US ENERGY CORP - Quarter Report: 2022 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

Commission File Number 000-06814

(Exact Name of Registrant as Specified in its Charter)

(303) 993-3200

(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 ☒

The registrant had 24,923,812 shares of its common stock, par value $0.01 per share, outstanding as of August 10, 2022.

TABLE OF CONTENTS

Cautionary Statement About Forward-Looking Statements

This Quarterly Report on Form 10-Q (this “Report” or “Form 10-Q”), including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains “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 (the “Exchange Act”) and the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts are forward-looking statements.

Examples of forward-looking statements in this Report include:

These forward-looking statements are identified by their use of terms and phrases such as “may,” “expect,” “estimate,” “project,” “plan,” “believe,” “intend,” “achievable,” “anticipate,” “will,” “continue,” “potential,” “should,” “could,” “up to,” and similar terms and phrases. Though we believe that the expectations reflected in these statements are reasonable, they involve certain assumptions, risks and uncertainties. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q, and in particular, under and incorporated by reference in, “Risk Factors”, below, the risks discussed in Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, and those discussed in other documents we file with the SEC. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

All forward-looking statements speak only at the date of the filing of this Report. 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

U.S. ENERGY CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

U.S. ENERGY CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2022 AND 2021

(In thousands, except share and per share amounts)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

U.S. ENERGY CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES

IN SHAREHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2022 AND 2021

(in thousands, except share amounts)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

U.S. ENERGY CORP. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2022 AND 2021

(in thousands)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. Please see Note-14- Supplemental Disclosures of Cash Flow Information.

U.S. ENERGY CORP. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION, OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Organization and Operations

U.S. Energy Corp. (collectively with its wholly-owned subsidiaries, Energy One LLC (“Energy One”) and New Horizon Resources LLC, referred to as the “Company” in these Notes to Unaudited Condensed Consolidated Financial Statements) was incorporated in the State of Wyoming on January 26, 1966. And recently reincorporated to Delaware, as discussed below. The Company’s principal business activities are focused on the acquisition, exploration and development of oil and natural gas properties in the United States. Effective on August 3, 2022, the Company changed its state of incorporation from the State of Wyoming to the State of Delaware (the “Reincorporation”) by means of a Plan of Conversion, effective August 3, 2022 (the “Plan of Conversion”). The Reincorporation, including the Plan of Conversion, was submitted to a vote of, and approved by, the Company’s stockholders at the Company’s 2022 Annual Meeting of Stockholders held on June 21, 2022. The Reincorporation was accomplished by filing: (i) an Application for Certificate of Transfer with the Secretary of State of the State of Wyoming (the “Wyoming Certificate of Transfer”); (ii) a Certificate of Conversion with the Secretary of State of the State of Delaware (the “Delaware Certificate of Conversion”); and (iii) a Certificate of Incorporation with the Secretary of State of the State of Delaware (the “Delaware Certificate of Incorporation”). In connection with the Reincorporation, the Company’s Board of Directors adopted new amended and restated bylaws in the form attached to the Plan of Conversion, which are as were set forth in the Definitive Proxy Statement (the “Delaware Bylaws”).

The Reincorporation did not result in any change in headquarters, business, jobs, management, location of any of the offices or facilities, number of employees, assets, liabilities or net worth (other than as a result of the costs incident to the Reincorporation) of the Company. The resulting Delaware corporation (“U.S. Energy-Delaware”) (i) is deemed to be the same entity as the Company as incorporated in Wyoming (“U.S. Energy-Wyoming”) for all purposes under Wyoming and Delaware law, (ii) continues to have all of the rights, privileges, and powers of U.S. Energy-Wyoming, (iii) continues to possess all of the properties of U.S. Energy-Wyoming, and (iv) continues to have all of the debts, liabilities, and duties of U.S. Energy-Wyoming.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements are presented in accordance with U.S. generally accepted accounting principles (“GAAP”) and have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. Accordingly, certain information and footnote disclosures required by GAAP for complete financial statements have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the consolidated financial statements have been included.

For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on March 28, 2022. Our financial condition as of June 30, 2022, and operating results for the three and six months ended June 30, 2022, 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, 2022.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include oil and natural gas reserves that are used in the calculation of depreciation, depletion, amortization and impairment of the carrying value of evaluated oil and natural gas properties; realizability of unevaluated properties; production and commodity price estimates used to record accrued oil and natural gas sales receivables; futures prices of commodities used in the valuation of commodity derivative contracts; 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 natural gas, these estimates could change in the near term and such changes could be material.

Industry Segment and Geographic Information

The Company operates in the exploration and production segment of the oil and gas industry, onshore in the United States. The Company reports as a single industry segment.

Principles of Consolidation

The accompanying financial statements include the accounts of U.S. Energy Corp. and its wholly-owned subsidiaries Energy One LLC (“Energy One”) and New Horizon Resources LLC (“New Horizon”). All inter-company balances and transactions have been eliminated in consolidation.

2. ACQUISITIONS

On January 5, 2022 (the “Closing Date”), the Company closed the acquisitions contemplated by three separate Purchase and Sale Agreements (the “Purchase Agreements” and the “Closing”), entered into by the Company on October 4, 2021, with each of (a) Lubbock Energy Partners LLC (“Lubbock”); (b) Banner Oil & Gas, LLC, Woodford Petroleum, LLC and Llano Energy LLC (collectively, “Banner”), and (c) Synergy Offshore LLC (“Synergy”, and collectively with Lubbock and Banner, (the “Sellers”). Pursuant to the Purchase Agreements, the Company acquired certain oil and gas properties from the Sellers, representing a diversified portfolio of primarily operated, producing, oil-weighted assets located across the Rockies, West Texas, Eagle Ford, and Mid-Continent. The acquisition also included certain wells, contracts, technical data, records, personal property and hydrocarbons associated with the acquired assets (collectively with the oil and gas properties acquired, the “Acquired Assets”).

The Company accounted for the acquisition of the Acquired Assets as an asset acquisition. The purchase price for the Acquired Assets was (a) $125,000 in cash and 6,568,828 shares of our common stock, as to Lubbock; (b) $1,000,000 in cash, the assumption of $3.3 million of debt, and 6,790,524 shares of common stock, as well as the novation of certain hedges which had a mark to market loss of approximately $3.1 million as of the Closing Date, as to Banner; and (c) $125,000 in cash and 6,546,384 shares of common stock, as to Synergy. The aggregate purchase price under all the Purchase Agreements was $67.4 million, representing $1.25 million in cash, the value of 19,905,736 shares of our common stock on the Closing Date of $64.7 million and purchase price adjustments on the Closing Date of $1.4 million. In addition, we assumed various liabilities, including the repayment of $3.3 million in debt, as well as a derivative liability from the novation of the hedges discussed above of $3.1 million, suspense accounts and asset retirement obligations.

 SUMMARY OF AMOUNTS INCURRED FOR ASSETS ACQUIRED

Liberty County, Texas Acquisition

On May 3, 2022, the Company acquired operated oil and gas producing properties in Liberty County, Texas, adjacent to its existing assets in the area, for $1.0 million in an all-cash transaction. The effective date of the transaction was April 1, 2022. The assets include approximately 1,022 acres, which are 100% held by production, a gas pipeline and associated infrastructure. In addition, the Company assumed suspense accounts of $0.2 million and asset retirement obligations of $0.5 million. The Company accounted for the acquisition as an asset acquisition.

East Texas Acquisition

On June 29, 2022, the Company entered into a Purchase and Sale Agreement (the “PSA”) with ETXENERGY, LLC. to acquire approximately 16,600 net acres and certain wells and gathering systems located in Henderson and Anderson Counties, Texas (the “East Texas Assets”). The initial base purchase price for the East Texas Assets was $11.8 million in cash. A total of $590 thousand of the purchase price was paid by the Company as a deposit towards the purchase price and $2 thousand of transaction costs were incurred related to the East Texas Assets. A total of $592 thousand is recorded under the caption Pending Acquisition in the condensed consolidated balance sheet at June 30, 2022. The acquisition of the East Texas Assets closed on July 27, 2022. See Note 15- Subsequent Events.

3. REVENUE RECOGNITION

The Company’s operated oil production is sold at the delivery point specified in the contract. The Company collects an agreed-upon index price, net of pricing differentials. The purchaser takes custody, title and risk of loss of the oil at the delivery point; therefore, control passes at the delivery point. The Company recognizes revenue at the net price received when control transfers to the purchaser. Natural gas and natural gas liquid (“NGL”) are sold at the lease location, which is generally when control of the natural gas and NGL transfers to the purchaser, and revenue is recognized as the amount received from the purchaser.

The Company does not disclose the values of unsatisfied performance obligations under its contracts with customers as it applies the practical exemption in accordance with Accounting Standards Codification (ASC) 606. The exemption applies to variable consideration that is recognized as control of the product is transferred to the customer. Since each unit of product represents a separate performance obligation, future volumes are wholly unsatisfied, and disclosure of the transaction price allocated to the remaining performance obligations is not required.

The Company reports revenue as the gross amount received from the well operators before taking into account production taxes and transportation costs. Production taxes are reported separately, and transportation costs are included in lease operating expense in the accompanying unaudited condensed consolidated statements of operations. The revenue and costs in the consolidated statements of operations were reported gross for the three and six months ended June 30, 2022 and 2021, as the gross amounts were known.

The Company’s non-operated revenues are derived from its interest in the sales of oil and natural gas production. The sales of oil and natural gas are made under contracts that operators of the wells have negotiated with third-party customers. The Company receives payment from the sale of oil and natural gas production between one to three months after delivery. At the end of each period when the performance obligation is satisfied, the variable consideration can be reasonably estimated and amounts due from customers are accrued in oil and natural gas sales receivable in the consolidated balance sheets. Variances between the Company’s estimated revenue and actual payments are recorded in the month the payment is received; however, differences have been and are insignificant. Accordingly, the variable consideration is not constrained. As a non-operator of its oil and natural gas properties, the Company records its share of the revenues and expenses based upon the information provided by the operators within the revenue statements.

The Company’s oil and natural gas production is typically sold at delivery points to various purchasers under contract terms that are common in the oil and natural gas industry. Regardless of the contract type, the terms of these contracts compensate the well operators for the value of the oil and natural gas at specified prices, and then the well operators remit payment to the Company for its share in the value of the oil and natural gas sold.

The Company disaggregates revenues from its share of revenue from the sale of oil and natural gas and liquids by region. The Company’s revenues in its Rockies, West Texas, South Texas, Gulf Coast and Mid- Continent regions for the three and six months ended June 30, 2022 and 2021, are presented in the following table:

SCHEDULE OF DISAGGREGATED REVENUE

Significant concentrations of credit risk

The Company has exposure to credit risk in the event of non-payment of oil and natural gas receivables by purchasers of its operated oil and natural gas properties and the joint interest operators of the Company’s non-operated oil and natural gas properties. The following table presents the purchasers that accounted for 10% or more of the Company’s total oil and natural gas revenue for at least one of the periods presented:

 SCHEDULE OF REVENUE FROM PURCHASERS

4. LEASES

During the six months ended June 30, 2022, the Company acquired right-of-use assets and operating lease liabilities of $953 thousand associated with entering into a 67-month non-cancellable, long-term lease agreement for office space in Houston, Texas. The Company’s right-of-use assets and lease liabilities are recognized at their discounted present value under the following captions in the consolidated balance sheets at June 30, 2022 and December 31, 2021:

 SCHEDULE OF CONSOLIDATED BALANCE SHEET

The Company recognizes lease expense on a straight-line basis excluding short-term and variable lease payments, which are recognized as incurred. Short-term lease costs represent payments for office space in Golden, Colorado and our Houston, Texas office lease, prior to February 2021. In May 2022, the Company entered into a new 67-month lease for additional office space in Houston, Texas. The Company subleases its former Denver, Colorado office and recognizes sublease income as a reduction of rent expense. Following are the amounts recognized as components of rental expense for the three and six months ended June 30, 2022 and 2021:

 SCHEDULE OF LEASE COSTS

The Company’s Denver and Houston office operating leases do not contain implicit interest rates that can be readily determined; therefore, the Company used the incremental borrowing rates in effect at the time the Company entered into the leases.

 SCHEDULE OF WEIGHTED AVERAGE LEASE

The future minimum lease commitments as of June 30, 2022 are presented in the table below in thousands. Such commitments are reflected at undiscounted values and are reconciled to the discounted present value on the consolidated balance sheet as follows:

 SCHEDULE OF FUTURE MINIMUM LEASE COMMITMENTS

In August 2021, the Company sold its 14-acre tract in Riverton, Wyoming with a two-story, 30,400 square foot office building. The Company recognized, rental property income, net of rental operating expenses of $6 thousand and $23 thousand related to its Riverton, Wyoming office building for the three and six months ended June 30, 2021, respectively.

5. OIL AND NATURAL GAS PRODUCTION ACTIVITIES

Divestitures

During the six months ended June 30, 2022, the Company divested of the Wildhorse Waterflood Unit in Osage County, Oklahoma, which was part of the Acquired Assets acquired on January 5, 2022. Net proceeds from sale of the waterflood unit were $1.2 million. During the six months ended June 30, 2021, the Company sold approximately 12 acres of undeveloped acreage in Midland County, Texas for approximately $30 thousand.

Ceiling Test and Impairment

The Company did not record a ceiling test write-down of its oil and natural gas properties during the six months ended June 30, 2022 or 2021. The reserves used in the ceiling test incorporate assumptions regarding pricing and discount rates over which management has no influence in the determination of present value. In the calculation of the ceiling test as of June 30, 2022, the Company used $85.78 per barrel for oil and $5.13 per one million British Thermal Units (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. The discount factor used was 10%.

6. DEBT

On January 5, 2022, the Company entered into a five-year credit agreement (“Credit Agreement”) with Firstbank Southwest (“Firstbank”) as administrative agent for one or more lenders (the “Lenders”), which provides for a revolving line of credit with an initial borrowing base of $15 million, and a maximum credit amount of $100 million. Under the Credit Agreement, revolving loans may be borrowed, repaid and re-borrowed until January 5, 2026, when all outstanding amounts must be repaid. Interest on the outstanding amounts under the Credit Agreement will accrue at an interest rate equal to (a) the greatest of (i) the prime rate in effect on such day, and (b) the Federal Funds rate in effect on such day (as determined in the Credit Agreement) plus 0.50%, and an applicable margin that ranges between 0.25% to 1.25% depending on utilization of the amount of the borrowing base (the “Applicable Margin”). The weighted average interest rate on the Credit Agreement for the three and six months ended June 30, 2022, was 4.7% and 4.5% per annum, respectively. The Company recognized interest expense inclusive of amortization of debt issuance costs on the Credit Agreement for the three and six months ended June 30, 2022 of $56 thousand and $100 thousand, respectively.

The Credit Agreement contains various restrictive covenants and compliance requirements, which include, among other things: (i) maintenance of certain financial ratios, as defined in the Credit Agreement tested quarterly, that limit the Company’s ratio of total debt to EBITDAX (as defined in the Credit Agreement) to 3:1 and require its ratio of consolidated current assets to consolidated current liabilities (as each is described in the Credit Agreement) to remain at 1:1 or higher; (ii) a restriction on the payment of cash dividends (subject to certain limited rights to declare and pay dividends as long as no event of default has occurred and certain financial ratios are met); (iii) limits on the incurrence of additional indebtedness; (iv) a prohibition on the entry into commodity swap contracts exceeding a specified percentage of our expected production; and (v) restrictions on the disposition of assets. As of June 30, 2022, the Company was in compliance with all covenants related to the Credit Agreement.

A total of $3.5 million was borrowed under the Credit Agreement immediately upon the entry into such Credit Agreement on January 5, 2022. The $3.5 million was immediately used to repay $3.3 million of debt assumed as part of the acquisition of the Acquired Assets. Since the acquisition of the Acquired Assets through June 30, 2022, the Company borrowed an additional $1.0 million for working capital needs and repaid $0.5 million. The amount outstanding on the Credit Agreement as of June 30, 2022, was $4.0 million.

On March 4, 2021, the Company closed a Debt Conversion Agreement (the “Conversion Agreement”) with APEG Energy II, L.P. (“APEG II”), which entity Patrick E. Duke, a former director of the Company, has shared voting power and shared investment power over. The Conversion Agreement was related to a $375,000 related party secured note payable the Company borrowed from APEG II on September 24, 2020 (the “Note”). The Note accrued interest at 10% per annum and had a maturity date of September 24, 2021. The Note was secured by the Company’s wholly-owned subsidiary, Energy One’s oil and natural gas producing properties. Under the terms of the Note, the Company may repay the Note prior to maturity, however, in the event of a prepayment of the Note, the Company was required to pay APEG II the amount of interest which would have accrued through maturity (at 10% per annum). Pursuant to the Conversion Agreement, the Company converted the related party secured note payable of $375,000 and accrued interest to the date of the Note’s September 24, 2021 maturity of $37,500 by issuing 97,962 shares of unregistered common stock with a value on the date of the Conversion Agreement of $438,000. The difference of $25,500 between the value of the shares issued and the $412,500 amount of the Note and accrued interest through the date of maturity is recorded as interest expense, net, in the condensed consolidated statements of operations.

7. COMMODITY DERIVATIVES

The Company’s results of operations and cash flows are affected by changes in market prices for crude oil and natural gas. To manage a portion of its exposure to price volatility from producing crude oil and natural gas the Company enters into commodity derivative contracts to protect against price declines in future periods. The Company does not enter into derivative contracts for speculative purposes. The Company has not elected to designate the derivative contracts as cash flow hedges; therefore, the instruments do not qualify for hedge accounting. Accordingly, changes in the fair value of the derivative contracts are recorded in the unaudited condensed consolidated statements of operations and are included in cash flows from operating activities in the condensed consolidated statement of cash flows.

On January 5, 2022, the Company and NextEra Energy Marketing LLC (“NextEra”) entered into an International Swap Dealers Association, Inc. Master Agreement and Schedule (the “Master Agreement”), facilitating the Company to enter into derivative contracts to manage the risk associated with its business relating to commodity prices. The Company’s obligations to NextEra under the Master Agreement are secured by the collateral which secures the loans under the Credit Agreement on a pari passu and pro rata basis with the principal of such loans. The structure of the derivative contacts may include swaps, caps, floors, collars, locks, forwards and options.

The Company’s entry into and the obligations of the Company under the Master Agreement were required conditions to the Closing of the Banner Purchase Agreement, pursuant to which the Company was required to assume and novate certain hedges of Banner which had a mark to market loss of approximately $3.1 million as of the Closing Date. In addition, on January 12, 2022, the Company entered into additional Nymex WTI crude oil commodity derivative contracts with NextEra for 2022 and 2023 production. As of June 30, 2022, the Company had commodity derivative contracts outstanding through the fourth quarter of 2023 as summarized in the tables below:

 SCHEDULE OF COMMODITY DERIVATIVE CONTRACTS

The following table details the fair value of commodity derivative contracts recorded in the accompanying balance sheets by category:

 SCHEDULE OF FAIR VALUE OF COMMODITY DERIVATIVE CONTRACTS

As of June 30, 2022, all commodity derivative contracts held by the Company were subject to master netting arrangements with its counterparty. The terms of the Company’s derivative agreements provide for offsetting of amounts payable or receivable between it and the counterparty for contracts that settle on the same date. The Company’s agreements also provide that in the event of an early termination, the counterparty has the right to offset amounts owed or owing under that and any other agreement. The Company’s accounting policy is to offset positions that settle on the same date with the same counterparty.

The following table summarizes the commodity components of the derivative settlement gain (loss) as well as the components of the net derivative loss line-item presentation in the accompanying condensed consolidated statement of operations:

 SCHEDULE OF DERIVATIVE SETTLEMENT GAIN LOSS

8. COMMITMENTS, CONTINGENCIES AND RELATED-PARTY TRANSACTIONS

Litigation

In July 2020, the Company received a request for arbitration from its former Chief Executive Officer, David Veltri claiming that it breached his employment agreement. The Company settled the litigation in December 2021 by paying Mr. Veltri and his attorneys $750 thousand, of which $375 thousand was reimbursed by the Company’s insurance carrier. Total amounts incurred by the Company related to the litigation was $427 thousand.

APEG II Litigation

From February 2019 until August 2020, the Company was involved in litigation with its former Chief Executive Officer, David Veltri, and at the time its largest shareholder, APEG II and APEG II’s general partner, APEG Energy II, GP (together with APEG II, “APEG”). In addition, Patrick E. Duke, a former director of the Company, had shared voting and shared investment power over APEG. The litigation arose as a result of a vote at the February 25, 2019 board of directors meeting to terminate Mr. Veltri for using Company funds outside of his authority and for other reasons (the “Texas Litigation”). In a separate lawsuit, APEG initiated a shareholder derivative action in Colorado against Mr. Veltri due to his refusal to recognize the Board’s decision to terminate him (the “Colorado Litigation”). The Company was named as a nominal defendant in the Colorado Litigation. The Colorado litigation was dismissed in May 2020 and the Texas Litigation was dismissed in August 2020. On March 4, 2021, the Company issued 90,846 shares of unregistered common stock, which had a value on the date of issuance of $406 thousand, to APEG in reimbursement of APEG’s legal costs in the Colorado and Texas Litigation.

9. SHAREHOLDERS’ EQUITY

Stock Options

From time to time, the Company may grant stock options under its incentive plan covering shares of common stock to employees of the Company. Stock options, when exercised, are settled through the payment of the exercise price in exchange for new shares of stock underlying the option. These awards typically expire ten years from the grant date.

For the three and six months ended June 30, 2022 and 2021, there was no compensation expense related to stock options. As of December 31, 2019, all stock options had vested. No stock options were granted or exercised during the six months ended June 30, 2022 or 2021. Stock options to purchase 750 shares expired during the six months ended June 30, 2022. No stock options expired during the six months ended June 30, 2021. Presented below is information about stock options outstanding and exercisable as of June 30, 2022, and December 31, 2021:

SCHEDULE OF STOCK OPTIONS ACTIVITY 

The following table summarizes information for stock options outstanding and for stock options exercisable at June 30, 2022. All shares and prices per share have been adjusted for a one share-for-ten shares reverse stock split that took effect on January 6, 2020:

SCHEDULE OF STOCK OPTIONS OUTSTANDING AND EXERCISABLE 

Restricted Stock

The Company grants restricted stock under its incentive plan covering shares of common stock to employees and directors of the Company. The restricted stock awards are time-based awards and are amortized ratably over the requisite service period. Restricted stock vests ratably on each anniversary following the grant date provided the grantee is employed on the vesting date. Restricted stock granted to employees, when vested are net settled through the issuance of shares, net of the number of shares required to pay withholding taxes.

The following table presents the changes in non-vested time-based restricted stock awards to all employees and directors for the six months ended June 30, 2022:

SCHEDULE OF NON-VESTED TIME-BASED RESTRICTED STOCK AWARDS 

The following table presents the stock compensation expense related to restricted stock grants for the three and six months ended June 30, 2022 and 2021:

 SCHEDULE OF STOCK COMPENSATION EXPENSE RELATED TO RESTRICTED STOCK GRANTS

Total compensation cost related to non-vested time-based awards and not yet recognized in the Company’s condensed consolidated statements of operations as of June 30, 2022, was $1.8 million. This cost is expected to be recognized over a weighted average period of 2.3 years.

10. ASSET RETIREMENT OBLIGATIONS

The Company has asset retirement obligations (“AROs”) associated with the future plugging and abandonment of proved properties. Initially, the fair value of a liability for an ARO is recorded in the period in which the ARO is incurred with a corresponding increase in the carrying amount of the related asset. The liability is accreted to its present value each period and the capitalized cost is depleted over the life of the related asset. If the liability is settled for an amount other than the recorded amount, an adjustment to the full-cost pool is recognized. The Company had no assets that are restricted for the purpose of settling AROs.

The Company recorded $9.6 million of ARO related to the assets acquired in the January 5, 2022 acquisition and $0.5 million of ARO in the May 3, 2022 acquisition of Liberty County, Texas assets. See Note 2- Acquisitions.

In the fair value calculation for the ARO there are numerous assumptions and judgments, including the ultimate retirement cost, inflation factors, credit-adjusted risk-free discount rates, timing of retirement and changes in legal, regulatory, environmental, and political environments. To the extent future revisions to assumptions and judgments impact the present value of the existing ARO, a corresponding adjustment is made to the oil and natural gas property balance.

The following is a reconciliation of the changes in the Company’s liabilities for asset retirement obligations as of June 30, 2022 and December 31, 2021:

SCHEDULE OF ASSET RETIREMENT OBLIGATIONS 

11. INCOME TAXES

The Company’s tax provision or benefit from income taxes for interim periods is generally determined using an estimate of its annual effective tax rate, adjusted for discrete items, if any. Each quarter the Company updates its estimate of the annual effective tax rate and makes a year-to-date adjustment to the provision. However, for the six months ended June 30, 2022, the estimated annual effective tax rate presented a distorted amount of expense in relation to the year-to-date results. As such, the Company has determined the tax benefit for the six months ended June 30, 2022 on an actual year-to-date basis instead of applying the estimated annual effective tax rate. The Company’s effective tax rate was approximately 45.5% and 0.0% for the six months ended June 30, 2022 and 2021, respectively. The primary difference in the Company’s effective tax rate and the statutory rate for the six months ended June 30, 2022 related to the movement in the valuation allowance against the Company’s net deferred tax assets.

The Company’s income tax benefit for the six months ended June 30, 2022 includes a discrete income tax benefit of $2.4 million related to the release of a portion of the Company’s previously established valuation allowance to offset deferred tax liabilities arising from the January 5, 2022 transaction.

Deferred taxes are recognized for the expected future tax consequences of temporary differences between the financial statement and tax basis of assets, liabilities, net operating losses and tax credit carry-forwards. We review our deferred tax assets (“DTAs”) and valuation allowance on a quarterly basis. As part of our review, we consider positive and negative evidence, including cumulative results in recent years. The January 5, 2022 transaction triggered an Internal Revenue Code (IRC) Section 382 ownership change, and therefore placed additional limitations on the Company’s pre-transaction net operating loss (NOL) and other tax attributes.

The Company recognizes, measures, and discloses uncertain tax positions whereby tax positions must meet a “more-likely-than-not” threshold to be recognized. During the six months ended June 30, 2022 and 2021, no adjustments were recognized for uncertain tax positions.

12. NET INCOME (LOSS) PER SHARE

Basic net income (loss) per common share is calculated by dividing net income (loss) attributable to common shareholders by the weighted-average number of common shares outstanding for the respective period. Diluted net income (loss) per common share is calculated by dividing adjusted net income (loss) by the diluted weighted average number of common shares outstanding, which includes the effect of potentially dilutive securities. Potentially dilutive securities for this calculation consist of stock options and warrants, which are measured using the treasury stock method, and unvested shares of restricted common stock. When the Company recognizes a net loss, as was the case for the six months ended June 30, 2022 and the three and six months ended June 30, 2021, all potentially dilutive shares are anti-dilutive and are consequently excluded from the calculation of dilutive net loss per common share.

The following table sets forth the calculation of basic and diluted net income (loss) per share for the three and six months ended June 30, 2022 and 2021:

SCHEDULE OF BASIC AND DILUTED NET LOSS PER SHARE 

For the three and six months ended June 30, 2022 and 2021, potentially dilutive securities excluded from the calculation of weighted average shares because they were anti-dilutive are as follows:

SCHEDULE OF ANTI-DILUTIVE WEIGHTED AVERAGE SHARES 

13. FAIR VALUE MEASUREMENTS

The Company’s fair value measurements are estimated pursuant to a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date, giving highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable data (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The lowest level input that is significant to a fair value measurement in its entirety determines the applicable level in the fair value hierarchy. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability, and may affect the valuation of the assets and liabilities and their placement within the hierarchy level. The three levels of inputs that may be used to measure fair value are defined as:

Level 1 - Quoted prices for identical assets and liabilities traded in active exchange markets.

Level 2 - Observable inputs other than Level 1 that are directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, or other observable inputs that can be 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.

Recurring Fair Value Measurements

Commodity Derivative Instruments

We measure the fair value of commodity derivative contracts using an income valuation technique based on the contract price of the underlying positions, crude oil forward curves, discount rates, and Company or counterparty non-performance risk. The fixed-price swaps and collar derivative contracts are included in Level 2. The fair value of commodity derivative contracts and their presentation in our condensed consolidated balance sheet as of June 30, 2022 are presented below:

SCHEDULE OF RECURRING MEASUREMENTS OF FAIR VALUE OF ASSETS AND LIABILITIES 

Marketable Equity Securities

We measure the fair value of marketable equity securities based on quoted market prices obtained from independent pricing services. The Company has an investment in the marketable equity securities of Anfield Energy (“Anfield”), which it acquired as consideration for sales of certain mining operations. Anfield is traded in an active market under the trading symbol AEC:TSXV and has been classified as Level 1.

SCHEDULE OF INVESTMENT IN THE MARKETABLE EQUITY SECURITIES 

Nonrecurring Fair Value Measurements

Asset Retirement Obligations

The Company measures the fair value of asset retirement obligations as of the date a well is acquired, the date a well begins drilling, or the date the Company revises its ARO assumptions using a discounted cash flow method based on unobservable inputs including estimates of the costs to abandon and the timing of when the Company will ultimately abandon the asset. These estimates are based on engineering estimates and estimated reserve life and therefore are designated as Level 3 within the valuation hierarchy See Note 10- Asset Retirement Obligations.

Other Assets and Liabilities

The Company evaluates the fair value on a non-recurring basis of properties acquired in asset acquisitions. The fair value of the oil and gas properties is determined based upon estimated future discounted cash flow, a Level 3 input, using estimated production which we reasonably expect, and estimated prices adjusted for differentials. Unobservable inputs include estimated future oil and natural gas production, prices, operating and development costs, and a discount rate of 10%, all Level 3 inputs within the fair value hierarchy.

The carrying value of financial instruments included in current assets and current liabilities approximate fair value due to the short-term nature of those instruments. The carrying value of the amounts borrowed under the Credit Agreement approximate fair value because the interest on the Credit Agreement is at a floating rate.

14. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

SCHEDULE OF SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION 

15. SUBSEQUENT EVENTS

Acquisition of East Texas Properties

On July 27, 2022, the Company closed on the acquisition of certain oil and natural gas producing properties from ETXENERGY, LLC totaling approximately 16,600 acres in Henderson and Anderson Counties, Texas for the initial purchase price of $11.9 million in cash (the “ETXENERGY Acquisition”). The Company financed the ETXENERGY Acquisition with $1.2 million of cash on hand and borrowings under its existing Credit Facility of $10.7 million. The asset acquired also include certain wells, pipelines, contracts technical data, records, personal property and hydrocarbons associated with the properties, including two pipeline gathering systems and related infrastructure. In addition, the Company assumed various liabilities including suspense accounts and asset retirement obligations. The Company is currently evaluating certain accounting and valuation considerations for the ETXENERGY Acquisition.

On July 26, 2022, the Company, in anticipation of the closing of the ETXENERGY Acquisition entered into a letter agreement with FirstBank Southwest, the administrative agent of its existing Credit Agreement, whereby it increased the borrowing base under the Credit Agreement from $15 million to $20 million. On July 27, 2022, in connection with the closing of the ETXENERGY Acquisition, the Company borrowed $10.7 million on the Credit Agreement. On August 4, 2022, the Company repaid $0.4 million on the Credit Agreement. The total amount outstanding on the Credit Agreement as of August 10, 2022 is $14.3 million.

On July 15, 2022, the Company’s Board of Directors approved a quarterly dividend of $0.0225 per share of common stock outstanding. The dividend will be paid on August 22, 2022, to stockholders of record as of the close of business on August 8, 2022.

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

Introduction

This information should be read in conjunction with the interim unaudited financial statements and the notes thereto included in this Quarterly Report on Form 10-Q, and the audited financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the Securities and Exchange Commission on March 28, 2022 (the “Annual Report”).

Certain abbreviations and oil and gas industry terms used throughout this Report are described and defined in greater detail under “Glossary of Oil and Natural Gas Terms” on page 3 of our Annual Report.

Certain capitalized terms used below and otherwise defined below, have the meanings given to such terms in the footnotes to our consolidated financial statements included above under “Part I - Financial Information” – “Item 1. Financial Statements”.

In this Quarterly Report on Form 10-Q, we may rely on and refer to information regarding the industries in which we operate in general from market research reports, analyst reports and other publicly available information. Although we believe that this information is reliable, we cannot guarantee the accuracy and completeness of this information, and we have not independently verified any of it.

See also “Cautionary Statement About “Forward-Looking Statements” above.

Unless the context requires otherwise, references to the “Company,” “we,” “us,” “our,” “U.S. Energy”, and “U.S. Energy Corp.” refer specifically to U.S. Energy Corp. and its consolidated subsidiaries

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

Where You Can Find Other Information

We file annual, quarterly, and current reports, proxy statements and other information with the SEC. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC like us at https://www.sec.gov (our filings can be found at https://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=0000101594) and on the “Investors – SEC Filings” page of our website at https://usnrg.com. Copies of documents filed by us with the SEC are also available from us without charge, upon oral or written request to our Secretary, who can be contacted at the address and telephone number set forth on the cover page of this Report.

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. MD&A is organized as follows:

General Overview

U.S. Energy Corp. - is a Delaware corporation, originally organized in Wyoming in 1966, and recently reincorporated to Delaware, as discussed below. We are an independent energy company focused on the acquisition and development of oil and natural gas producing properties in the continental United States. Our business activities are currently focused in West Texas, South Texas, the Gulf Coast, the Rockies and mid-continent.

Our strategic objective is to be a consolidator of high-quality producing assets in the United States with the potential to optimize production and generate free cashflow through low-risk development projects on existing assets, while maintaining an attractive shareholder returns program. We are committed to Environmental, Social, and Governance (ESG) stewardship and being a leader in reducing our carbon footprint in the areas in which we operate.

On August 3, 2022, the Company changed its state of incorporation from the State of Wyoming to the State of Delaware (the “Reincorporation”) by means of a Plan of Conversion, effective August 3, 2022 (the “Plan of Conversion”). The Reincorporation, including the Plan of Conversion, was submitted to a vote of, and approved by, the Company’s stockholders at the Company’s 2022 Annual Meeting of Stockholders held on June 21, 2022 (the “2022 Annual Meeting”), as set forth in the Company definitive proxy statement on Schedule 14A as filed with the Securities and Exchange Commission on April 29, 2022 (the “Definitive Proxy Statement”).

The Reincorporation was accomplished by filing: (i) an Application for Certificate of Transfer with the Secretary of State of the State of Wyoming (the “Wyoming Certificate of Transfer”); (ii) a Certificate of Conversion with the Secretary of State of the State of Delaware (the “Delaware Certificate of Conversion”); and (iii) a Certificate of Incorporation with the Secretary of State of the State of Delaware (the “Delaware Certificate of Incorporation”). In connection with the Reincorporation, the Company’s Board of Directors adopted new amended and restated bylaws in the form attached to the Plan of Conversion, which are as were set forth in the Definitive Proxy Statement (the “Delaware Bylaws”).

Upon the effectiveness of the Reincorporation on August 3, 2022:

Certain rights of the Company’s stockholders changed as a result of the Reincorporation, and such changes are described in greater detail in the Definitive Proxy Statement under the section entitled “Proposal 6: Approval of the Reincorporation of U.S. Energy Corp. From a Wyoming Corporation to a Delaware Corporation”.

The Reincorporation did not affect the trading of the Company’s shares of common stock on the Nasdaq Capital Market in any respect. The Company believes that the Reincorporation did not affect any of the Company’s material contracts with any third parties, and that the Company’s rights and obligations under such material contractual arrangements will continue to be rights and obligations of the Company after the Reincorporation. The Reincorporation did not result in any change in headquarters, business, jobs, management, location of any of the offices or facilities, number of employees, assets, liabilities or net worth (other than as a result of the costs incident to the Reincorporation) of the Company.

Recent Developments

Acquisition of Properties

On July 27, 2022, we closed on the acquisition of certain oil and natural gas producing properties from ETXENERGY, LLC totaling approximately 16,600 acres in Henderson and Anderson Counties, Texas for the initial purchase price of $11.9 million in cash (the “ETXENERGY Acquisition”). The Company financed the ETXENERGY Acquisition with $1.2 million of cash on hand and borrowings under its existing Credit Facility of $10.7 million. The asset acquired also include certain wells, pipelines, contracts technical data, records, personal property and hydrocarbons associated with the properties, including two pipeline gathering systems and related infrastructure.

On July 26, 2022, in anticipation of the closing of the ETXENERGY Acquisition we entered into a letter agreement with FirstBank Southwest, the administrative agent of our existing Credit Agreement, whereby we increased the borrowing base under the Credit Agreement from $15 million to $20 million. On July 27, 2022, in connection with the closing of the ETXENERGY Acquisition, we borrowed $10.7 million on the Credit Agreement. On August 4, 2022 we repaid $0.4 million on the Credit Agreement. The total amount outstanding on the Credit Agreement as of August 10, 2022, is $14.7 million.

Plan of Operations and Strategy

Continuing through 2022 and beyond, we intend to seek additional opportunities in the oil and natural gas sector, including but not limited to further acquisition of assets, participation with current and new industry partners in their exploration and development projects, acquisition of existing companies, and the purchase of oil and natural gas producing assets.

Key elements of our business strategy include:

Critical Accounting Policies and Estimates

The preparation of our unaudited condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) requires us to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities at the date of our financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or conditions. A summary of our significant accounting policies is detailed in Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations of our 2021 Annual Report on Form 10-K filed with the SEC on March 28, 2022.

Recently Issued Accounting Standards

We do not believe that any recently issued but not yet effective accounting standards, if currently adopted, would have a material effect on our Condensed Consolidated Financial Statements or related disclosures.

Results of Operations

Comparison of our Statements of Operations for the Three Months Ended June 30, 2022 and 2021

For the three months ended June 30, 2022, we recorded net income of $122 thousand, which was due to operating income of $2.7 million, primarily as a result of the assets acquired in January 2022. Partially offsetting our operating income, were losses on our commodity derivative contracts during the period of $2.1 million. For the three months ended June 30, 2021, we recorded a net loss of $207 thousand. In the following sections we discuss our revenue, operating expenses and non-operating income for the three months ended June 30, 2022, compared to the three months ended June 30, 2021.

Revenue. Presented below is a comparison of our oil and gas sales, production quantities and average sales prices for the three months ended June 30, 2022 and 2021: