Note 1 - Organization and Nature of Operations
Arête Industries, Inc. ("Arête" or the "Company"), is a Colorado corporation that was incorporated on July 21, 1987. The Company seeks to focus on acquiring interests in traditional oil and gas ventures and seek properties that offer profit potential from overlooked and by-passed reserves of oil and natural gas, which may include shut-in wells, in-field development, stripper wells, re-completion and re-working projects. In addition, the Company's strategy includes purchase and sale of acreage prospective for oil and natural gas and seeking to obtain cash flow from the sale and farm out of such prospects.
Note 2 - Summary of Significant Accounting Policies
Basis of presentation
These statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC") and accounting principles generally accepted in the United States ("GAAP") for interim financial information. They do not include all information and notes required by GAAP for complete financial statements. However, except as disclosed herein, there has been no material change in the information disclosed in the notes to financial statements included in Arête's Annual Report on Form 10-K for the year ended December 31, 2016 as filed with the SEC. In the opinion of management, the accompanying unaudited financial statements contain all adjustments, consisting of normal recurring accruals necessary for a fair presentation of the financial position as of September 30, 2017, and the results of operations, changes in stockholders' equity, and cash flows for the quarters ended September 30, 2017, and 2016. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for a full year. The Company's 2016 Annual Report on Form 10-K includes certain definitions and a summary of significant accounting policies and should be read in conjunction with this Form 10-Q.
In connection with the preparation of its unaudited condensed financial statements, the Company evaluated events subsequent to the balance sheet date of September 30, 2017, through the filing date of this report.
Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications had no impact on net income (loss) for any period presented.
Going Concern
The accompanying financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and liabilities and commitments in the normal course of business. The accompanying financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern. The Company does not generate adequate revenue to satisfy its current operations, has negative cash flows from operations, and incurred significant net operating losses during the quarter ended September 30, 2017, and the years ended December 31, 2016 and 2015, which raise substantial doubt about the Company's ability to continue as a going concern. The ability of the Company to continue as a going concern and appropriateness of using the going concern basis is dependent upon, among other things, additional cash infusion. The Company has historically obtained funds through private placement offerings of equity and debt, as well as, asset sales. There is no assurance that the Company will be able to continue raising the required capital.
Use of estimates
Preparation of the Company's financial statements in accordance with GAAP requires management to make various assumptions, judgments and estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Changes in these assumptions, judgments and estimates will occur as a result of the passage of time and the occurrence of future events and, accordingly, actual results could differ from amounts initially established.
The most significant areas requiring the use of assumptions, judgments and estimates relate to the volumes of natural gas and oil reserves used in calculating depreciation, depletion and amortization ("DD&A"), the amount of expected future cash flows used in determining possible impairments of oil and gas properties and the amount of future capital costs used in these calculations. Assumptions, judgments and estimates also are required in determining future asset retirement obligations and impairments of undeveloped properties.
Oil and Gas producing activities
The Company's oil and gas exploration and production activities are accounted for using the successful efforts method. Under this method, all property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending determination of whether the well has proved reserves. If an exploratory well does not result in proved reserves, the costs of drilling the well are charged to expense and included within cash flows from investing activities in the Statements of Cash Flows. The costs of development wells are capitalized whether productive or nonproductive. Oil and gas lease acquisition costs are also capitalized.
Other exploration costs, including certain geological and geophysical expenses and delay rentals for oil and gas leases, are charged to expense as incurred. The sale of a partial interest in a proved property is accounted for as a cost recovery and no gain or loss is recognized as long as this treatment does not significantly affect the unit-of-production DD&A rate. A gain or loss is recognized for all other sales of proved properties and is classified in other operating revenues. Maintenance and repairs are charged to expense, and renewals and betterments are capitalized to the appropriate property and equipment accounts.
The Company estimates the expected undiscounted future cash flows of its oil and gas properties and compares such undiscounted future cash flows to the carrying amount of the oil and gas properties to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, the Company will adjust the carrying amount of the oil and gas properties to fair value. The factors used to determine fair value include, but are not limited to, recent sales prices of comparable properties, the present value of estimated future cash flows, net of estimated operating and development costs using estimates of reserves, future commodity pricing, future production estimates, anticipated capital expenditures and various discount rates commensurate with the risk and current market conditions associated with realizing the expected cash flows projected. Once incurred, a write-down may not be reversed in a later period. During the nine month periods ended September 30, 2017 and 2016, the Company recorded impairment expense of $0 and $252,000, respectively, against its oil and gas properties.
The provision for DD&A of oil and gas properties is calculated based on proved reserves on a field-by-field basis using the unit-of-production method. Natural gas is converted to barrel equivalents, BOE, at the rate of six Mcf of natural gas to one barrel of oil. Estimated future dismantlement, restoration and abandonment costs, which are net of estimated salvage values, are taken into consideration.
Unproved oil and gas properties are periodically assessed for impairment on a project-by-project basis. These impairment assessments are affected by the results of exploration activities, commodity price outlooks, planned future sales or expirations of all or a portion of such projects. If the estimated future net cash flows attributable to such projects are not expected to be sufficient to fully recover the costs invested in each project, the Company will recognize an impairment loss at that time. There were no provisions for impairments recorded in the three and nine month periods ended September 30, 2017 and 2016.
Revenue recognition
The Company records revenues from the sale of crude oil, natural gas and natural gas liquids ("NGL") when delivery to the purchaser has occurred and title has transferred. The Company uses the sales method to account for gas imbalances. Under this method, revenue is recorded on the basis of gas actually sold by the Company. In addition, the Company will record revenue for its share of gas sold by other owners that cannot be volumetrically balanced in the future due to insufficient remaining reserves. The Company also reduces revenue for other owners' gas sold by the Company that cannot be volumetrically balanced in the future due to insufficient remaining reserves. The Company's remaining over and under produced gas balancing positions are considered in the Company's proved oil and gas reserves. Gas imbalances at September 30, 2017 and December 31, 2016 were not material.
Earnings per share
Basic net income (loss) per share of common stock is calculated by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during each period. Diluted net income (loss) attributable to common stockholders is calculated by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding and other dilutive securities. The only potentially dilutive securities for the diluted earnings per share calculations consist of Series A2 preferred stock that is convertible into common stock at an exchange price of $2.00 per common share. As of September 30, 2017 and December 31, 2016, the convertible preferred stock had an aggregate liquidation preference of $2,841,922 and was convertible to 1,384,000 shares of common stock. These shares were excluded from the earnings per share calculation for the three and nine month periods ended September 2017 and 2016 because they would be anti-dilutive.
New accounting pronouncements
Other than as disclosed in the 2016 Form 10-K, there are no other ASUs applicable to the Company that would have a material effect on the Company's financial statements and related disclosures that have been issued but not yet adopted by the Company as of September 30, 2017, and through the filing of this report.
Note 3 - Oil and Gas Properties
The following table sets forth information concerning the Company's oil and gas properties:
|
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
|
Proved oil and gas properties at cost, net of impairment
|
|
$
|
5,199,370
|
|
|
$
|
5,325,381
|
|
|
Unproved oil and gas properties at cost, net of impairment
|
|
|
154,982
|
|
|
|
154,977
|
|
|
Accumulated depreciation, depletion and amortization
|
|
|
(3,785,000
|
)
|
|
|
(3,662,000
|
)
|
|
Oil and gas properties, net
|
|
$
|
1,569,352
|
|
|
$
|
1,818,358
|
|
During the three month periods ended September 30, 2017 and 2016, the Company recorded depletion expense of $62,000 and $104,5238, respectively and for the nine months ended September 30, 2017 and 2016, the Company recorded DD&A expense of $198,000 and $403,333, respectively The Company recorded no impairment expense for the three month periods ended September 30, 2017 and 2016, but did record an impairment expense for $252,000 for the nine months ended September 30, 2016.
Note 4 – Fair Value Measurements
FASB ASC 820, "Fair Value Measurements and Disclosures", establishes a framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC 820 are described as follows:
|
|
-
|
Level 1 – Observable inputs, such as unadjusted quoted prices in active markets, for substantially identical assets and liabilities.
|
|
|
-
|
Level 2 – Observable inputs other than quoted prices within Level 1 for similar assets and liabilities. These include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data. If the asset or liability has a specified or contractual term, the input must be observable for substantially the full term of the asset or liability.
|
|
|
-
|
Level 3 – Unobservable inputs that are supported by little or no market activity, generally requiring a significant amount of judgment by management. The assets or liabilities fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.
|
The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Further, although the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.
Upon completion of wells, the Company records an asset retirement obligation at fair value using Level 3 assumptions and this is a non-recurring estimate.
Impairment of long-lived assets are determined on a non-recurring basis using Level 3 assumptions
The Company does not have any assets or liabilities that are measured at fair value on a recurring or nonrecurring basis as of September 30, 2017. The Company does not have any liabilities that are measured at fair value on a recurring basis or nonrecurring basis as of December 31, 2016. The following table represents the Company's assets that are measured at fair value on a nonrecurring basis in the accompanying balance sheets, and where they are classified within the fair value hierarchy as of December 31, 2016:
|
|
|
Quoted Prices in Active Markets for Identical Assets
(Level 1)
|
|
|
Significant Other Observable Inputs
(Level 2)
|
|
|
Significant Unobservable Inputs
(Level 3)
|
|
|
Proved oil and gas properties at cost, net of impairment
|
|
|
-
|
|
|
|
-
|
|
|
$
|
1,377,260
|
|
The fair values of the properties were determined using discounted cash flow models. The discounted cash flows were based on management's expectations for the future. The inputs included estimates of future crude oil and natural gas production, commodity prices based on sales contracted terms or commodity price curves as of the date of the estimate, estimated operating and development costs, at a risk-adjusted discount rate of 10%.
The carrying amounts of other financial instruments including cash and cash equivalents, accounts receivable, account payables, accrued liabilities and long-term debt in our balance sheet approximates fair value as of September 30, 2017 and December 31, 2016.
Note 5 - Income taxes
The book to tax temporary differences resulting in deferred tax assets and liabilities are primarily net operating loss carry forwards of approximately $10.5 million which expire in 2018 through 2036. A 100% valuation allowance has been established against the deferred tax assets, as utilization of the loss carry forwards and realization of other deferred tax assets cannot be reasonably assured. For the period ended September 30, 2017, the Company did not recognize any income tax benefit due to the valuation allowance.
The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, based upon the technical merits of the position. As of September 30, 2017, the Company had no unrecognized tax benefits.
Note 6 - Stock transactions and preferred stock dividends
Common stock
There were no issuances of common stock during the nine month period ended September 30, 2017.
Preferred stock
At September 30, 2017, the Company had $2,720,000 (272 shares) outstanding. A maximum amount of 600 shares at $10,000 per share or $6,000,000 are available for issuance.
The following are the terms of the Preferred Stock Series A2:
Authorized Shares, Stated Value and Liquidation Preference
. Six hundred shares are designated as the Series A2 7% Convertible Preferred Stock, which has a stated value and liquidation preference of $10,000 per share plus accrued and unpaid dividends.
Ranking
. The Series A2 Preferred Stock will rank senior to future classes or series of preferred stock established after the issue date of the Series A2 Preferred Stock, unless the Company's Board of Directors expressly provides otherwise when establishing a future class or series. The Series A2 Preferred Stock ranks senior to our common stock but it is junior to our outstanding debt and accounts payable.
Dividends
. Holders of Series A2 Preferred Stock are entitled to receive dividends at an annual rate of 7.0% of the $10,000 per share liquidation preference, payable quarterly on each of March 31, June 30, September 30 and December 31. Dividends are payable in cash or in shares of common stock (at its then fair market value), at the Company's election.
Voting Rights
. Holders of the Series A2 Preferred Stock will vote together with the holders of our common stock as a single class on all matters upon which the holders of common stock are entitled to vote. Each share of Series A Preferred Stock will be entitled to such number of votes as the number of shares of common stock into which such share of Preferred Stock is convertible; however, solely for the purpose of determining such number of votes, the conversion price per share will be deemed to be $2.00, subject to customary anti-dilution adjustment. In addition, the holders of the Series A2 Preferred Stock will vote as a separate class with respect to certain matters, including amendments to the Company's Articles of Incorporation that alter the voting powers, preferences and special rights of the Series A2 Preferred Stock.
Liquidation
. In the event we voluntarily or involuntarily liquidate, dissolve or wind up, the holders of the Series A2 Preferred Stock will be entitled, before any distribution or payment out of our assets may be made to or set aside for the holders of any of our junior capital stock and subject to the rights of our creditors, to receive a liquidation distribution in an amount equal to $10,000 per share, plus any unpaid dividends. A merger, consolidation or sale of all or substantially all of our property or business is not deemed to be a liquidation for purposes of the preceding sentence.
Redemption
. The Series A2 Preferred Stock is redeemable in whole or in part at our option at any time for cash. The redemption price is equal to $10,000 per share, plus any unpaid dividends.
Optional Redemption by Holder.
Unless prohibited by Colorado law governing distributions to shareholders, the Company, upon 90 days' prior written request from any holders of outstanding shares of Series A2 Preferred Stock, in its sole discretion, may redeem at a redemption price equal to the sum of (i) $10,000 per share and (ii) the accrued and unpaid dividends thereon, to the redemption date, up to one-third of each holder's outstanding shares of Series A2 Preferred Stock on: (i) the first anniversary of the Original Issue Date (the "
First Redemption Date
"), (ii) the second anniversary of the Original Issue Date (the "
Second Redemption Date
") and (iii) the third anniversary of the Original Issue Date (the "
Third Redemption Date
", along with the First Redemption Date and the Second Redemption Date, collectively, each a "
Redemption Date
"). If on any Redemption Date, Colorado law governing distributions to shareholders prevents the Company from redeeming all shares of Series A2 Preferred Stock to be redeemed, the Company may ratably redeem the maximum number of shares that it may redeem consistent with such law, and may also redeem the remaining shares as soon as it may lawfully do so under such law.
Preemptive Rights
. Holders of the Series A2 Preferred Stock do not have preemptive rights.
Mandatory Conversion
. Each share of Series A2 Preferred Stock remaining outstanding will automatically be converted into shares of our common stock upon the earlier of (i) any closing of underwritten public offering by us of shares of common stock pursuant to an effective registration statement under the Securities Act of 1933, in which the aggregate cash proceeds to be received by us and selling stockholders (if any) from such offering (without deducting underwriting discounts, expenses and commissions) are at least $7,000,000, and per share sales price is at least $3.00 (such price to be adjusted for any stock dividends, combinations or splits or (ii) the date agreed to by written consent of the holders of a majority of the outstanding Series A2 Preferred Stock.
Optional Conversion by Investors
. At any time, each holder of Series A2 Preferred Stock has the right, at the holder's option, to convert all or any portion of such holder's Series A2 Preferred Stock into shares of our common stock prior to the mandatory conversion of the Series A2 Preferred Stock.
Note 7 - Notes and advances payable
Notes payable consist of the following as of the date indicated:
|
|
|
|
|
|
|
|
|
|
|
September 30,
2017
|
|
|
December 31, 2016
|
|
|
Officers, directors and affiliates:
|
|
|
|
|
|
|
|
Note payable, interest 7.0%, due January 2019 (1)
|
|
|
20,057
|
|
|
|
30,546
|
|
|
Collateralized note payable (2)
|
|
|
120,728
|
|
|
|
120,728
|
|
|
Total officers, directors and affiliates
|
|
|
140,785
|
|
|
|
151,274
|
|
|
Less: Current portion of officers, directors, and affiliates
|
|
|
135,598
|
|
|
|
134,839
|
|
|
Long-term portion of officers, directors, and affiliates
|
|
$
|
5,187
|
|
|
$
|
16,435
|
|
|
Unrelated parties:
|
|
|
|
|
|
|
|
|
|
Notes payable, interest at 7.5%, due March 2018 (3)
|
|
$
|
100,000
|
|
|
$
|
100,000
|
|
|
Notes payable, interest at 7.0%, due January 2017 (4) *
|
|
|
15,815
|
|
|
|
22,737
|
|
|
Note payable, due March 2018 (5)
|
|
|
150,000
|
|
|
|
150,000
|
|
|
Note payable, due January 2019 (6)
|
|
|
10,088
|
|
|
|
13,566
|
|
|
Line of credit, interest variable (see below) due June 2018 (7)
|
|
|
523,000
|
|
|
|
523,000
|
|
|
Note payable, interest at 7.0%, due August 2016 (8) *
|
|
|
62,000
|
|
|
|
62,000
|
|
|
Notes payable, interest at 7.0%, due June 2018 (9)
|
|
|
183,000
|
|
|
|
183,000
|
|
|
Notes payable, net of discount, interest at 7.0%, due June 2018 (10)
|
|
|
98,650
|
|
|
|
97,300
|
|
|
Notes payable, net of discount, interest at 7.0%, due June 2018 (11)
|
|
|
99,100
|
|
|
|
98,200
|
|
|
Notes payable, net of discount, interest at 7.0%, due June 2018 (12)
|
|
|
24,439
|
|
|
|
23,875
|
|
|
Notes payable, interest at 5.0%, due October 2018 (13)
|
|
|
10,087
|
|
|
|
-
|
|
|
Total unrelated parties
|
|
|
1,276,179
|
|
|
|
1,273,678
|
|
|
Less: Current portion of unrelated parties
|
|
|
1,270,528
|
|
|
|
240,750
|
|
|
Long-term portion of unrelated parties
|
|
$
|
5,561
|
|
|
$
|
1,032,928
|
|
* Note is in default
All of the Company's debt matures in fiscal year 2018, except for one note payable to Don Prosser (see bullet 6 below), which is due on January 1, 2019.
|
|
(1)
|
In January 2014, we memorialized certain short-term liabilities owed to one of our directors, Charlie Davis, into a formal promissory note. This note accrues interest at an annual rate of 7.0% with monthly payments equal to $1,316 (principal and interest) and will mature on January 1, 2019. Interest paid through September 30, 2017 was $1,362.
|
|
|
(2)
|
On April 29, 2013, the Company executed a promissory note under which the Company agreed to pay Apex Financial Services Corp, a Colorado corporation, ("Apex") the principal sum of $120,728, with interest accruing at an annual rate of 7.5%, with principal and interest due on March 30, 2018. The Company also agreed to assign 75% of its operating income from its oil and gas operations and any lease or well sale or any other asset sales to Apex to secure the debt. Apex is 100% owned by the CEO, director, and shareholder of the Company, Nicholas L. Scheidt. The Company paid a loan fee to Apex of $10,000. In the event of default on the note and failure to cure the default in ten days, Apex may accelerate payment and the annual interest rate on the note will accrue at 18%. Default includes failure to pay the note when due or if the Company borrows any other monies or offers security in the Company or in the collateral securing the note prior to the note being paid in full. The Company obtained a default waiver from Apex related to the new notes entered into through the date of this report. The Company has not had operating income or had any lease or well sales in the current fiscal year; therefore, no payments have been made to Apex through September 30, 2017. There was no interest paid through September 30, 2017.
|
|
|
(3)
|
On March 28, 2012, the Company executed a promissory note with Pikerni, LLC ("Pikerni"). This note was extended and amended on April 1, 2015, extending the maturity date of the note to April 1, 2016, with principal payments of $5,000 due on June 30, 2015, September 30, 2015, December 31, 2015, and March 31, 2016, and the remaining principal balance of $80,000 due on April 1, 2016. The note accrues interest at an annual rate of 7.5% and is payable quarterly. The Company did not make any of the principal payments and was in default on this note, however, in January 2016 the Company entered into an extension agreement with Pikerni, with an effective date of June 15, 2016. The principal amount of $100,000 was extended to March 30, 2018, with interest continuing to accrue at an annual rate of 7.5% and interest payments continuing to be paid in 90-day intervals. Interest paid through September 30, 2017 was $5,625.
|
|
|
(4)
|
On January 1, 2014, the Company executed a promissory note with William Stewart, one of the Company's board members, subsequently assigned to Pikerni, LLC, for $49,500. This note accrues interest at a rate of 7.0% per annum with monthly payments equal to $980 (principal and interest) and matures on January 1, 2017. The monthly payments are based on a 60 month amortization schedule, with a balloon payment of $22,737 due on January 1, 2017. The balloon payment was not made at January 1, 2017, and this note is currently in default. The Company has continued making the monthly payments of $980 and is negotiating new terms. The principal balance is classified in current notes payable on the balance sheet at September 30, 2017. Interest paid through September 30, 2017 was $919.
|
|
|
(5)
|
On March 28, 2012, the Company executed a Promissory Note with Fairfield Management Group, LLC, subsequently assigned to Donald Prosser (former CFO and Director) ("Prosser") during the fiscal year ended December 31, 2015. The note has a principal balance of $150,000, accrues interest at 7.5% payable monthly and had a maturity date of March 31, 2016, which was subsequently extended to March 31, 2017 and extended again on May 3, 2017 to March 30, 2018. Interest paid through September 30, 2017 was $6,564.
|
|
|
(6)
|
On December 31, 2013, the Company executed a promissory note with Mr. Prosser for $28,500. This note accrues interest at a rate of 7.0% with monthly payments equal to $564 (principal and interest) and matures on January 1, 2019. Interest paid through September 30, 2017 was $472.
|
|
|
(7)
|
On January 28, 2014, we entered into a line of credit loan agreement ("Credit Facility") with Citywide Banks ("Citywide") for $1,500,000 due January 15, 2015, subsequently extended to June 28, 2018. The terms of the note are as follows: 1) the accrued interest is payable monthly starting February 28, 2014, 2) the interest rate is variable based on an index calculated based on a prime rate as published by the Wall Street Journal index plus an add on index with the current and minimum rate of 6.5%,
the note has draw provisions and is collateralized by the wells and leases owned by the Company, a certificate of deposit for $500,000 at CityWide Banks pledged by a related party, and 5) the personal guarantee of Nicholas Scheidt, Chief Executive Officer. The amount eligible for borrowing on the Credit Facility is limited to the lesser of (i) 65% of the Company's PV10 value of its carbon reserves based upon the most current engineering reserve report or (ii) 48 month cumulative cash flow based upon the most current engineering reserve report. In addition to the borrowing base limitation, the Company is required to maintain and meet certain affirmative and negative covenants and conditions in order to draw advances on the Credit Facility. At March 31, 2017, the borrowing base was $523,000. The Credit Facility contains certain representations, warranties, and affirmative and negative covenants applicable to the Company, which are customarily applicable to senior secured loan facilities. Key covenants include limitations on indebtedness, restricted payments, creation of liens on oil and gas properties, hedging transactions, mergers and consolidations, sales of assets, use of loan proceeds, change in business, and change in control. The above-referenced promissory note contains customary default and acceleration provisions and provides for a default interest rate of 21% per annum. In addition, the Credit Facility contains customary events of default, including: (a) failure to pay any obligations when due; (b) failure to comply with certain restrictive covenants; (c) false or misleading representations or warranties; (d) defaults of other indebtedness; (e) specified events of bankruptcy, insolvency or similar proceedings; (f) one or more final, non-appealable judgments in excess of $50,000 that is not covered by insurance; (g) change in control (25% threshold); (h) negative events affecting the Guarantor; and (i) lender in good faith believes itself insecure. In an event of default arising from the specified events, the Credit Facility provides that the commitments thereunder will terminate and the Lender may take such other actions as permitted including, declaring any principal and accrued interest owed on the line of credit to become immediately due and payable. The Credit Facility is secured by a security interest in substantially all of the assets of the Company, pursuant to a Security Agreement, Deed of Trust and Assignment of As-Extracted Collateral entered into between the Company and Citywide Banks. Interest paid through September 30, 2017 was $25,874.
|
|
|
(8)
|
On August 15, 2014, the Company redeemed the remaining 10 shares of Series A-1 Convertible Preferred Stock outstanding for consideration of $77,500, of which $15,500 was paid in cash and the remaining amount as a promissory note for $62,000. The note accrues interest at 7% per annum, payable in two installments as follows;
|
|
|
a.
|
A payment of $31,000, plus accrued and unpaid interest was payable on August 15, 2015
|
|
|
b.
|
A payment of $31,000, plus accrued and unpaid interest was payable on August 15, 2016
|
The Company did not make the August 15, 2015, or August 15, 2016, principal payment and is currently in default on this note. The Company is negotiating new terms with the note holder. Interest paid through September 30, 2017 was $3,279.
|
|
(9)
|
In June 2013, in connection with the conversions of Series A-1 Preferred Stock by Burlingame Equity Investors II, LP and Burlingame Equity Investors Master Fund, LP, the Company issued unsecured promissory notes in the original principal amounts of $48,000 and $552,000, respectively, with interest at 7% per annum payable quarterly and all unpaid interest and principal due on July 23, 2014. We have agreed in writing with the holders of these two existing notes to extend the maturity date of the notes to June 18, 2018. Interest paid through September 30, 2017 was $9,608.
|
|
|
(10)
|
On June 29, 2016, the Company entered into a promissory note with an unrelated party and received $100,000 and issued 30,000 shares of the Company's restricted common stock, valued at $3,600, as a loan servicing fee. This note accrues interest at the rate of 7.0% per annum with interest paid quarterly in arrears and all principal and interest due on June 29, 2018. In the event of a default, the loan will become due immediately and a default interest rate of 18.0% per year will be assessed on all amounts outstanding until paid in full. An event of default only occurs if any payment required by this note is not paid. All payments have been made on this note through the filing of this report. The loan servicing fee will be amortized over the life of the loan. Interest paid through September 30, 2017 was $5,178.
|
|
|
(11)
|
On June 30, 2016, the Company entered into a promissory note with an unrelated party for $100,000 and the issuance of 20,000 shares of the Company's restricted common stock, valued at $2,400, as a loan servicing fee. This note accrues interest at the rate of 7.0% per annum with interest paid quarterly in arrears and all principal and interest due on June 30, 2018. In the event of a default, the loan will become due immediately and a default interest rate of 18.0% per year will be assessed on all amounts outstanding until paid in full. An event of default only occurs if any payment required by this note is not paid. The proceeds for this note were received on July 1, 2016, upon formal closing of the transaction. The loan servicing fee will be amortized over the life of the loan. Interest paid through September 30, 2017 was $5,178.
|
|
|
(12)
|
On June 30, 2016, the Company entered into a promissory note with an unrelated party for $25,000 and the issuance of 12,500 shares of the Company's restricted common stock, valued at $1,500, as a loan servicing fee. This note accrues interest at the rate of 7.0% per annum with interest paid quarterly in arrears and all principal and interest due on June 29, 2018. In the event of a default, the loan will become due immediately and a default interest rate of 18.0% per year will be assessed on all amounts outstanding until paid in full. An event of default only occurs if any payment required by this note is not paid. The proceeds from this note were received on July 5, 2016, upon formal closing of the transaction. The loan servicing fee will be amortized over the life of the loan. Interest paid through September 30, 2017 was $1,295.
|
|
|
(13)
|
On March 16, 2017, the Company entered into a Commercial Premium Finance Agreement – Promissory Note in the amount of $32,529 to finance its D&O insurance policy. This note accrues interest at a rate of 5.0% and matures on October 17, 2017. This note was paid in full on October 17, 2017. Interest paid through September 30, 2017 was $508.
|
|
Note 8 -
|
Asset Retirement Obligation
|
The Company follows accounting for asset retirement obligations ("ARO") in accordance with ASC 410,
Asset Retirement and Environmental Obligations
, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it was incurred if a reasonable estimate of fair value can be made. The Company's ARO primarily represents the estimated present value of the amounts expected to be incurred to plug, abandon and remediate producing and shut-in wells at the end of their productive lives in accordance with applicable state and federal laws. The Company determines the estimated fair value of its ARO by calculating the present value of estimated cash flows related to plugging and abandonment liabilities. The significant inputs used to calculate such liabilities include estimates of costs to be incurred; the Company's credit adjusted discount rates, inflation rates and estimated dates of abandonment. The ARO is accreted to its present value each period and the capitalized asset retirement costs are amortized using the unit of production method.
A reconciliation of the Company's ARO as of September 30, 2017 and December 31, 2016, is as follows:
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
|
December 31, 2016
|
|
|
Balance, beginning of year
|
|
$
|
1,085,000
|
|
|
$
|
995,197
|
|
|
Liabilities settled
|
|
|
-
|
|
|
|
(4,530
|
)
|
|
Accretion expense
|
|
|
75,000
|
|
|
|
94,333
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, end of year
|
|
|
1,160,000
|
|
|
|
1,085,000
|
|
|
Less: current asset retirement obligations
|
|
|
(445,900
|
)
|
|
|
(425,200
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Long-term asset retirement obligations
|
|
$
|
714,100
|
|
|
$
|
659,800
|
|
|
|
|
|
|
|
|
|
|
|
Note 9 – Commitments and Contingencies
Legal Proceedings.
The Company is subject to the risk of litigation, claims and assessments that may arise in the ordinary course of its business activities, including contractual matters and regulatory proceedings. On September 30, 2016 plaintiff Eric Langan et al. filed a complaint in Maricopa County Superior Court for common law fraud under Arizona law against Arête Industries, Inc., Don and Jane Doe Prosser, and Charles and Jane Doe Davis. The action was removed to federal court on November 17, 2016, civil action number 16 – 03994 – PHX – SPL. On September 1, 2017, a judgment was entered in favor of the defendants and against plaintiffs and the case was dismissed.
As of September 30, 2017, the Company was not subject to any pending litigation and management is not currently aware of any asserted or unasserted claims and assessments that may impact the Company's future results of operations.
Note 10 - Subsequent Events
On September 11, 2017, the Company entered into an Offer to Purchase Letter with an unrelated party for a 25% working interest in two of the Company's oil and gas assets located in Clark County, Kansas for total consideration of $150,000 and an effective date of October 1, 2017. On November 15, 2017, the Company completed the sale, with an effective date of October 1, 2017.
On December 22, 2017, the Company entered into an Offer to Purchase Letter with an unrelated party for a 6.0% and 3.33% working interest in two of the Company's oil and gas assets located in Clark County, Kansas for total consideration of $50,000 and an effective date of January 1, 2018.
On January 16, 2018, the Company entered into a 90-day promissory note with an unrelated party for proceeds of $40,000. This note accrues interest at a rate of 7.0% and matures on April 17, 2018.
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations for the quarters ended September 30, 2017 and 2016 should be read together with our audited financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2016, and the financial statements and footnotes included in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q, including the following discussion, contains trend analysis and other forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements in this Quarterly Report on Form 10-Q that are not statements of historical facts are forward-looking statements. These forward-looking statements made herein are based on our current expectations, involve a number of risks and uncertainties and should not be considered as guarantees of future performance.
General Overview
We are an independent energy company whose business plan is to acquire, explore and develop oil, natural gas and natural gas liquids ("NGL's") in the United States. Due to our limited capital and low commodity prices, we have not been able to execute on our business plan since 2015. Our long-term strategy is to seek to deliver net asset value per share growth to our investors via attractive investments within the oil and gas industry. In the event we are able to obtain sufficient additional capital we expect to seek properties that offer profit potential from overlooked and by-passed reserves of oil and natural gas, which may include shut-in wells, in-field development, stripper wells, re-completion and re-working projects. In addition, we seek acreage, prospective for oil and natural gas, to purchase in order to obtain cash flow from the re-sale and farm out of such prospects.
We do not operate any of the properties in which we have an interest. As a result, we have limited ability to exercise influence over, and control the risks associated with operations of these properties. The failure of an operator of our wells to adequately perform operations, an operator's breach of the applicable agreements or an operator's failure to act in ways that are in our best interests could reduce our ability to be successful in finding reserves and could create a liability for us for the operator's failure to properly operate the project and adhere to applicable safety and environmental standards.
It is our desire to provide an understanding of the Company's past performance, its financial condition and its prospects for the future. Accordingly, we discuss and provide our analysis of the following:
|
|
•
|
Liquidity and capital resources;
|
|
|
•
|
Contractual obligations;
|
|
|
•
|
Off balance sheet arrangements;
|
|
|
•
|
Critical accounting policies; and
|
|
|
•
|
New accounting pronouncements.
|
Oil, Gas, and NGL Prices
Our financial condition and the results of our operations are significantly affected by the prices we receive for our oil, gas, and NGL production, which can fluctuate dramatically. Our oil and gas is sold under our operators' contracts paying us various industry posted prices, adjusted for basis differentials. We are paid the average of the daily settlement price for the respective posted prices for the period in which the product is sold, adjusted for quality, transportation and location differentials.
We expect future prices for oil, gas, and NGLs to continue to be volatile. In addition to supply and demand fundamentals, as a global commodity, the price of oil is affected by real or perceived geopolitical risks in all regions of the world as well as the relative strength of the dollar compared to other currencies. Oil markets continue to be unstable.
Results of Operations for the Three and Nine Months Ended September 30, 2017 and 2016
Presented below is a discussion of our results of operations for the three and nine month periods ended September 30, 2017 and 2016.
Net Loss Applicable to Common Stockholders
Net loss applicable to common stockholders for the three months ended September 30, 2017 and 2016 were $110,496 and $328,312, respectively. Lease operating expenses were lower in 2017 by $97,919 compared to the same period in the prior year. Lower production taxes due to the sales mix of the properties accounted for part of the decrease in the loss along with a decrease in DD&A. General and administrative costs ("G&A Expense") also were lower in the current period which also was a factor in the reduction from the prior year.
Net loss applicable to common stockholders for the nine month periods ended September 30, 2017 and 2016, were $524,525 and $1,259,424, respectively. The decrease in the net loss in 2017 compared to 2016 is due to an impairment charge of $252,000 during the first quarter of 2016, a decrease in DD&A of $205,333, reduced lease operating expenses of $140,344, and lower general and administrative costs by $69,847. In addition, our total revenues increased $40,255 compared to the prior year.
The discussion below further discusses our results of operation for the Three and Nine Month periods ended September 30, 2017 and 2016.
Oil and Gas Producing Activities
The results of our producing oil and gas properties are presented below for the three and nine months ended September 30, 2017 and 2016:
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
Oil Sales
|
|
$
|
243,848
|
|
|
$
|
219,404
|
|
|
$
|
683,827
|
|
|
$
|
633,961
|
|
|
Natural Gas Sales
|
|
|
21,385
|
|
|
|
20,220
|
|
|
|
55,828
|
|
|
|
65,638
|
|
|
Royalty sales
|
|
|
-
|
|
|
|
483
|
|
|
|
1,959
|
|
|
|
1,760
|
|
|
Total Revenue
|
|
|
265,233
|
|
|
|
240,107
|
|
|
|
741,614
|
|
|
|
701,359
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease Operating Expense
|
|
|
215,167
|
|
|
|
313,086
|
|
|
|
660,197
|
|
|
|
800,541
|
|
|
Production Taxes
|
|
|
18,595
|
|
|
|
19,367
|
|
|
|
47,604
|
|
|
|
55,434
|
|
|
Depreciation, depletion, amortization ("DD&A")
|
|
|
37,000
|
|
|
|
77,000
|
|
|
|
123,000
|
|
|
|
328,000
|
|
|
Accretion
|
|
|
25,000
|
|
|
|
27,523
|
|
|
|
75,000
|
|
|
|
75,133
|
|
|
Impairment expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
252,000
|
|
|
Total operating expenses
|
|
|
295,762
|
|
|
|
436,976
|
|
|
|
905,801
|
|
|
|
1,511,108
|
|
|
Net operating loss before general and administrative expense
|
|
|
(30,529
|
)
|
|
|
(196,869
|
)
|
|
|
(164,187
|
)
|
|
|
(809,949
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net barrels of oil sold
|
|
|
5,667
|
|
|
|
5,579
|
|
|
|
15,597
|
|
|
|
17,490
|
|
|
Net mcf of gas sold
|
|
|
7,610
|
|
|
|
10,407
|
|
|
|
23,987
|
|
|
|
35,834
|
|
|
BOE
|
|
|
6,935
|
|
|
|
7,314
|
|
|
|
19,595
|
|
|
|
23,462
|
|
|
Average price for oil
|
|
$
|
43.03
|
|
|
$
|
39.33
|
|
|
$
|
43.84
|
|
|
$
|
36.25
|
|
|
Average price for gas
|
|
$
|
2.81
|
|
|
$
|
1.94
|
|
|
$
|
2.33
|
|
|
$
|
1.83
|
|
|
Lease operating expense per BOE
|
|
$
|
31.02
|
|
|
$
|
42.81
|
|
|
$
|
33.69
|
|
|
$
|
34.12
|
|
|
DD&A per BOE
|
|
$
|
8.94
|
|
|
$
|
10.53
|
|
|
$
|
10.10
|
|
|
$
|
13.98
|
|
Three and Nine Months Ended September 30, 2017 and 2016
Our oil sales for the three month periods ended September 30, 2017 and 2016 were $243,848 and $219,404, respectively, an increase of $24,444 or 11.1%. This increase can be attributed to higher sales volumes and higher realized oil prices. . The average realized price per barrel of oil was $43.03 for the three month period ended September 30, 2017, an increase of 9.4% or $3.70 per barrel compared to $39.33 for the same period in the prior year. The increase in higher prices was accompanied with higher sales volumes, which increased 1.6% or 88 barrels in the current period to 5,667 barrels, compared to 5,579 barrels of oil in the same period in the prior year. The effect on our oil sales due to increased sales volumes was $3,795 higher sales and the effect of the higher average realized oil prices was $20,649 for a net increase in oil sales of $24,444.
Our oil sales for the nine month periods ended September 30, 2017 and 2016 were $683,827 and $633,961 respectively an increase of $49,866 or 7.9%. This increase can be attributed to higher realized sales prices but with lower sales volumes. The average realized price per barrel was $43.84 for the nine months ended September 30, 2017, an increase of $7.59 per barrel from the realized price of $36.25 for the nine months ended September 30, 2016. The increase in oil sales was partially offset by a decrease in sales volumes of 1,893 barrels from 17,490 barrels for the nine months ended September 30, 2016 down to 15,597 barrels for the same period in the current year. The effect on oil sales due to the increase in sales prices was $132,866 while there was a decrease in sales due to a decrease in volumes of $83,000 for a net increase in oil sales of $49,866.
Our natural gas sales for the three month periods ended September 30, 2017 and 2016, were $21,385 and $20,220, respectively, an increase of $1,165 or 5.8%. The average realized natural gas prices, including proceeds from sales of natural gas liquids, in 2017 and 2016, were $2.81 and $1.94 per Mcf, respectively, an increase of $0.87 or 44.8%. Natural gas sales volumes for the three month periods ended September 30, 2017 and 2016, were 7,610 Mcf and 10,407 Mcf, respectively, which was 26.9% lower or 2,797 Mcf than the prior period. The impact on natural gas sales in the current year due to the higher realized prices resulted in greater natural gas sales of $9,027. The effect of the lower volumes decreased sales by $7,862 for a net increase in natural gas sales of $1,165.
Our natural gas sales for the nine month periods ended September 30, 2017 and 2016 were $55,828 and $65,638 respectively, a decrease of $9,810 or 14.9%. The average realized natural gas prices, including proceeds from sales of natural gas liquids, in 2017 and 2016 were $2.33 and $1.83 per Mcf respectively, an increase of $.50 or 27.3%. Natural gas sales volumes for the nine months ended September 30, 2017 and 2016 were 23,987 Mcf and 35,834 Mcf respectively, which was 33.1% lower or 11,847 Mcf lower than the prior period. The impact on natural gas sales in the current year due to the higher realized prices resulted in greater natural gas sales of $17,761. The effect of the lower volumes decreased sales by $27,571 for a net decrease in sales of $9,810.
During the prior year we had performed a workover program in the Padgett Field after it was acquired in December 2015, which included increased maintenance, pump changes and chemical work during 2016 to upgrade the facilities and well equipment. This program continued through the first quarter of 2017. During the second quarter and third quarter of 2017, we had less workover expenses, but did have a slight increase in recurring lease operating expenses in order to maintain all of the work performed in the prior year.
Due to the workover program in the prior year, we experienced lower lease operating expense ("LOE") in the current year. LOE for the three month periods ended September 30, 2017 and 2016, were $215,167 and $313,086, respectively, resulting in a decrease of $97,919 or 31.3%. LOE per BOE for the three month periods ended September 30, 2017 and 2016, were $31.02 and $42.81, respectively, a decrease of $11.79 or 27.5% compared to the prior year. Lease operating expense for the nine month periods ended September 30, 2017 and 2016, were $660,197 and $800,541, respectively, a decrease of $140,344 or 17.5%. LOE per BOE in 2017 and 2016 were $33.69 and $34.12, respectively, a decrease of $.43 or 1.3% compared to the prior year.
Production taxes were $18,595 and $19,367, for the three month periods ended September 30, 2017 and 2016, respectively, a decrease of $772 or 4.0%. Production taxes for the nine month periods ended September 30, 2017 and 2016, were $47,604 and $55,434, respectively. We generally expect absolute production tax expense to trend as a percentage with oil, gas, and NGL production revenue within each state we have operations in. Production taxes as a percentage of revenue for the three and nine month periods ended September 30, 2017, were 7.0% and 6.4%, respectively, compared to 8.1% and 7.9% for the three and nine month periods ended September 30, 2016, respectively. Our production in Kansas and Nebraska has a blended production tax rate of approximately 4.4% and our Wyoming production is approximately 11.0%; therefore, as our sales increase in Kansas and Nebraska the tax rate as a percentage of sales decreases. We had more production in Kansas and Nebraska in 2017 compared to 2016; therefore, the tax rate as a percentage of revenue decreased.
Our DD&A expenses were $37,000 and $77,000, for the three month periods ended September 30, 2017 and 2016, respectively, a decrease of $40,000 or 51.9%. Our DD&A expense for the nine month periods ended September 30, 2017 and 2016, were $123,000 and $328,000, respectively, a decrease of $205,000 or 62.5%. These decreases for the three and nine month periods ended September 30, 2017, compared to the same periods in the prior year were due to a lower depletable base because of impairments of our oil and gas properties as of December 31, 2016.
We perform assessments of our long-lived assets to be held and used, including oil and gas properties, whenever events or circumstances indicate that the carrying value of those assets may not be recoverable. To the extent such assessments indicate a reduction of the estimated useful life or estimated future cash flows of our oil and gas properties, the carrying value may not be recoverable and therefore an impairment charge would be required to reduce the carrying value of the proved properties to their fair value.
The cash flow model we use to assess proved properties for impairment includes numerous assumptions. The primary factors that may affect estimates of future cash flows are (i) future reserve adjustments, both positive and negative, to proved reserves and appropriate risk-adjusted probable and possible reserves, (ii) results of future drilling activities, (iii) management's price outlook and (iv) increases or decreases in production costs and capital costs associated with those reserves. All inputs to the cash flow model are evaluated at each measurement date.
As a result of our impairment assessments of our oil and gas properties, a noncash charge to reduce the carrying values, we recorded impairment expense of $252,000 against our proved property at September 30, 2016, and an aggregate $3,358,000 of impairment expense at December 31, 2016.
General and Administrative
Presented below is a summary of general and administrative expenses for the three and nine months ended September 30, 2017 and 2016:
|
|
|
Three Months ended
|
|
|
Nine Months ended
|
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
General and administrative expenses:
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
Director fees
|
|
$
|
10,000
|
|
|
$
|
10,000
|
|
|
$
|
30,000
|
|
|
$
|
30,000
|
|
|
Investor relations
|
|
|
1,108
|
|
|
|
1,097
|
|
|
|
4,962
|
|
|
|
8,410
|
|
|
Legal, auditing and professional fees
|
|
|
2,473
|
|
|
|
23,185
|
|
|
|
66,219
|
|
|
|
109,069
|
|
|
Consulting fees - Related Parties
|
|
|
8,812
|
|
|
|
14,000
|
|
|
|
40,030
|
|
|
|
54,732
|
|
|
Other administrative expenses
|
|
|
8,132
|
|
|
|
10,103
|
|
|
|
24,428
|
|
|
|
33,275
|
|
|
Depreciation
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Total G&A Expense
|
|
$
|
30,525
|
|
|
$
|
58,385
|
|
|
$
|
165,639
|
|
|
$
|
235,486
|
|
Three and Nine Month Periods Ended September 30, 2017 and 2016
General and administrative expenses decreased $27,860 or 47.7% for the three month period ended September 30, 2017, compared to the same period in 2016. This reduction was primarily due to a decrease in legal, auditing and professional fees, and other administrative expenses. During the nine month period ended September 30, 2017, general and administrative expenses decreased $69,847 or 29.7%. This decrease in general and administrative expense is due to a decreases in all categories, with the majority of the decrease related to legal, auditing and professional fees, which decreased $42,850 and decreased consulting services, which decreased $14,702.
Interest Expense, net
Interest expense, net of interest income, for the three month period ended September 30, 2017 and 2016, remained flat at $25,296 and $25,067, respectively, an increase of only $229. We recorded $375 of interest expense to related parties and made principal and interest payments of $396 to one of the related parties during the three month period ended September 30, 2017.
Interest expense, net of interest income, for the nine month periods ended September 30, 2017 and 2016, were $77,831 and $70,019, respectively, an increase of $7,812, due to additional borrowings from three unrelated parties in June 2016. We recorded interest expense to non-related parties of $2,689 and we made principal and interest payments of $65,514 to unrelated parties during the nine month period ended September 30, 2017.
Liquidity and Capital Resources
We do not generate adequate revenue to satisfy our current operations, we have negative cash flows from operations, and we have incurred significant net operating losses during the nine month period ended September, 2017 and the year ended December 31, 2016, which raise substantial doubt about the Company's ability to continue as a going concern. The ability to continue as a going concern and appropriateness of using the going concern basis is dependent upon, among other things, additional cash infusion. We have historically obtained funds through private placement offerings of equity and debt, as well as, asset sales.
In late 2015, we raised approximately $1.7 million through a private placement of our Series A2 Preferred Stock. We have successfully negotiated extensions with some of our key notes payable holders resulting in extending the due dates of the notes. Since 2011, we have sold various interests in some of our oil and gas properties, which have resulted in aggregate net proceeds from these sales of $6,377,000. Still, our ability to continue as a going concern is dependent upon the ability to successfully accomplish our business plan and continue to secure other sources of financing and attain profitable operations. The Company continues to pursue additional sources of financing but there can be no assurance that such financing will be completed on terms favorable to the Company, if at all.
We had a working capital deficit as of September 30, 2017, and December 31, 2016, of $2.7 million and $1.4 million, respectively. The components of our working capital deficit at September 30, 2017, compared to December 31, 2016 were a decrease in our current assets by $102,530, primarily due to a decrease in our cash account, which was lower by $103,424. Our current liabilities increased by $1,157,214 compared to the prior year. This increase can be attributed primarily to our current portion of notes payable increasing due to maturities coming due within 12 months and an increase in trade accounts payable and related party accounts payable. These were offset with a decrease in accounts payable to DNR Oil and Gas, Inc.
We incurred negative cash flow of $174,413 from our operations during the nine month period ended September 30, 2017, compared to negative operating cash flow of $434,226 during the same period in the prior year, a decrease of $259,813 or 59.8%. This decrease in cash used in operating activities can be attributed to lower lease operating expenses, increased oil and gas revenues and the timing of our cash receipts and payments.
In the nine month period ended September 30, 2017 we had cash provided by investing activities of $149,850. This consisted of proceeds of $150,000 from the sale of oil and gas properties and expenditures of $150 for capital expenditures, which was related to the payment of some leasehold costs in which we own a very small working interest in. In the same period in 2016 we had cash used in investing activities of $373 for the payment of some leasehold interests in small working interest properties.
Financing activities used net cash of $78,861 during the nine month period ended September 30, 2017, which was related to the payment of $68,998 of dividends for our series A2 preferred stock, proceeds received on a note payable of $32,526, offset with principal payments of $42,389. We had $172,273 of net cash provided by financing activities for the nine month period ended September 30, 2016. We entered into a short-term note payable with an unrelated party for net proceeds of $25,500 to finance our D&O Insurance liability policy and additional notes of $225,000, we made principal payments on our debts in the amount of $137,248, we received $105,000 related to the A2 Preferred Stock issued during the prior year, as well as, receiving proceeds of $50,000 for an additional sale of 5 shares of our A2 Preferred Stock and paid $95,979 in dividends to our A2 Preferred Stock holders.
Off-Balance Sheet Arrangements
None
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
The Company is a "Smaller Reporting Company" and is not required to provide or disclose the information required by this item.
Item 4 - Controls and Procedures
As of June 30, 2017, our Chief Executive Officer and Chief Financial Officer (the "Certifying Officers") conducted evaluations of our disclosure controls and procedures. As defined under Sections 13a-15(e) and 15d-15(e) of the Exchange Act, the term "disclosure controls and procedures" means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including the Certifying Officers, to allow timely decisions regarding required disclosure.
Based on this evaluation, the Certifying Officers have concluded that our disclosure controls and procedures were not effective to ensure that material information is recorded, processed, summarized and reported by our management on a timely basis in order to comply with our disclosure obligations under the Exchange Act and the rules and regulations promulgated thereunder. As discussed in our Annual Report on Form 10-K for the year ended December 31, 2016, the ineffectiveness of our disclosure controls and procedures is due primarily to;
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our Board of Directors does not currently have any independent members that qualify as an audit committee financial expert,
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we have not developed and effectively communicated our accounting policies and procedures,
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our documentation of transaction in certain circumstances is not timely due to our limited staff and resources,
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our controls over financial statement disclosures were determined to be ineffective, including deficiencies in the preparation of the disclosure checklist and
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we do not maintain adequate and effective internal controls over our reserve estimation process as well as the underlying data upon which reserve estimates are based. The primary inputs to the reserve estimation process are technical information, financial data, ownership interest, and production data. The relevant field and reservoir technical information, which is updated annually, is assessed for validity when our independent petroleum engineering firm has technical meetings with our officers
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We have not maintained a tax basis property roll-forward and we have not filed tax returns since 2011 and therefore the tax assets disclosed are managements best estimate and this estimate could change as the company completes it tax returns. There were no changes in internal control since December 1, 2016.
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PART II - OTHER INFORMATION
Item 1 - Legal Proceedings.
From time to time, the Company is a party to routine litigation and proceedings that are considered part of the ordinary course of its business. On September 30, 2016 plaintiff Eric Langan et al. filed a complaint in Maricopa County Superior Court for common law fraud under Arizona law against Arête Industries, Inc., Don and Jane Doe Prosser, and Charles and Jane Doe Davis. The action was removed to federal court on November 17, 2016, civil action number 16 – 03994 – PHX – SPL. On September 1, 2017 a judgment was entered in favor of the defendants and against plaintiffs and the case was dismissed in its entirety for lack of personal jurisdiction.
We are unaware of any other dispute which might lead to future litigation.
Item 1A - Risk Factors.
There have been no material changes to the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC on December 1, 2017. The risk factors in our Annual Report on Form 10-K for the year ended December 31, 2016, in addition to the other information set forth in this quarterly report, could materially affect our business, financial condition or results of operations. Additional risks and uncertainties not currently known to us or that we deem to be immaterial could also materially adversely affect our business, financial condition or results of operations.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds.
None
Item 3 - Defaults upon Senior Securities.
None
Item 4 - Mine Safety Disclosures.
Not Applicable
Item 5 - Other Information.
None
Item 6 - Exhibits
The following documents are filed as exhibits to this report on Form 10-Q or incorporated by reference herein.
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The following materials are filed herewith: (i) XBRL Instance, (ii) XBRL Taxonomy Extension Schema, (iii) XBRL Taxonomy Extension Calculation, (iv) XBRL Taxonomy Extension Labels, (v) XBRL Taxonomy Extension Presentation, and (vi) XBRL Taxonomy Extension Definition. In accordance with Rule 406T of Regulation S-T, the information in these exhibits is furnished and deemed not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Exchange Act of 1934, and otherwise is not subject to liability under these sections and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by the specific reference in such filing.
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ARÊTE INDUSTRIES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
By:
/s/ Nicholas Scheidt, CEO
Nicholas L Scheidt, Principal Executive Officer
Dated: March 29, 2018
By:
/s/ Tristan R. Farel
Tristan R Farel, Chief Financial Officer
Dated: March 29, 2018