The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
(Dollars in Thousands, Except Per Share Amounts)
|
1.
|
ORGANIZATION, OPERATIONS AND SIGNIFICANT ACCOUNTING
POLICIES
|
Organization and Operations
U.S. Energy Corp. (collectively with its subsidiaries
referred to as the “Company” or “U.S. Energy”) was incorporated in the State of Wyoming on January 26,
1966. The Company’s principal business activities are focused on the acquisition, exploration and development of oil and
gas properties in the United States.
Basis of Presentation.
The accompanying unaudited condensed consolidated
financial statements are presented in accordance with U.S. generally accepted accounting principles (“GAAP”) and have
been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”)
regarding interim financial reporting. Accordingly, certain information and footnote disclosures required by GAAP for complete
financial statements have been condensed or omitted in accordance with such rules and regulations. In the opinion of management,
all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the consolidated financial
statements have been included.
For further information, refer to the consolidated
financial statements and footnotes thereto included in our Annual Report on Form 10-K, as amended, for the year ended December
31, 2015. The Company’s financial condition as of September 30, 2016, and operating results for the three and nine months
ended September 30, 2016 are not necessarily indicative of the financial condition and results of operations that may be expected
for any future interim period or for the year ending December 31, 2016.
As discussed in Note 5, during the fourth quarter
of 2015 the Company began accounting for its mining operations as a Discontinued Operation. Accordingly, certain reclassifications
have been made to the prior period balances in order to conform to the current period presentation. These and other reclassifications
had no impact on working capital, net loss, shareholders’ equity or cash flows as previously reported.
Reverse Stock Split
The Company held its annual meeting of shareholders
on June 20, 2016. At the meeting, the Company’s shareholders approved Articles of Amendment to Restated Articles of Incorporation
(the “Amendment”) to effect a six shares for one share reverse stock split of the Company’s $0.01 par value common
stock (the “Reverse Stock Split”). The Amendment was filed with the Wyoming Secretary of State and was effective on
June 20, 2016.
As a result of the Reverse Stock
Split, every six shares of issued and outstanding common stock were automatically combined into one issued and outstanding
share of common stock, without any change in the par value per share or the number of shares of common stock authorized. No
fractional shares were issued as a result of the Reverse Stock Split. Fractional shares that would otherwise have resulted
from the Reverse Stock Split were paid in a proportionate amount based on the average closing price of $2.23 per share for
the five trading days immediately preceding the date of the Reverse Stock Split. The aggregate number of fractional shares
canceled in the Reverse Stock Split was 1,245 shares, resulting in a total cash payment of $3. All references in the
accompanying financial statements to the number of shares of common stock and per share amounts have been retroactively
adjusted to give effect to the Reverse Stock Split.
Use of Estimates
The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Significant estimates include oil and gas reserves that are used in the calculation of depreciation,
depletion, amortization and impairment of the carrying value of evaluated oil and gas properties; production and commodity price
estimates used to record accrued oil and gas sales receivable; valuation of commodity derivative instruments; and the cost of future
asset retirement obligations. The Company evaluates its estimates on an on-going basis and bases its estimates on historical experience
and on various other assumptions the Company believes to be reasonable. Due to inherent uncertainties, including the future prices
of oil and gas, these estimates could change in the near term and such changes could be material.
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
Principles of Consolidation
The accompanying financial statements include
the accounts of the Company and its wholly owned subsidiaries Energy One, LLC (“Energy One”), Highlands Ranch LLC (“Highlands
Ranch”) and Remington Village, LLC (“Remington Village”). All inter-company balances and transactions have been
eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current period presentation
of the accompanying financial statements.
Comprehensive Income (Loss)
Comprehensive income (loss) is used to refer
to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses,
gains, and losses that under GAAP are reported as separate components of shareholders’ equity instead of net income (loss).
Recent Accounting Pronouncements
The following recently issued accounting standards are not yet effective;
the Company is assessing the impact these standards will have on its consolidated financial statements, as well as the method of
adoption and period in which adoption is expected to occur:
In May 2014, the Financial Accounting Standards Board
(“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09,
“Revenue from Contracts with
Customers”
. This comprehensive guidance, as subsequently amended by the FASB, will replace all existing revenue recognition
guidance and is effective for annual reporting periods beginning after December 15, 2018, and interim periods therein.
In August 2014, the FASB issued ASU No. 2014-15,
“Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”
that will require
management to evaluate whether there are conditions and events that raise substantial doubt about the Company’s ability to
continue as a going concern within one year after the financial statements are issued on both an interim and annual basis. Management
will be required to provide certain footnote disclosures if it concludes that substantial doubt exists or when its plans alleviate
substantial doubt about the Company’s ability to continue as a going concern. This ASU becomes effective for annual periods
beginning in 2016 and for interim reporting periods starting in the first quarter of 2017.
In January 2016, the FASB issued ASU 2016-01,
Financial
Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.
This ASU is intended
to improve the recognition and measurement of financial instruments. Among other things, this ASU requires certain equity investments
to be measured at fair value with changes in fair value recognized in net income. This guidance is effective for fiscal years beginning
after December 15, 2017, and interim periods therein.
In February 2016, the FASB issued ASU 2016-02,
Leases
,
which will supersede the existing guidance for lease accounting. This ASU will require lessees to recognize leases on their balance
sheets, and leaves lessor accounting largely unchanged. This guidance is effective for fiscal years beginning after December 15,
2018 and interim periods within those fiscal years, and early adoption is permitted.
In March 2016, the FASB issued ASU 2016-09,
Improvements
to Employee Share-Based Payment Accounting.
The core change with ASU 2016-09 is the simplification of several aspects of the
accounting for share-based payment transactions, including the income tax consequences, classifications of awards as either equity
or liabilities, and classification in the statement of cash flows. This guidance is effective for fiscal years beginning after
December 15, 2016 and interim periods within those fiscal years, and early adoption is permitted.
In August 2016, the FASB issued ASU No. 2016-15,
Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments.
ASU 2016-15 is intended to simplify
and clarify how certain transactions are classified in the statement of cash flows, and to reduce diversity in practice for such
transactions. This ASU addresses eight specific issues regarding classification of cash flows. This guidance
is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, and early adoption
is permitted.
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
The following recently issued accounting standards
were adopted effective January 1, 2016; the impact of adoption did not have a material impact on the Company’s consolidated
financial statements:
In November 2014, the FASB issued ASU 2014-16,
“Derivatives
and Hedging: Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin
to Debt or to Equity
”. This ASU does not change the current criteria in GAAP for determining when separation of certain
embedded derivative features in a hybrid financial instrument is required, but clarifies how current GAAP should be interpreted
in the evaluation of the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued
in the form of a share, reducing existing diversity in practice.
In January 2015, the FASB issued ASU 2015-01, “
Income
Statement—Extraordinary and Unusual Items”
, that simplifies income statement classification by removing the concept
of extraordinary items from GAAP. The separate disclosure of extraordinary items after income from continuing operations in the
income statement is no longer permitted.
In February 2015, the FASB issued ASU No. 2015-02,
“Consolidation: Amendments to the Consolidation Analysis”
. The new standard is intended to improve targeted areas
of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures.
During 2015, the FASB issued ASUs No. 2015-03 and No.
2015-15 titled
“Interest-Imputation of Interest”,
which generally requires the presentation of debt issuance
costs as a direct deduction from the carrying amount of the related debt liabilities. However, for debt issuance costs related
to line-of-credit arrangements, the Company is permitted to continue presenting debt issuance costs as an asset and subsequently
amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement. The Company elected to continue
to present its deferred line of credit fees as an asset in its consolidated balance sheets.
|
2.
|
LIQUIDITY AND GOING CONCERN
|
As of September 30, 2016, the Company
has a working capital deficit of $9,091 and an accumulated deficit of $124,788. Additionally, the Company incurred a net loss
of $15,083 for the nine months ended September 30, 2016. During 2015 and 2016, compliance was not maintained with
certain financial ratio covenants in the credit agreement with Wells Fargo as discussed below and in Note 7. In July 2015,
Wells Fargo agreed to enter into a third amendment to the credit agreement and provided waivers for non-compliance with the
financial ratio covenants for the fiscal quarters ended June 30, 2015 and September 30, 2015.
In April 2016, Wells Fargo provided a waiver for non-compliance with the covenants in the credit agreement for the fiscal quarter ended December 31, 2015. As discussed in Note 7, in August 2016 Wells Fargo agreed to enter into a fourth amendment to the credit agreement that provides for, among other things, a limited waiver of the negative financial covenants for the fiscal quarters ended March 31, 2016 and June 30, 2016. The Company violated the financial ratio covenants for the fiscal quarter ended September 30, 2016, which constitutes an event of default under the credit agreement. Accordingly, Wells Fargo has the immediate right to demand acceleration of all outstanding borrowings and has the ability to foreclose upon the existing collateral. Management believes that Wells Fargo will not demand repayment until an alternative lender can be obtained. However, no assurance can be provided unless a waiver is subsequently obtained to cure the existing event of default. Additionally, management expects that further non-compliance with the financial ratio covenants is likely when results are reported for the fourth quarter of 2016. The ongoing availability of borrowings under this credit agreement through the maturity date of July 30, 2017, or the receipt of funding from alternative sources, is critical to the Company’s ability to survive until oil and gas prices recover.
Commencing in September 2015, the Company completed
the following actions to address liquidity constraints and improve the Company’s operating results to enable the Company
to survive the current oil and gas industry price environment:
|
·
|
During the third quarter of 2015, the Company began to implement restructuring actions to reduce
corporate overhead through a reduction in the size of the Company’s workforce from 14 employees at the end of 2014 to one
employee by January 2016. Additionally, in December 2015 the Company completed a move of its corporate headquarters to Denver,
Colorado for better access to financial services and to improve access to oil and gas deal flow. Management expects its restructuring
and other cost-cutting actions will result in an overhead reduction of approximately $4,000 on an annualized basis. During the
nine months ended September 30, 2016, these actions contributed to a reduction in general and administrative
expenses by $2,360 or 53% as compared to the nine months ended September 30, 2015.
|
|
·
|
As discussed in Note 5, in February 2016 the Company completed the disposition of its mining
segment, including the Keystone Mine, a related water treatment plant and other related properties. A significant objective
for completing the disposition was to improve future profitability through the elimination of the obligations to operate the
water treatment plant and mine holding costs, which are expected to result in estimated annual cash savings of $3,000. During
the nine months ended September 30, 2016, this disposition contributed to a reduction in operating expenses associated with
the mining segment of $2,012 from $2,385 for the nine months ended September 30, 2015 to $373 for the nine months ended
September 30, 2016. Management believes the disposition of the Company’s mining segment is a major step in the
transformation of U.S. Energy to solely focus on its existing oil and gas business.
|
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
The Company expects that its share of the
drilling and completion costs associated with proved undeveloped oil and gas properties that it will be required to fund is
approximately $1,000 in 2017 and $3,800 in 2018. Additionally, the Company has a commitment to fund its share of drilling and
completion costs of approximately $9,600 under the IronHorse Agreement discussed in Note 9. However, the specific timing and
amount of these expenditures is controlled by the operators of the respective properties and can change based on a variety of
economic and operating conditions. The Company’s ability to finance these planned capital expenditures is contingent
upon its ability to repay $6,000 of outstanding borrowings under the Wells Fargo credit agreement and to obtain alternative
sources of financing. In order to reduce the financing commitments, the Company intends to pursue sales of non-core assets to
generate near-term liquidity. Alternatives that may be pursued include selling or joint venturing an interest in certain oil
and gas properties, selling real estate assets in Wyoming, selling marketable equity securities, issuing shares of common
stock for cash or as consideration for acquisitions, and other alternatives, as the Company determines how to best fund its
capital programs and meet its financial obligations.
As of September 30, 2016, the Company had cash
and equivalents of $1,204. Management believes approximately $7,000 of annualized overhead and mining expense reductions have poised
the Company to survive the current low commodity price environment. Management believes the Company’s new singular industry
focus, combined with attractive producing properties and a low-cost overhead structure makes the Company an attractive vehicle
to partner with for potential investors and lenders during this industry downturn and low commodity price environment. However,
there can be no assurance that the Company will be able to complete future financings, dispositions or acquisitions on acceptable
terms or at all.
|
3.
|
OIL PRICE RISK DERIVATIVES
|
The Company’s wholly-owned subsidiary
Energy One has entered into crude oil derivative contracts (“economic hedges”) with Wells Fargo, the Company’s
lender as discussed further in Note 7. The derivative contracts are priced based on West Texas Intermediate (“WTI”)
quoted prices for crude oil. The Company is a guarantor of Energy One’s obligations under the economic hedges. The objective
of utilizing the economic hedges is to reduce the effect of price changes on a portion of the Company’s future oil production,
achieve more predictable cash flows in an environment of volatile oil and gas prices and to manage the Company’s exposure
to commodity price risk. The use of these derivative instruments limits the downside risk of adverse price movements. However,
there is a risk that such use may limit the Company’s ability to benefit from favorable price movements. Energy One may,
from time to time, add incremental derivatives to hedge additional production, restructure existing derivative contracts or enter
into new transactions to modify the terms of current contracts in order to realize the current value of its existing positions.
The Company does not engage in speculative derivative activities or derivative trading activities, nor does it use derivatives
with leveraged features. Presented below is a summary of outstanding “costless collars” with Wells Fargo as of September
30, 2016 (which total an aggregate of 27,600 barrels of oil production during the final three months of 2016):
Settlement Period
|
|
|
Quantity
|
|
|
Contract Price
|
|
Begin
|
|
|
End
|
|
|
(bbls/ day)
|
|
|
Put
|
|
|
Call
|
|
|
10/1/16
|
|
|
|
12/31/16
|
|
|
|
300
|
|
|
$
|
50.00
|
|
|
$
|
65.25
|
|
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
As of September 30, 2016, the aggregate fair
value of oil derivative put contracts was an asset of $78 and the aggregate fair value of oil derivative call contracts was a liability
of $1. Since these contracts are with the same counterparty, the Company recognizes the net asset of $77 in the accompanying balance
sheet as of September 30, 2016. Since all of the derivative contracts expire within three months of the balance sheet date, the
entire amount is included in current assets. As of December 31, 2015, the aggregate fair value of oil derivative put contracts
was an asset of $1,674 and the aggregate fair value of oil derivative call contracts was a liability of $40, resulting in a net
asset of $1,634.
Unrealized gains and losses resulting from
derivatives are recorded at fair value in the consolidated balance sheet. Changes in fair value, as well as realized gains (losses)
arising upon derivative contract settlements, are included in the “change in unrealized gain (loss) on oil price risk derivatives”
in the consolidated statements of operations.
|
4.
|
CEILING TEST FOR OIL AND GAS PROPERTIES
|
The reserves used in the Company’s full
cost ceiling test incorporate assumptions regarding pricing and discount rates over which management has no influence in the determination
of present value. In the calculation of the ceiling test as of September 30, 2016, the Company used a price of $41.68 per barrel
for oil and $2.28 per MMbtu for natural gas (as further adjusted for property specific gravity, quality, local markets and distance
from markets) to compute the future cash flows of the Company’s producing properties. These prices compare to $50.28 per
barrel for oil and $2.59 per MMbtu for natural gas used in the calculation of the Ceiling Test as of December 31, 2015. The discount
factor used was 10%.
The Company did not recognize a ceiling test
impairment charged for the three months ended September 30, 2016, compared to the three months ended September 30, 2015 when a
charge of $21,446 was recognized. For the nine months ended September 30, 2016 and 2015, ceiling test impairment charges for the
Company’s oil and gas properties amounted to $9,568 and $43,894, respectively. These impairment charges were primarily related
to (i) a decline in the price of oil, (ii) reductions in the estimated quantities that are economically recoverable in the current
low oil price environment, and (iii) the transfer of approximately $1,000 of unevaluated properties during the first quarter of
2016 to the full cost pool due to impairment.
|
5.
|
DISCONTINUED OPERATIONS AND PREFERRED STOCK ISSUANCE
|
Disposition of Mining Segment
In February 2006, the Company reacquired the Mt. Emmons molybdenum
mining properties (the “Property”). From the time of the Company’s reacquisition of the Property until its transfer
as described below, the Company did not conduct any extractive mining operations at the Property and was obligated under existing
permits to operate a water treatment plant (“WTP”) and to incur holding costs associated with the retention of the
mining properties, which resulted in aggregate annual expenses of approximately $3,000 during each of the three years in the period
ended December 31, 2015.
The market price for molybdenum oxide was approximately $11 per
pound during 2013 and 2014 with a decrease to approximately $5 per pound by the fourth quarter of 2015. In light of the considerable
ongoing costs related to the Property and the deteriorating market for molybdenum, during 2015 the Company began to explore the
viability of alternative structures to the development of the Property that could result in a sharing or elimination of the ongoing
costs and liabilities. In February 2016, the Company decided to dispose of the Property rather than
continuing the Company’s long-term development strategy whereby the Company entered into the following agreements:
|
A.
|
An Acquisition Agreement (the “Acquisition Agreement”)
was entered into with Mt. Emmons Mining Company, a subsidiary of Freeport-McMoRan Inc. (“MEM”), whereby MEM acquired
the Property which consists of the Mt. Emmons mine site located in Gunnison County, Colorado, including the Keystone Mine, the
WTP and other related properties. Under the Acquisition Agreement, MEM replaced the Company as the permittee and operator of the
WTP and will discharge the obligation of the Company to operate the WTP from and after the closing in accordance with the applicable
permits issued by the Colorado Department of Public Health and Environment. The Company did not receive any cash consideration
for the disposition; the sole consideration for the transfer was that MEM assumed the Company’s obligations to operate the
WTP and to pay the future mine holding costs for portions of the Property that it desires to retain.
|
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
As a result of the February 2016 disposition of the Property, the
Company determined that an impairment charge of $22,620 was required to be recorded in the fourth quarter of 2015 and the disposal
of the Company’s mining segment was reported as discontinued operations in the Company’s financial statements. Presented
below are the assets and liabilities associated with the Company’s mining segment as of September 30, 2016 and December 31,
2015:
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Assets retained by the Company:
|
|
|
|
|
|
|
|
|
Performance bonds and refundable deposits
|
|
$
|
135
|
|
|
$
|
114
|
|
|
|
|
|
|
|
|
|
|
Net assets conveyed to Purchaser:
|
|
|
|
|
|
|
|
|
Undeveloped mining claims
|
|
|
-
|
|
|
|
21,942
|
|
Mining equipment
|
|
|
-
|
|
|
|
1,774
|
|
Less accumulated depreciation of mining equipment
|
|
|
-
|
|
|
|
(892
|
)
|
Less write-down due to impairment
|
|
|
-
|
|
|
|
(22,620
|
)
|
|
|
|
|
|
|
|
|
|
Net book value of assets conveyed
|
|
|
-
|
|
|
|
204
|
|
|
|
|
|
|
|
|
|
|
Total assets of discontinued operations
|
|
$
|
135
|
|
|
$
|
318
|
|
|
|
|
|
|
|
|
|
|
Asset retirement obligations assumed by Purchaser
|
|
$
|
-
|
|
|
$
|
204
|
|
|
B.
|
Concurrent with entry into the Acquisition Agreement and as additional consideration for MEM to accept transfer of the
Property, the Company entered into a Series A Convertible Preferred Stock Purchase Agreement (the “Series A Purchase
Agreement”) with MEM, whereby the Company issued 50,000 shares of newly designated Series A Convertible Preferred
Stock (the “Preferred Stock”) to MEM in exchange
for (i) MEM accepting the transfer of the Property and replacing the
Company as the permittee and operator of the WTP, and (ii) the payment of approximately $1 to the Company. The Series A
Purchase Agreement contains customary representations and warranties on the part of the Company. As contemplated by the
Acquisition Agreement and the Series A Purchase Agreement and as approved by the Company’s Board of Directors, the
Company filed with the Secretary of State of the State of Wyoming Articles of Amendment containing a Certificate of
Designations with respect to the Preferred Stock (the “Certificate of Designations”). Pursuant to the
Certificate of Designations, the Company designated 50,000
shares of its authorized preferred stock as Series A Convertible Preferred
Stock. The Preferred Stock accrues dividends at a rate of 12.25% per annum of the Adjusted Liquidation Preference (as
defined); such dividends are not payable in cash but are accrued and compounded quarterly in arrears on the first business
day of the succeeding calendar quarter. At issuance, the aggregate fair value of the Preferred Stock was $2,000 based on the
initial liquidation preference of $40 per share. The “Adjusted Liquidation Preference” is initially $40 per
share of Preferred Stock, with increases each quarter by the
accrued quarterly dividend. The Preferred Stock is senior to other
classes or series of shares of the Company with respect to dividend rights and rights upon liquidation. No dividend
or distribution will be declared or paid on junior stock, including the Company’s common stock, (1) unless approved by
the holders of Preferred Stock and (2) unless and until a like dividend has been declared and paid on the Preferred Stock on
an as-converted basis.
|
At the option of the holder, each share of Preferred
Stock was initially convertible into approximately 13.33 shares of the Company’s $0.01 par value common stock (the “Conversion
Rate”) for an aggregate of 666,667 shares of common stock. The Conversion Rate is subject to anti-dilution adjustments for
stock splits, stock dividends, certain reorganization events, and to price-based anti-dilution protections if the Company subsequently
issues shares for less than 90% of fair value on the date of issuance. Each share of Preferred Stock will be convertible into a
number of shares of common stock equal to the ratio of the initial conversion value to the conversion value as adjusted for accumulated
dividends multiplied by the Conversion Rate. In no event will the aggregate number of shares of common stock issued upon conversion
be greater than approximately 793,000 shares. The Preferred Stock will generally not vote with the Company’s common stock
on an as-converted basis on matters put before the Company’s shareholders. The holders of the Preferred Stock have the right
to approve specified matters as set forth in the Certificate of Designations and have the right to require the Company to repurchase
the Preferred Stock in connection with a change of control. However, the Company’s Board of Directors has the ability to
prevent any change of control that could trigger a redemption obligation related to the Preferred Stock.
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
During the first quarter of 2016, the Company recorded
the fair value of the Preferred Stock based on the initial liquidation preference of $2,000. Since the cash consideration paid
by MEM for the Preferred Stock was $1, the Company recorded a charge to discontinued operations of approximately $1,999 associated
with the issuance. This charge represents additional consideration to induce MEM to assume the Company’s previous obligations
to operate the WTP. As of September 30, 2016, the aggregate Adjusted Liquidation Preference was $2,097 which was convertible into
699,004 shares of common stock, and accrued dividends not yet included in the Adjusted Liquidation Preference amounted to $66.
|
C.
|
Concurrent with entry into the Acquisition Agreement and the Series A Purchase Agreement, the Company and MEM entered into
an Investor Rights Agreement, which provides MEM with the rights to certain information and Board observer rights. MEM has agreed
that it, along with its affiliates, will not acquire more than 16.86% of the Company’s issued and outstanding shares of common
stock. In addition, MEM has the right to request registration of the shares of common stock issuable upon conversion of the Preferred
Stock under the Securities Act of 1933, as amended.
|
Results of Operations for Discontinued Operations
The results of operations of the discontinued
mining operations are presented separately in the accompanying financial statements for all periods presented. Presented below
are the components for the three and nine months ended September 30, 2016 and 2015:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30:
|
|
|
September 30:
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of preferred stock to induce disposition
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(1,999
|
)
|
|
$
|
-
|
|
Operating expenses of mining segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Water treatment plant
|
|
|
-
|
|
|
|
(470
|
)
|
|
|
(256
|
)
|
|
|
(1,383
|
)
|
Mine property holding costs
|
|
|
-
|
|
|
|
(365
|
)
|
|
|
(117
|
)
|
|
|
(912
|
)
|
Depreciation of mine equipment
|
|
|
-
|
|
|
|
(30
|
)
|
|
|
-
|
|
|
|
(90
|
)
|
Professional fees related to disposition
|
|
|
-
|
|
|
|
-
|
|
|
|
(76
|
)
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total results for discontinued operations
|
|
$
|
-
|
|
|
$
|
(865
|
)
|
|
$
|
(2,448
|
)
|
|
$
|
(2,385
|
)
|
As of September 30, 2016, the Company owns
three parcels of land in Wyoming for an aggregate of approximately 13 acres of land with a carrying value of $653. This land is
currently listed for sale and management expects to sell the land within the following year at prices in excess of the carrying
value.
|
7.
|
BORROWINGS UNDER CREDIT AGREEMENT
|
Energy One, a wholly-owned subsidiary of
the Company, has a credit facility with Wells Fargo Bank, National Association (“Wells Fargo”), which provides
for a maturity date of July 30, 2017. As of September 30, 2016 and December 31, 2015, outstanding borrowings under the credit
agreement amounted to $6,000, which is also the maximum amount of the borrowing base. Borrowings under the credit agreement
are collateralized by Energy One’s oil and gas producing properties and substantially all of the Company’s cash
and equivalents. On August 11, 2016, the Company and Wells Fargo entered into a fourth amendment (the "Fourth
Amendment") to the credit agreement. The Fourth Amendment provides for, among other things: (i) a limited waiver of the
negative financial covenants as it relates to the fiscal quarters ended March 31, 2016 and June 30, 2016, (ii) implementation
of a new negative covenant that prohibits the Company’s consolidated general and administrative expenses (as defined)
from exceeding $3,000 for each of the years ending December 31, 2016 and 2017, (iii) deferral of the next borrowing base
redetermination until December 1, 2016, and (iv) the pledge of additional collateral consisting of certain real estate assets
with a net carrying value of $1,830, and 7,436,505 shares of Anfield Resources, Inc., which had a fair value of $1,244 as of
September 30, 2016. Each borrowing under the agreement has a term of six months, but can be continued at the Company’s
election through July 2017 if the Company is in compliance with the covenants under the credit agreement. The weighted
average interest rate on this debt is 3.19% as of September 30, 2016.
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
Energy One is required to comply with customary
affirmative covenants and with certain negative covenants. The principal negative financial covenants do not permit (i) the interest
coverage ratio (EBITDAX to interest expense) to be less than 3.0 to 1; (ii) total debt to EBITDAX to be greater than 3.5 to 1;
and (iii) the current ratio to be less than 1.0 to 1.0. EBITDAX is defined in the credit agreement as consolidated net income,
plus certain non-cash charges. Additionally, the credit agreement prohibits or limits Energy One’s ability to incur additional
debt, pay cash dividends and other restricted payments, sell certain assets, enter into transactions with affiliates, and to merge
or consolidate with another company. The Company is a guarantor of Energy One’s obligations under the credit agreement.
Energy One failed to comply with the financial
ratio covenants in the credit agreement for the fiscal quarter ended December 31, 2015 and in April 2016, Wells Fargo provided
a waiver for such non-compliance. Due to the Company’s expectation that ongoing non-compliance with the financial ratio covenants
was likely during 2016, the entire principal balance of $6,000 was classified as a current liability as of December 31, 2015. Energy
One failed to comply with the financial ratio covenants for each of the first two fiscal quarters in 2016. The Fourth Amendment
discussed above provides a limited waiver of the negative financial covenants for the fiscal quarters ended March 31, 2016 and
June 30, 2016. However, the Company violated the financial ratio covenants for the fiscal quarter ended September 30, 2016, which
constitutes an event of default under the credit agreement. Accordingly, Wells Fargo has the immediate right to demand acceleration
of all outstanding borrowings and has the ability to foreclose upon the existing collateral. Management believes that Wells Fargo
will not demand repayment until an alternative lender can be obtained. However, no assurance can be provided unless a waiver is
subsequently obtained to cure the existing event of default. Additionally, management believes further non-compliance with the
financial ratio covenants is likely when results are reported for the fourth quarter of 2016. In the event that Energy One is unable
to obtain further waivers under the credit agreement to address the anticipated future breaches of the financial ratio covenants,
and other actual or potential future breaches that may occur, Wells Fargo could elect to declare some or all of the Company’s
debt to be immediately due and payable and could elect to terminate its commitment.
|
8.
|
EXECUTIVE RETIREMENT PLAN
|
In October 2005, the Board of Directors adopted
an Executive Retirement Policy (the “Retirement Plan”) for the benefit of certain executive officers of the Company.
To be eligible to participate in the Retirement Plan, the executive officer was required to serve as one of the designated executive
officers for at least 15 years, reached the age of 60, and been an employee of the Company on December 31, 2010. Upon retirement,
the executive was entitled to cash payments equaling 50% of the greater of (i) the amount of compensation earned as base cash pay
on the final regular pay check or (ii) the average annual pay, less all bonuses, received over the last five years of employment
with the Company. The Company periodically engaged the services of a third party actuary to determine the estimated liability under
the Retirement Plan. In December 2015, the Company and the Retirement Plan participants mutually agreed to terminate the Retirement
Plan. As of December 31, 2015, the liability for retirement plan benefits was $583 and this entire balance was paid to participants
during the first quarter of 2016.
|
9.
|
COMMITMENTS AND CONTINGENCIES
|
Commitments
Earnings & Participation
Agreement.
On September 14, 2016, the Company and IronHorse Resources, LLC (“IronHorse”), entered into an
Earnings & Participation Agreement (the “IronHorse Agreement”), pursuant to which the Company has agreed to
purchase 40% of IronHorse’s interest in five farmout agreements previously acquired by IronHorse (the “Farmout
Agreements”). Thomas Bandy, a member of the Board of Directors of the Company, has an ownership interest in IronHorse.
The Farmout Agreements cover oil and gas leases and interests in 21 horizontal oil and gas wells (the “Wells”) to
be drilled in Weld County, Colorado, targeting the A, B, and C benches of the Niobrara and Codell formations.
Management estimates that
the Company’s share of the aggregate drilling and completion costs for the Wells will be approximately
$9,600. Additionally, the terms of the IronHorse Agreement provide for a finder’s fee payable to IronHorse which
consists of an aggregate of 69,192 shares of the Company’s common stock to be issued in three tranches of 23,064 shares
as certain property interests are assigned to the Company. The terms of the IronHorse Agreement initially provided that on or
before October 10, 2016, the Company was required to provide to IronHorse reasonable evidence that it has sufficient funding
for its obligations under the IronHorse Agreement; otherwise, the IronHorse Agreement would terminate and the Company would
have no further rights or obligations thereunder. On October 10, 2016, the parties amended the IronHorse Agreement to extend
the date to demonstrate sufficient funding until November 10, 2016, and on November 11, 2016, the parties agreed to a second
extension of this date until December 11, 2016.
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
The IronHorse Agreement further provides
for creation of an Area of Mutual Interest covering three prospect areas within Weld County, Colorado, as further described
therein (the “AMI Areas”), whereby the Company and IronHorse will have the right to elect to share
equally in any other oil and gas interests acquired in the AMI Areas.
Contingencies
From time to time, the Company is party to
certain legal actions and claims arising in the ordinary course of business. While the outcome of these events cannot be predicted
with certainty, management does not expect these matters to have a materially adverse effect on the Company’s financial position
or results of operations. Following is updated information related to currently pending legal matters:
Arbitration of Employment Claim.
A
former at-will employee has asserted a claim that a change of control occurred and he was involuntarily terminated without
cause, thereby entitling him to compensation under a purported Executive Severance and Non-Compete agreement (the
“Severance and Non-Compete Agreement”), which provided for cash payments if the Company experienced a change of
control. The Company contends that no change of control occurred that would entitle the former at-will employee to benefits
under the Severance and Non-Compete Agreement. The former employee has claimed that the Company owes up to $1,800 under the
Severance and Non-Compete Agreement which requires that any disputes be submitted to binding arbitration. A request for
arbitration was submitted by the former employee in March 2016 and, the arbitration proceedings are expected to be conducted during 2017.
Management does not believe there is any merit
to the claim of termination without cause or that a change of control occurred. The ultimate outcome of this matter cannot presently
be determined. Accordingly, adjustments, if any, that may result from the resolution of this matter have not been reflected in
the accompanying consolidated financial statements.
Liability for Contingent Ownership Interests.
As of September 30, 2016 and December 31, 2015, the Company had recognized a contingent liability associated with uncertain
ownership interests of $4,582 and $3,108, respectively. This liability arises when the calculations of respective joint ownership
interests by operators differs from the Company’s calculations. These differences relate to a variety of matters, including
allocation of non-consent interests, complex payout calculations for individual wells and groups of wells, and the timing
of reversionary interests. Accordingly, these matters are subject to legal interpretation and the related obligations are presented
as a contingent liability in the accompanying consolidated balance sheets. While the Company has classified these amounts as current
liabilities, most of these issues are expected to be resolved through arbitration, mediation or litigation; due to the complexity
of the issues involved, there can be no assurance that the outcome of these contingencies will be resolved in the next year.
Contingent Gain for Joint Interest
Audit Recoveries.
The Company has performed joint interest audits of certain drilling, completion and operating costs
charged by the Major Operator discussed in Note 13. The results of the audits indicated that $5,269 of costs incurred by the
Major Operator in 2011 and 2012 were improperly charged to the accounts for all of the joint interest owners in the wells,
including $1,919 related to the Company. During 2015, the Major Operator (i) agreed to issue refunds to the joint interest
owners for aggregate charges of $606, (ii) denied claims for aggregate charges of $4,432, and (iii) indicated
that it is continuing to review claims for aggregate charges of $231. The Company has disputed the $4,432 of denied charges,
of which its share is approximately $1,600. Since the Company previously paid the full amounts billed by the Major Operator,
the dispute will be resolved in accordance with the terms of the joint operating agreements. Except for the refunds issued
during 2015, no amounts have been recorded in the accompanying consolidated financial statements for additional recoveries
that may result from the joint interest audits.
Stock Options
For the three months ended September 30, 2016
and 2015, total stock-based compensation expense related to stock options was $18 and $34, respectively. For the nine months ended
September 30, 2016 and 2015, total stock-based compensation expense related to stock options was $61 and $138, respectively. As
of September 30, 2016, there was $80 of unrecognized expense related to unvested stock options, which will be recognized as stock-based
compensation expense through January 2018. For the three and nine months ended September 30, 2016, no stock options were granted,
exercised, forfeited or expired. Presented below is information about stock options outstanding and exercisable as of September
30, 2016 and December 31, 2015:
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
|
|
Shares
|
|
|
Price
(1)
|
|
|
Shares
|
|
|
Price
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options outstanding
|
|
|
390,525
|
|
|
$
|
20.64
|
|
|
|
390,525
|
|
|
$
|
20.64
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options exercisable
|
|
|
376,084
|
|
|
$
|
20.97
|
|
|
|
365,693
|
|
|
$
|
21.17
|
|
|
(1)
|
Represents the weighted average price.
|
The following table summarizes information
for stock options outstanding and for stock options exercisable at September 30, 2016:
Options Outstanding
|
|
|
Options Exercisable
|
|
Number
|
|
|
Exercise Price
|
|
|
Remaining
|
|
|
Number
|
|
|
Weighted
|
|
of
|
|
|
Range
|
|
|
Weighted
|
|
|
Contractual
|
|
|
of
|
|
|
Average
|
|
Shares
|
|
|
Low
|
|
|
High
|
|
|
Average
|
|
|
Term (years)
|
|
|
Shares
|
|
|
Exercise Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56,786
|
|
|
$
|
9.00
|
|
|
$
|
9.00
|
|
|
$
|
9.00
|
|
|
|
8.3
|
|
|
|
45,675
|
|
|
$
|
9.00
|
|
|
49,504
|
|
|
|
12.48
|
|
|
|
12.48
|
|
|
|
12.48
|
|
|
|
6.8
|
|
|
|
49,504
|
|
|
|
12.48
|
|
|
98,396
|
|
|
|
13.92
|
|
|
|
17.10
|
|
|
|
15.01
|
|
|
|
3.1
|
|
|
|
98,396
|
|
|
|
15.01
|
|
|
185,839
|
|
|
|
22.62
|
|
|
|
30.24
|
|
|
|
29.35
|
|
|
|
1.3
|
|
|
|
182,509
|
|
|
|
29.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
390,525
|
|
|
$
|
9.00
|
|
|
$
|
30.24
|
|
|
$
|
20.64
|
|
|
|
3.5
|
|
|
|
376,084
|
|
|
$
|
20.97
|
|
As of September 30, 2016, no shares are available
for future grants under the Company’s stock option plans. Based upon the closing price for the Company’s common stock
of $1.75 per share on September 30, 2016, there was no intrinsic value related to stock options outstanding as of September 30,
2016.
Restricted Stock Grants
In January 2015, the Board of Directors granted
56,786 shares of restricted stock under the 2012 Equity Plan to four officers of the Company. These shares originally vested annually
over a period of three years. However, during 2015 vesting was accelerated for three of the four officers in connection with severance
agreements for an aggregate of 40,119 shares. The remaining 16,667 shares vested for 5,556 shares in January 2016 and the remaining
11,111 shares will vest for 5,556 shares in January 2017, and 5,555 shares in January 2018. The fair market value of the 56,786
shares on the date of grant was approximately $511.
On September 23, 2016, the Board of
Directors granted restricted stock to each member of the Board for 58,500 shares per Board member for an aggregate grant of
351,000 shares. Such shares vest for 50% of the shares on September 23, 2017 and the remaining 50% of the shares vest on
September 23, 2018. The closing price of the Company’s common stock on the grant date was $1.74, which will result in
an aggregate compensation charge of $611 over the two-year vesting period.
The 351,000 shares of restricted common stock
were granted pursuant to the Company’s 2012 Equity Plan, which provides that each grant constitutes an immediate transfer
of ownership that entitles the Board members to voting, dividend and other ownership rights. However, the shares of restricted
stock are subject to a substantial risk of forfeiture until vesting occurs. Prior to vesting, the shares are not permitted to be
sold or transferred and the directors do not maintain physical custody of the shares.
All shares of restricted common stock are included
in issued and outstanding shares in the accompanying financial statements. However, until vesting occurs the restricted shares
will be excluded from the calculation of basic earnings per share. For the three months ended September 30, 2016 and 2015, total
stock-based compensation expense related to restricted stock grants was $6 and $73, respectively. For the nine months ended September
30, 2016 and 2015, total stock-based compensation expense related to restricted stock grants was $31 and $193, respectively. As
of September 30, 2016, there was $680 of unrecognized expense related to unvested restricted stock grants, which will be recognized
as stock-based compensation expense through January 2018.
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
Employee Stock Ownership Plan
The Board of Directors of the Company adopted
the U.S. Energy Corp. 1989 Employee Stock Ownership Plan ("ESOP") in 1989, for the benefit of all the Company’s
employees. Employees become eligible to participate in the ESOP after one year of service which must consist of at least 1,000
hours worked. Employees become 20% vested after three years of service and increase their vesting by 20% each year thereafter until
such time as they are fully vested after seven years of service.
On an annual basis, the Company historically
contributed shares of its common stock to the ESOP with an aggregate fair value equal to 10% of compensation for employees that
were eligible to participate. Employees were not eligible for ESOP contributions to the extent that their annual taxable compensation
exceeded $265 for 2015. All shares of the Company’s common stock contributed to the ESOP have been allocated to specific
employees and are vested. Total shares held by the ESOP as of September 30, 2016 and December 31, 2015 were 90,112 and 131,518,
respectively. In September 2016, the Company’s Board of Directors terminated the ESOP, which is expected to result
in a distribution of the remaining shares held by the ESOP to the vested employees during the fourth quarter of 2016.
For the three months ended September 30, 2015,
total stock-based compensation expense related to the ESOP was $23. No expense related to the ESOP has been recorded for the three
months ended September 30, 2016 since the Company’s Board of Directors has not determined if a discretionary contribution
will be made for 2016. For the year ended December 31, 2015, the Company’s Board of Directors approved a mandatory contribution
of $170 which is either payable in cash or may be settled through the issuance of common stock at the election of the Company.
On July 7, 2016, the Board of Directors elected to issue 68,128 shares of the Company’s common stock with a fair value of
$2.49 per share to settle this obligation.
For Federal income tax purposes, as of December
31, 2015 the Company had net operating loss and percentage depletion carryovers of approximately $57,000 and $7,000, respectively.
The net operating loss carryovers may be carried back two years and forward twenty years from the year the net operating loss was
generated. The net operating losses may be used to offset future taxable income and expire in varying amounts through 2035. In
addition, the Company has alternative minimum tax credit carry-forwards of approximately $700 which are available to offset future
federal income taxes over an indefinite period. The Company has established a valuation allowance for all deferred tax assets including
the net operating loss and alternative minimum tax credit carryforwards discussed above since the “more likely than not”
realization criterion was not met as of September 30, 2016 and 2015. Accordingly, the Company did not recognize an income tax benefit
for the three and nine months ended September 30, 2016 and 2015.
The Company recognizes, measures, and discloses
uncertain tax positions whereby tax positions must meet a “more-likely-than-not” threshold to be recognized. As of
September 30, 2016, gross unrecognized tax benefits are immaterial and there was no change in such benefits during the three and
nine months ended September 30, 2016. The Company does not expect a significant increase or decrease to the uncertain tax positions
within the next twelve months.
|
12.
|
EARNINGS (LOSS) PER SHARE
|
Basic earnings (loss) per share is computed
based on the weighted average number of common shares outstanding. For the three and nine months ended September 30, 2016 and 2015,
common stock equivalents excluded from the calculation of weighted average shares because they were antidilutive are as follows:
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30:
|
|
|
September 30:
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
|
390,525
|
|
|
|
436,132
|
(1)
|
|
|
390,525
|
|
|
|
435,924
|
(1)
|
Unvested shares of restricted common stock
|
|
|
37,818
|
(1)
|
|
|
55,698
|
(1)
|
|
|
20,078
|
(1)
|
|
|
39,972
|
(1)
|
Series A convertible preferred stock
|
|
|
699,004
|
(1)
|
|
|
-
|
|
|
|
581,535
|
(1)
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,127,347
|
|
|
|
491,830
|
|
|
|
992,138
|
|
|
|
475,896
|
|
|
(1)
|
Includes weighted average number of shares for options issued during the period and shares of restricted stock that vested
during the period.
|
|
13.
|
SIGNIFICANT CONCENTRATIONS
|
The Company has exposure to credit risk in
the event of nonpayment by the joint interest operators of the Company’s oil and gas properties. Approximately 22% of the
Company’s proved developed oil and gas reserve quantities are associated with wells that are operated by a single operator
(the “Major Operator”). As of September 30, 2016 and December 31, 2015, the Company had a liability to the Major Operator
of $2,394 and $4,159, respectively, for accrued operating expenses and overpayments of net revenues when the Major Operator failed
to recognize that the Company’s ownership interest reverted after payout, which was achieved for certain wells during 2014
and 2015. Beginning in the second quarter of 2015, the Major Operator began withholding the Company’s net revenues from all
wells that it operates for the Company and management expects the Major Operator will continue to withhold the Company’s
net revenues until this liability is paid in full. Based on the oil and gas prices and costs used to calculate the Company’s
estimated reserves as of September 30, 2016, this liability is not expected to be fully settled. However, under higher pricing
scenarios the Company expects the liability will be repaid from future production. Accordingly, the aggregate balances are presented
as current liabilities in the accompanying consolidated balance sheets.
|
14.
|
FAIR VALUE MEASUREMENTS
|
Fair value is the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In
determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches,
the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including
assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable,
market corroborated, or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use
of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the
valuation techniques the Company is required to provide the following information according to the fair value hierarchy. The fair
value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities
carried at fair value will be classified and disclosed in one of the following three categories:
Level 1 - Quoted prices for identical assets
and liabilities traded in active exchange markets, such as the New York Stock Exchange.
Level 2 - Observable inputs other than Level
1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that
can be corroborated by observable market data. Level 2 also includes derivative contracts whose value is determined
using a pricing model with observable market inputs or can be derived principally from or corroborated by observable market data.
Level 3 - Unobservable inputs supported by
little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies,
or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment
or estimation; also includes observable inputs for nonbinding single dealer quotes not corroborated by observable market data.
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
Continued
(Dollars in Thousands, Except Per Share Amounts)
The Company has processes and controls in place
to attempt to ensure that fair value is reasonably estimated. The Company performs due diligence procedures over third-party pricing
service providers in order to support their use in the valuation process. Where market information is not available to support
internal valuations, independent reviews of the valuations are performed and any material exposures are evaluated through a management
review process.
While the Company believes its valuation methods
are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the
fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The following
is a description of the valuation methodologies used for complex financial instruments measured at fair value:
Oil Price Risk Derivative Valuation Methodologies
The Company determines its estimate
of the fair value of derivative instruments using a market approach based on several factors, including quoted market prices
in active markets, quotes from third parties, the credit rating of the counterparty and the Company’s own credit
rating. In consideration of counterparty credit risk, the Company assessed the likelihood that the counterparty to the
derivative would default by failing to make any contractually required payments. Additionally, the Company believes that
the counterparty has the financial resources and willingness to meet its potential
repayment obligations associated with the derivative transactions. At September 30, 2016 and December 31, 2015, derivative
instruments utilized by the Company consisted of crude oil costless collars. The crude oil derivative markets are highly
active. Although the Company’s derivative instruments are valued using indices, the instruments themselves are traded
with third-party counterparties and are not openly traded on an exchange. As such, the Company has classified these
instruments as Level 2.
Marketable Equity Securities Valuation Methodologies
The fair value of available for sale securities
is based on quoted market prices obtained from independent pricing services. In consideration of the increase in trading volumes
for both of the Company’s investments in marketable equity securities, the Company determined that they should be classified
in Level 1 as of September 30, 2016.
Executive Retirement Liability Valuation
Methodologies
The executive retirement program is a standalone
liability for which there is no available market price, principal market, or market participants. The Company records the estimated
fair value of the long-term liability for estimated future payments under the executive retirement program based on the discounted
value of estimated future payments associated with each individual in the program. The inputs available for this estimate are unobservable
and are therefore classified as Level 3 inputs.
Other Financial Instruments
The carrying amount of cash and equivalents,
oil and gas sales receivable, other current assets, accounts payable and accrued expenses approximate fair value because of the
short-term nature of those instruments. The recorded amounts for borrowings under the credit agreement discussed in Note 7 approximates
the fair market value due to the variable nature of the interest rates, and the fact that market interest rates have remained substantially
the same since the latest amendment to the credit agreement.
Recurring Fair Value Measurements
Recurring measurements of the fair value of
assets and liabilities as of September 30, 2016 and December 31, 2015 are as follows:
U.S. ENERGY CORP.
AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS, Continued
(Dollars in Thousands,
Except Per Share Amounts)
Recurring measurements of the fair value
of assets and liabilities as of September 30, 2016 and December 31, 2015 are as follows:
|
|
September
30, 2016
|
|
|
December
31, 2015
|
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sutter Gold Mining
Company
|
|
$
|
19
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
19
|
|
|
$
|
-
|
|
|
$
|
13
|
|
|
$
|
-
|
|
|
$
|
13
|
|
Anfield
Resources, Inc.
(1)
|
|
|
1,903
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,903
|
|
|
|
-
|
|
|
|
-
|
|
|
|
238
|
|
|
|
238
|
|
Crude oil price risk derivatives
|
|
|
-
|
|
|
|
174
|
|
|
|
-
|
|
|
|
174
|
|
|
|
-
|
|
|
|
1,634
|
|
|
|
-
|
|
|
|
1,634
|
|
Total
|
|
$
|
1,922
|
|
|
$
|
174
|
|
|
$
|
-
|
|
|
$
|
2,096
|
|
|
$
|
-
|
|
|
$
|
1,647
|
|
|
$
|
238
|
|
|
$
|
1,885
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Executive retirement liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
584
|
|
|
$
|
584
|
|
|
(1)
|
For
the period from September 1, 2015 when the Company acquired its investment in Anfield
Resources, Inc. (“Anfield”) through March 31, 2016, average daily trading
volume was approximately 10,000 shares and management concluded that the quoted marked
price was not an accurate indicator of fair value. Accordingly, alternative methods were
used to determine fair value upon receipt of the shares in September 2015, which required
classification under Level 3 of the fair value hierarchy. During the second quarter of
2016, average daily trading volume increased to more than 240,000 shares and management
now classifies its investment in Anfield under Level 1 of the fair value hierarchy. Primarily
as a result of the reclassification of Anfield to Level 1, the Company recognized an
unrealized gain of $921 during the nine months ended September 30, 2016. See Note 15
for changes in the fair value of the investment in Anfield after September 30, 2016.
|
As discussed in Note 9, the Agreement
entered into with IronHorse in September 2016 provided that by October 10, 2016, the Company was required to demonstrate to
IronHorse that it has adequate funding to carry out its obligations under the IronHorse Agreement; otherwise the IronHorse
Agreement would terminate. On October 10, 2016, the Company and IronHorse entered into an amendment to the IronHorse
Agreement whereby the date to demonstrate sufficient funding was extended until November 10, 2016. On November 11,
2016, IronHorse agreed to a second extension of this date until December 11, 2016.
As of September 30, 2016, the Company
owned an aggregate of 11,374,157 shares of common stock of Anfield Resources, Inc. with a fair market value of $1,904. As of November
16, 2016, the fair market value of these shares was approximately $560, resulting in an unrealized loss of $1,344 for the period
from October 1, 2016 through November 16, 2016.