The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.
Please note that 2016 “Loss
per share- basic & diluted” may differ from results reported on the Company’s quarterly report on Form 10-Q for
the period ending March 31, 2016 due to fractional shares associated with the Company’s 6 for 1 stock split in June 2016.
The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements
|
1.
|
ORGANIZATION, OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
|
Organization and Operations
U.S. Energy Corp. (collectively with its subsidiaries
referred to as the “Company” or “U.S. Energy”) was incorporated in the State of Wyoming on January 26,
1966. The Company’s principal business activities are focused in the acquisition, exploration and development of oil and
gas properties in the United States.
Basis of Presentation
The accompanying unaudited condensed consolidated
financial statements are presented in accordance with U.S. generally accepted accounting principles (“GAAP”) and have
been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”)
regarding interim financial reporting. Accordingly, certain information and footnote disclosures required by GAAP for complete
financial statements have been condensed or omitted in accordance with such rules and regulations. In the opinion of management,
all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the consolidated financial
statements have been included.
We have substantial debt obligations and our
ongoing capital and operating expenditures will exceed the revenue we expect to receive from our oil and natural gas operations
in the near future. If we are unable to raise substantial additional funding, refinance existing indebtedness or consummate significant
asset sales on a timely basis and/or on acceptable terms, we may be required to significantly curtail our business and operations.
The consolidated financial statements included in this report on Form 10-Q have been prepared on a going concern basis of accounting,
which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The consolidated
financial statements do not reflect any adjustments that might be necessary should we be unable to continue as a going concern.
Our ability to continue as a going concern is subject to, among other factors, our ability to monetize assets, our ability to obtain
financing or refinance existing indebtedness, our ability to continue our cost cutting efforts, oil and gas commodity prices, our
ability to recognize, acquire and develop strategic interests and prospects, the speed and cost with which we can develop our prospects
and the ability to adapt our business by integrating specific operations associated with operating companies. There can be no assurance
that we will be able to obtain additional funding on a timely basis and on satisfactory terms, or at all. In addition, no assurance
can be given that any such funding, if obtained, will be adequate to meet our capital needs and support our growth. If additional
funding cannot be obtained on a timely basis and on satisfactory terms, then our operations would be materially negatively impacted
and we may be unable to continue as a going concern. If we become unable to continue as a going concern, we may find it necessary
to file a voluntary petition for reorganization under the Bankruptcy Code in order to provide us additional time to identify an
appropriate solution to our financial situation and implement a plan of reorganization aimed at improving our capital structure.
For further information, refer to the consolidated
financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016. Our
financial condition as of March 31, 2017, and operating results for the three months ended March 31, 2017 are not necessarily indicative
of the financial condition and results of operations that may be expected for any future interim period or for the year ending
December 31, 2017.
Use of Estimates
The preparation of financial statements in
conformity with generally accepted accounting principles in the United States (“U.S. GAAP”) requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
Significant estimates include oil and gas reserves that are used in the calculation of depreciation, depletion, amortization and
impairment of the carrying value of evaluated oil and gas properties; production and commodity price estimates used to record accrued
oil and gas sales receivable; valuation of commodity derivative instruments; the impact of commodity prices and other events affecting
impairment of mining properties; and the cost of future asset retirement obligations. The Company evaluates its estimates on an
on-going basis and bases its estimates on historical experience and on various other assumptions the Company believes to be reasonable.
Due to inherent uncertainties, including the future prices of oil and gas, these estimates could change in the near term and such
changes could be material.
Principles of Consolidation
The accompanying financial statements include
the accounts of the Company and its wholly-owned subsidiary Energy One LLC (“Energy One”). All inter-company balances
and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current
period presentation of the accompanying financial statements.
Comprehensive Income (Loss)
Comprehensive income (loss) is used to refer
to net income (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses,
gains, and losses that under GAAP are reported as separate components of shareholders’ equity instead of net income (loss).
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards
Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts
with Customers”. This comprehensive guidance will replace all existing revenue recognition guidance and is effective for
annual reporting periods beginning after December 15, 2017, and interim periods therein. This update is not expected to have a
significant impact on the Company’s financial statements.
In January 2016, the FASB issued ASU 2016-01, Financial
Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This ASU is intended to
improve the recognition and measurement of financial instruments. Among other things, this ASU requires certain equity investments
to be measured at fair value with changes in fair value recognized in net income. This guidance is effective for fiscal years beginning
after December 15, 2017, and interim periods therein. This update is not expected to have a significant impact on the Company’s
financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases,
which will supersede the existing guidance for lease accounting. This ASU will require lessees to recognize leases on their balance
sheets, and leaves lessor accounting largely unchanged. This guidance is effective for fiscal years beginning after December 15,
2018 and interim periods within those fiscal years, and early adoption is permitted. This update is not expected to have a
significant impact on the Company’s financial statements.
2016-05
In March 2016, the FASB issued ASU 2016-06
,
Derivatives and Hedging: Contingent Put and Call Options in Debt Instruments.
The amendments clarify the steps required
to assess whether a call or put option meets the criteria for bifurcation as an embedded derivative. The amendment is effective
for fiscal years and interim periods beginning after December 1, 2016. This amendment did not have a significant impact on the
Company’s financial statements.
2016-11
In May 2016, the FASB issued ASU No. 2016-11,
Revenue
Recognition
(Topic 605) and
Derivatives and Hedging
(Topic 815): Rescission of SEC Guidance Because of
Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting ("ASU 2016-11").
The SEC Staff is rescinding the following SEC Staff Observer comments that are codified in Topic 605, Revenue Recognition, and
Topic 932, Extractive Activities-Oil and Gas, effective upon adoption of Topic 606. Specifically, registrants should not rely on
the following SEC Staff Observer comments upon adoption of Topic 606: a) Revenue and Expense Recognition for Freight Services in
Process which is codified in 605-20-S99-2; b) Accounting for Shipping and Handling Fees and Costs, which is codified in paragraph
605-45-S99-1; c) Accounting for Consideration Given by a Vendor to a Customer, which is codified in paragraph 605-50-S99-1 and
d) Accounting for Gas-Balancing Arrangements (that is, use of the “entitlements method”), which is codified in paragraph
932-10-S99-5. We do not use the entitlements method of accounting and are not impacted by this specific SEC Staff Observer comment;
however, we are assessing the potential impact of other SEC Staff Observer comments included in ASU 2016-11 on our consolidated
financial condition and results of operations.
2016-15
In August 2016, the FASB issued ASU No. 2016-15,
Statement
of Cash Flows
(Topic 230)
:
Classification of Certain
Cash
Receipts and Cash Payments
("ASU
2016-15"). ASU 2016-15 reduces diversity in practice in how certain transactions are classified in the statement of cash flows.
The amendments in ASU 2016-15 provide guidance on specific cash flow issues including debt prepayment or debt extinguishment costs,
settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation
to the effective interest rate of the borrowing, contingent consideration payments made after a business combination, proceeds
from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies and distributions
received from equity method investees. ASU 2016-15 is effective for annual and interim periods beginning after December 15, 2017.
We are currently assessing the potential impact of ASU 2016-15 on our consolidated financial condition and results of operations.
2017-03
In January 2017, the FASB issued ASU No. 2017-03,
Accounting
Changes and Error Corrections
(Topic 250)
and Investments – Equity Method and Joint Ventures
(Topic
323), which stated additional qualitative disclosures should be considered to assess the significance of the impact upon adoption.
This ASU is effective for the annual period beginning after December 15, 2018, and for annual and interim periods thereafter. Early
adoption is permitted. The Company is currently evaluating the new guidance to determine the impact it will have on its consolidated
financial condition and results of operations.
|
2.
|
LIQUIDITY & GOING CONCERN
|
As of March 31, 2017, the Company has a working
capital deficit of $6.8 million and an accumulated deficit of $124.6 million. Additionally, the Company incurred a net loss of
$0.7 million for the three months ended March 31, 2017. As of March 31, 2017, the Company failed to remain in compliance with financial
covenants in its credit agreement. Accordingly, the entire balance of $6.0 million is required to be classified as a current liability.
On May 2, 2017, the credit facility between U.S. Energy Corp.’s wholly-owned subsidiary, Energy One and Wells Fargo was sold,
assigned and transferred to APEG Energy II, L.P. (“APEG”). APEG purchased and assumed all of Wells Fargo’s rights
and obligations as the lender to Energy One under the credit facility. Concurrently, U.S. Energy Corp., Energy One and APEG entered
into a Limited Forbearance Agreement dated May 2, 2017. The Company believes that the Forbearance Agreement will provide the parties
sufficient time to work toward a long-term solution that enables the Company to execute its operational strategy and ensure value
for existing shareholders. Please refer to Note 13 entitled “Subsequent Events” for further information.
As of March 31, 2017, the Company had cash
and equivalents of $2.2 million. Management believes overhead and mining expense reductions have poised the Company to survive
the current low commodity price environment. However, there can be no assurance that the Company will be able to complete future
financings, dispositions or acquisitions on acceptable terms or at all.
The significantly lower oil price environment
that we have experienced since late 2014 has substantially decreased our cash flows from operating activities. Sustained low oil
prices could significantly reduce or eliminate our planned capital expenditures. If production is not replaced through the acquisition
or drilling of new wells our production levels will lower due to the natural decline of production from existing wells.
Our strategy is to continue to (1) maintain
adequate liquidity and selectively participate in new drilling and completion activities, subject to economic and industry conditions,
(2) pursue acquisition and disposition opportunities as available liquidity permits and (3) evaluate various avenues to strengthen
our balance sheet and improve our liquidity position. We expect to fund any near-term capital requirements and working capital
needs from current cash on hand. Our activity could be further curtailed if our cash flows decline from expected levels. Because
production from existing oil and natural gas wells declines over time, further reductions of capital expenditures used to drill
and complete new oil and natural gas wells would likely result in lower levels of oil and natural gas production in the future.
|
3.
|
OIL PRICE RISK DERIVATIVES
|
The Company’s wholly-owned subsidiary
Energy One has historically entered into crude oil derivative contracts (“economic hedges”). The derivative contracts
are priced based on West Texas Intermediate (“WTI”) quoted prices for crude oil. The Company is a guarantor of Energy
One’s obligations under the economic hedges. The objective of utilizing the economic hedges is to reduce the effect of price
changes on a portion of the Company’s future oil production, achieve more predictable cash flows in an environment of volatile
oil and gas prices and to manage the Company’s exposure to commodity price risk. The use of these derivative instruments
limits the downside risk of adverse price movements. However, there is a risk that such use may limit the Company’s ability
to benefit from favorable price movements. Energy One may, from time to time, add incremental derivatives to hedge additional production,
restructure existing derivative contracts or enter into new transactions to modify the terms of current contracts in order to realize
the current value of its existing positions. The Company does not engage in speculative derivative activities or derivative trading
activities, nor does it use derivatives with leveraged features. As of March 31, 2017, the Company did not have any outstanding
crude oil derivative contracts.
Unrealized gains and losses resulting from
derivatives are recorded at fair value in the consolidated balance sheet. Changes in fair value, as well as realized gains (losses)
arising upon derivative contract settlements, are included in the “change in unrealized gain (loss) on oil price risk derivatives”
in the consolidated statements of operations. For the three months ended March 31, 2017 and 2016, the Company’s unrealized
losses from derivatives amounted to $0 and $0.6 million, respectively.
Please refer to Note 13 entitled “Subsequent
Events” for more information.
|
4.
|
CEILING TEST FOR OIL AND GAS PROPERTIES
|
The reserves used in the Company’s full
cost ceiling test incorporate assumptions regarding pricing and discount rates in the determination of present value. In the calculation
of the ceiling test as of March 31, 2017, the Company used a price of $42.09 per barrel for oil and $2.65 per MMbtu for natural
gas (as further adjusted for property specific gravity, quality, local markets and distance from markets) to compute the future
cash flows of the Company’s producing properties. These prices compare to $42.75 per barrel for oil and $2.48 per MMbtu for
natural gas used in the calculation of the Ceiling Test as of December 31, 2016. The discount factor used was 10%.
For the three months ended March 31, 2017 and
2016, ceiling test impairment charges for the Company’s oil and gas properties amounted to $0 and $6,957, respectively.
|
5.
|
DISCONTINUED OPERATIONS AND PREFERRED STOCK ISSUANCE
|
Disposition of Mining Segment
In February 2006, the Company reacquired the
Mt. Emmons molybdenum mining properties (the “Property”). In February 2016, the Company’s Board of Directors
decided to dispose of the Property rather than continuing the Company’s long-term development strategy whereby the Company
entered into the following agreements:
|
A.
|
The Company entered into an Acquisition Agreement (the “Acquisition Agreement”) with
Mt. Emmons Mining Company, a subsidiary of Freeport-McMoRan Inc. (“MEM”), whereby MEM acquired the Property. The Company
did not receive any cash consideration for the disposition; the sole consideration for the transfer was that MEM assumed the Company’s
obligations to operate the WTP and to pay the future mine holding costs for portions of the Property that it desires to retain.
|
Under U.S. GAAP, the disposal of
a segment is reported as discontinued operations in the Company’s financial statements. Presented below are the assets and
liabilities associated with the Company’s mining segment as of March 31, 2017 and December 31, 2016:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Assets retained by the Company:
|
|
|
|
|
|
|
|
|
Performance bonds
|
|
$
|
114
|
|
|
$
|
114
|
|
|
|
|
|
|
|
|
|
|
Total assets of discontinued operations
|
|
$
|
114
|
|
|
$
|
114
|
|
|
B.
|
Concurrent with entry into the
Acquisition Agreement and as additional consideration for MEM to accept transfer of the
Property, the Company entered into a Series A Convertible Preferred Stock Purchase Agreement
(the “Series A Purchase Agreement”) with MEM, whereby the Company issued
50,000 shares of newly designated Series A Convertible Preferred Stock (the “Preferred
Stock”) to MEM in exchange for (i) MEM accepting the transfer of the Property
and replacing the Company as the permittee and operator of the WTP, and (ii) the payment
of approximately $1 to the Company. The Series A Purchase Agreement contains customary
representations and warranties on the part of the Company. As contemplated by the Acquisition
Agreement and the Series A Purchase Agreement and as approved by the Company’s
Board of Directors, the Company filed with the Secretary of State of the State of Wyoming
Articles of Amendment containing a Certificate of Designations with respect to the Preferred
Stock (the “Certificate of Designations”). Pursuant to the Certificate of
Designations, the Company designated 50,000 shares of its authorized preferred stock
as Series A Convertible Preferred Stock. The Preferred Stock accrues dividends at a rate
of 12.25% per annum of the Adjusted Liquidation Preference (as defined); such dividends
are not payable in cash but are accrued and compounded quarterly in arrears on the first
business day of the succeeding calendar quarter. At issuance, the aggregate fair value
of the Preferred Stock was $2,000 based on the initial liquidation preference of $40
per share. The “Adjusted Liquidation Preference” is initially $40 per share
of Preferred Stock, with increases each quarter by the accrued quarterly dividend. The
Preferred Stock is senior to other classes or series of shares of the Company with respect
to dividend rights and rights upon liquidation. No dividend or distribution will be declared
or paid on junior stock, including the Company’s common stock, (1) unless approved
by the holders of Preferred Stock and (2) unless and until a like dividend has been declared
and paid on the Preferred Stock on an as-converted basis.
|
At the option of the holder, each
share of Preferred Stock was initially convertible into approximately 13.33 shares of the Company’s $0.01 par value common
stock (the “Conversion Rate”) for an aggregate of 666,667 shares of common stock. The Conversion Rate is subject to
anti-dilution adjustments for stock splits, stock dividends, certain reorganization events, and to price-based anti-dilution protections
if the Company subsequently issues shares for less than 90% of fair value on the date of issuance. Each share of Preferred Stock
will be convertible into a number of shares of common stock equal to the ratio of the initial conversion value to the conversion
value as adjusted for accumulated dividends multiplied by the Conversion Rate. In no event will the aggregate number of shares
of common stock issued upon conversion be greater than approximately 793,000 shares. The Preferred Stock will generally not vote
with the Company’s common stock on an as-converted basis on matters put before the Company’s shareholders. The holders
of the Preferred Stock have the right to approve specified matters as set forth in the Certificate of Designations and have the
right to require the Company to repurchase the Preferred Stock in connection with a change of control. However, the Company’s
Board of Directors has the ability to prevent any change of control that could trigger a redemption obligation related to the Preferred
Stock.
During the first quarter of 2016,
the Company recorded the fair value of the Preferred Stock based on the initial liquidation preference of $2,000. Since the cash
consideration paid by MEM for the Preferred Stock was a nominal amount, the Company recorded a charge to operations of approximately
$2,000 associated with the issuance.
|
C.
|
Concurrent with entry into the
Acquisition Agreement and the Series A Purchase Agreement, the Company and MEM entered
into an Investor Rights Agreement, which provides MEM rights to certain information and
Board observer rights. MEM has agreed that it, along with its affiliates, will not acquire
more than 16.86% of the Company’s issued and outstanding shares of Common Stock.
In addition, MEM has the right to demand registration of the shares of Common Stock issuable
upon conversion of the Preferred Stock under the Securities Act of 1933, as amended.
|
Combined Results of Operations for Discontinued
Operations
The results of operations of the discontinued
mining operations are presented separately in the accompanying financial statements. Presented below are the components for the
three months ended March 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Issuance of preferred stock to induce disposition
|
|
$
|
-
|
|
|
$
|
(1,999
|
)
|
|
|
|
|
|
|
|
|
|
Operating expenses of mining segment:
|
|
|
|
|
|
|
|
|
Water treatment plant
|
|
|
-
|
|
|
|
(211
|
)
|
Mine property holding costs
|
|
|
-
|
|
|
|
(117
|
)
|
|
|
|
|
|
|
|
|
|
Total results for discontinued operations
|
|
$
|
-
|
|
|
$
|
(2,327
|
)
|
Energy One, a wholly-owned subsidiary the Company,
has a credit facility with Wells Fargo Bank, National Association (“Wells Fargo”). As of March 31, 2017 and 2016, outstanding
borrowings under the credit facility amounted to $6.0 million. As of March 31, 2017 and 2016, the borrowing base was $6.0 million.
Borrowings under the credit facility are collateralized by Energy One’s oil and gas producing properties and substantially
all of the Company’s cash and equivalents. Each borrowing under the agreement has a term of six months, but can be continued
at the Company’s election through July 2017 if the Company remains in compliance with the covenants under the credit facility.
The weighted average interest rate on this debt is 7.39% as of March 31, 2017.
Energy One is required to comply with customary
affirmative covenants and with certain negative covenants. The principal negative financial covenants do not permit (i) the interest
coverage ratio (EBITDAX to interest expense) to be less than 3.0 to 1; (ii) total debt to EBITDAX to be greater than 3.5 to 1;
and (iii) the current ratio to be less than 1.0 to 1.0. EBITDAX is defined in the Credit Agreement as consolidated net income,
plus non-cash charges. Additionally, the Credit Agreement prohibits or limits Energy One’s ability to incur additional debt,
pay cash dividends and other restricted payments, sell assets, enter into transactions with affiliates, and to merge or consolidate
with another company. The Company is a guarantor of Energy One’s obligations under the Credit Agreement.
As of March 31, 2017, Energy One and the Company
were not in compliance with any of the financial covenants.
Because the Company projects that it is unlikely
that Energy One will regain compliance with all of the financial covenants before the July 30, 2017 maturity date, outstanding
borrowings of $6.0 million are presented as a current liability in the accompanying consolidated balance sheet as of March 31,
2017.
On May 2, 2017, the credit facility between
U.S. Energy Corp.’s wholly-owned subsidiary, Energy One and Wells Fargo was sold, assigned and transferred to APEG Energy
II, L.P. (“APEG”). APEG purchased and assumed all of Wells Fargo’s rights and obligations as the lender to Energy
One under the credit facility. Concurrently, U.S. Energy Corp., Energy One and APEG entered into a Limited Forbearance Agreement
dated May 2, 2017. The Company believes that the Forbearance Agreement will provide the parties sufficient time to work toward
a long-term solution that enables the Company to execute its operational strategy and ensure value for existing shareholders.
The credit facility requires the Company’s
compliance with certain restricted financial covenants. The Company previously violated the financial ratio covenants for the fiscal
quarters ended September 30, 2016 and December 31, 2016, which constituted an event of default under the credit agreement, and
the violation of said covenants has continued in 2017. Subject to continued performance and compliance by the Company and Energy
One with the terms and conditions of the Forbearance Agreement and credit facility, APEG has agreed not to exercise its rights
and remedies arising as a result of certain existing and prospective events of default under the credit facility until July 30,
2017. Commencing on May 2, 2017, interest shall accrue on the outstanding principal balance of the loans under the credit facility
at a rate of 8.75% per annum. In the event of default under the Forbearance Agreement, the forbearance period will terminate immediately
and, without further notice or opportunity to cure, APEG will be entitled to exercise all of its rights and remedies under the
credit facility and Forbearance Agreement, including acceleration of the debt and foreclosure. Please refer to Note 13 entitled
“Subsequent Events” for more information.
|
7.
|
COMMITMENTS AND CONTINGENCIES
|
Commitments
Lessee Operating Leases.
In November
2015, the Company took assignment of a lease agreement for office space in Denver, Colorado. The future minimum rental commitment
under this sublease requires payments of $59,000 in 2017, when the sublease expires.
Letter of Credit.
In connection with
the Company’s sublease of office space in Denver, Colorado, a security deposit was provided in the form of an irrevocable
letter of credit for $35,000. The letter of credit expires in September 2017. Collateral for the letter of credit is a certificate
of deposit for $35,000 that is included in other assets in the accompanying balance sheet as of March 31, 2017.
Contingencies
From time to time, the Company is party to
certain legal actions and claims arising in the ordinary course of business. While the outcome of these events cannot be predicted
with certainty, management does not expect these matters to have a materially adverse effect on the Company’s financial position
or results of operations. Following are currently pending legal matters:
North Dakota Properties.
On June 8,
2011, Brigham Oil & Gas, L.P. (“Brigham”), as the operator of the Williston 25-36 #1H Well, filed an action in
the State of North Dakota, County of Williams, in District Court, Northwest Judicial District, Case No. 53-11-CV-00495 to interplead
to the court with respect to the undistributed suspended royalty funds from this well to protect itself from potential litigation.
Brigham became aware of an apparent dispute with respect to ownership of the mineral interest between the ordinary high water mark
and the ordinary low water mark of the Missouri River. Brigham suspended payment of certain royalty proceeds of production related
to the minerals in and under this property pending resolution of the apparent dispute. Brigham was subsequently sold to Statoil
ASA (“Statoil”) who assumed Brigham’s rights and obligations under this case. The Company owns a working interest,
not royalty interest, in this well and no funds have been withheld.
On January 28, 2013, the District Court Northwest
Judicial District issued an Order for Partial Summary Judgment holding that the State of North Dakota as part of its title to the
beds of navigable waterways owns the minerals in the area between the ordinary high and low watermarks on these waterways, and
that this public title excludes ownership and any proprietary interest by riparian landowners. This issue has been appealed to
the North Dakota Supreme Court. The Company’s legal position is aligned with Brigham, who will continue to provide legal
counsel in this case for the benefit of all working interest owners.
The Company is also a party to litigation that
seeks to reform certain assignments of mineral interests it acquired from Brigham. This matter involves the depth below the surface
to which the assignments were effective. The plaintiff is seeking to reform the agreement such that the Company’s assignment
would be revised to be 12 feet closer to the surface. This dispute affects one of the Company’s producing wells.
The ultimate outcome of these matters is ongoing
and cannot presently be determined. However, in management’s opinion the likelihood of a material adverse outcome is remote.
Accordingly, adjustments, if any, that might result from the resolution of this matter have not been reflected in the accompanying
consolidated financial statements.
Quiet Title Action – Willerson Lease.
In September 2013, the Company acquired from Chesapeake a 15% working interest in approximately 4,244 gross mineral acres referred
to as the Willerson lease. In January 2014, Willerson inquired if their lease had terminated due to the failure to achieve production
in paying quantities pursuant to the terms of the lease. The Company along with Crimson and Liberty filed a declaratory judgment
action in the District Court of Dimmit County in May 2014 seeking a determination from the court that the lease remains valid and
in effect. The lessors counterclaimed for breach of contract, trespass, and related causes of action. In January 2016, the lessors
filed a third-party petition alleging breach of contract, trespass, and related causes of action against Chesapeake and EXCO Operating
Company, LP. As of March 31, 2017 unevaluated oil and gas properties include $1,171,000 related to the leasehold costs that are
subject to this matter. The matter has settled in 2017 with the Company’s portion being $75,000 plus the related legal fees
of $165,000 as reflected in the Company’s financial statements under “Professional fees, insurance and other”
as of March 31, 2017.
Arbitration of Employment Claim.
A former
employee has claimed that the Company owes up to $1.8 million under an Executive Severance and Non-Compete agreement (the “Agreement”)
due to a change of control and termination of employment without cause. The Agreement requires that any disputes be submitted to
binding arbitration and a request for arbitration was submitted by the parties in March 2016. This matter was settled in May 2017
for $175,000 plus non-essential equipment of $13,000 as reflected in the Company’s financial statements under “Rental
and other income/(loss)” as of March 31, 2017.
Contingent Ownership Interests.
As of
March 31, 2017, the Company had recognized a contingent liability associated with uncertain ownership interests of $1,383. This
liability arises when the calculations of respective joint ownership interests by operators differs from the Company’s calculations.
These differences relate to a variety of matters, including allocation of non-consent interests, complex payout calculations for
individual wells and groups of wells, along with the timing of reversionary interests. Accordingly, these matters are subject to
legal interpretation and the related obligations are presented as a contingent liability in the accompanying condensed consolidated
balance sheet as of March 31, 2017. While the Company has classified this entire amount as a current liability, most of these issues
are expected to be resolved through arbitration, mediation or litigation; due to the complexity of the issues involved, there can
be no assurance that the outcome of these contingencies will be resolved during 2017.
Anfield Gain Contingency.
In 2007, the
Company sold all of our uranium assets for cash and stock of the purchaser, Uranium One Inc. (“Uranium One”). The assets
sold included a uranium mill in Utah and unpatented uranium claims in Wyoming, Colorado, Arizona and Utah. Pursuant to the asset
purchase agreement, the Company was entitled to additional consideration from Uranium One up to $40,000 based on the performance
of the mill, achievement of commercial production and royalties, but no additional consideration was ever received from Uranium
One. In August 2014, the Company entered into an agreement with Anfield Resources Inc. (“Anfield”) whereby if Anfield
was successful in acquiring the property from Uranium One, Anfield would be released from the future payment obligations stemming
from the 2007 sale to Uranium One. On September 1, 2015, Anfield acquired the property from Uranium One and is now obligated to
provide the following consideration to the Company:
|
·
|
Issuance of $2,500 in Anfield common shares to the Company. The Anfield shares are to be held in
escrow and released in tranches over a 36-month period. Pursuant to the agreement, if any of the share issuances result in the
Company holding in excess of 20% of the then issued and outstanding shares of Anfield (the “Threshold”), such shares
in excess of the Threshold would not be issued at that time, but deferred to the next scheduled share issuance. If, upon the final
scheduled share issuance the number of shares to be issued exceeds the Threshold, the value in excess of the Threshold is payable
to the Company in cash,
|
|
·
|
$2,500 payable in cash upon 18 months of continuous commercial production, and
|
|
·
|
$2,500 payable in cash upon 36 months of continuous commercial production.
|
The first tranche of common shares resulted
in the issuance of 7,436,505 shares of Anfield with a market value of $750,000 and such shares were delivered to us in September
2015. The second tranche of shares resulted in the issuance of 3,937,652 additional shares of Anfield with a market value of $750,000,
and such shares were delivered to us in September 2016. Since the trading volume in Anfield shares has increased beginning primarily
in the quarterly period ending June 30, 2016, we determined a mark-to-market technique would be the most appropriate method to
determine the fair value for Anfield shares. The primary factor in using a mark-to-market valuation in determining the fair value
of Anfield shares is justified because of our belief that due to the increased liquidity in the stock, using current market prices
for Anfield shares reflects the most accurate fair value calculation. At March 31, 2017, we determined the fair value of the Anfield
shares to be approximately $0.9 million. The timing of any future receipt of cash from Anfield is not determinable and there can
be no assurance that any cash will ever be received from Anfield or that the shares received from Anfield will ever be liquidated
for cash.
Preferred Stock
The Company’s articles of incorporation
authorize the issuance of up to 100,000 shares of preferred stock, $0.01 par value. Shares of preferred stock may be issued with
such dividend, liquidation, voting and conversion features as may be determined by the Board of Directors without shareholder approval. As
discussed in Note 5, in February 2016 the Board of Directors approved the designation of 50,000 shares of Series A Convertible
Preferred Stock in connection with the disposition of the Company’s mining segment.
Warrants
On December 21, 2016, the Company completed
a registered direct offering of 1.0 million shares of common stock at a net price of $1.50 per share. Concurrently, the investors
received warrants to purchase 1.0 million shares of Common Stock of the Company at an exercise price of $2.05 per share, subject
to adjustment, for a period of five years from closing. The total net proceeds received by the Company was approximately $1.32
million. The fair value of the warrants upon issuance was $1.24 million, with the remaining $0.08 million being attributed to common
stock. The warrants contain a dilutive issuance and other liability provisions which cause the warrants to be accounted for as
a liability. Such warrant instruments are initially recorded as a liability and are accounted for at fair value with changes in
fair value reported in earnings.
Stock Options
For the three months ended March 31, 2017 and
2016, total stock-based compensation expense related to stock options was $18,000 and $21,000 respectively. As of March 31, 2017, there
was $62,000 of unrecognized expense related to unvested stock options, which will be recognized as stock-based compensation expense
through January 2018. For the three months ended March 31, 2017, no stock options were granted, exercised, forfeited or expired.
Presented below is information about stock options outstanding and exercisable as of March 31, 2017 and December 31, 2016:
|
|
March 31, 2017
|
|
|
December 31, 2016
|
|
|
|
Shares
|
|
|
Price
(1)
|
|
|
Shares
|
|
|
Price
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options outstanding
|
|
|
390,525
|
|
|
$
|
20.64
|
|
|
|
390,525
|
|
|
$
|
20.64
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options exercisable
|
|
|
381,640
|
|
|
$
|
20.79
|
|
|
|
376,084
|
|
|
$
|
20.97
|
|
|
(1)
|
Represents the weighted average price.
|
The following table summarizes information
for stock options outstanding and exercisable at March 31, 2017:
Options Outstanding
|
|
|
Options Exercisable
|
|
Number
|
|
|
Exercise Price
|
|
|
Remaining
|
|
|
Number
|
|
|
Weighted
|
|
of
|
|
|
Range
|
|
|
Weighted
|
|
|
Contractual
|
|
|
of
|
|
|
Average
|
|
Shares
|
|
|
Low
|
|
|
High
|
|
|
Average
|
|
|
Term (years)
|
|
|
Shares
|
|
|
Exercise Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
56,786
|
|
|
$
|
9.00
|
|
|
$
|
9.00
|
|
|
$
|
9.00
|
|
|
|
7.8
|
|
|
|
51,231
|
|
|
$
|
9.00
|
|
|
49,504
|
|
|
|
12.48
|
|
|
|
12.48
|
|
|
|
12.48
|
|
|
|
6.3
|
|
|
|
49,504
|
|
|
|
12.48
|
|
|
98,396
|
|
|
|
13.92
|
|
|
|
17.10
|
|
|
|
15.01
|
|
|
|
2.5
|
|
|
|
98,396
|
|
|
|
15.01
|
|
|
185,839
|
|
|
|
22.62
|
|
|
|
30.24
|
|
|
|
29.35
|
|
|
|
1.0
|
|
|
|
182,509
|
|
|
|
29.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
390,525
|
|
|
$
|
9.00
|
|
|
$
|
30.24
|
|
|
$
|
20.64
|
|
|
|
3.2
|
|
|
|
381,640
|
|
|
$
|
20.97
|
|
As of March 31, 2017, no shares are available
for future grants under the Company’s stock option plans. Based upon the closing price for the Company’s common stock
of $0.89 per share on March 31, 2017, there was no intrinsic value related to stock options outstanding as of March 31, 2017.
Restricted Stock Grants
In January 2015, the Board of Directors granted
340,711 shares of restricted stock under the 2012 Equity Plan to four officers of the Company. These shares originally vested annually
over a period of three years. However, during 2015 vesting was accelerated for three of the four officers in connection with severance
agreements for an aggregate of 240,711 shares. The remaining 100,000 shares vested for 33,333 shares in both January 2016 and January
2017 and the remaining shares will vest for 33,334 shares in January 2018. The fair market value of the 340,711 shares on the date
of grant was approximately $511,000. On September 23, 2016, the Board of Directors granted restricted stock to each member of the
Board for 58,500 shares per Board member for an aggregate grant of 351,000 shares. The vesting of 292,500 of such shares was accelerated
in May 2017 in connection with the resignations of members of the Company’s Board of Directors. The closing price of the
Company’s common stock on the grant date was $1.74, which is expected to result in an aggregate compensation charge of $611,000
as the stock vests. For the three months ended March 31, 2017 and 2016, total stock-based compensation expense related to restricted
stock grants was $88,000 and $13,000 respectively. As of March 31, 2017, there was $84,000 of unrecognized expense related to unvested
restricted stock grants, which will be recognized as stock-based compensation expense through January 2018.
For Federal income tax purposes, as of December
31, 2016 the Company had net operating loss and percentage depletion carryovers of approximately $74.7 million and $2.5 million,
respectively. The net operating loss carryovers may be carried back two years and forward twenty years from the year the net operating
loss was generated. The net operating losses may be used to offset future taxable income and expire in varying amounts through
2035. In addition, the Company has alternative minimum tax credit carry-forwards of approximately $0.7 million which are available
to offset future federal income taxes over an indefinite period. The Company has established a valuation allowance for all deferred
tax assets including the net operating loss and alternative minimum tax credit carryforwards discussed above since the “more
likely than not” realization criterion was not met as of March 31, 2017 and 2016. Accordingly, the Company did not recognize
an income tax benefit for the three months ended March 31, 2017 and 2016.
The Company recognizes, measures, and discloses
uncertain tax positions whereby tax positions must meet a “more-likely-than-not” threshold to be recognized. As of
March 31, 2017, gross unrecognized tax benefits are immaterial and there was no change in such benefits during the three months
ended March 31, 2017. The Company does not expect significant increase or decrease to the uncertain tax positions within the next
twelve months.
|
10.
|
EARNINGS (LOSS) PER SHARE
|
Basic earnings (loss) per share is computed
based on the weighted average number of common shares outstanding. For the three months ended March 31, 2017 and 2016, common stock
equivalents excluded from the calculation of weighted average shares because they were antidilutive are as follows:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Stock options
|
|
|
390,525
|
|
|
|
390,525
|
(1)
|
Unvested shares of restricted common stock
|
|
|
356,555
|
|
|
|
11,111
|
(1)
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
747,080
|
|
|
|
401,636
|
|
|
(1)
|
Includes weighted average number of shares for options and shares of restricted stock issued during
the period.
|
|
11.
|
SIGNIFICANT CONCENTRATIONS
|
The Company has exposure to credit risk in
the event of nonpayment by the joint interest operators of the Company’s oil and gas properties. Approximately 27% of the
Company’s proved developed oil and gas reserve quantities are associated with wells that are operated by a single operator
(the “Major Operator”). As of March 31, 2017 and December 31, 2016, the Company had a liability to the Major Operator
of $2,923,000 and $2,710,000 respectively, for accrued operating expenses and overpayments of net revenues when the Major Operator
failed to recognize that the Company’s ownership interest reverted after payout was achieved for certain wells during 2014
and 2015. Beginning in the second quarter of 2015, the Major Operator began withholding the Company’s net revenues from all
wells that it operates for the Company and management expects the Major Operator will continue to withhold the Company’s
net revenues until this liability is paid in full. Based on the oil and gas prices and costs used in the Company’s reserve
report as of March 31, 2017, this liability is not expected to be fully settled until the first quarter of 2020, but under higher
pricing scenarios the Company expects the liability will be repaid from future production. Accordingly, the aggregate balances
are presented as current liabilities in the accompanying consolidated balance sheets.
|
12.
|
FAIR VALUE MEASUREMENTS
|
Fair value is the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In
determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches,
the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including
assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable,
market corroborated, or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use
of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the
valuation techniques the Company is required to provide the following information according to the fair value hierarchy. The fair
value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities
carried at fair value will be classified and disclosed in one of the following three categories:
Level 1 - Quoted prices for identical assets
and liabilities traded in active exchange markets, such as the New York Stock Exchange.
Level 2 - Observable inputs other than Level
1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that
can be corroborated by observable market data. Level 2 also includes derivative contracts whose value is determined
using a pricing model with observable market inputs or can be derived principally from or corroborated by observable market data.
Level 3 - Unobservable inputs supported by
little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies,
or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment
or estimation; also includes observable inputs for nonbinding single dealer quotes not corroborated by observable market data.
The Company has processes and controls in place
to attempt to ensure that fair value is reasonably estimated. The Company performs due diligence procedures over third-party pricing
service providers in order to support their use in the valuation process. Where market information is not available to support
internal valuations, independent reviews of the valuations are performed and any material exposures are evaluated through a management
review process.
While the Company believes its valuation methods
are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the
fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The following
is a description of the valuation methodologies used for complex financial instruments measured at fair value:
Marketable Equity Securities Valuation Methodologies
The fair value of available for sale securities
is based on quoted market prices obtained from independent pricing services. Accordingly, the Company has classified these instruments
as Level 1.
Warrant Valuation Methodologies
The warrants contain a dilutive issuance and
other liability provisions which cause the warrants to be accounted for as a liability. Such warrant instruments are initially
recorded and valued as a level 3 liability and are accounted for at fair value with changes in fair value reported in earnings.
The Company estimated the value of the warrants
issued with the Securities Purchase Agreement on December 31, 2016 to be $1,030,000, or $1.03 per warrant, using the Monte Carlo
model with the following assumptions: a term expiring June 21, 2022, exercise price of $2.05, stock price of $1.28, average volatility
rate of 90%, and a risk-free interest rate of 2.01%. The Company re-measured the warrants as of March 31, 2017, using the same
Monte Carlo model, using the following assumptions: a term expiring June 21, 2022, exercise price of $2.05, stock price of $0.89,
average volatility rate of 88%, and a risk-free interest rate of 1.97%. As of March 31, 2017, the fair value of the warrants was
$690,000, or $0.69 per warrant, and was recorded as a liability on the accompanying consolidated balance sheets. An increase in
any of the variables would cause an increase in the fair value of the warrants. Likewise, a decrease in any variable would cause
a decrease in the value of the warrants.
Other Financial Instruments
The carrying amount of cash and equivalents,
oil and gas sales receivable, other current assets, accounts payable and accrued expenses approximate fair value because of the
short-term nature of those instruments. The recorded amounts for the Senior Secured Revolving Credit Facility discussed in Note
6 approximates the fair market value due to the variable nature of the interest rates, and the fact that market interest rates
have remained substantially the same since the latest amendment to the credit facility.
Recurring Fair Value Measurements
Recurring measurements of the fair value of
assets and liabilities as of March 31, 2017 and December 31, 2016 are as follows:
|
|
March 31, 2017
|
|
|
December 31, 2016
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Marketable equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sutter Gold Mining Company
|
|
$
|
15
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
15
|
|
|
$
|
16
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
16
|
|
Anfield Resources, Inc.
|
|
|
846
|
|
|
|
-
|
|
|
|
-
|
|
|
|
846
|
|
|
|
930
|
|
|
|
-
|
|
|
|
-
|
|
|
|
930
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
861
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
861
|
|
|
$
|
946
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
946
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding warrant liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
690
|
|
|
$
|
690
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,030
|
|
|
$
|
1,030
|
|
The following table presents a reconciliation of changes in assets
and liabilities measured at fair value on a recurring basis for the period ended March 31, 2017 and the year ended December 31,
2016.
|
|
Assets
|
|
|
Liabilities
|
|
|
|
|
|
|
Marketable Securities
|
|
|
|
|
|
|
|
|
|
Sutter
|
|
|
Anfield
|
|
|
Warrants
|
|
|
|
|
|
|
(Level 1)
|
|
|
(Level 1)
|
|
|
(Level 3)
|
|
|
Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value, December 31, 2016
|
|
$
|
16
|
|
|
$
|
930
|
|
|
$
|
1,030
|
|
|
$
|
1,976
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net losses included in:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss
|
|
|
(1
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(1
|
)
|
Fair value adjustments included in net loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized gain on warrant fair value adjustment
|
|
|
-
|
|
|
|
-
|
|
|
|
(340
|
)
|
|
|
(340
|
)
|
Net unrealized loss on Anfield shares
|
|
|
-
|
|
|
|
(84
|
)
|
|
|
-
|
|
|
|
(84
|
)
|
Fair value, March 31, 2017
|
|
$
|
15
|
|
|
$
|
846
|
|
|
|
690
|
|
|
$
|
1,551
|
|
On April 5, 2017, for the period beginning
May 1, 2017 through December 31, 2017, the Company entered into crude oil swap contracts for 300 barrels per day at $52.40 per
barrel.
On May 2, 2017, the credit facility between
U.S. Energy Corp.’s wholly-owned subsidiary, Energy One and Wells Fargo was sold, assigned and transferred to APEG Energy
II, L.P. (“APEG”). APEG purchased and assumed all of Wells Fargo’s rights and obligations as the lender to Energy
One under the credit facility. Concurrently, U.S. Energy Corp., Energy One and APEG entered into a Limited Forbearance Agreement
dated May 2, 2017. The Company believes that the Forbearance Agreement will provide the parties sufficient time to work toward
a long-term solution that enables the Company to execute its operational strategy and ensure value for existing shareholders.
The credit facility requires the Company’s
compliance with certain restricted financial covenants. The Company previously violated the financial ratio covenants for the fiscal
quarters ended September 30, 2016 and December 31, 2016, which constituted an event of default under the credit agreement, and
the violation of said covenants has continued in 2017. Subject to continued performance and compliance by the Company and Energy
One with the terms and conditions of the Forbearance Agreement and credit facility, APEG has agreed not to exercise its rights
and remedies arising as a result of certain existing and prospective events of default under the credit facility until July 30,
2017. Commencing on May 2, 2017, interest shall accrue on the outstanding principal balance of the loans under the credit facility
at a rate of 8.75% per annum. In the event of default under the Forbearance Agreement, the forbearance period will terminate immediately
and, without further notice or opportunity to cure, APEG will be entitled to exercise all of its rights and remedies under the
credit facility and Forbearance Agreement, including acceleration of the debt and foreclosure. For additional information please
see the 8-K filed by the Company on May 8, 2017.