PEDEVCO CORP. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context and reporting period
PEDEVCO is an oil and gas company focused on legacy properties in the Permian Basin of New Mexico and the D-J Basin of Colorado. In August, it acquired approximately 23,441 net Permian Basin acres and producing assets, and acquired Condor, adding approximately 2,340 net D-J Basin acres and four operated producing wells. At September 30, it reported approximately 23,441 net Permian acres and 11,957 net D-J Basin acres.
In June, the company completed a major debt restructuring and changed its senior leadership and board. CEO Simon Kukes is also the owner and controller of its principal lender, SK Energy.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Oil and gas revenue | $1.259 | $0.744 | $2.801 | $2.290 |
| Operating income (loss) | $(2.236) | $(1.374) | $(4.098) | $(3.602) |
| Interest expense | $0.497 | $3.231 | $6.888 | $9.489 |
| Net income (loss) | $(2.733) | $(4.605) | $59.323 | $(13.091) |
| Basic earnings (loss) per share | $(0.19) | $(0.76) | $6.04 | $(2.28) |
- Nine-month 2018 net income included a $70.309 million gain on debt restructuring. It was a one-time, noncash gain; excluding it, the reported net loss was approximately $11.0 million.
- Q3 lease operating costs were $0.936 million, up from $0.304 million; SG&A was $1.622 million, up from $0.511 million. Management cited workovers, higher production-related costs, new hires, and acquisition-related expenses. Q3 depreciation, depletion, amortization and accretion was $0.937 million versus $1.299 million.
- Q3 oil volume increased to 18,870 barrels from 13,657, while reported total volume equivalent declined to 25,605 Boe from 37,606 Boe. Nine-month total volume equivalent was 57,319 Boe versus 79,674 Boe. The filing attributes revenue growth mainly to higher oil volumes and acquired properties; total volumes were affected by lower gas and NGL volumes.
- At September 30, cash was $0.460 million and restricted cash was $2.316 million, held for New Mexico plugging and abandonment bonds. Current assets were $3.826 million, current liabilities $2.590 million, and working capital $1.2 million. Total assets were $58.893 million, total liabilities $36.668 million, and shareholders’ equity $22.225 million.
- Notes payable totaled approximately $31.1 million, including $23.2 million of related-party subordinated notes, $7.527 million net of discount under the SK Energy note, and $0.4 million of other subordinated notes. Total liabilities also include accrued expenses, revenue payable, and asset retirement obligations.
- Nine-month cash used in operations was $0.704 million; investing cash use was $19.911 million, mainly for oil and gas properties; financing provided $22.474 million. Cash and restricted cash together ended the period at $2.776 million.
Material changes versus the prior comparable period
- Revenue increased 69% in Q3 and 22% for the first nine months, while Q3 net loss narrowed by $1.872 million, largely because interest expense fell after the restructuring.
- The June restructuring retired approximately $78.3 million of debt and accrued interest for cash payments and new debt, producing a $70.309 million gain. The company reported liabilities of $36.7 million at September 30 versus $73.5 million at year-end 2017.
- Oil and gas properties, net, increased to $54.877 million from $34.922 million at year-end 2017, reflecting acquisitions and other additions. Common shares outstanding increased to 15.109 million from 7.279 million, principally including conversion of Series A preferred stock into 6.663 million common shares.
Outlook, risks, contingencies and unusual items
- Management outlined a combined 2018–2019 capital budget of $50–$60 million. The Permian plan calls for $45–$50 million for four initial horizontal wells, followed by up to 12 additional wells through 2019 depending on results and funding. The D-J Basin plan was under evaluation and projected to require $5–$10 million.
- Management said it expected sufficient funding for the foreseeable future from operating cash flow, cash on hand, potential SK Energy loans, and additional funding verbally committed by SK Energy through 2019 if attractive outside funding is unavailable. The commitment is subject to mutually agreed terms; the filing cautions that financing may not be available on favorable terms, or at all. The company may defer drilling into 2020.
- After quarter-end, PEDEVCO borrowed another $7.0 million from SK Energy under an 8.5% convertible note due October 2021, convertible at $1.79 per share subject to a 49.9% ownership cap. It also converted $167,000 of accrued interest on the June SK Energy note into 75,118 common shares. The August $23.6 million convertible notes also bear 8.5% interest and mature in 2021.
- Key risks include dependence on related-party financing, potential dilution from convertible notes, execution and funding of the drilling plan, uncertain well results and costs, commodity-price exposure, concentration in two basins, infrastructure and service constraints, water production, environmental and regulatory requirements, and possible conflicts of interest. Restricted cash is not freely available for general liquidity.
- Management concluded disclosure controls and procedures were not effective as of September 30. The company reported no material legal proceedings and no material changes to previously disclosed risk factors, other than updates relating to additional convertible debt and management conflicts.
Most important facts for investors to verify
- Whether the stated SK Energy funding support is documented and available on acceptable terms, and whether it can cover the planned capital program and debt service.
- Conversion terms, potential share issuance and dilution under the June, August and October notes, including the different conversion prices and ownership limits.
- Results, timing, costs and funding of the initial Permian horizontal wells, and whether they support the planned additional development.
- Underlying operating performance excluding the restructuring gain, including production trends, lease operating costs and operating cash flow.
- Reasons for ineffective disclosure controls and the company’s progress toward remediation.