PEDEVCO CORP quarterly report, Q2 FY2018

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PEDEVCO CORP. — Q2 2018 Form 10-Q

Reporting period: Three and six months ended June 30, 2018. Unaudited consolidated financial statements; amounts below are in U.S. dollars unless stated otherwise.

Business context

PEDEVCO is an oil and gas exploration and production company focused on its Denver-Julesburg Basin assets in Weld County, Colorado. At June 30, it reported approximately 9,607 net acres and interests in 62 gross (17.4 net) wells. Its strategy centers on developing those assets and seeking additional acreage and acquisitions.

Financial performance and position

  • Revenue: Q2 oil and gas sales were $898,000, up 11% from $812,000 a year earlier. First-half sales were $1.542 million, approximately flat with $1.546 million in 2017. Management attributed Q2 growth mainly to higher oil prices, partly offset by lower production; first-half revenue was similarly affected by price gains and lower volumes.
  • Production: Q2 production was 17,451 BOE versus 20,421 BOE; first-half production was 31,714 BOE versus 35,419 BOE. Management cited natural well declines and periodic shut-ins.
  • Operating results: Q2 operating loss was $864,000 versus $1.152 million; first-half operating loss was $1.862 million versus $2.228 million. Q2 SG&A was $616,000 (down $78,000), and DD&A was $701,000 (down $172,000). First-half SG&A was $1.354 million (down $140,000), and DD&A was $1.283 million (down $270,000).
  • Net income: Q2 net income was $66.290 million versus a $4.314 million loss; first-half net income was $62.056 million versus an $8.486 million loss. The 2018 profit primarily reflects a one-time, noncash $70.309 million gain from debt restructuring. Interest expense was $3.155 million for Q2 and $6.391 million for the first half.
  • Cash flow: First-half operating cash use was $276,000, compared with $233,000 in 2017. Investing cash flow was nil. Financing cash use was $95,000, versus $465,000 provided in the prior-year period. Cash declined to $546,000 from $917,000 at year-end.
  • Liquidity and debt: Current assets were $1.322 million and current liabilities $1.282 million, leaving working capital of less than $100,000. Total liabilities fell to $9.299 million from $73.541 million; shareholders’ equity improved to $25.772 million from a $37.140 million deficit. The June restructuring retired substantial legacy debt for discounted cash payments, producing the reported gain. PEDEVCO borrowed $7.7 million from related-party lender SK Energy at 8% annual interest; the note is due June 25, 2021 and interest may be paid in cash or shares, subject to terms and a share cap.
  • Margins: Gross profit and a specific operating-margin percentage are not presented in the filing text.

Material changes and unusual items

  • In June, PEDEVCO settled Tranche A and junior debt with aggregate stated balances of approximately $77.6 million for approximately $7.7 million in cash, and settled $475,000 of Bridge Note principal for $119,000. The company reported approximately $70.7 million of net liabilities removed and a $70.309 million gain, net of warrant issuance expense.
  • As part of the restructuring, the company issued 1,448,472 warrants to certain junior noteholders, with a three-year term and an exercise price reported as approximately $0.32 per share. It also issued SK Energy 600,000 common shares in connection with its loan.
  • After quarter-end, SK Energy converted all Series A preferred shares into 6,662,500 common shares. Together with the loan shares, SK Energy’s ownership was reported at approximately 49.9%. Dr. Simon Kukes became CEO and a director in July; Frank Ingriselli remained President and Chairman.
  • NYSE American notified the company on June 29 that it had regained compliance with continued-listing standards.

Outlook, risks and contingencies

  • Management planned up to $8.37 million of 2018 capital expenditures, including approximately 2.1 net wells, and an additional 6.4 net wells in 2019; the combined 2018–2019 drilling budget was $34.85 million. The filing states that none of the 2018 budget had been spent as of the date discussed.
  • Funding for the plan was not fully in place. Potential sources included operating cash flow, cash on hand, up to $1.359 million remaining under the at-the-market offering (subject to SEC limitations), and possible additional financing from SK Energy. The company and SK Energy were negotiating possible further funding, but no definitive agreement existed and SK Energy had no obligation to provide it. Management said spending could be deferred into 2020 if financing or market conditions were unfavorable.
  • Management stated that planned funding sources were expected to meet needs over the next 12 months and that prior substantial doubt about going concern had been alleviated. That expectation depends on financing and operating assumptions; the filing warns funding may be unavailable or unfavorable and that a shortfall could impair operations.
  • Risks include the SK Energy note’s default provisions, potential dilution from stock-paid interest and outstanding options and warrants, and potential conflicts because SK Energy is both lender and controlled by the CEO. The CEO’s approximately 49.9% ownership gives him significant influence over shareholder matters.
  • Sales to one customer represented 66% of first-half 2018 oil and gas revenue, versus 56% in 2017. The company reported no material pending legal proceedings and no material change to previously disclosed risk factors, apart from updates described in the filing.
  • Management concluded disclosure controls and procedures were not effective as of June 30, 2018. The company reported no material changes in internal control over financial reporting during the quarter.

Important facts for investors to verify

  • Whether the planned drilling program can be funded, including the status and terms of any further SK Energy financing and the remaining ATM capacity.
  • The company’s normalized operating performance and cash generation excluding the one-time debt-restructuring gain.
  • Debt-note maturity, payment terms, covenant/default exposure, and the extent of possible share issuance for interest.
  • Potential dilution and trading effects from SK Energy’s ownership, outstanding warrants and options, and registered shares available for resale.
  • Progress addressing ineffective disclosure controls, and the effect of declining production, customer concentration, and lease expirations on future operations.