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, 2016, filed with the SEC on March 27, 2017,
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 completed a 1-for-10 reverse split of its outstanding
common stock, which took effect as of market close on April 7,
2017. All outstanding shares, options, warrants, preferred stock
and other securities convertible into the Company's common stock
have been retrospectively adjusted to reflect the reverse stock
split as required by the terms of such securities with a
proportional increase in the related share or exercise
price.
NOTE 2 – DESCRIPTION OF BUSINESS
PEDEVCO’s
primary business plan is engaging in the acquisition, exploration,
development and production of oil and natural gas shale plays in
the United States, with a secondary focus on conventional oil and
natural gas plays. The Company’s principal operating
properties are located in the Wattenberg, Wattenberg Extension, and
Niobrara formation in the Denver-Julesburg Basin (the “D-J
Basin” and the “D-J Basin Asset”) in Weld County,
Colorado, all of which properties are owned by the Company through
its wholly-owned subsidiary, Red Hawk Petroleum, LLC (“Red
Hawk”).
The
Company plans to focus on the development of shale oil and gas
assets held by the Company in its D-J Basin Asset.
The
Company plans to seek additional shale oil and gas and conventional
oil and gas asset acquisition opportunities in the U.S. utilizing
its strategic relationships and technologies that may provide the
Company a competitive advantage in accessing and exploring such
assets. Some or all of these assets may be acquired by existing
subsidiaries or other entities that may be formed at a future
date.
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) Pacific Energy Development Corp.
(“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 (which is currently in the process of being dissolved); (v)
White Hawk Petroleum, LLC, a Nevada limited liability company
(dissolved on November 30, 2016); (vi) Red Hawk Petroleum, LLC, a
Nevada limited liability company; (vii) Pacific Energy Development
MSL, LLC (owned 50% by us) (dissolved in September 2016) and is
included in our consolidated results for the periods prior to its
dissolution (“PEDCO MSL”); (viii) PEDEVCO Acquisition
Subsidiary, Inc., a Texas corporation which was formed on May 21,
2015 in connection with the planned reorganization transaction with
Dome Energy, Inc. (“Dome Energy”), which was
subsequently terminated (dissolved in April 2016); and (ix) 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. 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, 2017, and
December 31, 2016, cash equivalents consisted of money market funds
and cash on deposit.
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, 2017, approximately $646,000 of the Company’s cash
balances were uninsured. The Company has not experienced any losses
on such accounts.
Sales
to one customer comprised 52% of the Company’s total oil
and gas revenues for the nine months ended September 30, 2017.
Sales to one customer comprised 51% of the Company’s
total oil and gas revenues for the nine months ended September 30,
2016. 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 $-0- 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, 2017
and 2016 (in thousands):
|
|
|
|
|
Asset retirement
obligations at January 1
|
$
246
|
$
189
|
|
Accretion
expense
|
28
|
24
|
|
Obligations
incurred for acquisition
|
-
|
19
|
|
Changes in
estimates
|
(20
)
|
(7
)
|
|
Asset retirement
obligations at September 30
|
$
254
|
$
225
|
Revenue Recognition.
All revenue is recognized when
persuasive evidence of an arrangement exists, the service or sale
is complete, the price is fixed or determinable and collectability
is reasonably assured. Revenue is derived from the sale of crude
oil and natural gas. Revenue from crude oil and natural gas sales
is recognized when the product is delivered to the purchaser and
collectability is reasonably assured. The Company follows the
“sales method” of accounting for oil and natural gas
revenue, so it recognizes revenue on all natural gas or crude oil
sold to purchasers, regardless of whether the sales are
proportionate to its ownership in the property. A receivable or
liability is recognized only to the extent that the Company has an
imbalance on a specific property greater than its share of the
expected remaining proved reserves. If collection is uncertain,
revenue is recognized when cash is collected.
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.
Loss per Common Share.
Basic loss per common share equals
net loss divided by weighted average common shares outstanding
during the period. Diluted loss per share includes the impact on
dilution from all contingently issuable shares, including options,
warrants and convertible securities. The common stock equivalents
from contingent shares are determined by the treasury stock method.
The Company incurred net losses for the nine months ended September
30, 2017 and 2016, and therefore, basic and diluted loss per share
for those periods are the same as all potential common equivalent
shares would be anti-dilutive. The Company excluded 473,727 and
302,484 potentially issuable shares of common stock related to
options, 1,248,045 and 1,256,608 potentially issuable shares of
common stock related to warrants and 147,695 and 136,295
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 and 2016,
respectively.
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 May
2014, the Financial Accounting Standards Board (“FASB”)
issued a comprehensive new revenue recognition standard that will
supersede nearly all existing revenue recognition guidance under
U.S. GAAP. The standard’s core principle (issued as
Accounting Standards Update (“ASU”) 2014-09 by the
FASB), is that a company will recognize revenue when it transfers
promised goods or services to customers in an amount that reflects
the consideration to which the company expects to be entitled in
exchange for those goods or services. These may include identifying
performance obligations in the contract, estimating the amount of
variable consideration to include in the transaction price and
allocating the transaction price to each separate performance
obligation. The new guidance must be adopted using either a full
retrospective approach for all periods presented in the period of
adoption or a modified retrospective approach. In August 2015, the
FASB issued ASU No. 2015-14, which defers the effective date of ASU
2014-09 by one year, and would allow entities the option to early
adopt the new revenue standard as of the original effective date.
This ASU is effective for public reporting companies for interim
and annual periods beginning after December 15, 2017. The Company
has evaluated the adoption of the standard and due to the nature of
the Company’s oil and gas revenue agreements method there
will be no impact of the standard on its consolidated financial
statements.
In
April 2016, the FASB issued ASU No. 2016-10, “
Revenue from Contracts with Customers:
Identifying Performance Obligations and Licensing
”
(Topic 606). In March 2016, the FASB issued ASU No. 2016-08,
“Revenue from Contracts with Customers: Principal versus
Agent Considerations (Reporting Revenue Gross verses Net)”
(Topic 606). These amendments provide additional clarification and
implementation guidance on the previously issued ASU 2014-09,
“Revenue from Contracts with Customers”. The amendments
in ASU 2016-10 provide clarifying guidance on materiality of
performance obligations; evaluating distinct performance
obligations; treatment of shipping and handling costs; and
determining whether an entity's promise to grant a license provides
a customer with either a right to use an entity's intellectual
property or a right to access an entity's intellectual property.
The amendments in ASU 2016-08 clarify how an entity should identify
the specified good or service for the principal versus agent
evaluation and how it should apply the control principle to certain
types of arrangements. The adoption of ASU 2016-10 and ASU 2016-08
is to coincide with an entity's adoption of ASU 2014-09, which
would be adopted for interim and annual reporting periods beginning
after December 15, 2017. The Company has evaluated the
adoption of the standard and due to the nature of the
Company’s oil and gas revenue agreements method there will be
no impact of the standard on its consolidated financial
statements.
In
February 2016, the FASB issued 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 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. The Company is currently in the
process of evaluating the impact of ASU 2016-15 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. The Company
is currently evaluating the impact of the new
standard.
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 – GOING CONCERN
Although
the Company’s senior Tranche A Notes (as defined and
discussed below under “Note 8 – Notes Payable –
2016 Senior Note Restructuring”) do not mature until May 11,
2019 and all of the Company’s other debt expressly
subordinated thereto due, June 11, 2019, at the earliest, with no
amounts due or owing under such subordinated debt until such date,
with the exception of the New MIEJ Note (as defined and discussed
below under “Note 8 – Notes Payable – MIE
Jurassic Energy Corporation”), which matures on March 8, 2019
and with interest accruing thru March 8, 2018 being payable on such
date, the realization of the Company’s assets and
satisfaction of its liabilities remains contingent on the
completion of a future financing. The Company anticipates that it
will need approximately $11 million in the next twelve months to
execute its current business plan and is currently actively seeking
the necessary financing. In the event that the Company
is unable to consummate the financing currently being sought, and
is otherwise unable to replace such financing on a timely basis, it
would materially affect the Company’s ability to continue as
a going concern. If such financing is not completed,
among other things, the Company expects that it would incur an
impairment of its oil and gas properties in the range of $27
million and the Company’s ability to meet its obligations
from existing cash flows would be significantly affected. If the
Company would be required to seek financing from other sources,
such financings may not be available or, if available, may not be
on terms acceptable to the Company or its existing lenders.
Accordingly, the consolidated financial statements do not include
any adjustments related to the recoverability of assets or
classification of liabilities that might be necessary should the
Company be unable to continue as a going concern. The ability of
the Company to continue as a going concern is dependent upon its
ability to raise capital to meet its debt obligations, working
capital needs, and develop its oil and gas properties to attain
profitable operations. Management has concluded that there is
substantial doubt as to the Company’s ability to continue as
a going concern within one year after the issuance date of these
financial statements.
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, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil and gas
properties, subject to amortization
|
$
68,306
|
$
-
|
$
-
|
$
-
|
$
68,306
|
|
Oil and gas
properties, not subject to amortization
|
-
|
-
|
-
|
-
|
-
|
|
Asset retirement
costs
|
163
|
(20
)
|
-
|
-
|
143
|
|
Accumulated
depreciation, depletion and impairment
|
(11,074
)
|
(2,824
)
|
-
|
-
|
(13,898
)
|
|
Total oil and gas
assets
|
$
57,395
|
$
(2,844
)
|
$
-
|
$
-
|
$
54,551
|
The
depletion recorded for production on proved properties for the
three and nine months ended September 30, 2017 and 2016, amounted
to $1,304,000 compared to $512,000 and $2,824,000 compared to
$2,296,000, respectively.
Acquisition of Properties from Dome Energy, Inc.
On
November 19, 2015, the Company entered into a Letter Agreement with
certain parties including Dome Energy AB and its wholly-owned
subsidiary Dome Energy, Inc. (collectively “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.
On
March 29, 2016, the Company entered into a Settlement Agreement
with Dome Energy, pursuant to which Dome Energy re-conveyed to the
Company the interests in these eight wells assigned to Dome Energy
by the Company on November 18, 2015, with the Company becoming
responsible for its proportionate share of all the working interest
owner expenses, and having the right to receive all corresponding
revenues with respect to these eight wells, from the initial
production date of the wells. As part of this transaction, the
Company also settled $659,000 of outstanding payables due from the
Company to Dome Energy that was accounted for as a purchase price
adjustment to the value of the oil and gas properties acquired. The
transaction was closed on May 12, 2016.
The
following tables summarize the allocation of the purchase price to
the net assets acquired (in thousands):
|
Assets
Acquired:
|
|
|
Accounts receivable
– oil and gas
|
$
793
|
|
Oil and gas
properties, subject to amortization
|
3,587
|
|
Total
assets
|
$
4,380
|
|
|
|
|
Liabilities
Assumed:
|
|
|
Accounts
payable
|
$
(4,361
)
|
|
Asset retirement
obligation
|
(19
)
|
|
Total
liabilities
|
(4,380
)
|
|
Net purchase
price
|
$
-
|
NOTE 6 – ACCOUNTS RECEIVABLE
On
November 18, 2015, when the Company assigned its interests in the
eight wells to Dome Energy (as described above in Note 5), Dome
Energy also agreed to pay an additional $250,000 to the Company in
the event the anticipated merger 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. To
guarantee payment of the Dome Promissory Note, Dome Energy
deposited $250,000 into an escrow account. During the year ended
December 31, 2016, the Company collected this receivable of
$250,000 in full satisfaction of the Dome Promissory
Note.
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
September 30, 2017, 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 would 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
Company entered into an agreement with Golden Globe Energy (US),
LLC (“GGE”) to convey 50% of the Company’s
interests in Asia Sixth in connection with an acquisition
transaction in March 2014.
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 addition, on the date of
conversion of the A6 Promissory Note, Mr. Frank Ingriselli, our
Chairman and then Chief Executive Officer, was appointed as a
non-executive director of Caspian Energy and currently serves as
the Chairman of its Board of Directors.
In
February 2015, we expanded our D-J Basin position through the
acquisition of acreage from GGE (the “GGE Acquisition”
and the “GGE Acquired Assets”). In connection with our
GGE Acquisition, on February 23, 2015, we provided GGE a one-year
option to acquire our interest in Caspian Energy for $100,000
payable upon exercise of the option 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 option provided to GGE was not exercised and
expired on February 23, 2016, resulting in the Company retaining
ownership of the 23,182,880 shares of Caspian Energy.
In
connection with the Company’s May 2016 debt restructuring as
more fully described below under “Note 8 – Notes
Payable – 2016 Senior Note Restructuring”, the Company
entered into a new Call Option Agreement with GGE, dated May 12,
2016 (the “GGE Option Agreement”), pursuant to which
the Company provided GGE an option to purchase the 23,182,880
common shares of Caspian Energy upon payment of $100,000 by GGE to
the Company at any time. The option expires on May 12, 2019, which
is the maturity date of the debt evidenced by that certain Note and
Security Agreement, dated April 10, 2014, as amended on February
23, 2015, and May 12, 2016, issued by the Company to RJ Credit LLC
(“RJC” and the “RJC Junior Note”), as
described below. The $100,000 option is classified as part of other
current assets as of September 30, 2017.
NOTE 8 – NOTES PAYABLE
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”), which also provided for an additional $15.5 million
available under the financing agreement to fund the Company’s
future drilling costs to be evidenced by notes with substantially
similar terms as the Initial Notes (the “Subsequent
Notes,” and together with the Initial Notes, the
“Senior 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.
The
Initial Notes, as originally issued, accrued interest at the rate
of 15% per annum, payable monthly, required us to make certain
mandatory principal payments and was originally to mature on March
7, 2017.
On
August 28, 2015, January 29, 2016, March 7, 2016 and April 1, 2016,
the Company entered into several letter agreements and amendments
with certain of the holders to: (i) defer until the maturity date
of their Senior Notes the mandatory principal payments that would
otherwise be due and payable by the Company to them on payment
dates occurring from August 2015 through April 2016; and (ii) defer
until the maturity date of their Senior Notes and the RJC Junior
Note all of the interest payments that would otherwise be due and
payable by the Company to them from August 2015 to April 2016, with
all interest amounts deferred being added to principal on the first
business day of the month following the month in which such
deferred interest is accrued. The purpose of these deferrals was to
provide the Company with temporary relief from cash requirements to
focus and execute upon its contemplated business
combinations.
During
the three and nine months ended September 30, 2017, there were no
payments made to reduce the outstanding principal due under the
Initial Notes, however, such Notes were restructured as described
below.
2016 Senior Note Restructuring
Following
a series of temporary payment deferrals as described above, 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, 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
Junior Note (discussed below under "Notes Payable - Related Party
Financings - 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 amended the Senior Notes as follows:
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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”);
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The
Company capitalized all accrued and unpaid interest under the
Tranche B Notes as a term loan with an aggregate outstanding
principal balance as of May 12, 2016 equal to $39,065,000 (as of
September 30, 2017, the aggregate outstanding principal balance is
$46,568,000). The Tranche B Notes mature on June 11, 2019 except
for the Tranche B Note issued to RJC, which matures on July 11,
2019;
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Amended
the provisions of the Senior Notes which required mandatory
prepayments from our revenues, replacing them with a Net Revenue
Sweep as described below; and
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Provides
that interest on the Tranche B Notes will continue to accrue at the
rate of 15% per annum, but all accrued interest through December
31, 2017 shall be deferred until due and payable on the maturity
date, with all interest amounts deferred being added to the
principal of the Tranche B Notes on a monthly basis and that
following December 31, 2017, all interest will accrue and be paid
monthly in arrears in cash to the Tranche B Note holders, provided,
however, no payment may be made on the Tranche B Notes unless and
until the Tranche A Notes are repaid in full.
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The
Tranche A Notes are substantially similar to the Tranche B Notes,
except that such notes are senior to the Tranche B Notes, accrue
interest until maturity and have priority to the payment of Monthly
Net Revenues as discussed below. Amounts paid to the Agent through
the Net Revenue Sweep are applied first to the repayment of
principal and interest due under the Tranche A Notes until such
notes are paid in full and then to the repayment of principal and
interest amounts due under the Tranche B Notes. As of September 30,
2017, the Company has paid $682,000 of principal under the Net
Revenue Sweep, of which $30,000 was paid during the current nine
month period.
On the
Closing Date, Tranche A Investors BHLN and BBLN loaned the Company
their pro rata share of an aggregate of $6,422,000 (the
“Initial Tranche A Funding”). The Initial Tranche A
Funding net proceeds (amounting to $6,422,000 less legal fees of
$127,000) were used by the Company to (i) fund approximately $5.1
million due to a third party operator for drilling and completion
expenses related to the acquired working interests in eight wells
from Dome Energy, (ii) pay $750,000 of the Company’s past due
payables to Liberty (defined below under “Note 9 –
Commitments and Contingencies” – “Other
Commitments”), (iii) pay $445,000 of unpaid interest payments
due to Heartland Bank under its Tranche B Note through February 29,
2016, and (iv) pay fees and expenses of
$127,000.
Subject
to the terms and conditions of the Amended NPA, the Company may
request each Tranche A Investor, from time to time, to advance to
the Company additional amounts of funding (each, a
“Subsequent Tranche A Funding”), provided that: (i) the
Company may not request a Subsequent Tranche A Funding more than
one time in any calendar month; (ii) Agent shall have received a
written request from the Company at least 15 business days prior to
the requested date of such advance (the “Advance
Request”); (iii) no Event of Default shall have occurred and
be continuing; and (iv) the Company shall provide to the Agent such
documents, instruments, certificates and other writings as the
Agent shall reasonably require in its sole and absolute discretion.
The advancement of all or any portion of the Subsequent Tranche A
Funding is in the sole and absolute discretion of the Agent and the
Investors and no Investor is obligated to fund all or any part of
the Subsequent Tranche A Funding. Each Subsequent Tranche A Funding
shall be in a minimum amount of $500,000 and multiples of $100,000
in excess thereof. The aggregate amount of Subsequent Tranche A
Fundings that may be made by the Investors under the Amended NPA
shall not exceed $18,577,876 and any Subsequent Tranche A Funding
repaid may not be re-borrowed.
In
addition, subject to the terms and conditions of the Amended NPA,
RJC agreed to loan $240,000 to the Company, within 30 days of the
Closing Date and within 30 days of each of July 1, 2016, October 1,
2016 and January 1, 2017 (collectively, the “RJC
Fundings” and collectively with the Investor Tranche A
Fundings, the “Fundings”), provided that no Event of
Default or Default shall exist. The aggregate amount of the RJC
Fundings made by RJC under the Amended NPA shall not exceed
$960,000 and any Funding repaid may not be re-borrowed. As of
September 30, 2017, the Company has received no loan proceeds under
this agreement, and RJC is in default of its funding obligations
thereunder.
To
guarantee RJC’s obligation in connection with the RJC
Fundings as required under the Amended NPA, GGE entered into a
Share Pledge Agreement with the Company, dated May 12, 2016 (the
“GGE Pledge Agreement”), pursuant to which GGE agreed
to pledge an aggregate of 10,000 shares of the Company’s
Series A Convertible Preferred Stock held by GGE (convertible into
1,000,000 shares of Company common stock), which pledged shares are
subject to automatic cancellation and forfeiture based on a
schedule set forth in the GGE Share Pledge Agreement, in the event
RJC fails to meet each of its RJC Funding obligations pursuant to
the Amended NPA. To date, RJC has not met its RJC Funding
obligations under the Amended NPA and the Company is entitled to
cancel and forfeit the entire 10,000 pledged shares of the
Company’s Series A Convertible Preferred Stock held by GGE
pursuant to the terms of the GGE Pledge Agreement, which
determination to cancel shares has not been made, and which shares
have not been cancelled, as of the date of this
filing.
As
additional consideration for the entry into the Amended NPA, the
Company granted to BHLN and BBLN, warrants exercisable for an
aggregate of 596,280 shares of common stock of the Company (the
“Investor Warrants”). The warrants have a 3-year term,
are transferrable, and are exercisable on a cashless basis at any
time at $2.50 per share (as amended). The Investor Warrants include
a beneficial ownership limitation that prohibits the exercise of
the Investor Warrants to the extent such exercise would result in
the holder, together with its affiliates, holding more than 9.99%
of the Company’s outstanding voting stock (the “Blocker
Provision”). The estimated fair value of the Investor
Warrants issued is approximately $707,000 based on the
Black-Scholes option pricing model. The relative fair value
allocated to the Tranche A Notes and recorded as debt discount was
$636,000.
Other
than the Investor Warrants, no additional warrants exercisable for
common stock of the Company are due, owing, or shall be granted to
the Lenders pursuant to the Senior Notes, as amended. In addition,
warrants exercisable for an aggregate of 34,912 shares of the
Company’s common stock at an exercise price of $15.00 per
share and warrants exercisable for an aggregate of 120,101 shares
of the Company’s common stock at an exercise price of $7.50
per share previously granted by the Company to certain of the
Lenders on September 10, 2015 in connection with prior interest
payment deferrals have been amended and restated to provide that
all such warrants are exercisable on a cashless basis and to
include a Blocker Provision (the “Amended and Restated
Warrants”).
Additionally,
the Company also agreed to (a) provide to the Agent and the
Investors a monthly projected general and administrative expense
report (the “Projected G&A”) and a monthly
comparison report of the Projected G&A provided for the
preceding month, with an explanation of any variances, provided
that in no event shall such variances exceed $150,000, and (b) pay
to the Agent within 2 business days following the end of each
calendar month all of the Company’s oil and gas revenue
received by the Company during such month (the “Net Revenue
Sweep”), less (i) lease operating expenses, (ii) interest
payments due to Investors under the New Senior Notes, (iii) general
and administrative expenses not to exceed $150,000 per month unless
preapproved by the Agent (the “G&A Cap”), and (iv)
preapproved extraordinary expenses (together the “Monthly Net
Revenues”). Amounts paid to the Agent through the Net Revenue
Sweep are applied first to the repayment of principal and interest
due under the Tranche A Notes until such notes are paid in full and
then to the repayment of principal and interest amounts due under
the Tranche B Notes. As of September 30, 2017, the Company has paid
$682,000 of principal under the Net Revenue Sweep, of which $30,000
was paid during the current nine-month period. The amount of
interest deferred under the Tranche A and Tranche B Notes as of
September 30, 2017 and December 31, 2016, equaled $2,709,000 and
$1,266,000, respectively, and was accounted for on the balance
sheet under long-term accrued expenses and accrued expenses -
related party.
The
amounts outstanding under the New Senior Notes are secured by a
first priority security interest in all of the Company’s and
its subsidiaries’ assets, property, real property,
intellectual property, securities and proceeds therefrom, granted
in favor of the Agent for the benefit of the Lenders, pursuant to a
Security Agreement and a Patent Security Agreement, each entered
into as of March 7, 2014, as amended on May 12, 2016 (the
“Amended Security Agreement” and “Amended Patent
Agreement,” respectively). Additionally, the Agent, for the
benefit of the Lenders, was granted a mortgage and security
interest in all of the Company’s and its subsidiaries real
property as located in the State of Colorado and the State of Texas
pursuant to (i) a Leasehold Deed of Trust, Fixture Filing,
Assignment of Rents and Leases, and Security Agreements, dated
March 7, 2014, as amended May 12, 2016, filed in Weld County and
Morgan County, Colorado; and (ii) a Mortgage, Deed of Trust,
Security Agreement, Financing Statement and Assignment of
Production filed in Matagorda County, Texas (collectively, the
“Amended Mortgages”).
Other
than as described above, the terms of the Amended NPA (including
the covenants and obligations thereunder) are substantially the
same as the March 2014 Notes Purchase Agreement described above,
and the terms of the Tranche A Notes and Tranche B Notes (including
the events of default, interest rates and conditions associated
therewith) are substantially the same as the Senior
Notes.
All
debt discount amounts are 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,
2017 and December 31, 2016 was $4,553,000 and $6,988,000,
respectively. Amortization of debt discount and total interest
expense for the initial notes (New Senior Notes – Tranche B)
was $2,434,000 and $5,025,000, respectively, for the nine months
ended September 30, 2017 and $4,638,000 and $5,715,000,
respectively, for the nine months ended September 30,
2016.
Amortization
of debt discount and total interest expense for the initial notes
(New Senior Notes – Tranche B) was $791,000 and $1,747,000,
respectively, for the three months ended September 30, 2017 and was
$882,000 and $2,069,000, respectively, for the three months ended
September 30, 2016.
Junior Debt Restructuring
On May
12, 2016, the Company entered into an Amendment No. 2 to Note and
Security Agreement with RJC (the “Second Amendment”).
The Company and RJC agreed to amend the RJC Junior Note to (i)
capitalize all accrued and unpaid interest under the RJC Junior
Note as of May 12, 2016, and add it to the note principal, making
the outstanding principal amount of the RJC Junior Note as of May
12, 2016 equal to $9,379,000, (ii) extend the maturity date
(“Termination Date”) from December 31, 2017 to July 11,
2019, (iii) provide that all future interest accruing under the RJC
Junior Note is deferred until payable on the Termination Date, with
all future interest amounts deferred being added to the principal
on a monthly basis, and (iv) subordinate the RJC Junior Note to the
New Senior Notes.
Bridge Note Financing
As of
September 30, 2017, the Company had Bridge Notes with an aggregate
principal amount of $475,000 remaining outstanding, plus accrued
interest of $216,000 and additional payment-in-kind
(“PIK”) of $48,000. The aggregate principal and accrued
and unpaid interest and PIK amounts are available for
conversion into common stock pursuant to the terms of the Bridge
Notes into common stock of the Company, subject to no more than
19.99% of the Company’s outstanding common stock on the date
the Second Amended Notes were entered into. Upon a conversion, the
applicable holder shall receive that number of shares of common
stock as is determined by dividing the Conversion Amount by a
conversion price as follows:
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(A)
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prior
to June 1, 2014, the conversion price was $21.50 per share;
and
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(B)
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following
June 1, 2014, the denominator used in the calculation described
above is the greater of (i) 80% of the average of the closing price
per share of the Company’s publicly-traded common stock for
the five (5) trading days immediately preceding the date of the
conversion notice provided by the holder; and (ii) $5.00 per
share.
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Additionally,
each Amended Bridge Investor entered into a Subordination and
Intercreditor Agreement in favor of the Agent, subordinating and
deferring the repayment of the Bridge Notes until full repayment of
certain senior notes. The Subordination and Intercreditor
Agreements also prohibit the Company from repaying the Bridge Notes
until certain senior notes have been paid in full. The interest
expense related to these notes for the three and nine months ended
September 30, 2017 and 2016 was $15,000 compared to $15,000 and
$43,000 compared to $43,000, respectively.
The
unamortized debt premium on the Convertible Bridge Notes as of
September 30, 2017 and December 31, 2016, was
$113,000.
MIE Jurassic Energy Corporation
On
February 14, 2013, PEDCO entered into a Secured Subordinated
Promissory Note with MIE Jurassic Energy Corp.
(“MIEJ”), which was amended on March 25, 2013 and
July 9, 2013 (the “MIEJ Note”, as amended through
December 31, 2014) with MIEJ.
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 September 30, 2017, the amount outstanding under the New MIEJ
Note was $4,925,000.
The New
MIEJ Note has an interest rate of 10.0%, with no interest due until
maturity, is secured by all of the Company’s assets, and is
subordinated to the Senior Notes. MIEJ also agreed to subordinate
its note up to an additional $60 million of new senior lending,
with any portion of new senior lending in excess of this amount
required to be paid first to MIEJ until the New MIEJ Note is paid
in full. Further, for every $20 million in new senior lending the
Company raises, MIEJ is required to be paid all interest and fees
accrued on the New MIEJ Note through such date. The New MIEJ Note
was due and payable on March 8, 2017, subject to automatic
extensions upon the occurrence of a Long Term Financing (defined
below), which as described below has occurred to date.
On a
one-time basis, the Secured Promissory Notes may be refinanced by a
new loan (“Long-Term Financing”) by one or more third
party replacement lenders (“Replacement Lenders”), and
in such event the Company shall undertake commercially reasonable
best efforts to cause the Replacement Lenders to simultaneously
refinance both the Senior Notes and the New MIEJ Note as part of
such Long-Term Financing. If the Replacement Lenders are unable or
unwilling to include the New MIEJ Note in such financing, then the
Long-Term Financing may proceed without including the New MIEJ
Note, and the New MIEJ Note shall remain in place and shall be
automatically subordinated, without further consent of MIEJ, to
such Long-Term Financing. Furthermore, upon the occurrence of a
Long-Term Financing, the maturity of the New MIEJ Note is
automatically extended to the same maturity date of the Long-Term
Financing, but to no later than March 8, 2020. Additionally, in
connection with a contemplated Long-Term Financing:
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The
Long-Term Financing must not exceed $95 million;
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The
Company must make commercially reasonable best efforts to include
adequate reserves or other payment provisions whereby MIEJ is paid
all interest and fees accrued on the New MIEJ Note commencing as of
March 8, 2017 and annually thereafter, and to allow for
quarterly interest payments starting March 31, 2017 of not less
than 5% per annum on the outstanding balance of the New MIEJ Note,
plus a one-time payment of accrued interest (not to exceed
$500,000) as of March 31, 2017; and
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Commencing
on March 8, 2017, MIEJ shall have the right to convert the balance
of the New MIEJ Note into the Company’s common stock at a
price equal to 80% of the average closing price per share of our
stock over the then previous 60 days, subject to a minimum
conversion price of $3.00 per share. MIEJ shall not be permitted to
convert if the conversion would result in MIEJ holding more than
19.9% of the Company’s outstanding common stock without
approval from the Company’s shareholders, which approval the
Company obtained at its 2016 annual shareholder meeting held on
December 28, 2016.
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In the
event the Senior Notes are not refinanced, restructured or extended
by the Lenders, the maturity of both the New MIEJ Note and the
Senior Notes may be extended to no later than March 8, 2019,
without requiring the consent of MIEJ. However, (i) any such
maturity extension of the New MIEJ Note will give MIEJ the right to
convert the note into our common stock as described above,
commencing on March 8, 2017, and (ii) such extension agreement must
provide that MIEJ is paid all interest and fees accrued on the New
MIEJ Note as of March 8, 2018. The New MIEJ Note may be prepaid any
time without penalty.
As a
result of the Company’s May 2016 senior debt restructuring
pursuant to the Amended NPA (as described above under “Note
Purchase Agreement and Sale of Secured Promissory Notes”
– “2016 Senior Note Restructuring”), the maturity
date of the New MIEJ Note has automatically been extended to March
8, 2019, and as a result of the Company’s shareholders
approving the conversion terms of the MIEJ Note at the
Company’s annual shareholder meeting held on December 28,
2016, MIEJ has had the Right of Conversion (described above) since
March 8, 2017.
The
interest expense related to this note for the three and nine months
ended September 30, 2017 and 2016 was $123,000 compared to $123,000
and $369,000 compared to $371,000, respectively, with the total
cumulative interest equal to $1,354,000 through September 30,
2017.
For
financial reporting purposes, MIEJ was considered a related party
for all periods presented prior to the MIEJ Settlement Agreement
signed in February 2015. After that date, MIEJ is no longer
considered a related party.
Related Party Financings
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 Junior Note”). The amount
outstanding on the RJC Junior Note as of September 30, 2017 and
December 31, 2016 was $11,138,000 and $10,173,000, respectively.
The lender under the RJC Junior Note is RJC, which is one of the
lenders under the Senior Notes and is an affiliate of GGE. The note
was originally due and payable on December 31, 2017, but has been
extended to July 11, 2019 in connection with the May 2016
restructuring as described above. The assumed note payable is
subordinate to the Senior Notes, as well as any future secured
indebtedness from a lender with an aggregate principal amount of at
least $20,000,000. Should the Company repay the Senior Notes or
replace them with secured indebtedness from a lender with an
aggregate principal amount of at least $20,000,000, RJC agreed to
further amend the subordinated note payable to adjust the frequency
of interest payments or to eliminate the payments and replace them
with a single payment of the accrued interest to be paid at
maturity.
The
interest expense related to this note for the three and nine months
ended September 30, 2017 and 2016 was $334,000 compared to $297,000
and $964,000 compared to $858,000, respectively.
2016 RJC Subordinated Note Deferrals
On
January 29, 2016 and March 7, 2016, the Company entered into
agreements with RJC to defer until maturity the payment of interest
and principal due under the RJC Junior Note through March 31, 2016,
and reduce the interest rate to 12% per annum effective January 31,
2016.
The
deferral period was further extended on May 12, 2016, on which date
the Company entered into an Amendment No. 2 to Note and Security
Agreement with RJC (the “Second Amendment”). The
Company and RJC agreed to amend the RJC Junior Note to (i)
capitalize all accrued and unpaid interest under the RJC Junior
Note as of May 12, 2016, and add it to the note principal, making
the outstanding principal amount of the RJC Junior Note as of
June 12, 2016 equal to $9,379,432, (ii) extend the maturity
date from December 31, 2017 to July 11, 2019, (iii) provide that
all future interest accruing under the RJC Junior Note is deferred
until payable on the maturity date, with all future interest
amounts deferred being added to the principal on a monthly basis,
and (iv) subordinate the RJC Junior Note to the New Senior Notes.
The warrants previously granted to RJC on September 10, 2015 were
also amended to provide that such warrants are exercisable on a
cashless basis and to include a Blocker Provision (as defined
above).
As of
September 30, 2017 and December 31, 2016, interest deferred and
capitalized since May 12, 2016 under Amendment No. 2 to the Note
amounted to $1,758,000 and $794,000, respectively, and amounted to
total deferred interest of $964,000 since January 1, 2017. The
outstanding principal amount of the RJC Junior Note as of September
30, 2017 and December 31, 2016 was equal to $11,138,000 and
$10,173,000, respectively.
NOTE 9 – COMMITMENTS AND CONTINGENCIES
Office Lease
In June
2017, the Company entered into a second lease addendum to the
original lease agreement signed in July 2012 and the first lease
addendum signed in May 2016, as amended, which extends the term of
the lease by an additional one year, now ending in July 2018, for
its corporate office space located in Danville, California. The
obligation under this one-year lease extension for the remainder of
the lease through July 2018 is $43,000.
In
September 2014, the Company entered into a lease agreement for
office space located in Houston, Texas, with a term of five years
ending on March 1, 2020, which location served as the
Company’s operations office. Effective April 1, 2016, the
Company terminated this lease agreement and issued the landlord
70,000 shares of restricted common stock valued at $161,000, with
no further obligations due thereunder.
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, 6 net acres are due to
expire during the three months remaining in 2017 (571 net acres did
expire during the nine months ended September 30, 2017), 398 net
acres expire in 2018, 129 net acres expire in 2019, 1,288 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, 2017, the Company had fully impaired its unproved
leasehold costs based on management’s revised re-leasing
program.
Other Commitments
On
December 18, 2015, a complaint was filed against Red Hawk, our
wholly-owned subsidiary, in the District Court, County of Weld,
State of Colorado (Case Number: 2015CV31079) (the
“Court”), pursuant to which Liberty Oilfield Services,
LLC (“Liberty”) made various claims against Red Hawk in
connection with certain completion services provided by Liberty to
Red Hawk in November and December 2014, and accrued in accounts
payable as of December 31, 2014. The complaint alleges causes of
action for foreclosure of lien, breach of contract, quantum meruit
and account stated, and seeks payment of amounts allegedly owed,
pre- and post-judgment interest, attorneys’ fees and court
costs in connection with Red Hawk’s alleged failure to pay
Liberty approximately $2.9 million in fees due for completion
services provided by Liberty. On May 12, 2016, the Company and
Liberty entered into a settlement agreement, pursuant to which the
Company paid to Liberty $750,000 and issued 245,000 fully-vested
shares of the Company’s restricted common stock, valued at
$588,000, based on the market price on the grant date, as full
settlement of all amounts due for the services previously rendered,
for which the Company owed approximately $2.6 million. As a result
of the settlement, the Company recognized a gain on settlement of
payables of $1,282,000 during the year ended December 31,
2016.
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.
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’ DEFICIT
PREFERRED STOCK
At
September 30, 2017, 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 Preferred
shares to GGE as part of the consideration paid for the GGE
Acquired Assets. The grant date fair value of the Series A
Preferred stock was $28,402,000, based on a calculation using a
binomial lattice option pricing model. See Note 13
below.
The
66,625 shares of Series A Preferred stock issued to GGE were
originally contingently redeemable in 4 tranches as follows: (i)
15,000 shares in Tranche One; (ii) 15,000 shares in Tranche Two;
(iii) 11,625 shares in Tranche Three; and (iv) 25,000 shares in
Tranche Four.
In
addition, upon the original issuance of the 66,625 shares of Series
A Preferred stock issued to GGE, the Series A preferred stock had
the following features:
●
a
liquidation preference senior to all of the Company’s common
stock equal to $400 per share;
●
a
dividend, payable annually, of 10% of the liquidation
preference;
●
voting
rights on all matters, with each share having 1 vote;
and
●
a
conversion feature at GGE’s option which would allow the
Series A Preferred stock to be converted into shares of the
Company’s common stock on a 100:1 basis.
However,
following the October 7, 2015 approval of the Company shareholders
of the issuance of shares of common stock upon the conversion of
the Series A Preferred stock, the Series A Preferred features have
been modified as follows:
●
the
Series A Preferred stock ceased accruing dividends and all accrued
and unpaid dividends have been automatically forfeited and
forgiven; and
●
the
liquidation preference of the Series A Preferred stock has been
reduced to $0.001 per share from $400 per share.
GGE was
also subject to a lock-up provision that prohibited it from selling
the shares of common stock through the public markets for less than
$10 per share (on an as-converted to common stock basis) until
February 23, 2016, and subject to a provision which prohibits GGE
from converting shares of Series A Preferred stock if upon such
conversion it would beneficially own more than 9.99% of our
outstanding common stock or voting stock, subject to waiver by the
Company.
On
November 23, 2015, the Company lost the right to redeem any of the
Series A Preferred and the holder also lost the right to force any
redemption because, pursuant to the Series A Certificate of
Designations, the Company did not repurchase any shares within nine
months of the initial Series A issuance. Accordingly, the Series A
Preferred is no longer redeemable.
As of
September 30, 2017 and December 31, 2016, there were 66,625 shares
of the Company’s Series A Preferred outstanding, 10,000
shares of which are now subject to cancellation and forfeiture as
described further in the Notes above due to RJC’s failure to
meet its RJC Funding obligations under the Amended
NPA.
COMMON STOCK
At
September 30, 2017, the Company was authorized to issue 200,000,000
shares of its common stock with a par value of $0.001 per
share.
The
Company completed a 1-for-10 reverse split of its outstanding
common stock, which took effect as of market close on April 7,
2017. Before the split, the Company had approximately 54.9 million
shares of common stock issued and outstanding, and following the
reverse split, the Company had approximately 5.49 million shares of
common stock issued and outstanding (subject to adjustment for
settlement of fractional shares which were rounded up to the
nearest whole share). All outstanding options, warrants, preferred
stock and other securities convertible into the Company's common
stock have been adjusted as a result of the reverse stock split as
required by the terms of such securities with a proportional
increase in the exercise price.
During
the nine months ended September 30, 2017, the Company issued a
total of 590,335 shares of common stock under the At Market
Issuance Sales Agreement with National Securities Corporation
effective September 29, 2016 for gross proceeds of $641,000 and
proceeds net of all issuance costs equal to $622,000.
As of
September 30, 2017, there were 6,084,729 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, 2017 and
2016 was $73,000 compared to $95,000 and $535,000 compared to
$904,000, respectively. The remaining unamortized stock-based
compensation expense at September 30, 2017 related to restricted
stock was $66,000.
NOTE 11 – STOCK OPTIONS AND WARRANTS
Blast 2003 Stock Option Plan and 2009 Stock Incentive
Plan
Prior
to June 2005, we were known as Blast Energy Services, Inc.
(“Blast”). Under Blast’s 2003 Stock Option Plan
and 2009 Stock Incentive Plan, options to acquire 343 shares of
common stock were granted and remained outstanding and exercisable
as of September 30, 2017 and December 31, 2016. No new options were
issued under these plans in 2017 or 2016.
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 to increase by 500,000, 300,000 and 500,000, respectively, the
number of shares of common stock reserved for issuance under the
Plan. A total of 1,500,000 shares of common stock are eligible to
be issued under the 2012 Incentive Plan as of September 30, 2017
and December 31, 2016, of which 1,102,099 shares have been
issued as restricted stock, 396,700 shares are subject to
issuance upon exercise of issued and outstanding options,
and 1,201 remain available for future issuance as of
September 30, 2017 and December 31, 2016.
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 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, 2017 and
December 31, 2016, options to purchase an aggregate of 31,014
shares of the Company’s common stock and 66,583 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 did not grant any options during the nine-month period
ending September 30, 2017.
During
the three and nine months ended September 30, 2017 and 2016, the
Company recognized stock option expense of $7,000 compared to
$22,000 and $62,000 compared to $278,000, respectively. The
remaining amount of unamortized stock options expense at September
30, 2017, was $10,000.
The
intrinsic value of outstanding and exercisable options at September
30, 2017 was $-0-.
The
intrinsic value of outstanding and exercisable options at December
31, 2016 was $-0-.
Option
activity during the nine months ended September 30, 2017
was:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at
January 1, 2017
|
518,727
|
$
5.00
|
4.3
|
|
Granted
|
-
|
-
|
-
|
|
Exercised
|
-
|
-
|
-
|
|
Forfeited and
cancelled
|
-
|
-
|
-
|
|
|
|
|
|
|
Outstanding at
September 30, 2017
|
518,727
|
$
5.00
|
3.5
|
|
|
|
|
|
|
Exercisable at
September 30, 2017
|
473,727
|
$
5.32
|
3.4
|
Warrants
During
the three and nine months ended September 30, 2017 and 2016, the
Company recognized warrant expense of $-0-. The remaining amount of
unrecognized warrant expense at September 30, 2017 was
$-0-.
The
intrinsic value of outstanding as well as exercisable warrants at
September 30, 2017 and December 31, 2016 was $-0- and $-0-,
respectively.
Warrant
activity during the nine months ended September 30, 2017
was:
|
|
|
Weighted
Average
Exercise
Price
|
Weighted
Average
Remaining
Contract
Term
(#
years)
|
|
Outstanding at
January 1, 2017
|
1,256,618
|
$
8.00
|
2.4
|
|
Granted
|
-
|
-
|
-
|
|
Exercised
|
-
|
-
|
-
|
|
Forfeited and
cancelled
|
(8,573
)
|
52.50
|
-
|
|
|
|
|
|
|
Outstanding at
September 30, 2017
|
1,248,045
|
$
7.65
|
1.7
|
|
|
|
|
|
|
Exercisable at
September 30, 2017
|
1,248,045
|
$
7.65
|
1.7
|
NOTE 12 – RELATED PARTY TRANSACTIONS
Note Amendments and Warrant Issuances to RJC
See
Note 8 above for a discussion of certain amendments to the Senior
Note and RJC Junior Note held by RJC.
See
Note 8 above for a discussion of certain warrants issued to RJC by
the Company in connection with the amendment of the Senior Note and
RJC Junior Note held by RJC.
GGE Acquisition
As a
result of the 66,625 restricted shares of the Company’s
Series A Convertible Preferred Stock issued to GGE which can be
converted into shares of the Company’s common stock on a
100:1 basis as described below in greater detail, and the
appointment by GGE of a representative to the Company’s Board
of Directors, GGE became a related party to the Company in 2015.
The following table reflects the related party amounts for GGE
included in the September 30, 2017 balance sheet (in
thousands):
|
|
|
|
Accrued
expenses
|
$
1,467
|
|
Long-term notes
payable – Secured Promissory Notes, net of discount of
$1,431,000
|
15,268
|
|
Long notes payable
– Subordinated
|
11,138
|
|
Total
liabilities
|
$
27,873
|
NOTE 13 – FAIR VALUE OF FINANCIAL INSTRUMENTS
As
defined in our accounting policy on the fair value of financial
instruments, financial assets and liabilities are classified based
on the lowest level of input that is significant to the fair value
measurement. The Company’s assessment of the significance of
a particular input to the fair value measurement requires judgment,
and may affect the valuation of the fair value of assets and
liabilities and their placement within the fair value hierarchy
levels.
The
following table sets forth by level within the fair value hierarchy
our financial instruments that were accounted for at fair value as
of September 30, 2017 (in thousands):
|
|
Fair Value
Measurements At September 30, 2017
|
|
|
Quoted Prices in
Active Markets for Identical Assets
|
Significant
Other Observable Inputs
|
Significant
Unobservable Inputs
|
|
|
|
|
|
|
|
|
Series A
Convertible Preferred Stock
|
$
-
|
$
-
|
$
28,402
|
$
28,402
|
The
Company believes there is no active market or significant other
market data for the Series A Preferred as it is held by a limited
number of closely held entities, therefore the Company has
determined it should use Level 3 inputs.
The
Series A Convertible Preferred was valued using the binomial
lattice model of which the significant assumptions were
expected term and expected volatility. The binomial lattice model
used a probablistic approach in which the Company assigned
percentages to each scenario based on the chance of repayment.
The percentages used were as follows: the non-repayment scenario
was assigned a 25% probability and the repayment scenario was
assigned a 75% probability.
NOTE 14 – INCOME TAXES
Due to
the Company’s net losses, there was no provision for income
taxes for the nine months ended September 30, 2017 and
2016.
The
difference between the income tax expense of zero shown in the
statement of operations and pre-tax book net loss times the federal
statutory rate of 34% is principally due to the increase in the
valuation allowance.
Deferred
income tax assets as of September 30, 2017 and December 31,
2016 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
Deferred
Tax Assets (Liabilities)
|
|
|
|
Difference in
depreciation, depletion, and capitalization methods – oil and
natural gas properties
|
$
(463
)
|
$
479
|
|
Net operating
losses
|
4,469
|
5,507
|
|
Impairment –
oil and natural gas properties
|
-
|
-
|
|
Other
|
41
|
438
|
|
Total deferred tax
asset
|
4,047
|
6,424
|
|
|
|
|
|
Less: valuation
allowance
|
(4,047
)
|
(6,424
)
|
|
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,
2017. The net change in the total valuation allowance from December
31, 2016 to September 30, 2017 was a decrease of
$2,377,000.
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, 2017, 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, 2017.
As of
September 30, 2017, the Company had net operating loss
carryforwards (“NOLs”) of approximately $89,687,000 and
$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 2009.