PEDEVCO CORP - Quarter Report: 2022 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended: September 30, 2022

For the transition period from            to           

Commission file number: 001-35922

(713) 221-1768

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐ 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes ☐ No ☒

At November 11, 2022, there were 85,790,267 shares of the Registrant’s common stock outstanding.

PEDEVCO CORP.

TABLE OF CONTENTS

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements contained in this Quarterly Report on Form 10-Q (this “Report”) include forward-looking statements within the meaning of the federal securities laws, including Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended and the Private Securities Litigation Reform Act of 1995. Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,” “projects,” “estimates,” “plans,” “may,” and similar expressions or future or conditional verbs such as “should”, “would”, and “could” are generally forward-looking in nature and not historical facts. Forward-looking statements which are subject to a number of risks and uncertainties, many of which are beyond our control. All statements, other than statements of historical fact included in this Report, regarding our strategy, future operations, financial position, estimated revenues and losses, projected costs and cash flows, prospects, plans and objectives of management are forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous important assumptions and other important factors that could cause actual results to differ materially from those in the forward-looking statements. Forward-looking statements include the information concerning our future financial performance, business strategy, projected plans and objectives. These factors include, among others, the factors set forth below under the heading “Risk Factors.” Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Most of these factors are difficult to predict accurately and are generally beyond our control. Readers are cautioned not to place undue reliance on these forward-looking statements.

Forward-looking statements may include statements about our:

All forward-looking statements speak only at the date of the filing of this Quarterly Report. The reader should not place undue reliance on these forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make in this Quarterly Report are reasonable, we provide no assurance that these plans, intentions or expectations will be achieved. We disclose important factors that could cause our actual results to differ materially from our expectations under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report, and our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on March 11, 2022. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf. We do not undertake any obligation to update or revise publicly any forward-looking statements except as required by law, including the securities laws of the United States and the rules and regulations of the SEC. 

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PEDEVCO CORP.

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share and per share data)

See accompanying notes to unaudited condensed consolidated financial statements.

PEDEVCO CORP.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(amounts in thousands, except share and per share data)

See accompanying notes to unaudited condensed consolidated financial statements.

PEDEVCO CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(amounts in thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

PEDEVCO CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2022 AND 2021

(Unaudited)

(amounts in thousands, except share amounts)

See accompanying notes to unaudited condensed consolidated financial statements.

PEDEVCO CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – BASIS OF PRESENTATION

The accompanying interim unaudited condensed 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, 2021, filed with the SEC on March 11, 2022 (the “2021 Annual Report”), have been omitted.

The Company’s consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and subsidiaries in which the Company has a controlling financial interest. All significant inter-company accounts and transactions have been eliminated in consolidation.

The Company's future financial condition and liquidity will be impacted by, among other factors, the success of our drilling program, the number of commercially viable oil and natural gas discoveries made and the quantities of oil and natural gas discovered, the speed with which we can bring such discoveries to production, the actual cost of exploration, appraisal and development of our prospects, the prevailing prices for, and demand for, oil and natural gas.

NOTE 2 – DESCRIPTION OF BUSINESS

PEDEVCO is an oil and gas company focused on the development, acquisition and production of oil and natural gas assets where the latest in modern drilling and completion techniques and technologies have yet to be applied. In particular, the Company focuses on legacy proven properties where there is a long production history, well defined geology and existing infrastructure that can be leveraged when applying modern field management technologies. The Company’s current properties are located in the San Andres formation of the Permian Basin situated in West Texas and eastern New Mexico (the “Permian Basin”) and in the Denver-Julesburg Basin (“D-J Basin”) in Colorado.  The Company holds its Permian Basin acres located in Chaves and Roosevelt Counties, New Mexico, through its wholly-owned operating subsidiary, Pacific Energy Development Corp. (“PEDCO”), which asset the Company refers to as its “Permian Basin Asset,” and it holds its D-J Basin acres located in Weld and Morgan Counties, Colorado, through its wholly-owned operating subsidiary, Red Hawk Petroleum, LLC (“Red Hawk”), which asset the Company refers to as its “D-J Basin Asset.”

The Company believes that horizontal development and exploitation of conventional assets in the Permian Basin and development of the Wattenberg and Wattenberg Extension in the D-J Basin represent among the most economic oil and natural gas plays in the United States (“U.S.”).  Moving forward, the Company plans to optimize its existing assets and opportunistically seek additional acreage proximate to its currently held core acreage, as well as other attractive onshore U.S. oil and gas assets that fit the Company’s acquisition criteria, that Company management believes can be developed using its technical and operating expertise and be accretive to shareholder value.  

NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company has provided a discussion of significant accounting policies, estimates and judgments in its 2021 Annual Report. There have been no changes to the Company’s significant accounting policies since December 31, 2021.

Recently Issued Accounting Pronouncements

The Company does not expect the adoption of any other 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 condensed consolidated financial statements were issued for subsequent event disclosure consideration.

NOTE 4 – REVENUE FROM CONTRACTS WITH CUSTOMERS

Disaggregation of Revenue from Contracts with Customers. The following table disaggregates revenue by significant product type in the periods indicated (in thousands):

There were no significant contract liabilities or transaction price allocations to any remaining performance obligations as of September 30, 2022. 

NOTE 5 – CASH

The following table provides a reconciliation of cash and restricted cash reported within the balance sheets, which sum to the total of such amounts in the periods indicated (in thousands): 

                Total restricted cash increased $200,000 during the current period due to an additional collateralized deposit related to an increase in a plugging and abandonment bond with the State of New Mexico.

NOTE 6 – OIL AND GAS PROPERTIES

The following table summarizes the Company’s oil and gas activities by classification for the nine months ended September 30, 2022 (in thousands):

For the nine-month period ended September 30, 2022, the Company incurred $9,622,000 of capital costs primarily related to drilling operations, completion and facility construction for the two new wells started at the end of 2021 for our Permian Basin Asset and the acquisition and development of assets in the D-J Basin.

In January 2022, the Company consummated the acquisition of certain additional assets located in the D-J Basin from a third-party effective July 1, 2021, for approximately $500,000 in cash consideration. These assets include approximately 46.6 net leasehold acres and interests in 14 horizontal wells currently producing from the acreage.  The Company incurred $1.2 million (included in the total number above) in net capital costs for its working interest in these 14 new well interests during the nine months ended September 30, 2022.

During the nine months ended September 30, 2022, the Company acquired approximately 289 net mineral acres and 612 net lease acres in and around its existing footprint in the D-J Basin through multiple transactions at total acquisition and due diligence costs of $443,000 and $534,000, respectively.

The depletion recorded for production on proved properties for the three and nine months ended September 30, 2022 and 2021, amounted to $2,084,000, compared to $1,576,000, and $5,956,000, compared to $4,520,000, respectively. 

NOTE 7 – ASSET RETIREMENT OBLIGATIONS

Activity related to the Company’s asset retirement obligations is as follows (in thousands):

NOTE 8 – COMMITMENTS AND CONTINGENCIES

Lease Agreements

Currently, the Company has one operating lease for office space that requires Accounting Standards Codification (“ASC”) Topic 842 treatment, discussed below.

The Company’s leases typically do not provide an implicit rate. Accordingly, the Company is required to use its incremental borrowing rate in determining the present value of lease payments based on the information available at the commencement date. The Company’s incremental borrowing rate would reflect the estimated rate of interest that it would pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment. However, the Company currently maintains no debt, and in order to apply an appropriate discount rate, the Company used an average discount rate of eight publicly-traded peer group companies similar to it based on size, geographic location, asset types, and/or operating characteristics.

The Company has a sublease for its corporate offices in Houston, Texas on approximately 5,200 square feet of office space that expires on August 31, 2023 and has a base monthly rent of approximately $10,000.

Supplemental cash flow information related to the Company’s operating lease is included in the table below (in thousands):

Supplemental balance sheet information related to operating leases is included in the table below (in thousands):

The weighted-average remaining lease term for the Company’s operating lease is 0.9 years as of September 30, 2022, with a weighted-average discount rate of 5.35%.

Lease liability with enforceable contract terms that have greater than one-year terms are as follows (in thousands):

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, no net acres expire during the remainder of 2022, and 612 net acres expire thereafter (net to our direct ownership interest only). In the Permian Basin Asset, 63 acres are due to expire during the remainder of 2022 and 106 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 sufficient to hold the acreage before lease expiration, the Company may seek to extend leases where able. 

Other Commitments

Although the Company may, from time to time, be involved in litigation and claims arising out of its operations in the normal course of business, the Company is not currently a party to any material legal proceeding. In addition, the Company is not aware of any material legal or governmental proceedings against it or contemplated to be brought against it.

As part of its regular operations, the Company may become party to various pending or threatened claims, lawsuits and administrative proceedings seeking damages or other remedies concerning its commercial operations, products, employees and other matters.

Although the Company provides no assurance about the outcome of any future 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 9 – SHAREHOLDERS’ EQUITY

Common Stock

During the nine months ended September 30, 2022, the Company granted an aggregate of 1,440,000 restricted stock awards to various employees and board members of the Company (see Note 10 below).

On June 10, 2022, the Company sold 87,121 shares of common stock at a sales price of $1.66 per share via an ongoing “at the market offering” (the “ATM Offering”) for net proceeds of $141,000, which includes $4,000 in commission fees. The Company also incurred $91,000 in initial legal and audit fees for registration and placement of the ATM Offering.

The ATM Offering was made pursuant to the terms of that certain November 17, 2021, Sales Agreement (the “Sales Agreement”) with Roth Capital Partners, LLC (“Roth Capital”, or the “Agent”). The Company will pay the sales agent a commission of 3.0% of the gross sales price of any shares sold under the Sales Agreement, less reimbursement of the first $40,000 of such gross proceeds. The Company has also provided the Agent with customary indemnification rights and has agreed to reimburse the sales agent for certain specified expenses up to $25,000. The Company currently has $3.5 million remaining available in securities which it may sell in the future under the Sales Agreement.

NOTE 10 – SHARE-BASED COMPENSATION

The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award over the vesting period.

Common Stock

On January 25, 2022, an aggregate of 1,200,000 shares of restricted common stock were granted to officers of the Company, under the Company’s 2021 Equity Incentive Plan. The grant of the 1,200,000 shares of restricted common stock vest as follows: 33.3% vest each subsequent year from the date of grant, contingent upon the recipient’s continued service with the Company. These shares have a total fair value of $1,404,000 based on the market price on the issuance date.

On August 25, 2022, restricted stock awards were granted to three board members for an aggregate of 240,000 shares of the Company’s restricted common stock, under the Company’s 2021 Equity Incentive Plan.  The grant of the 240,000 shares of restricted common stock vest as follows: 100% of 170,000 shares and 100% of 70,000 shares vesting on July 12, 2023 and September 27, 2023, respectively, contingent upon each recipient’s continued service with the Company. These shares have a total fair value of $280,000, based on the market price on the grant date.

Stock-based compensation expense recorded related to the vesting of restricted stock for the nine months ended September 30, 2022, was $1,260,000. The remaining unamortized stock-based compensation expense at September 30, 2022 related to restricted stock was $1,291,000.

Options

On January 25, 2022, the Company granted options to purchase an aggregate of 520,000 shares of common stock to various Company employees at an exercise price of $1.17 per share. The options have a term of five years and fully vest on January 2025, with 33.3% vesting each subsequent year from the date of grant, contingent upon the recipient’s continued service with the Company. The aggregate fair value of the options on the date of grant, using the Black-Scholes model, was $454,000. Variables used in the Black-Scholes option-pricing model for the options issued include: (1) a discount rate of 1.56% based on the applicable US Treasury bill rate, (2) expected term of 3.5 years, (3) expected volatility of 120% based on the trading history of the Company, and (4) zero expected dividends.

During the nine months ended September 30, 2022, the Company recognized stock option expense of $312,000. The remaining amount of unamortized stock options expense at September 30, 2022 was $318,000.

The intrinsic value of outstanding and exercisable options at September 30, 2022 was $-0-.

Option activity during the nine months ended September 30, 2022 was: 

NOTE 11 – EARNINGS PER COMMON SHARE

Earnings (loss) per common share-basic is calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Net income (loss) per common share-diluted assumes the conversion of all potentially dilutive securities and is calculated by dividing net (loss) income by the sum of the weighted average number of shares of common stock, as defined above, outstanding plus potentially dilutive securities. Net (loss) income per common share-diluted considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares, as defined above, would have an anti-dilutive effect.

The calculation of earnings per share for the periods indicated below were as follows (amounts in thousands, except share and per share data):

For the three and nine months ended September 30, 2022 and 2021, share equivalents related to options to purchase 1,456,000, compared to 1,143,436, and 1,456,000, compared to 1,126,769, shares of common stock, respectively, were excluded from the computation of diluted net income per share as the inclusion of such shares would be anti-dilutive.

NOTE 12 – INCOME TAXES

The Company has estimated that its effective tax rate for U.S. purposes will be zero for the 2022 and 2021 fiscal years as a result of prior net losses and a full valuation allowance against the net deferred tax assets. Consequently, the Company has recorded no provision or benefit for income taxes for the three and nine months ended September 30, 2022 and 2021, respectively.

NOTE 13 – SUBSEQUENT EVENTS

On August 2, 2022, the Company received correspondence from the State of New Mexico Energy, Minerals and Natural Resources Department (“EMNRD”) alleging that the Company’s New Mexico operating subsidiaries, Ridgeway Arizona Oil Corp. (“Ridgeway”) and EOR Operating Company (“EOR”), failed to comply with certain requirements of Agreed Compliance Orders previously negotiated and entered into by each of Ridgeway and EOR with the EMNRD (the “ACOs”), specifically alleging that Ridgeway and EOR failed to provide reports and proof of conducting certain well tests by dates specified in the ACOs.  Further, in the correspondence, the EMNRD notified us that the ACOs were now void due to alleged non-compliance, that an aggregate of approximately 333 legacy vertical wells inherited by the Company when it acquired the fields in 2018 were required to be brought back online or plugged immediately, and further demanded that Ridgway and EOR pay civil penalties totaling an aggregate of $850,500 no later than August 31, 2022, with additional penalties accruing thereafter as a result of our alleged non-compliance and interest accruing on unpaid portions thereof at 8.75% per annum.  The Company immediately engaged in discussions with the EMNRD regarding the issues raised in the correspondence, and in mid-August 2022 the EMNRD confirmed that it had erred in alleging that Ridgeway was in violation of its ACO pertaining to approximately 284 legacy vertical wells operated by Ridgeway, and that the EMNRD’s demand letter related to the Ridgeway ACO was invalid and withdrawn.  Following additional correspondence between the Company and the EMNRD related to EOR’s ACO pertaining to approximately 49 legacy vertical wells operated by EOR, on November 10, 2022, EOR entered into an amended ACO with the EMNRD (the “Amended EOR ACO”), which provides, among other things, that (i) the EMNRD’s demand for payment of penalties was resolved, (ii) EOR would restore to production, or plug and abandon, the 49 wells listed in the Amended EOR ACO by no later than December 31, 2024, (iii) EOR would provide monthly reports to the Director of the Oil Conservation Division (“OCD”) regarding actions taken for each well, (iv) EOR would maintain financial assurance for the wells and place $50,000 cash in an escrow account in New Mexico designating the OCD as beneficiary, which escrowed funds will be forfeit in the event EOR fails to meet any well plugging deadline, (v) EOR may request, and the OCD may grant, an extension of the deadlines under the Amended EOR ACO for good cause shown, and (vi) EOR may not transfer a well to another operator unless approved by the OCD.  Accordingly, the Company believes that the issues raised in the August 2, 2022 correspondence from the EMNRD regarding compliance failures by its New Mexico operating subsidiaries, Ridgeway and EOR, have been favorably resolved.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

The following is management’s discussion and analysis of the significant factors that affected the Company’s financial position and results of operations during the periods included in the accompanying unaudited consolidated financial statements. You should read this in conjunction with the discussion under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2021, and the unaudited consolidated financial statements included in this quarterly Report.

Certain abbreviations and oil and gas industry terms used throughout this Quarterly Report are described and defined in greater detail under “Glossary of Oil And Natural Gas Terms” on page 2 of our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the Securities and Exchange Commission on March 11, 2022.

Our fiscal year ends on December 31st. Interim results are presented on a quarterly basis for the quarters ended March 31st, June 30th, and September 30th, the first quarter, second quarter and third quarter, respectively, with the quarter ending December 31st being referenced herein as our fourth quarter. Fiscal 2022 means the year ended December 31, 2022, whereas fiscal 2021 means the year ended December 31, 2021.

Certain capitalized terms used below but not otherwise defined, are defined in, and shall be read along with the meanings given to such terms in, the notes to the unaudited financial statements of the Company for the three and nine months ended September 30, 2022, above.

Unless the context requires otherwise, references to the “Company,” “we,” “us,” “our,” “PEDEVCO” and “PEDEVCO Corp.” refer specifically to PEDEVCO Corp. and its wholly and majority-owned subsidiaries.

In addition, unless the context otherwise requires and for the purposes of this Report only:

Available Information

The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Exchange Act, are filed with the SEC. The Company is subject to the informational requirements of the Exchange Act and files or furnishes reports, proxy statements and other information with the SEC. Such reports and other information filed by the Company with the SEC are available free of charge at our website (www.pedevco.com) under “Investors” – “SEC Filings”, when such reports are available on the SEC’s website. The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The Company periodically provides other information for investors on its corporate website, www.pedevco.com. This includes press releases and other information about financial performance, information on corporate governance and details related to the Company’s annual meeting of shareholders. The information contained on the websites referenced in this Form 10-Q is not incorporated by reference into this filing. Further, the Company’s references to website URLs are intended to be inactive textual references only.

Summary of The Information Contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying consolidated financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. Our MD&A is organized as follows:

General Overview

We are an oil and gas company focused on the development, acquisition and production of oil and natural gas assets where the latest in modern drilling and completion techniques and technologies have yet to be applied.  In particular, we focus on legacy proven properties where there is a long production history, well defined geology and existing infrastructure that can be leveraged when applying modern field management technologies. Our current properties are located in the San Andres formation of the Permian Basin situated in West Texas and eastern New Mexico and in the Denver-Julesburg Basin in Colorado.  As of September 30, 2022, we held approximately 31,309 net Permian Basin acres located in Chaves and Roosevelt Counties, New Mexico, through our wholly-owned operating subsidiary, Pacific Energy Development Corp. (“PEDCO”), and approximately 12,188 net D-J Basin acres located in Weld and Morgan Counties, Colorado, through our wholly-owned operating subsidiary, Red Hawk Petroleum, LLC (“Red Hawk”). As of September 30, 2022, we held interests in 382 gross (303 net) wells in our Permian Basin Asset of which 35 are active  producers, 16 are active injectors and two are active Saltwater Disposal Wells (“SWDs”), all of which are held by PEDCO and operated by its wholly-owned operating subsidiaries, and interests in 86 gross (22.1 net) wells in our D-J Basin Asset, of which 18 gross (16.2 net) wells are operated by Red Hawk and currently producing, 47 gross (5.8 net) wells are non-operated, and 21 wells have an after-payout interest.

Strategy

We believe that horizontal development and exploitation of conventional assets in the Permian Basin and development of the Wattenberg and Wattenberg Extension in the D-J Basin, represent among the most economic oil and natural gas plays in the U.S. We plan to optimize our existing assets and opportunistically seek additional acreage proximate to our currently held core acreage, as well as other attractive onshore U.S. oil and gas assets that fit our acquisition criteria, that Company management believes can be developed using our technical and operating expertise and be accretive to stockholder value. 

Specifically, we seek to increase stockholder value through the following strategies:

We also are committed to developing and monitoring environmental, social and governance (“ESG”) initiatives and the Board of Directors plans to evaluate the potential adoption of ESG initiatives from time to time, provided that no definitive ESG plans have been adopted to date.

Our strategy is to be the operator and/or a significant working interest owner, directly or through our subsidiaries and joint ventures, in the majority of our Permian Basin acreage so we can dictate the pace of development in order to execute our business plan. Our D-J Basin strategy is to participate in projects we deem highly economic on an operated or non-operated basis as our acreage position does not always allow for us to serve as operator in the D-J Basin. Our net capital expenditures for 2022 are estimated at the time of this Quarterly Report to range between $24 million to $30 million (of which we have incurred approximately $9.6 million in expenses through September 30, 2022). This estimate includes a range of $22 million to $28 million for drilling and completion costs on our Permian Basin and D-J Basin Assets (of which we have incurred approximately $7.4 million in expenses through September 30, 2022) and approximately $2.8 million in estimated capital expenditures through the end of the year for electric submersible pumps (“ESP”) purchases, rod pump conversions, recompletions, well cleanouts, leasing, facilities, and other miscellaneous capital expenses (of which we have incurred $2.2 million in expenses through September 30, 2022).  The remaining $14.4 million to $20.4 million in capital expenditures estimated to be incurred in 2022 relates to our anticipated proportionate share of drilling and completion expenses incurred by third party operators in 2022 with respect to non-operated wells in the D-J Basin in which we have elected to participate in 2022, but for which we have not yet been invoiced by the operators (and may not be invoiced for in full in 2022). These estimates do not include anything for acquisitions or other projects that may arise but are not currently anticipated. We periodically review our capital expenditures and adjust our capital forecasts and allocations based on liquidity, drilling results, leasehold acquisition opportunities, proposals from third party operators, and commodity prices, while prioritizing our financial strength and liquidity.

We plan to continue to evaluate D-J Basin well proposals as received from third party operators and participate in those we deem most economic and prospective. If new proposals are received that meet our economic thresholds and require material capital expenditures, we have flexibility to move capital from our Permian Asset to our D-J Basin Asset, or vice versa, as our Permian Asset is 100% operated and nearly all held by production (“HBP”), allowing for flexibility of timing on development. Our 2022 development program incorporates an increase in both basins relating to service cost and materials inflation resulting in an estimated cost increase of approximately 25 to 30 percent per well on our Permian Asset and 10 to 20 percent on our D-J Asset, based on costs we have experienced commencing in the third quarter of 2021 and continuing through the second quarter of 2022.  Our 2022 development program is based upon our current outlook for the remainder of the year and is subject to revision, if and as necessary, to react to market conditions, product pricing, contractor availability, requisite permitting and capital availability, capital allocation changes between assets, acquisitions, divestitures and other adjustments determined by the Company in the best interest of its shareholders while prioritizing our financial strength and liquidity.

We expect that we will have sufficient cash available to meet our needs over the foreseeable future, including to fund the remainder of our 2022 development program, discussed above, which cash we anticipate being available from (i) projected cash flow from our operations, (ii) existing cash on hand, (iii) equity infusions or loans (which may be convertible) made available from Simon Kukes, our Chief Executive Officer and director, which funding he is under no obligation to provide, (iv) public or private debt or equity financings, including up to $3.5 million in securities which we may sell in the future under our “at the market” Sales Agreement, and (v) funding through credit or loan facilities. In addition, we may seek additional funding through asset sales, farm-out arrangements, and credit facilities to fund potential acquisitions over the next twelve months.

How We Conduct Our Business and Evaluate Our Operations

Our use of capital for acquisitions and development allows us to direct our capital resources to what we believe to be the most attractive opportunities as market conditions evolve. We have historically acquired properties that we believe had significant appreciation potential. We intend to continue to acquire both operated and non-operated properties to the extent we believe they meet our return objectives.

We will use a variety of financial and operational metrics to assess the performance of our oil and natural gas operations, including:

Results of Operations and Financial Condition

Market Conditions and Commodity Prices

Our financial results depend on many factors, particularly the price of natural gas and crude oil and our ability to market our production on economically attractive terms. Commodity prices are affected by many factors outside of our control, including changes in market supply and demand, which are impacted by among other factors, weather conditions, inventory storage levels, basis differentials and other factors. As a result, we cannot accurately predict future commodity prices and, therefore, we cannot determine with any degree of certainty what effect increases or decreases in these prices will have on our production volumes or revenues. In addition to production volumes and commodity prices, finding and developing sufficient amounts of natural gas and crude oil reserves at economical costs are critical to our long-term success. We expect prices to remain volatile for the remainder of the year. For information about the impact of realized commodity prices on our natural gas and crude oil and condensate revenues, refer to “Results of Operations” below.

Results of Operations

The following discussion and analysis of the results of operations for the three and nine-month periods ended September 30, 2022 and 2021, should be read in conjunction with our consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q. The majority of the numbers presented below are rounded numbers and should be considered as approximate.

Three Months Ended September 30, 2022 vs. Three Months Ended September 30, 2021

We reported net income for the three-month period ended September 30, 2022 of $1.1 million, or $0.01 per share, compared to a net loss for the three-month period ended September 30, 2021 of $0.3 million or ($0.00) per share. The increase in net income of $1.4 million, when comparing the current period to the prior year’s period, was primarily due to a $3.4 million increase in net revenues offset by a $2.0 million increase in total operating expenses. (which are discussed in more detail below). 

Net Revenues

The following table sets forth the operating results and production data for the periods indicated:

Total crude oil, natural gas and NGL revenues for the three-month period ended September 30, 2022, increased $3.4 million, or 84%, to $7.5 million, compared to $4.1 million for the same period a year ago, due to a favorable price variance of $1.5 million, due to the average sales prices for crude oil, natural gas and NGLs realized by the Company increasing compared to the three-month period ended September 30, 2021, coupled with a favorable volume variance of $1.9 million. The increase in production volume is related to the positive performance from our participation in non-operated wells in the D-J Basin Asset, as well as production contributions from two new wells in our operated Permian Basin Asset that were completed in the first quarter of 2022.

Operating Expenses and Other Income

The following table summarizes our production costs and operating expenses for the periods indicated (in thousands):

+ Includes severance, ad valorem taxes and marketing costs.

                * Less than 1%.

Lease Operating Expenses. The increase of $1.5 million was primarily related to non-recurring workovers for artificial lift repairs and optimizations that were executed to maximize production volumes, as well as approximately $0.6 million of one-time non-recurring operating expenses for improving the Permian Basin Asset’s water handling infrastructure and approximately $0.2 million of non-recurring costs for environmental cleanup and reclamations of historic well and facility sites that were inherited from previous operators in our Permian Basin Asset.  Increased commodity pricing period over period caused increased production taxes coupled with increased marketing fees from higher production volumes.  Service and materials costs have also increased accordingly with general supply chain and inflation issues seen throughout the industry leading to increased operating costs.

Depreciation, Depletion, Amortization and Accretion. The $0.6 million increase was primarily the result of an increase in production (noted above) in the current period when compared to the prior period.

General and Administrative Expenses (excluding share-based compensation). There was a nominal increase in general and administrative expenses (excluding share-based compensation) as the Company continues to strive to contain costs and remain within budget from period to period.

Share-Based Compensation. Share-based compensation, which is included in general and administrative expenses in the Statements of Operations, decreased by $0.1 million, primarily due to the forfeiture of certain employee stock-based options and nonvested restricted shares due to certain voluntary employee terminations. Share-based compensation is utilized for the purpose of conserving cash resources for use in field development activities and operations.

Interest Income and Other Income (Expense). Includes interest earned from our interest-bearing cash accounts, for which interest rates have increased in the current period, compared to the prior period. Other income in the current period is primarily related to a $24,000 non-refundable two-year rent payment made in September 2022 to the Company for office space leased by SK Energy, which is 100% owned and controlled by Simon Kukes, our Chief Executive Officer and director, coupled with a $9,000 sale of old equipment.

Nine Months Ended September 30, 2022 vs. Nine Months Ended September 30, 2021

We reported net income for the nine-month period ended September 30, 2022 of $5.6 million, or $0.07 per share, compared to net income for the nine-month period ended September 30, 2021 of $0.2 million or $0.00 per share. The increase in net income of $5.4 million was primarily due to a $12.8 million increase in revenue, offset by an increase of $5.2 million in total operating expenses in the current period, offset further by a $0.4 million gain from forgiveness of our $0.4 million Paycheck Protection Program loan (the “New PPP Loan”) in May 2021, coupled with a $1.8 million gain on sale of oil and gas properties each in the prior period (all of which are discussed in more detail below).

Net Revenues

The following table sets forth the operating results and production data for the periods indicated: