Office rent,
communications and other
|
122
|
39
|
83
|
Total selling,
general and administrative expenses
|
$1,622
|
$511
|
$1,111
|
Depreciation, Depletion and Amortization and Accretion
(“DD&A”). For
the three months ended September 30, 2018, DD&A costs were
$937,000, compared to $1,299,000 for the three months ended
September 30, 2017. The $362,000 decrease was primarily the result
of lower total production volumes in the current period (lower gas
and NGL volumes, offset by higher oil production).
Interest Expense. For the three months ended September
30, 2018, interest expense was $497,000, compared to $3,231,000 for
the three months ended September 30, 2017. The decrease of
$2,734,000 was due primarily to lower loan balances compared to the
prior year’s period as a result of the
Restructuring.
Net Income (Loss). For the three months ended September
30, 2018, net loss was $2,733,000, compared to a net loss of
$4,605,000 for the three months ended September 30, 2017. The
decrease in net loss of $1,872,000 was primarily due to the lower
interest expense, offset somewhat by higher operating expenses,
during the three months ended September 30, 2018 when compared to
the prior year’s period.
Comparison of the Nine Months Ended September 30, 2018 with the
Nine Months Ended September 30, 2017
Oil and Gas Revenue. For the nine months ended
September 30, 2018, we generated a total of $2,801,000 in revenues
from the sale of oil and gas, compared to $2,290,000 for the nine
months ended September 30, 2017. The increase of $511,000 was
primarily due to an increase in oil volume as additional oil and
gas properties were acquired during the nine months ended September
30, 2018, resulting in an increase in production from our oil and
gas assets.
Lease Operating Expenses. For the nine months ended
September 30, 2018, lease operating expenses associated with our
oil and gas properties were $1,665,000, compared to $1,031,000
for the nine months ended September 30, 2017. The increase of
$634,000 was primarily due to workover expenses and somewhat higher
variable lease operating expenses associated with the higher oil
volume resulting from the increased number of wells and increased
oil production.
Exploration Expense. For the nine months ended
September 30, 2018, exploration expense was $38,000, compared
to $-0- for the nine months ended September 30, 2017. The increase
of $38,000 was due to a small increase in exploration activity
undertaken by the Company in the current
period.
Selling, General and Administrative Expenses. For the nine
months ended September 30, 2018, SG&A expenses were $2,976,000,
compared to $2,005,000 for the nine months ended September 30,
2017. The increase of $971,000 was primarily due to increases in
payroll, as well as other cost increases in various areas as shown
in the table below. The increases are primarily due to hiring of
additional personnel and expenses associated with two acquisitions.
The components of SG&A expenses for the nine months ended
September 30, 2018 and 2017 are summarized below (amounts in
thousands):
|
For the Nine
Months Ended
|
|
|
|
|
(in
thousands)
|
|
|
|
Payroll and related
costs
|
$1,330
|
$807
|
$523
|
Stock-based
compensation expense
|
566
|
597
|
(31)
|
Legal
fees
|
237
|
105
|
132
|
Accounting and
other professional fees
|
354
|
240
|
114
|
Insurance
|
123
|
81
|
42
|
Travel and
entertainment
|
84
|
9
|
75
|
Bad debt expense
(recovery)
|
-
|
(25)
|
25
|
Office rent,
communications and other
|
282
|
191
|
91
|
Total selling,
general and administrative expenses
|
$2,976
|
$2,005
|
$971
|
Depreciation, Depletion, Amortization and
Accretion. For the nine months ended September 30,
2018, DD&A costs were $2,220,000, compared to $2,852,000 for
the nine months ended September 30, 2017. The $632,000 decrease was
primarily the result of lower total production volumes in the
current period (lower gas and NGL volumes, offset by higher oil
production).
Gain on Debt Restructuring. For the nine months ended
September 30, 2018, gain on debt restructuring was $70,309,000,
compared to a gain of $-0- for the nine months ended September 30,
2017. The gain in 2018 was related to the debt restructuring
agreements that were recorded in the nine months ended September
30, 2018 as discussed above “Restructuring and Management
Change”.
Interest Expense. For the nine months ended September
30, 2018, interest expense was $6,888,000, compared to $9,489,000
for the nine months ended September 30, 2017. The decrease in
interest expense of $2,601,000 was primarily due to lower average
loan balances compared to the prior year’s period as a result
of the Restructuring.
Net Income (Loss). For the nine months ended September
30, 2018, net income was $59,323,000, compared to a net loss of
$13,091,000 for the nine months ended September 30, 2017. The
increase in net income of $72,414,000 was primarily due to the
one-time non-cash gain on debt restructuring recorded during the
nine months ended September 30, 2018.
Liquidity and Capital Resources
The Company's future financial condition and liquidity will be
impacted by, among other factors, our ability to execute our
drilling program, the success of such 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 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. 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, 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.
Our capital budget may be adjusted as business conditions warrant.
The amount, timing and allocation of capital expenditures are
largely discretionary and within our control. We plan to
optimize our existing assets and opportunistically seek additional
acreage proximate to our currently held core acreage, as well as
other attractive onshore oil and gas assets elsewhere in the U.S.,
that Company management believes can be acquired at attractive
prices, developed using our operating expertise, and be accretive
to shareholder value. If oil and natural gas prices continue
to decline or fail to improve or costs increase significantly, we
could defer a significant portion of our budgeted capital
expenditures until later periods to prioritize capital projects
that we believe have the highest expected returns and potential to
generate near-term cash flows. We routinely monitor and adjust our
capital expenditures in response to changes in prices, availability
of financing, drilling and acquisition costs, industry conditions,
timing of regulatory approvals, availability of rigs, success or
lack of success in drilling activities, contractual obligations,
internally generated cash flows and other factors both within and
outside our control.
We
acknowledge that adequate funds may not be available when needed or
may not be available on favorable terms. If we need to raise funds
in the future by issuing equity securities, dilution to existing
shareholders will result, and such securities may have rights,
preferences, and privileges senior to those of our common stock. If
funding is insufficient at any time in the future and we are unable
to generate sufficient revenue from new business arrangements, to
complete planned acquisitions or operations, our results of
operations and the value of our securities could be adversely
affected.
Financial Summary
We had
total current assets of $3.8 million as of September 30, 2018,
including cash of $2.8 million, compared to total current assets of
$1.4 million as of December 31, 2017, including a cash balance of
$0.9 million.
We had
total assets of $58.9 million as of September 30, 2018, compared to
$36.4 million as of December 31, 2017. Included in total assets as
of September 30, 2018 and December 31, 2017, were $54.9 million and
$34.9 million, respectively, of proved oil and gas properties
subject to amortization.
We had
total liabilities of $36.7 million as of September 30, 2018,
including current liabilities of $2.6 million, compared to total
liabilities of $73.5 million as of December 31, 2017, including
current liabilities of $3.4 million.
We
had working capital of $1.2 million, total shareholders’
equity of $22.2 million and a total accumulated deficit of $78.8
million as of September 30, 2018, compared to negative working
capital of $2.0 million, total shareholders’ deficit of $37.1
million and a total accumulated deficit of $138.1 million as of
December 31, 2017.
See
also the description of the Company’s accounts receivable
(Note 6 to the consolidated financial statements),
other current assets (Note 7), notes payable (Note 8), related
party transactions (Note 12), and subsequent event (Note 14), as
described in the footnotes to the Company’s consolidated
financial statements included in Part I, Item 1, of this report,
which are incorporated herein by reference, for more details
regarding the Company’s balance sheet line
items.
Cash Flows From Operating Activities. We had net cash
used in operating activities of $704,000 for the nine months
ended September 30, 2018, which was an increase in cash used of
$486,000, compared to the prior year’s period of $218,000 due
mostly to an increase in oil and gas accounts receivable offset by
an increase in accrued expenses and accounts payable.
Cash Flows From Investing Activities. We had net
cash used by investing activities for the nine months ended
September 30, 2018 of $19,911,000, compared to none for the prior
year’s period, primarily due to cash paid for the acquisition
of oil and gas properties.
Cash Flows From Financing Activities. We had net cash
provided by financing activities for the nine months ended
September 30, 2018 of $22,474,000, compared to net cash provided of
$500,000 for the prior year’s period. The cash provided in
the current period consisted primarily of proceeds from notes that
were issued, offset by the repayment of notes payable in connection
with the Restructuring, while the cash provided for the previous
period was due to proceeds realized from the sale of common
stock.
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 will require 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 is to
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Pursuant
to Item 305(e) of Regulation S-K (§ 229.305(e)), the Company
is not required to provide the information required by this Item as
it is a “smaller
reporting company,” as defined by Rule
229.10(f)(1).
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Disclosure
controls and procedures are designed to ensure that information
required to be disclosed in our reports filed or submitted under
the Exchange Act is recorded, processed, summarized and reported,
within the time period specified in the SEC’s rules and forms
and is accumulated and communicated to the Company’s
management, as appropriate, in order to allow timely decisions in
connection with required disclosure.
Evaluation of Disclosure Controls and Procedures
Under
the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer,
we conducted an evaluation of the effectiveness of the design and
operation of our disclosure controls and procedures, as defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end
of the period covered by this Quarterly Report. Based on this
evaluation, our Chief Executive Officer and Chief Financial Officer
concluded as of September 30, 2018, that our disclosure controls
and procedures were not effective.
Changes in Internal Control over Financial Reporting
There
were no changes in our internal control over financial reporting
during the three months ended September 30, 2018, that have
materially affected or are reasonably likely to materially affect,
our internal control over financial reporting, including any
corrective actions with regard to significant deficiencies and
material weaknesses. Effective July 11, 2018, Frank C. Ingriselli
resigned as Chief Executive Officer of the Company and was replaced
by Dr. Simon Kukes on August 1, 2018, J. Douglas Schick was
appointed as the President of the Company (with Mr. Ingriselli
stepping down as President on the same date).
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Although we may, from time to time, be involved in litigation and
claims arising out of our operations in the normal course of
business, we are not currently a party to any material legal
proceeding. In addition, we are not aware of any material legal or
governmental proceedings against us, or contemplated to be brought
against us.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors
previously disclosed in the Company’s Annual Report on Form
10-K for the year ended December 31, 2017, filed with the
Commission on March 28, 2018, as updated and supplemented by the
Company in the Company’s Quarterly Report on Form 10-Q for
the six-month period ended June 30, 2018, filed with the Commission
on July 7, 2018 (the “Q2 2018 Quarterly
Report”), except as
discussed below, and investors are encouraged to review such risk
factors in the Annual Report and below, prior to making an
investment in the Company.
Due to the incurrence of additional debt pursuant to those certain
August 2018 Convertible Notes and the October 2018 Convertible
Note, each as discussed above, the risk factors included in the Q2
2018 Quarterly Report relating to the SK Energy Note, including
potential material adverse effects in the event of default
thereunder and dilution upon issuance of common stock upon
conversion thereof, are supplemented to include reference to the
August 2018 Convertible Notes and October 2018 Convertible Note in
each instance where the SK Energy Note is referenced.
The “Risk
Factors” set forth below
are in addition to, and/or replace and supersede, as applicable,
the risk factors set forth in the Annual Report, as updated and
supplemented by the Q2 2018 Quarterly Report:
Risks Related to the Oil, NGL and Natural Gas Industry and Our
Business
Potential conflicts of interest could arise for certain members of
our management team and Board of Directors that hold management
positions with other entities and our senior lender.
Dr. Simon Kukes, our Chief Executive Officer and member of our
Board of Directors, J. Douglas Schick, our President, and Clark R.
Moore, our Executive Vice President, General Counsel and Secretary,
hold various other management positions with privately-held
companies, both within and outside of, in the oil and gas industry.
In addition, Dr. Simon Kukes is the principal of SK Energy LLC, the
Company’s most significant senior lender, and Mr. Schick is
affiliated with one of the Company’s senior lenders holding
an August 2018 Convertible Note with a principal amount of
$500,000. We believe these positions require only an immaterial
amount of each officers’ time and will not conflict with
their roles or responsibilities with our company. If any of
these companies enter into one or more transactions with our
company, or if the officers’ position with any such company
requires significantly more time than currently
anticipated, potential conflicts of interests could arise from
the officers performing services for us and these other
entities.
A substantial part of our crude oil, natural gas and NGLs
production is located in the Permian Basin and the D-J Basin,
making us vulnerable to risks associated with operating in only two
geographic areas. In addition, we have a large amount of proved
reserves attributable to a small number of producing
formations.
Our operations are focused solely in the Permian Basin located in
Chavez and Roosevelt Counties, New Mexico, and the D-J Basin of
Weld County, Colorado, which means our current producing properties
and new drilling opportunities are geographically concentrated in
those areas. Because our operations are not as diversified
geographically as many of our competitors, the success of our
operations and our profitability may be disproportionately exposed
to the effect of any regional events, including:
●
fluctuations
in prices of crude oil, natural gas and NGLs produced from the
wells in these areas;
●
natural
disasters such as the flooding that occurred in the D-J Basin area
in September 2013;
●
restrictive
governmental regulations; and
●
curtailment
of production or interruption in the availability of gathering,
processing or transportation infrastructure and services, and any
resulting delays or interruptions of production from existing or
planned new wells.
For example, bottlenecks in processing and transportation that have
occurred in some recent periods in the D-J Basin have negatively
affected our results of operations, and these adverse effects may
be disproportionately severe to us compared to our more
geographically diverse competitors. Similarly, the concentration of
our assets within a small number of producing formations exposes us
to risks, such as changes in field-wide rules that could adversely
affect development activities or production relating to those
formations. Such an event could have a material adverse effect on
our results of operations and financial condition. In addition, in
areas where exploration and production activities are increasing,
as has been the case in recent years in the Permian Basin and D-J
Basin, the demand for, and cost of, drilling rigs, equipment,
supplies, personnel and oilfield services increase. Shortages or
the high cost of drilling rigs, equipment, supplies, personnel or
oilfield services could delay or adversely affect our development
and exploration operations or cause us to incur significant
expenditures that are not provided for in our capital forecast,
which could have a material adverse effect on our business,
financial condition or results of operations.
Drilling for and producing oil and natural gas are highly
speculative and involve a high degree of risk, with many
uncertainties that could adversely affect our business. We have not
recorded significant proved reserves, and areas that we decide to
drill may not yield oil or natural gas in commercial quantities or
at all.
Exploring for and developing hydrocarbon reserves involves a high
degree of operational and financial risk, which precludes us from
definitively predicting the costs involved and time required to
reach certain objectives. Our potential drilling locations are in
various stages of evaluation, ranging from locations that are ready
to drill to locations that will require substantial additional
interpretation before they can be drilled. The budgeted costs of
planning, drilling, completing and operating wells are often
exceeded and such costs can increase significantly due to various
complications that may arise during the drilling and operating
processes. Before a well is spud, we may incur significant
geological and geophysical (seismic) costs, which are incurred
whether a well eventually produces commercial quantities of
hydrocarbons or is drilled at all. Exploration wells bear a much
greater risk of loss than development wells. The analogies we draw
from available data from other wells, more fully explored locations
or producing fields may not be applicable to our drilling
locations. If our actual drilling and development costs are
significantly more than our estimated costs, we may not be able to
continue our operations as proposed and could be forced to modify
our drilling plans accordingly.
If we decide to drill a certain location, there is a risk that no
commercially productive oil or natural gas reservoirs will be found
or produced. We may drill or participate in new wells that are not
productive. We may drill wells that are productive, but that do not
produce sufficient net revenues to return a profit after drilling,
operating and other costs. There is no way to predict in advance of
drilling and testing whether any particular location will yield oil
or natural gas in sufficient quantities to recover exploration,
drilling or completion costs or to be economically viable. Even if
sufficient amounts of oil or natural gas exist, we may damage the
potentially productive hydrocarbon-bearing formation or experience
mechanical difficulties while drilling or completing the well,
resulting in a reduction in production and reserves from the well
or abandonment of the well. Whether a well is ultimately productive
and profitable depends on a number of additional factors, including
the following:
●
general
economic and industry conditions, including the prices received for
oil and natural gas;
●
shortages
of, or delays in, obtaining equipment, including hydraulic
fracturing equipment, and qualified personnel;
●
potential
significant water production which could make a producing well
uneconomic, particularly in the Permian Basin Asset, where abundant
water production is a known risk;
●
potential
drainage by operators on adjacent properties;
●
loss
of, or damage to, oilfield development and service
tools;
●
problems
with title to the underlying properties;
●
increases
in severance taxes;
●
adverse
weather conditions that delay drilling activities or cause
producing wells to be shut down;
●
domestic
and foreign governmental regulations; and
●
proximity
to and capacity of transportation facilities.
If we do not drill productive and profitable wells in the future,
our business, financial condition and results of operations could
be materially and adversely affected.
Our operations are subject to operational hazards and unforeseen
interruptions for which we may not be adequately
insured.
There are numerous operational hazards inherent in oil and natural
gas exploration, development, production and gathering,
including:
●
unusual
or unexpected geologic formations;
●
adverse
weather conditions;
●
unanticipated
pressures;
●
loss of
drilling fluid circulation;
●
blowouts
where oil or natural gas flows uncontrolled at a
wellhead;
●
cratering
or collapse of the formation;
●
pipe or
cement leaks, failures or casing collapses;
●
releases
of hazardous substances or other waste materials that cause
environmental damage;
●
pressures
or irregularities in formations; and
●
equipment
failures or accidents.
In addition, there is an inherent risk of incurring significant
environmental costs and liabilities in the performance of our
operations, some of which may be material, due to our handling of
petroleum hydrocarbons and wastes, our emissions to air and water,
the underground injection or other disposal of our wastes, the use
of hydraulic fracturing fluids and historical industry operations
and waste disposal practices.
Any of these or other similar occurrences could result in the
disruption or impairment of our operations, substantial repair
costs, personal injury or loss of human life, significant damage to
property, environmental pollution and substantial revenue losses.
The location of our wells, gathering systems, pipelines and other
facilities near populated areas, including residential areas,
commercial business centers and industrial sites, could
significantly increase the level of damages resulting from these
risks. Insurance against all operational risks is not available to
us. We are not fully insured against all risks, including
development and completion risks that are generally not recoverable
from third parties or insurance. In addition, pollution and
environmental risks generally are not fully insurable. We maintain
$2 million general liability coverage and $10 million umbrella
coverage that covers our and our subsidiaries’ business and
operations. Our wholly-owned subsidiary, Red Hawk, which operates
our D-J Basin Asset, also maintains a $10 million control of well
insurance policy that covers its operations in Colorado, and our
wholly-owned subsidiary, PEDCO, which operates our Permian Basin
Asset through its wholly-owned subsidiaries EOR and RAOC, also
maintains a $10 million control of well insurance policy that
covers its operations in New Mexico. With respect to our other
non-operated assets, we may elect not to obtain insurance if we
believe that the cost of available insurance is excessive relative
to the perceived risks presented. Losses could, therefore, occur
for uninsurable or uninsured risks or in amounts in excess of
existing insurance coverage. Moreover, insurance may not be
available in the future at commercially reasonable prices or on
commercially reasonable terms. Changes in the insurance markets due
to various factors may make it more difficult for us to obtain
certain types of coverage in the future. As a result, we may not be
able to obtain the levels or types of insurance we would otherwise
have obtained prior to these market changes, and the insurance
coverage we do obtain may not cover certain hazards or all
potential losses that are currently covered, and may be subject to
large deductibles. Losses and liabilities from uninsured and
underinsured events and delay in the payment of insurance proceeds
could have a material adverse effect on our business, financial
condition and results of operations.
Our strategy as an onshore resource player may result in operations
concentrated in certain geographic areas and may increase our
exposure to many of the risks described in this
report.
Our current operations are concentrated in the states of New
Mexico and Colorado. This concentration may increase the potential
impact of many of the risks described in this prospectus. For
example, we may have greater exposure to regulatory actions
impacting New Mexico and/or Colorado, natural disasters in New
Mexico and/or Colorado, competition for equipment, services and
materials available in, and access to infrastructure and markets
in, these states.
If we complete acquisitions or enter into business combinations in
the future, they may disrupt or have a negative impact on our
business.
If we complete acquisitions or enter into business combinations in
the future, funding permitting, we could have difficulty
integrating the acquired companies’ assets, personnel and
operations with our own. Additionally, acquisitions, mergers or
business combinations we may enter into in the future could result
in a change of control of the Company, and a change in the board of
directors or officers of the Company. In addition, the key
personnel of the acquired business may not be willing to work for
us. We cannot predict the effect expansion may have on our core
business. Regardless of whether we are successful in making an
acquisition or completing a business combination, the negotiations
could disrupt our ongoing business, distract our management and
employees and increase our expenses. In addition to the risks
described above, acquisitions and business combinations are
accompanied by a number of inherent risks, including, without
limitation, the following:
●
the
difficulty of integrating acquired companies, concepts and
operations;
●
the
potential disruption of the ongoing businesses and distraction of
our management and the management of acquired
companies;
●
change
in our business focus and/or management;
●
difficulties
in maintaining uniform standards, controls, procedures and
policies;
●
the
potential impairment of relationships with employees and partners
as a result of any integration of new management
personnel;
●
the
potential inability to manage an increased number of locations and
employees;
●
our
ability to successfully manage the companies and/or concepts
acquired;
●
the
failure to realize efficiencies, synergies and cost savings;
or
●
the
effect of any government regulations which relate to the business
acquired.
Our business could be severely impaired if and to the extent that
we are unable to succeed in addressing any of these risks or other
problems encountered in connection with an acquisition or business
combination, many of which cannot be presently identified. These
risks and problems could disrupt our ongoing business, distract our
management and employees, increase our expenses and adversely
affect our results of operations.
Any acquisition or business combination transaction we enter into
in the future could cause substantial dilution to existing
stockholders, result in one party having majority or significant
control over the Company or result in a change in business focus of
the Company.
We currently have outstanding indebtedness and we may incur
additional indebtedness which could reduce our financial
flexibility, increase interest expense and adversely impact our
operations and our unit costs.
We currently have outstanding indebtedness and in the future, we
may incur significant amounts of additional indebtedness in order
to make acquisitions or to develop our properties. Our level of
indebtedness could affect our operations in several ways, including
the following:
●
a
significant portion of our cash flows could be used to service our
indebtedness;
●
a high
level of debt would increase our vulnerability to general adverse
economic and industry conditions;
●
any
covenants contained in the agreements governing our outstanding
indebtedness could limit our ability to borrow additional
funds;
●
dispose
of assets, pay dividends and make certain investments;
●
a high
level of debt may place us at a competitive disadvantage compared
to our competitors that are less leveraged and, therefore, may be
able to take advantage of opportunities that our indebtedness may
prevent us from pursuing; and
●
debt
covenants to which we may agree may affect our flexibility in
planning for, and reacting to, changes in the economy and in our
industry.
A high level of indebtedness increases the risk that we may default
on our debt obligations. We may not be able to generate sufficient
cash flows to pay the principal or interest on our debt, and future
working capital, borrowings or equity financing may not be
available to pay or refinance such debt. If we do not have
sufficient funds and are otherwise unable to arrange financing, we
may have to sell significant assets or have a portion of our assets
foreclosed upon which could have a material adverse effect on our
business, financial condition and results of
operations.
New or amended environmental legislation or regulatory initiatives
could result in increased costs, additional operating restrictions,
or delays, or have other adverse effects on us.
The environmental laws and regulations to which we are subject
change frequently, often to become more burdensome and/or to
increase the risk that we will be subject to significant
liabilities. New or amended federal, state, or local laws or
implementing regulations or orders imposing new environmental
obligations on, or otherwise limiting, our operations could make it
more difficult and more expensive to complete oil and natural gas
wells, increase our costs of compliance and doing business, delay
or prevent the development of resources (especially from shale
formations that are not commercial without the use of hydraulic
fracturing), or alter the demand for and consumption of our
products. Any such outcome could have a material and adverse impact
on our cash flows and results of operations.
For example, in 2014 and 2016, opponents of hydraulic fracturing
sought statewide ballot initiatives in Colorado that would have
restricted oil and gas development in Colorado and could have had
materially adverse impacts on us, and in the November 2018
election, Colorado voters rejected a proposition that would have
prohibited drilling within 2,500 feet from certain dwelling
structures and “vulnerable areas,” which would have
made the vast majority of the surface area of the state ineligible
for drilling, including substantially all of our planned future
drilling locations. Although none of the proposed initiatives were
implemented and the November 2018 proposition was rejected, future
initiatives are likely. Similarly, proposals are made from time to
time to adopt new, or amend existing, laws and regulations to
address hydraulic fracturing or climate change concerns through
further regulation of exploration and development
activities. Please read
“Part
I” –
“Item 1.
Business” —
“Regulation of the Oil
and Gas Industry” and
“Regulation of
Environmental and Occupational Safety and Health
Matters” of our Annual
Report on Form 10-K for the year ended December 31, 2017, for a
further description of the laws and regulations that affect
us.
We cannot predict the nature, outcome, or effect on us of future
regulatory initiatives, but such initiatives could materially
impact our results of operations, production, reserves, and other
aspects of our business.
Part of our strategy involves drilling in existing or emerging oil
and gas plays using some of the latest available horizontal
drilling and completion techniques. The results of our planned
exploratory drilling in these plays are subject to drilling and
completion technique risks, and drilling results may not meet our
expectations for reserves or production. As a result, we may incur
material write-downs and the value of our undeveloped acreage could
decline if drilling results are unsuccessful.
Our operations in the Permian Basin in Chavez and Roosevelt
Counties, New Mexico, and the D-J Basin in Weld and Morgan
Counties, Colorado, involve utilizing the latest drilling and
completion techniques in order to maximize cumulative recoveries
and therefore generate the highest possible returns. Risks that we
may face while drilling include, but are not limited to, landing
our well bore in the desired drilling zone, staying in the desired
drilling zone while drilling horizontally through the formation,
running our casing the entire length of the well bore and being
able to run tools and other equipment consistently through the
horizontal well bore. Risks that we may face while completing our
wells include, but are not limited to, being able to fracture
stimulate the planned number of stages, being able to run tools the
entire length of the well bore during completion operations and
successfully cleaning out the well bore after completion of the
final fracture stimulation stage.
The results of our drilling in new or emerging formations will be
more uncertain initially than drilling results in areas that are
more developed and have a longer history of established production.
Newer or emerging formations and areas have limited or no
production history and consequently we are less able to predict
future drilling results in these areas.
Ultimately, the success of these drilling and completion techniques
can only be evaluated over time as more wells are drilled and
production profiles are established over a sufficiently long time
period. If our drilling results are less than anticipated or we are
unable to execute our drilling program because of capital
constraints, lease expirations, access to gathering systems and
limited takeaway capacity or otherwise, and/or natural gas and oil
prices decline, the return on our investment in these areas may not
be as attractive as we anticipate. Further, as a result of any of
these developments we could incur material write-downs of our oil
and natural gas properties and the value of our undeveloped acreage
could decline in the future.
Competition for hydraulic fracturing services and water
disposal could impede our ability to develop our oil and gas
plays.
The unavailability or high cost of high pressure pumping services
(or hydraulic fracturing services), chemicals, proppant, water and
water disposal and related services and equipment could limit our
ability to execute our exploration and development plans on a
timely basis and within our budget. The oil and natural gas
industry is experiencing a growing emphasis on the exploitation and
development of shale natural gas and shale oil resource plays,
which are dependent on hydraulic fracturing for economically
successful development. Hydraulic fracturing in oil and gas plays
requires high pressure pumping service crews. A shortage of service
crews or proppant, chemical, water or water disposal options,
especially if this shortage occurred in eastern New Mexico or
eastern Colorado, could materially and adversely affect our
operations and the timeliness of executing our development plans
within our budget.
A substantial percentage of our recently acquired New Mexico
properties are undeveloped; therefore, the risk associated with our
success is greater than would be the case if the majority of such
properties were categorized as proved developed
producing.
Because a substantial percentage of our recently acquired New
Mexico properties are undeveloped, we will require significant
additional capital to develop such properties before they may
become productive. Further, because of the inherent uncertainties
associated with drilling for oil and gas, some of these properties
may never be developed to the extent that they result in positive
cash flow. Even if we are successful in our development efforts, it
could take several years for a significant portion of our
undeveloped properties to be converted to positive cash
flow.
Part of our strategy involves using certain of the latest available
horizontal drilling and completion techniques, which involve
additional risks and uncertainties in their application if compared
to conventional drilling.
We plan to utilize some of the latest horizontal drilling and
completion techniques as developed by us, other oil and gas
exploration and production companies and our service providers. The
additional risks that we face while drilling horizontally include,
but are not limited to, the following:
●
drilling wells that
are significantly longer and/or deeper than more conventional
wells;
●
landing our
wellbore in the desired drilling zone;
●
staying in the
desired drilling zone while drilling horizontally through the
formation;
●
running our casing
the entire length of the wellbore; and
●
being able to run
tools and other equipment consistently through the horizontal
wellbore.
Risks that we face while completing our wells include, but are not
limited to, the following:
●
the ability to
fracture stimulate the planned number of stages in a horizontal or
lateral well bore;
●
the ability to run
tools the entire length of the wellbore during completion
operations; and
●
the ability to
successfully clean out the wellbore after completion of the final
fracture stimulation stage.
Prospects that we decide to drill may not yield oil or natural gas
in commercially viable quantities.
Our prospects are in various stages of evaluation, ranging from
prospects that are currently being drilled to prospects that will
require substantial additional seismic data processing and
interpretation. There is no way to predict in advance of drilling
and testing whether any particular prospect will yield oil or
natural gas in sufficient quantities to recover drilling or
completion costs or to be economically viable. This risk may be
enhanced in our situation, due to the fact that a significant
percentage of our reserves is undeveloped. The use of seismic data
and other technologies and the study of producing fields in the
same area will not enable us to know conclusively prior to drilling
whether oil or natural gas will be present or, if present, whether
oil or natural gas will be present in commercial quantities. We
cannot assure you that the analogies we draw from available data
obtained by analyzing other wells, more fully explored prospects or
producing fields will be applicable to our drilling
prospects.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
The
Company did not sell any unregistered equity securities during the
quarter ended September 30, 2018, and through the date of the
filing of this Report, which were not previously disclosed in a
prior Quarterly Report on Form 10-Q, Annual Report on Form 10-K or
in a Current Report on Form 8-K.
Use of Proceeds From Sale of Registered Securities
Our Registration Statement on Form S-3 (Reg. No. 333-214415) in
connection with the potential sale by us of up to $100 million in
securities (common stock, preferred stock, warrants and units),
subject to limitations under the SEC's “Baby Shelf
Rules”, was declared
effective by the Securities and Exchange Commission on January 17,
2017.
On September 29, 2016, we entered into an At Market Issuance Sales
Agreement (the “Sales
Agreement”) with National
Securities Corporation (“NSC”), a wholly-owned subsidiary of National
Holdings Corporation (NasdaqCM:NHLD), pursuant to which the Company
may issue and sell shares of its common stock, having an aggregate
offering price of up to $2,000,000 (the “Shares”)
from time to time, as the Company deems prudent, through NSC (the
“Offering”)
(of which $1.359 million remains available for issuance, subject to
limitation under the SEC’s “Baby Shelf
Rules”). Upon delivery of
a placement notice and subject to the terms and conditions of the
Sales Agreement, NSC may sell the Shares by methods deemed to be an
“at the market
offering” as defined in
Rule 415 promulgated under the Securities Act.
With the Company’s prior written approval, NSC may also sell
the Shares by any other method permitted by law, including in
negotiated transactions. The Company may elect not to issue and
sell any additional Shares in the Offering and the Company or NSC
may suspend or terminate the offering of Shares upon notice to the
other party and subject to other conditions. NSC will act as sales
agent on a commercially reasonable efforts basis consistent with
its normal trading and sales practices and applicable state and
federal law, rules and regulations and the rules of the NYSE
American.
The Company has agreed to pay NSC commissions for its services in
acting as agent in the sale of the Shares in the amount equal to
3.0% of the gross sales price of all Shares sold pursuant to the
Agreement. The Company also paid various expenses in connection
with the offering, including reimbursing $30,000 of NSC’s
legal fees, which was paid. The Company has also agreed to provide
NSC with customary indemnification and contribution
rights.
The Company has used and intends to use the net proceeds from the
offering to fund development and for working capital and general
corporate purposes, including general and administrative purposes.
The Company is not obligated to make any additional sales of common
stock under the Sales Agreement, and no assurance can be given that
the Company will sell any additional shares under the Sales
Agreement, or, if it does, as to the price or amount of Shares that
it will sell, or the dates on which any such sales will take
place.
The Company has filed a final prospectus in connection with such
offering with the SEC (as part of the Form S-3 registration
statement).
During the nine months ended September 30, 2018 and through the
date of this filing, the Company made no sales of common stock
under the Sales Agreement and the prospectus associated
therewith.
No payments for our expenses will be made in connection with the
offering described above directly or indirectly to (i) any of our
directors, officers or their associates, (ii) any person(s) owning
10% or more of any class of our equity securities or (iii) any of
our affiliates. We plan to use the net proceeds from the offering
as described in our final prospectus filed with the SEC pursuant to
Rule 424(b).
There has been no material change in the planned use of proceeds
from our offering as described in our final prospectuses filed with
the SEC pursuant to Rule 424(b).
Issuer Purchases of Equity Securities
On August 31, 2018, we entered into Warrant Repurchase Agreements
with certain former holders of the Company’s Tranche B
Secured Promissory Notes, pursuant to which we repurchased and
cancelled warrants to purchase an aggregate of 1,105,935 shares
(the “Warrant
Shares”) of the
Company’s common stock for an aggregate of $1,095,000 or
$0.99 per Warrant Share.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not
Applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
See the
Exhibit Index following the signature page to this Quarterly Report
on Form 10-Q for a list of exhibits filed or furnished with this
report, which Exhibit Index is incorporated herein by
reference.
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
|
PEDEVCO Corp.
|
|
|
|
|
|
|
November
14,
2018
|
By:
|
/s/ Dr.
Simon Kukes
|
|
|
|
Dr.
Simon Kukes
|
|
|
|
Chief
Executive Officer
|
|
|
|
(Principal
Executive Officer)
|
|
|
PEDEVCO Corp.
|
|
|
|
|
|
|
November
14,
2018
|
By:
|
/s/ Gregory
L. Overholtzer
|
|
|
|
Gregory
L. Overholtzer
|
|
|
|
Chief
Financial Officer
|
|
|
|
(Principal
Financial and Accounting Officer)
|
|
EXHIBIT INDEX
|
|
|
|
Incorporated By Reference
|
Exhibit No.
|
|
Description
|
|
Form
|
|
Exhibit
|
|
Filing Date/Period End Date
|
|
File Number
|
2.1#
|
|
|
|
8-K
|
|
2.1
|
|
August
1, 2018
|
|
001-35922
|
4.1
|
|
|
|
S-8
|
|
4.1
|
|
September
27, 2018
|
|
333-227566
|
10.1
|
|
|
|
8-K
|
|
10.1
|
|
August
1, 2018
|
|
001-35922
|
10.2#
|
|
Stock Purchase Agreement dated August 1, 2018, by and between
Pacific Energy Development Corp. and Hunter Oil Production
Corp. |
|
8-K
|
|
10.2
|
|
August 1, 2018
|
|
001-35922
|
10.3#
|
|
|
|
8-K
|
|
10.3
|
|
August
1, 2018
|
|
001-35922
|
10.4***
|
|
|
|
8-K
|
|
10.4
|
|
August
1, 2018
|
|
001-35922
|
10.5
|
|
|
|
8-K
|
|
10.1
|
|
September
4, 2018
|
|
001-35922
|
10.6
|
|
|
|
8-K
|
|
10.2
|
|
September
4, 2018
|
|
001-35922
|
10.7***
|
|
|
|
8-K
|
|
10.1
|
|
September
10, 2018
|
|
001-35922
|
10.8***
|
|
|
|
8-K
|
|
10.2
|
|
September
10, 2018
|
|
001-35922
|
10.9
|
|
|
|
8-K
|
|
10.1
|
|
October
26, 2018
|
|
001-35922
|
16.1
|
|
|
|
8-K
|
|
16.1
|
|
August
1, 2018
|
|
001-35922
|
31.1*
|
|
|
|
|
|
|
|
|
|
|
31.2*
|
|
|
|
|
|
|
|
|
|
|
32.1**
|
|
|
|
|
|
|
|
|
|
|
32.2**
|
|
|
|
|
|
|
|
|
|
|
101.INS*
|
|
XBRL
Instance Document
|
|
|
|
|
|
|
|
|
101.SCH*
|
|
XBRL
Taxonomy Extension Schema Document
|
|
|
|
|
|
|
|
|
101.CAL*
|
|
XBRL
Taxonomy Extension Calculation Linkbase Document
|
|
|
|
|
|
|
|
|
101.DEF*
|
|
XBRL
Taxonomy Extension Definition Linkbase Document
|
|
|
|
|
|
|
|
|
101.LAB*
|
|
XBRL
Taxonomy Extension Label Linkbase Document
|
|
|
|
|
|
|
|
|
101.PRE*
|
|
XBRL
Taxonomy Extension Presentation Linkbase Document
|
|
|
|
|
|
|
|
|
* Filed herewith.
** Furnished herewith.
***
Management contract or compensatory plan, contract or
arrangement.
# Schedules and exhibits have been omitted pursuant to Item
601(b)(2) of Regulation S-K. A copy of any omitted schedule or
exhibit will be furnished supplementally to the Securities and
Exchange Commission upon request; provided, however that PEDEVCO
Corp. may request confidential treatment pursuant to Rule 24b-2 of
the Securities Exchange Act of 1934, as amended, for any schedule
or exhibit so furnished.