ITEM
2
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MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Forward-Looking
Information
This
Form 10-Q quarterly report of Houston American Energy Corp. (the “Company”) for the six months ended June 30, 2017,
contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, which are intended to be covered by the safe harbors created thereby.
To the extent that there are statements that are not recitations of historical fact, such statements constitute forward-looking
statements that, by definition, involve risks and uncertainties. In any forward-looking statement, where we express an expectation
or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable
basis, but there can be no assurance that the statement of expectation or belief will be achieved or accomplished.
The
actual results or events may differ materially from those anticipated and as reflected in forward-looking statements included
herein. Factors that may cause actual results or events to differ from those anticipated in the forward-looking statements included
herein include the Risk Factors described in Item 1A herein and in our Form 10-K for the year ended December 31, 2016.
Readers
are cautioned not to place undue reliance on the forward-looking statements contained herein, which speak only as of the date
hereof. We believe the information contained in this Form 10-Q to be accurate as of the date hereof. Changes may occur after that
date, and we will not update that information except as required by law in the normal course of our public disclosure practices.
Additionally,
the following discussion regarding our financial condition and results of operations should be read in conjunction with the financial
statements and related notes contained in Item 1 of Part 1 of this Form 10-Q, as well as the Risk Factors in Item 1A and the financial
statements in Item 7 of Part II of our Form 10-K for the fiscal year ended December 31, 2016.
Critical
Accounting Policies
The
discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally accepted in the United States of America. We believe
certain critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial
statements. A description of our critical accounting policies is set forth in our Form 10-K for the year ended December 31, 2016.
As of, and for the six months ended, June 30, 2017, there have been no material changes or updates to our critical accounting
policies.
Unevaluated
Oil and Gas Properties
Unevaluated
oil and gas properties not subject to amortization, include the following at June 30, 2017:
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June
30, 2017
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Acquisition costs
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$
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1,128,256
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Development and
evaluation costs
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3,335,002
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Total
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$
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4,463,258
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Of
the carrying value of unevaluated oil and gas prospects above, $2,300,930 was attributable to properties in the South American
country of Colombia and $2,162,328 was attributable to properties in the United States. We are maintaining our interest in these
properties.
Recent
Developments
Leasing
Activity
During
the six months ended June 30, 2017, we acquired, for $986,000, a 25% working interest (subject to a proportionate 5% back-in after
payout) in two lease blocks (the Johnson tract and the O’Brien tract) covering 717.25 acres in Reeves County, Texas.
In
conjunction with the planned drilling and development of our O’Brien tract, and in order to optimize the length of the planned
horizontal leg and anticipated recoveries, our operator entered into a pooling agreement pursuant to which the owner of an adjoining
acreage block contributed a portion of that acreage to the contract area covering our O’Brien tract. As a result, our effective
acreage under the O’Brien lease is increased and our working interest in wells drilled under the pooling agreement was reduced.
Drilling
Activity
During
the six months ended June 30, 2017, our drilling operations consisted of:
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Johnson
State #1H well, our first well on our Reeves County, Texas acreage was drilled; hydraulic fracturing operations on the well
were ongoing at June 30, 2017; and
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●
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O’Brien
#3H well, our second Reeves County well, commenced drilling operations and drilling was ongoing at June 30, 2017
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During
the six months ended June 30, 2017, our capital investment expenditures for drilling operations totaled $1,166,438.
In
Colombia, our operator is continuing to carry on discussions with federal and local officials in order to overcome opposition
to their efforts to secure necessary permits to commence drilling operations on our Serrania concession. Until a satisfactory
resolution is reached allowing the issuance of necessary permits, substituting equivalent prospects or otherwise compensating
for the value of, and investments in, our Serrania concession, our operator is continuing to defer further efforts to commence
drilling on the Serrania concession.
Our
operator has also deferred commencement of work on the Los Picachos and Macaya concessions until satisfactory resolution of the
permitting issues on the Serrania concession.
In
July 2017, hydraulic fracturing operations were completed on the Johnson State #1H well and drilling operations were completed
on the O’Brien #3H well. Sales from the Johnson State #1H well and hydraulic fracturing operations on the O’Brien
#3H well are expected to commence in August 2017 and sales from the O’Brien #3H well are expected to commence in September
2017.
Financing
Activity
In
January 2017, we issued 1,200 shares of 12% Series A Convertible Preferred Stock (the “Series A Preferred Stock”)
for aggregate gross proceeds of $1.2 million.
The
Series A Preferred Stock (i) accrues a cumulative dividend, commencing July 1, 2017, at 12% payable, if and when declared, quarterly;
(ii) is convertible at the option of the holder into shares of common stock at a conversion price of $0.20 per share, (iii) has
a liquidation preference of $1,000 per share plus accrued and unpaid dividends; and (iv) is redeemable at our option, commencing
on the second anniversary of the issue date, at a premium to issue price, which premium decreases from 12% to 0% following the
fifth anniversary of the issue date, plus accrued and unpaid dividends. Proceeds from the issuance of the Series A Preferred Stock
were used to acquire our interest in oil and gas properties in Reeves County, Texas and the balance, after offering expenses,
was added to working capital.
In
May 2017, we received $909,600 from the sale of 909.6 Units (the “Units”), each Unit consisting of one share of 12.0%
Series B Convertible Preferred Stock (the “Series B Preferred Stock”) and a Warrant (the “Series B Warrant”).
Proceeds from the sale of Units were used to fund our share of drilling costs on a first well on our Reeves County, Texas acreage
with proceeds in excess of such costs, after offering costs, added to working capital.
The
Series B Preferred Stock (i) accrues a cumulative dividend at 12% payable, if and when declared, quarterly; (ii) is convertible
at the option of the holder into shares of common stock at a conversion price of $0.36 per share, (iii) has a liquidation preference
of $1,000 per share plus accrued and unpaid dividends; and (iv) is redeemable at our option, commencing on the second anniversary
of the issue date, at a premium to issue price, which premium decreases from 12% to 0% following the fifth anniversary of the
issue date, plus accrued and unpaid dividends. During the six months ended June 30, 2017, we paid $17,282 of dividends on our
Series B Preferred Stock.
The
Series B Warrants are exercisable, for a period of nine months, to purchase an aggregate of 3,001,680 shares of common stock at
$0.43 per share. The relative fair value of the warrants were valued on the date of grant at $194,934 using the Black-Scholes
option-pricing model with the following parameters: (1) risk-free interest rate of 1.10%; (2) expected life in years of 0.75;
(3) expected stock volatility of 92.36%; and (4) expected dividend yield of 0%.
In
June 2017, we issued promissory notes (the “Bridge Loan Notes”) in the principal amount of $600,000 and warrants (the
“Bridge Loan Warrants”) to purchase common stock. We received aggregate consideration for the Bridge Loan Notes and
Warrants of $570,000. Proceeds from the issuance of the Bridge Loan Notes were used to fund our share of drilling costs on the
O’Brien #3H well and the balance, after offering expenses, was added to working capital.
The
Bridge Loan Notes are unsecured obligations bearing interest at 12.0% per annum and payable interest only on the last day of each
calendar month with any unpaid principal and accrued interest being payable in full in 120 calendar days.
The
Bridge Loan Notes are subject to mandatory prepayment from and to the extent of (i) 100% of net proceeds we receive from any sales,
for cash, of equity or debt securities (other than Bridge Loan Notes), (ii) 100% of net proceeds we receive from the sale of assets
(other than sales in the ordinary course of business); and (iii) 75% of net proceeds we receive from the sale of oil and gas produced
from our Reeves County, Texas properties. Additionally, we have the option to prepay the Bridge Loan Notes, at its sole election,
without penalty.
The
Bridge Loan Warrants are exercisable, for a period of one year, to purchase an aggregate of 600,000 shares of common stock at
$0.50 per share.
In
July 2017, we entered into an At-the-Market Issuance Sales Agreement (the “Sales Agreement”) with WestPark Capital,
Inc. (“WestPark Capital”) pursuant to which we may sell, at our option, up to an aggregate of $5 million in shares
of our common stock through WestPark Capital, as sales agent. Sales of shares under the Sales Agreement (the “ATM Offering”)
will be made, in accordance with one or more placement notices we may deliver to WestPark Capital, which notices shall set parameters
under which shares may be sold. The ATM Offering will be made pursuant to a shelf registration statement by methods deemed to
be “at the market,” as defined in Rule 415 promulgated under the Securities Act of 1933. We will pay WestPark a commission
in cash equal to 3% of the gross proceeds from the sale of shares in the ATM Offering. Additionally, we reimbursed WestPark Capital
for $25,000 of expenses incurred in connection with the ATM Offering. Proceeds from the ATM Offering are expected to be used to
repay the Bridge Loan Notes, to pay drilling and development costs and for working capital.
As
of August 14, 2017, we had sold an aggregate of 2,957,327 shares in the ATM Offering and had received proceeds, net of commissions
and expenses, of $1,708,149, of which $300,000 was used to prepay Bridge Loan Notes.
In
July 2017, holders of Bridge Loan Notes in the face amount totaling $300,000 agreed to waive mandatory prepayment at July 31,
2017 otherwise payable from proceeds of the ATM Offering.
Employment
Arrangements
During
the quarter ended March 31, 2017, our compensation committee approved revised employment terms of John Boylan, our Chairman, CEO
and President, and we hired a Vice President – Business Development to assist in implementation of our growth plan.
The
principal terms of Mr. Boylan’s compensation, as revised during the quarter, include (i) an annual base salary of $250,000,
effective January 1, 2017, with $10,000 per month being payable on a current basis, and full salary and accrued unpaid salary
being payable at such time as the compensation committee determines that the Company has sufficient financial capability to pay
such amounts; (ii) annual bonuses as determined by the compensation committee; (iii) grant, pursuant to our Production Incentive
Compensation Plan, of a 1% interest in our revenues from all wells drilled on our Reeves County, Texas acreage; and (iv) grant
of a stock option to purchase 500,000 shares of common stock.
During
the six months ended June 30, 2017, we terminated our newly hired Vice President – Business Development and options granted
pursuant to the terms of employment expired unvested and unexercised.
Results
of Operations
Oil
and Gas Revenues.
Total oil and gas revenues increased by 37% to $46,275 in the three months ended June 30, 2017 compared
to $33,887 in the three months ended June 30, 2016. Oil and gas revenues increased 26% to $103,908 in the six months ended
June 30, 2017 compared to $82,147 in the six months ended June 30, 2016. The increase in revenue was due to improved commodity
pricing, including 47% and 36% increases, respectively in oil prices realized for the three and six month periods and 45% and
46% increases, respectively, in natural gas prices realized for the three and six month periods, and by 9% and 3% increases, respectively,
in crude oil production for the three- and six-month periods which was partially offset by 36% and 33% declines, respectively,
in natural gas production for the three- and six-month periods.
The
following table sets forth the gross and net producing wells, net oil and gas production volumes and average hydrocarbon sales
prices for the quarter and six months ended June 30, 2017 and 2016:
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Three
Months Ended
June 30,
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Six
Months Ended
June 30,
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2017
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2016
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2017
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2016
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Gross producing wells
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9
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9
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9
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9
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Net producing wells
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0.47
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0.47
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0.47
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0.47
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Net oil production (bbl)
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702
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646
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1,578
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1,528
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Net gas production (mcf)
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3,439
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5,375
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8,029
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11,954
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Average sales price – oil (per barrel)
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$
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50.32
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$
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34.23
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48.99
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$
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35.97
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Average sales price – natural gas (per mcf)
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$
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3.18
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$
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2.19
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3.31
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$
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2.27
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The
decline in gas production reflects natural decline rates with no new production coming on line, partially offset by resumption
of production from a well that had been off line. The change in average sales prices realized reflects a partial recovery in global
commodity prices following a steep drop in prices beginning in late 2014 and continuing to mid-2016.
With
the commencement of drilling operations in Reeves County, we anticipate that production levels and revenues will increase beginning
in the second half of 2017.
Oil
and gas sales revenues by region were as follows:
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Colombia
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U.S.
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Total
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2017 First Six Months
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Oil
sales
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$
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—
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$
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77,307
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$
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77,307
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Gas sales
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—
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26,601
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26,601
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2016 First Six Months
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Oil sales
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$
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—
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$
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54,961
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$
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54,961
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Gas sales
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—
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27,186
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27,186
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Lease
Operating Expenses.
Lease operating expenses decreased by 37% to $16,861 during the three months ended June 30, 2017 from
$26,973 during the three months ended June 30, 2016. During the six months ended June 30, 2017, lease operating expenses increased
by 7% to $40,015 from $37,361 during the six months ended June 30, 2016. The change in total lease operating expenses was attributable
to the resumption of production from a well that had been offline and increased salt water disposal fees.
Following
is a summary comparison of lease operating expenses, by region, for the periods.
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Colombia
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U.S.
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Total
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Quarter ended June 30,
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-2017
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$
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—
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$
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16,861
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$
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16,861
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-2016
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$
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—
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$
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26,973
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$
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26,973
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Six Months ended June 30,
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-2017
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$
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—
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$
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40,015
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$
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40,015
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-2016
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$
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—
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$
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37,361
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$
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37,361
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Consistent
with our business model and operating history, we experience steep declines in lease operating expenses following strategic divestitures
and anticipate lease operating expenses to ramp up to levels consistent with regional costs as new wells are brought on line.
With
the commencement of drilling operations in Reeves County, we anticipate that lease operating expenses will increase beginning
in the second half of 2017.
General
and Administrative Expenses.
General and administrative expense decreased by 2.2% to $485,142 during the three months ended
June 30, 2017 from $474,865 during the three months ended June 30, 2016, and increased 21% to $1,004,439 during the six months
ended June 30, 2017 from $831,135 during the six months ended June 30, 2016. The change in general and administrative expense
was primarily attributable to (i) an increase in the base salary of our principal officer effective January 1, 2017, including
deferred and accrued salary totaling $65,000 which will not be paid until our compensation committee determines that we
have sufficient financial capacity to pay the same, (ii) hiring of a non-executive officer for a two-month period, (iii) increased
legal, professional and other costs associated with our efforts to finalize the acquisition of our Reeves County acreage, increase
investor visibility, maintain our exchange listing and secure funding to satisfy our financial commitments with respect to the
Reeves County acreage, (iv) increased stock compensation expense associated with 2017 option grants, and (v) increased insurance
costs; all partially offset by select salary reductions and timing related decreases in director fees.
Depreciation
and Depletion Expense.
Depreciation and depletion expense was $13,510 and $24,251 for the three months ended June 30, 2017
and 2016, respectively, and $31,206 and $49,264 for the six months ended June 30, 2017 and 2016, respectively. The decrease was
due to a lower depletion base and lower production rates.
With
the commencement of drilling operations in Reeves County, we anticipate that depreciation and depletion expenses will increase
beginning in the second half of 2017.
Other
Income (Expense)
. Other income, net, totaled $2,964 and $1,796 during the three months ended June 30, 2017 and 2016, respectively,
and totaled $3,079 and $5,756 during the six months ended June 30, 2017 and 2016, respectively. Other income, net, consisted of
a one-time lease participation fee of $10,000 received from a third-party and interest income net of interest expense. Interest
expense during the three and six months ended June 30, 2017 consisted of $740 of interest paid on Bridge Loan Notes entered into
in June 2017 plus $6,362 of amortization of debt discount attributable to the $128, 734 value of the Bridge Loan Warrants included
with the Bridge Loan Notes and the $30,000 excess of the face amount of the Bridge Loan Notes over the consideration paid for
the Bridge Loan Notes.
Financial
Condition
Liquidity
and Capital Resources.
At June 30, 2017, we had a cash balance of $229,778 and a working capital deficit of $324,778, compared
to a cash balance of $481,172 and working capital of $423,795 at December 31, 2016. The change in working capital during the period
was primarily attributable to investments in acquiring and commencement of drilling on the Reeves County acreage, borrowing pursuant
to the Bridge Loan Notes and the operating loss for the first six months of 2017, partially offset by equity capital raising efforts.
Operating
activities used cash of $743,594 during the six months ended June 30, 2017 compared to $713,669 used during the six months ended
June 30, 2016. The change in operating cash flow was primarily attributable to an increase in our net loss, reflecting increased
compensation and legal, professional and other costs associated with increased investor visibility activities and regulatory matters,
partially offset by the accrual of deferred salary and additional non-cash charges during 2017.
Investing
activities used cash of $2,170,118 during the six months ended June 30, 2017 compared to $71,010 used during the six months ended
June 30, 2016. The increase in funds used by investing activities during 2017 reflects the acquisition of our Reeves County acreage
($986,000) and investments in drilling operations on the Reeves County acreage ($1,176,328).
Financing
activities provided cash of $2,662,318 during the six months ended June 30, 2017 compared to $90,079 used during the six months
ended June 30, 2016. The change in cash flow from financing activity reflects the receipt of gross funds totaling $2,679,600 from
the sale, during 2017, of Series A Preferred Stock, Series B Preferred and Series B Warrants, and Bridge Loan Notes and Bridge
Loan Warrants, partially offset by the payment of dividends on the Series B Preferred Stock ($17,282), while funds were used during
2016 for the purchase of treasury stock.
Long-Term
Liabilities
. At June 30, 2017, we had long-term liabilities of $35,560 compared to $27,444 at December 31, 2016. Long-term
liabilities at June 30, 2017 and December 31, 2016 consisted of a reserve for plugging costs.
Capital
and Exploration Expenditures and Commitments.
Our principal capital and exploration expenditures relate to ongoing efforts
to acquire, drill and complete prospects, in particular our Reeves County acreage.
During
the six months ended June 30, 2017, we invested $2,170,118 for the acquisition and development of oil and gas properties, consisting
of (1) cost of acquisition of U.S. properties $986,937, principally attributable to acreage acquired in Reeves County, Texas,
(2) cost of drilling our Johnson State #1H well and cost incurred through June 30, 2017 with respect to hydraulic fracturing of
the Johnson State #1H well and with respect to drilling operations on the O’Brien #3H well, totaling in the aggregate $1,166,438,
and (3) preparation and evaluation costs in Colombia of $16,743. Of the amount invested, we capitalized $2,172,077 to oil and
gas properties not subject to amortization and reduced oil and gas properties subject to amortization by $1,959.
Our
estimated capital expenditure budget for the second half of 2017 is approximately $3.7 million and relates to completion of ongoing
hydraulic fracturing operations on the Johnson State #1H well, completion of ongoing drilling operations on the O’Brien
#3H well and hydraulic fracturing of that well and the planned drilling and completion of up to two additional wells on our Reeves
County acreage.
Capital
expenditure plans for 2017 may change depending on (1) our ability to fund our share of drilling and completion costs on wells
on our Reeves County acreage, (2) the results of drillings on our Reeves County acreage, (3) the schedule of future drilling operations
on our Reeves County acreage, (4) the timing and ultimate resolution of permitting issues at Serrania, and (5) field conditions
and other factors beyond our control or the control of the operators of our prospects. Accordingly, there can be no assurance
as to the timing of these operations or the amount actually spent on such operations.
Financing
Requirements
. Our cash holdings, taking into account $1,708,149, net, raised from the ATM Offering subsequent to June
30, 2017, are not adequate to fund our share of planned drilling and completion costs on our Reeves County acreage or support
operations through year-end 2017. While we expect to realize a significant increase in revenues from initial production in Reeves
County commencing during the second-half of 2017, those revenues will not be adequate to fund our drilling budget.
In
order to fully fund our estimated drilling and completion budget and support operations through the end of 2017, we expect that
we will be required to raise additional capital. While we may, among other efforts, pursue additional sales of shares in our ATM
Offering, private sales of equity and debt securities and may realize up to $1.59 million of additional funding from exercise
of outstanding warrants, we presently have no commitments to provide additional funding and there can be no assurance that we
can secure the necessary capital to support such plans and operations on acceptable terms or at all. If, for any reason, we are
unable to fully fund our drilling budget and fail to satisfy commitments reflected therein, we may be subject to penalties or
to the possible loss of some of our rights and interests in prospects with respect to which we fail to satisfy funding commitments
and we may be required to curtail operations and forego opportunities.
Outlook
Continued
low oil and natural gas prices during 2015 and 2016 and recurring delays in drilling of our Serrania prospect in Colombia had
a significant adverse impact on our business. Our financial statements include a “going concern” qualification reflecting
substantial doubt as to our ability to continue as a going concern. We will continue to operate at a loss absent substantial increases
in production, pricing or both. Our present focus in addressing our recurring operating losses is drilling on our Reeves County
acreage. If we are able to fund our share of drilling and completion costs and if those wells experience success and production
rates similar to recent wells in the vicinity, we anticipate that we will be able to achieve profitability and positive cash flows
once production from those wells commence. While we have secured the necessary capital to support drilling operations to date
in Reeves County, we have not yet secured financing to fund our share of estimated costs to support planned operations in Reeves
County through year end 2017. We can provide no assurance as to our ultimate ability to fully fund our share of estimated drilling
and completion costs, as to the ultimate success of those wells or of the ultimate production rates, if any, of those wells. If,
for any reason, we are unable to finance our portion of drilling and completion costs on our planned Reeves County wells, or if
one or more of those wells is not successful or if production rates are less than anticipated, we may continue to operate at a
loss and may lack the financial resources to continue as a going concern and may be required to divest certain assets or pursue
other strategic alternatives to support operations.
Off-Balance
Sheet Arrangements
We
had no off-balance sheet arrangements or guarantees of third party obligations at June 30, 2017.
Inflation
We
believe that inflation has not had a significant impact on operations since inception.