As
filed with the Securities and Exchange Commission on October 13, 2020
Registration
Statement No. 333-
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
S-4
REGISTRATION
STATEMENT
UNDER
THE
SECURITIES ACT OF 1933
PEDEVCO
CORP.
(Exact
name of Registrant as specified in its charter)
|
|
|
|
|
Texas
|
|
1311
|
|
22-3755993
|
(State
or other jurisdiction of
incorporation or organization)
|
|
(Primary
Standard Industrial
Classification Code Number)
|
|
(I.R.S.
Employer
Identification Number)
|
575
N. Dairy Ashford
Energy
Center II, Suite 210
Houston,
Texas 77079
(713)
221-1768
(Address,
including zip code, and telephone number, including area code, of Registrants’ principal executive offices)
Dr.
Simon G. Kukes
Chief
Executive Officer
PEDEVCO
Corp.
575
N. Dairy Ashford
Energy
Center II, Suite 210
Houston,
Texas 77079
(713)
221-1768
(Name,
address, including zip code, and telephone number, including area code, of agent for service)
Copy
to:
Clint
Smith
Jones
Walker LLP
201
St. Charles Avenue, Suite 5100
New
Orleans, LA 70170
(504)
582-8429
Approximate
date of commencement of proposed sale of the securities to the public: As soon as practicable after this registration statement
becomes effective and upon completion of the transactions described in the enclosed offer to exchange.
If
the securities being registered on this Form are being offered in connection with the formation of a holding company and there
is compliance with General Instruction G, check the following box. ☐
If
this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the
following box and list the Securities Act registration statement number of the earlier effective registration statement for the
same offering. ☐
If
this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list
the Securities Act registration statement number of the earlier effective registration statement for the same offering. ☐
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting
company, or 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:
Large
accelerated filer ☐
|
|
|
|
Accelerated
filer ☐
|
Non-accelerated
filer ☒
|
|
Smaller
reporting company ☒
|
|
|
|
|
Emerging
growth company ☐
|
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 7(a)(2)(B) of the Securities Act.
☐
If
applicable, place an X in the box to designate the appropriate rule provision relied upon in conducting this transaction:
Exchange
Act Rule 13e-4(i) (Cross-Border Issuer Tender Offer) ☐
Exchange
Act Rule 14d-1(d) (Cross-Border Third-Party Tender Offer) ☐
CALCULATION
OF REGISTRATION FEE
Title
of Each Class of Securities to be Registered
|
|
Amount
to be
registered
|
|
Proposed
maximum
offering price per share
|
|
Proposed
maximum
aggregate offering price
|
|
Amount
of
registration fee
|
Common
Stock, par value $0.001 per share
|
|
21,000,000(1)
|
|
N/A
|
|
$23,520,000.00(2)
|
|
$2,567(3)
|
|
(1)
|
Represents
the maximum number of shares of common stock, $0.001 par value per share, of PEDEVCO
Corp. (“PEDEVCO”), estimated to be issuable upon completion of the offer
and second-step merger.
|
|
(2)
|
Pursuant
to Rule 457(c) and Rule 457(f) under the Securities Act of 1933, as amended (the “Securities
Act”), and solely for the purpose of calculating the registration fee, the market
value of the securities to be received was calculated as the product of: (1) 52,500,000
common units of beneficial interest (“Trust Common Units”) of SandRidge Permian
Trust (the “Trust”) being the number of outstanding Trust Common Units as
reported on the cover page of the Trust’s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2020, and (2) the last sale price as reported on OTC Pink Market
on October 6, 2020 ($0.4610).
|
|
(3)
|
Computed
in accordance with Rule 457(f) under the Securities Act and Fee Rate Advisory No. 1 for
fiscal Year 2021 to be $2,567, which is equal to 0.0001091 multiplied by the proposed
maximum aggregate offering price of $23,520,000.00.
|
The
Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until
the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become
effective in accordance with Section 8(a) of the Securities Act or until this registration statement shall become effective on
such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.
THE
INFORMATION IN THIS OFFER TO EXCHANGE MAY CHANGE. WE MAY NOT COMPLETE THE OFFER AND ISSUE THESE SECURITIES UNTIL THE REGISTRATION
STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS OFFER TO EXCHANGE IS NOT AN OFFER TO SELL THESE
SECURITIES AND WE ARE NOT SOLICITING OFFERS TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER IS NOT PERMITTED.
Offer
to Exchange
Each
Outstanding Trust Common Unit
of
SandRidge
Permian Trust
for
4/10ths
of One Share of Common Stock of PEDEVCO CORP.,
subject
to the procedures described in this offer to
exchange and the related letter of transmittal,
by
SRPT
Acquisition, LLC,
a
wholly owned subsidiary
of
PEDEVCO
CORP.
|
THE
OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME,
ON NOVEMBER 30, 2020, UNLESS THE OFFER IS EXTENDED.
|
SRPT
Acquisition, LLC, Texas limited liability company (“Purchaser”) and a wholly owned subsidiary of PEDEVCO Corp., a
Texas corporation (“PEDEVCO,” “we,” “us” or “our”), hereby offers, upon the terms
and subject to the conditions set forth in this offer to exchange and in the related letter of transmittal, to exchange each issued
and outstanding common unit of beneficial interest (“Trust Common Unit”), of SandRidge Permian Trust (the “Trust”),
for 4/10ths of one share of common stock of PEDEVCO, par value $0.001 per share (the “PEDEVCO Common Stock”), which
we refer to as the “Consideration,” subject to the procedures described in this offer to exchange and in the related
letter of transmittal.
The
purpose of the offer is for PEDEVCO to acquire all of the outstanding Trust Common Units in order to combine the businesses of
PEDEVCO and the Trust. PEDEVCO intends, promptly after consummation of the offer and satisfaction of the conditions in the Trust’s
trust agreement (the “Trust Agreement”), including the Trustee’s consent, which is a condition to this offer,
to cause the Trust to merge with Purchaser (the “second-step merger”) after which the Trust would be a direct or indirect,
wholly owned subsidiary of PEDEVCO.
THE
OFFER IS SUBJECT TO THE CONDITIONS SET FORTH IN THE SECTION OF THIS OFFER TO EXCHANGE TITLED “THE OFFER—CONDITIONS
TO THE OFFER.” These include the Minimum Tender Condition, the Trustee Consent Condition, the PEDEVCO Shareholder Approval
Condition, the Government Approval Condition, the No Trust Material Adverse Effect Condition and the other conditions set forth
in the section of this offer to exchange titled “The Offer—Conditions to the Offer.”
PEDEVCO
Common Stock trades on the NYSE American under the symbol “PED.” Prior to September 9, 2020, the Trust Common Units
traded on the New York Stock Exchange under the symbol “PER”. On and after September 9, 2020, the Trust Common Units
are traded on the OTC Pink Market under the symbol “PERS.”
The
trustee of the Trust (the “Trustee”), has declined to enter into discussions with PEDEVCO regarding the offer, indicating
that the Trust Agreement does not authorize the Trustee to enter into an arrangement with an offeror or with respect to a negotiated
exchange offer or tender offer for the outstanding Trust Common Units. PEDEVCO remains willing to negotiate with the Trust with
respect to a combination of PEDEVCO and the Trust. However, in light of the Trustee’s indicated inability to negotiate with
PEDEVCO, and because PEDEVCO believes that holders of Trust Common Units should nevertheless be entitled to make their own decision
with respect to an exchange offer, PEDEVCO is making the offer directly to holders of Trust Common Units upon the terms and subject
to the conditions set forth in this offer to exchange as an alternative to a negotiated transaction. See the section of this offer
to exchange titled “Background of the Offer.”
See
the section of this offer to exchange titled “Risk Factors” beginning on page 20 for a discussion of various factors
that you should consider about the offer.
Neither
the Securities and Exchange Commission (the “SEC”) nor any state securities commission or regulatory authority has
approved or disapproved of these securities or passed upon the adequacy or accuracy of this offer to exchange. Any representation
to the contrary is a criminal offense.
The
date of this offer to exchange is October 13, 2020
This
offer to exchange incorporates important business and financial information about PEDEVCO and the Trust from documents filed with
the SEC that have not been included in, or delivered with, this offer to exchange. This information is available on the SEC’s
website at http://www.sec.gov and from other sources. See the section of this offer to exchange titled “Where You Can Find
More Information”.
You
may also request copies of these documents from us, without charge, upon written or oral request to our information agent, InvestorCom,
19 Old Kings Highway S. – Suite 210, Darien, CT 06820, Toll Free (877) 972-0090 (Banks and Brokers call collect (203) 972-9300),
or info@investor-com.com.
In
order to receive timely delivery of the documents, you must make requests no later than five business days before the scheduled
expiration date of the offer, as it may be extended from time to time.
TABLE
OF CONTENTS
QUESTIONS
AND ANSWERS ABOUT THE OFFER
The
following are some of the questions you, as a holder of Trust Common Units, may have and answers to those questions. These questions
and answers, as well as the following summary, are not meant to be a substitute for the information contained in the remainder
of this offer to exchange and the related letter of transmittal, and this information is qualified in its entirety by the more
detailed descriptions and explanations contained in this offer to exchange and in the letter of transmittal, which we refer to
together as the offer. We urge you to read both documents in their entirety prior to making any decision as to your Trust Common
Units.
Q:
|
|
WHO
IS OFFERING TO ACQUIRE MY TRUST COMMON UNITS?
|
A:
|
|
The offer is being
made by PEDEVCO through Purchaser, a wholly owned subsidiary of PEDEVCO formed for the purpose of making this offer. PEDEVCO
is an oil and gas company focused on the acquisition and development of oil and natural gas assets where the latest in modern
drilling and completion techniques and technologies have yet to be applied. In particular, PEDEVCO focuses on legacy proven
properties where there is a long production history, well defined geology and existing infrastructure that can be leveraged
when applying modern field management technologies. PEDEVCO’s current properties are located in the San Andres formation
of the Permian Basin situated in West Texas and Eastern New Mexico, which we refer to as the Permian Basin, and in the Denver-Julesberg
Basin in Colorado, which we refer to as the D-J Basin.
|
Q:
|
|
WHAT ARE THE
CLASSES AND AMOUNTS OF TRUST COMMON UNITS PEDEVCO IS OFFERING TO EXCHANGE IN THE OFFER?
|
A:
|
|
PEDEVCO is seeking
to acquire all of the issued and outstanding Trust Common Units.
|
Q:
|
|
WHAT WILL I RECEIVE
FOR MY TRUST COMMON UNITS?
|
A:
|
|
PEDEVCO
is offering to exchange each of the issued and outstanding Trust Common Units for the Consideration set forth on the cover
page of this offer to exchange subject, in each case, to the procedures described in this offer to exchange and in the related
letter of transmittal. PEDEVCO will not allot or issue fractional PEDEVCO Common Stock to holders of Trust Common Units who
accept the offer. To the extent that you would be entitled to fractional shares, those fractional entitlements will be aggregated
and, if a fractional share results from such aggregation, you will be entitled to receive, in lieu of such fractional share,
an amount in cash determined by multiplying the fractional share by a price equal to the average of the closing prices of
PEDEVCO Common Stock on the NYSE American on each of the five NYSE American trading days ending on the 10th business day prior
to the date of expiration of the offer.
|
Q:
|
|
WILL I HAVE TO
PAY ANY FEES OR COMMISSIONS TO EXCHANGE TRUST COMMON UNITS?
|
A:
|
|
If you are the owner
of record of your Trust Common Units and you tender your Trust Common Units directly to American Stock Transfer & Trust
Company, LLC, the exchange agent for the offer (“AST”), you will not have to pay brokerage fees, commissions or
incur similar expenses. If you own your Trust Common Units through a broker, dealer, commercial bank, trust company or other
nominee, and your broker, dealer, commercial bank, trust company or other nominee tenders the Trust Common Units on your behalf,
your broker or such other nominee may charge you a fee for doing so. You should consult your broker, dealer, commercial bank,
trust company or other nominee to determine whether any charges will apply.
|
Q:
|
|
WHAT IS THE PURPOSE
OF THE OFFER?
|
A:
|
|
The purpose of the
offer is for PEDEVCO to acquire all of the outstanding Trust Common Units in order to combine the business of PEDEVCO and
the Trust. PEDEVCO intends, promptly after consummation of the offer and satisfaction of the conditions in the Trust Agreement,
including the Trustee’s consent which is a condition to this offer, to cause the Trust to merge with Purchaser, which
we refer to as the second-step merger, after which the Trust would be a direct or indirect wholly owned subsidiary of PEDEVCO.
The purpose of the second-step merger is for PEDEVCO to acquire all issued and outstanding Trust Common Units that are not
acquired in the offer. In the second-step merger, each remaining Trust Common Unit (other Trust Common Units held by PEDEVCO
and its subsidiaries) will be cancelled and converted into the right to receive the Consideration. After the second-step merger,
PEDEVCO will own all of the issued and outstanding Trust Common Units. See the sections of this offer to exchange titled “The
Offer—Purpose of the Offer; Second-Step Merger”; “The Offer—Statutory Requirements; Approval of the
Second-Step Merger”; and “The Offer—Plans for the Trust.”
|
Q:
|
|
HAVE YOU DISCUSSED
THE OFFER WITH THE TRUSTEE?
|
A:
|
|
The
Trustee has declined to enter into discussions with PEDEVCO regarding the offer, and has stated that the Trust Agreement
does not authorize the Trustee to enter into an arrangement with an offeror or with respect to a negotiated exchange offer
or tender offer for the outstanding Trust Common Units. PEDEVCO has continued to express a desire to enter into a negotiated
business combination with the Trust and remains willing to negotiate with the Trust with respect to a combination of PEDEVCO
and the Trust. However, in light of the Trustee’s indicated inability to negotiate with PEDEVCO, and because PEDEVCO
believes that holders of Trust Common Units should be entitled to make their own decision with respect to an exchange
offer, PEDEVCO is making the offer directly to holders of Trust Common Units upon the terms and subject to the conditions
set forth in this offer to exchange as an alternative to a negotiated transaction. See the section of this offer to exchange
titled “Background of the Offer”.
Within
ten business days after the date of this offer to exchange, the Trustee is required by law to publish, send or give to
you (and file with the SEC) a statement as to whether it recommends acceptance or rejection of the offer, that it has
no opinion with respect to the offer, or that it is unable to take a position with respect to the offer.
|
Q:
|
|
WHY IS PEDEVCO
MAKING THE OFFER?
|
A:
|
|
PEDEVCO
believes that the combination of PEDEVCO and the Trust represents a financially and strategically compelling, value-creating
opportunity for both PEDEVCO stockholders and holders of Trust Common Units. PEDEVCO believes that the value that could
be created by combining PEDEVCO and the Trust significantly outweighs—and is incremental to—anything holders
of Trust Common Units may realize by remaining a holder of Trust Common Units. PEDEVCO believes the offer is the best
available option for holders of Trust Common Units to maximize the value of their investment while retaining potential
upside.
See
the section of this offer to exchange titled “Reasons for the Offer” for more information on these anticipated
benefits.
|
Q:
|
|
WILL I BE TAXED
ON THE PEDEVCO COMMON STOCK THAT I RECEIVE IN THE OFFER AND THE SECOND-STEP MERGER?
|
A:
|
|
The
offer and the second-step merger will be taxable transactions for U.S. federal income tax purposes. U.S. holders of Trust
Common Units will generally recognize gain or loss equal to the difference, if any, between (1) the sum of the fair market
value of PEDEVCO Common Stock received by such U.S. holder in the offer and the second-step merger and cash received in
lieu of fractional shares and (2) such U.S. holder’s adjusted tax basis in the Trust Common Units surrendered in
exchange therefor.
Any
gain or loss recognized upon the offer or the second-step merger generally will be treated as a capital gain or loss.
However, a portion of this gain or loss, which could be substantial, will be separately computed and taxed as ordinary
income or loss under Section 751 of the Internal Revenue Code of 1986, as amended (the “Code”) to the extent
attributable to “unrealized receivables,” including depreciation recapture, or to “inventory items”
owned by the Trust. Passive losses that were not deductible by a U.S. holder in prior taxable periods because they exceeded
a U.S. holder’s share of the Trust’s income may become available to offset a portion of the gain recognized
by such U.S. holder.
The
U.S. federal income tax consequences of the offer and the second-step merger to a U.S. holder of Trust Common Units will
depend on such U.S. holder’s own personal tax situation. Accordingly, you are strongly urged to consult your tax
advisor for a full understanding of the particular tax consequences of the offer and the second-step merger to you.
For
a more complete description of the tax consequences of the offer and the second step-merger, see the section of this offer
to exchange titled “The Offer—Material U.S. Federal Income Tax Consequences.”
|
Q:
|
|
WHEN DO YOU EXPECT
THE OFFER TO BE COMPLETED?
|
A:
|
|
The
timing for consummation of the offer and the second-step merger will depend on the satisfaction of the conditions to the offer.
As a result, there can be no certainty as to when, and whether, PEDEVCO will be able to complete the offer.
|
Q:
|
|
WHAT ARE THE
CONDITIONS TO THE OFFER?
|
A:
|
|
The offer is subject
to a number of conditions, including the Minimum Tender Condition, the Trustee Consent Condition, the PEDEVCO Shareholder
Approval Condition, the Government Approval Condition, the No Trust Material Adverse Effect Condition and the other conditions
set forth in the section of this offer to exchange titled “The Offer—Conditions to the Offer.”
|
Q:
|
|
DO
I NEED TO VOTE AT ANY MEETING TO APPROVE THE OFFER OR THE SECOND-STEP MERGER?
|
A:
|
|
Your vote is not
required in connection with the offer. You simply need to tender your Trust Common Units, if you choose to do so. In the event
that PEDEVCO accepts Trust Common Units for exchange in the offer, PEDEVCO intends to acquire the Trust in its entirety pursuant
to the second-step merger. If the conditions to the offer are satisfied and PEDEVCO accepts Trust Common Units for exchange,
PEDEVCO does not believe that a vote of the holders of Trust Common Units will be necessary to complete the second-step merger
as PEDEVCO, as a holder of a majority of the Trust Common Units, believes it would be able to approve the second-step merger
through a written consent in lieu of a special meeting. Please see “Risk Factors— Risk Factors Relating to the
Offer and the Second-Step Merger—If PEDEVCO completes the exchange offer in accordance with the Minimum Tender Condition
and Trustee Consent Condition, it believes it will be able to approve the second-step merger without a vote of holders of
Trust Common Units who did not accept the exchange offer.”
|
Q:
|
|
HOW DOES THE
OFFER RELATE TO PEDEVCO’S WRITTEN CONSENT IN LIEU OF A SPECIAL MEETING OF SHAREHOLDERS?
|
A:
|
|
Because
PEDEVCO’s shares are listed on the NYSE American, PEDEVCO must comply with the shareholder approval requirements
for the issuance of PEDEVCO Common Stock found in the NYSE American Company Guide (the “NYSE Guide”). Section
712 of the NYSE Guide requires shareholder approval as a prerequisite to list additional shares issued as sole or partial
consideration for an acquisition of the stock of another company where the present or potential issuance of common stock,
or securities convertible into common stock, could result in an increase in outstanding common stock of 20% or more.
As
of October 13, 2020, directors, executive officers and their affiliates held approximately 63,759,778 issued and outstanding
shares of PEDEVCO Common Stock, representing 88% of the voting power of the issued and outstanding PEDEVCO Common Stock.
PEDEVCO’s Bylaws provide that any action that may be taken at a special meeting of PEDEVCO stockholders may be taken
without a meeting without prior notice and without a vote, if a consent in writing setting forth the action so taken is
signed by holders of PEDEVCO Common Stock representing at least the minimum number of votes that would be necessary to
take the action at a meeting in which each stockholder entitled to vote on the action is present and votes. The written
consent of certain shareholders of PEDEVCO in lieu of a special meeting will be used to approve the issuance of PEDEVCO
Common Stock in connection with the offer and the second-step merger. Accordingly, PEDEVCO expects to file a preliminary
information statement promptly after the date of this offer to exchange for the approval of the issuance of shares in
the exchange offer and second-step merger by shareholders by written consent in lieu of a special meeting. You do not
need to take any action with respect to the written consent in lieu of a special meeting.
|
Q:
|
|
IS PEDEVCO’S
FINANCIAL CONDITION RELEVANT TO MY DECISION TO TENDER MY TRUST COMMON UNITS IN THE OFFER?
|
A:
|
|
Yes.
Trust Common Units accepted in the offer will be exchanged for PEDEVCO Common Stock and therefore you should consider PEDEVCO’s
financial condition before you decide to become a PEDEVCO shareholder by accepting the offer. You also should consider the
effect that the proposed acquisition of the Trust may have on PEDEVCO’s financial condition. In considering PEDEVCO’s
financial condition, you should review the documents, including the financial statements, included in this offer to exchange,
as well as the unaudited pro forma condensed combined financial information set forth under the section of this offer to exchange
titled “Unaudited Pro Forma Condensed Combined Financial Statements,” because they contain detailed business,
financial and other information about PEDEVCO.
|
Q:
|
|
DOES PEDEVCO
HAVE THE COMMON STOCK NECESSARY TO COMPLETE THE OFFER AND THE SECOND-STEP MERGER?
|
A:
|
|
Yes.
PEDEVCO’s Certificate of Formation authorizes 200,000,000 shares of PEDEVCO Common Stock. As of October 13, 2020, there
were 72,463,340 shares of Common Stock issued and outstanding. At the proposed exchange ratio of 4/10ths of one share of
PEDEVCO Common Stock for each Trust Common Unit, PEDEVCO would issue 21,000,000 shares of PEDEVCO Common Stock. See the
section of this offer to exchange titled “The Offer—Financing of the Offer”
|
Q:
|
|
WHAT PERCENTAGE
OF PEDEVCO’S COMMON STOCK WILL FORMER HOLDERS OF TRUST COMMON UNITS OWN AFTER THE OFFER?
|
A:
|
|
PEDEVCO estimates
that, upon consummation of the offer and the second-step merger, former holders of Trust Common Units will own, in the aggregate,
approximately 22.5% of the issued and outstanding PEDEVCO Common Stock (approximately 22.1% on a fully diluted basis) as a result
of having been holders of Trust Common Units. For a more detailed discussion of the assumptions on which this estimate is based,
see the section of this offer to exchange
|
|
|
titled “The
Offer—Ownership of PEDEVCO After the Offer.”
|
Q:
|
|
WHEN DOES THE
OFFER EXPIRE?
|
A:
|
|
The offer is scheduled
to expire at 5:00 p.m., New York City time, on November 30, 2020, which we refer to as the expiration time, unless further
extended by PEDEVCO, in which case the expiration time will be the latest time and date on which the offer, as so extended,
expires. We refer to such time, as it may be extended, as the expiration time, and the date on which the expiration time occurs
as the expiration date. For more information, you should read the discussion under the section of this offer to exchange titled
“The Offer—Extension, Termination and Amendment.”
|
Q:
|
|
CAN THE OFFER
BE EXTENDED AND, IF SO, UNDER WHAT CIRCUMSTANCES?
|
A:
|
|
PEDEVCO may, in
its sole discretion, at any time or from time to time until 9:00 a.m., New York City time, on the first business day after
the previously scheduled expiration time, extend the offer to a later expiration date and time. For instance, the offer may
be extended if any of the conditions specified in “The Offer—Conditions to the Offer” are not satisfied
prior to the scheduled expiration time. The expiration time of the offer may be subject to multiple extensions. Any decision
to extend the offer, and if so, for how long, will be made by PEDEVCO. Any decision by PEDEVCO to extend the offer will be
made public by an announcement regarding such extension as described in the section of this offer to exchange titled “The
Offer—Extension, Termination and Amendment.”
|
Q:
|
|
HOW DO I TENDER
MY TRUST COMMON UNITS?
|
A:
|
|
In order for a holder
of Trust Common Units to validly tender Trust Common Units pursuant to the offer, the exchange agent must receive prior to
the expiration time the letter of transmittal (or a manually signed facsimile thereof), properly completed and duly executed,
together with any required signature guarantees or, in the case of a book-entry transfer, an Agent’s Message (as defined
in the section of this offer to exchange titled “The Offer—Exchange of Trust Common Units; Delivery of PEDEVCO
Common Stock”), and any other documents required by the letter of transmittal, at its address set forth on the back
cover of this offer to exchange and either (1) the certificates representing tendered Trust Common Units must be received
by the exchange agent at such address or such Trust Common Units must be tendered pursuant to the procedure for book-entry
transfer and a book-entry confirmation must be received by the exchange agent (including an Agent’s Message), in each
case prior to the expiration time, or (2) the tendering holder of Trust Common Units must comply with the guaranteed delivery
procedures described in this offer to exchange. For a complete discussion on the procedures for tendering your Trust Common
Units, see the section of this offer to exchange titled “The Offer—Procedure for Tendering.”
|
Q:
|
|
UNTIL WHAT TIME
CAN I WITHDRAW TENDERED TRUST COMMON UNITS?
|
A:
|
|
You may withdraw
previously tendered Trust Common Units any time prior to the expiration time, and, if PEDEVCO has not accepted your Trust
Common Units for exchange after the expiration time, at any time following 60 days from commencement of the offer.
|
Q:
|
|
HOW DO I WITHDRAW
PREVIOUSLY TENDERED TRUST COMMON UNITS?
|
A:
|
|
To withdraw previously
tendered Trust Common Units, a written or facsimile transmission notice of withdrawal must be timely received by the exchange
agent at its address set forth on the back cover page of this offer to exchange. Any such notice of withdrawal must specify
the name of the person who tendered the Trust Common Units to be withdrawn, the number of Trust Common Units to be withdrawn
and the name of the registered holder of such Trust Common Units, if different from that of the person who tendered such Trust
Common Units. If certificates representing Trust Common Units to be withdrawn have been delivered or otherwise identified
to the exchange agent, then, prior to the physical release of such certificates, the serial numbers shown on such certificates
must be submitted to the exchange agent and, unless such Trust Common Units have been tendered by or for the account of an
Eligible Institution as described below, the signature(s) on the notice of withdrawal must be guaranteed by an Eligible Institution.
If Trust Common Units have been tendered pursuant to the procedure for book-entry transfer as set forth in the section of
this offer to exchange titled “The Offer—Procedure for Tendering,” any notice of withdrawal must specify
the name and number of the account at The Depository Trust Company (“DTC”), to be credited with the Trust Common
Units. For a complete discussion on the procedures for withdrawing your Trust Common Units, see the section of this offer
to exchange titled “The Offer—Withdrawal Rights.”
|
Q:
|
|
WHEN AND HOW
WILL I RECEIVE THE OFFER CONSIDERATION IN EXCHANGE FOR MY TENDERED TRUST COMMON UNITS?
|
A:
|
|
PEDEVCO will exchange
all tendered and not properly withdrawn Trust Common Units promptly after the expiration time, upon the terms hereof and subject
to the satisfaction or waiver of the conditions to the offer, as set forth in the section of this offer to exchange titled
“The Offer—Conditions to the Offer.” PEDEVCO will deliver the PEDEVCO common stock for your validly tendered
and not properly withdrawn Trust Common Units by depositing the PEDEVCO common stock therefor with the exchange agent, which
will act as your agent for the purpose of receiving PEDEVCO common stock offered in the offer, which we refer to as the offer
consideration, from PEDEVCO and transmitting such PEDEVCO common stock to you. In all cases, an exchange of tendered Trust
Common Units will be made only after timely receipt by the exchange agent of certificates for such Trust Common Units (or
of a confirmation of a book-entry of such Trust Common Units as set forth in the section of this offer to exchange titled
“The Offer—Procedure for Tendering”) and a properly completed and duly executed letter of transmittal (or
Agent’s Message) and any other required documents.
|
Q:
|
|
ARE DISSENTERS’
OR APPRAISAL RIGHTS AVAILABLE IN EITHER THE OFFER AND/OR THE SECOND-STEP MERGER?
|
A:
|
|
No dissenters’
or appraisal rights are available in connection with the offer or the second-step merger. See the section of this offer to
exchange titled “The Offer—Appraisal/Dissenters’ Rights” and “The Offer—Conditions to
the Offer.”
|
Q:
|
|
WHAT IS THE MARKET
VALUE OF MY TRUST COMMON UNITS AS OF A RECENT DATE?
|
A:
|
|
The closing price
of a Trust Common Unit on the OTC Market on October 12, 2020 was $0.44.
|
Q:
|
|
WHAT IS THE TOTAL
CONSIDERATION WORTH?
|
A:
|
|
Based on the closing
price of PEDEVCO Common Stock NYSE American on October 12, 2020 ($1.34), the equivalent market value of the Consideration
would be $0.536. The closing price of PEDEVCO common stock used in the above calculation is for purposes of
illustration only. The price of PEDEVCO common stock fluctuates and may be higher or lower than the price assumed in this
example at the time Trust Common Units are exchanged pursuant to the offer. Holders of Trust Common Units are encouraged to
obtain current market quotations for Trust Common Units and PEDEVCO Common Stock prior to making any decision with respect
to the offer.
|
Q:
|
|
HOW MAY I CHANGE
MY ELECTION TO TENDER?
|
A:
|
|
An election to tender
is irrevocable, except the Trust Common Units tendered pursuant to the offer may be withdrawn at any time prior to the expiration
time and, if PEDEVCO has not accepted Trust Common Units stock for exchange, at any time following 60 days from commencement
of the offer. After a valid withdrawal, Trust Common Units may be re-tendered at any time prior to the expiration time and
a new election may be made by following one of the procedures described in the section of this offer to exchange titled “The
Offer—Procedure for Tendering.”
|
Q:
|
|
WHERE CAN I FIND
OUT MORE INFORMATION ABOUT PEDEVCO AND THE TRUST?
|
A:
|
|
You can find out
information about PEDEVCO and the Trust from the sources described under the section of this offer to exchange titled “Where
You Can Find More Information.” Please also refer to “Information about PEDEVCO” and “Information
about the Trust.”
|
Q:
|
|
WHO CAN I CONTACT
WITH ANY ADDITIONAL QUESTIONS ABOUT THE OFFER?
|
A:
|
|
You can call the
information agent. The information agent is InvestorCom, 19 Old Kings Highway S. – Suite 210, Darien, CT 06820,
Toll Free (877) 972-0090 (Banks and Brokers call collect (203) 972-9300), or info@investor-com.com.
|
FORWARD-LOOKING
STATEMENTS
This
offer to exchange contains certain statements that are forward-looking. The words “anticipate,” “believe,”
“estimate,” “expect,” “intend,” “will,” “should,” “targeting,”
“projecting” and similar expressions, as they relate to PEDEVCO, the Trust, performance of PEDEVCO or the Trust and/or
their assets, including statements regarding the proposed transaction, benefits and synergies of the proposed transaction and
future opportunities for the combined company, are intended to identify forward-looking statements. These statements reflect management’s
current beliefs, assumptions and expectations and are subject to a number of factors that may cause actual results to differ materially.
Such factors include but are not limited to:
|
●
|
the
ultimate outcome of the offer and the second-step merger;
|
|
●
|
the
failure of the holders of Trust Common Units, if required, to approve the terms of any
transaction;
|
|
●
|
uncertainties
as to whether the Trustee will cooperate with PEDEVCO regarding the proposed transaction;
|
|
●
|
the
dissolution and/or termination of the Trust prior to any future transaction being completed;
|
|
●
|
PEDEVCO’s
ability to consummate the proposed transaction with the Trust;
|
|
●
|
the
conditions to the completion of the proposed transaction, including PEDEVCO’s ability
to obtain shareholder approval and/or being able to obtain effectiveness of any registration
statement required to be filed to register PEDEVCO Common Stock issuable in such transaction,
on a timely basis, if at all;
|
|
●
|
the
possibility that PEDEVCO may be unable to achieve the expected benefits of acquiring
the Trust within the expected time-frames or at all;
|
|
●
|
that
the integration of the Trust into PEDEVCO may be more difficult, time-consuming or costly
than expected;
|
|
●
|
that
PEDEVCO’s costs and business disruption may be greater than expected following
the proposed transaction or the public announcement of the proposed transaction;
|
|
●
|
proved
oil, natural gas and NGL reserves associated with the Underlying Properties;
|
|
●
|
the
Trust’s or Avalon Energy, LLC’s, as operator of the Underlying Properties
(“Avalon”) future financial position, business strategy, project costs and
plans and objectives for future operations;
|
|
●
|
the
effect of COVID-19 on the U.S. and global economy, the effect of U.S. and global efforts
to reduce the spread of the virus, including ‘stay-at-home’ and other orders,
and the resulting effect of such pandemic and governmental responses thereto on the market
for oil and gas and the U.S. and global economy in general;
|
|
●
|
information
regarding costs and production and reserve growth;
|
|
●
|
timing
and amount of future production of oil and natural gas;
|
|
●
|
availability
of oil field labor;
|
|
●
|
the
amount, nature and timing of capital expenditures, including future exploration and development
costs;
|
|
●
|
government
regulation and taxation of the oil and natural gas industry;
|
|
●
|
marketing
of oil and natural gas;
|
|
●
|
exploitation
projects or property acquisitions;
|
|
●
|
costs
of exploiting and developing our properties and conducting other operations;
|
|
●
|
general
economic conditions in the United States and around the world, including the effect of
regional or global health pandemics (such as, for example, COVID-19);
|
|
●
|
competition
in the oil and natural gas industry;
|
|
●
|
effectiveness
of risk management activities;
|
|
●
|
environmental
liabilities;
|
|
●
|
counterparty
credit risk;
|
|
●
|
developments
in oil-producing and natural gas-producing countries;
|
|
●
|
future
operating results;
|
|
●
|
future
acquisition transactions;
|
|
●
|
estimated
future reserves and the present value of such reserves;
|
|
●
|
the
outcome of litigation and regulatory proceedings; and
|
|
●
|
the
risks and uncertainties described herein under “Risk Factors.”
|
Additional
risks that may affect PEDEVCO’s or the Trust’s operations and other important factors are set forth in the “Risk
Factors” section, and the sections entitled “Information about PEDEVCO—Management’s Discussion and Analysis
of Financial Condition and Results of Operations” and “Information about the Trust—Trustee’s Discussion
and Analysis of Financial Condition and Results of Operations,” as well as in other filings that PEDEVCO and the Trust make
with the SEC. These forward-looking statements speak only as of the date of this communication or as of the date to which they
refer, and PEDEVCO assumes no obligation to update any forward-looking statements as a result of new information or future events
or developments, except as required by law. See also the section of this offer to exchange titled “Risk Factors.”
SUMMARY
This
summary highlights the material information in this offer to exchange. To more fully understand the offer to holders of Trust
Common Units, and for a more complete description of the terms of the offer and the second-step merger, you should read carefully
this entire document, including the exhibits and schedules, and the other documents referred to herein. For information on how
to obtain the documents that are on file with the SEC, see the section of this offer to exchange titled “Where You Can Find
More Information.”
Information
About the Companies (see page 68)
PEDEVCO
The
offer is being made by PEDEVCO through Purchaser, a wholly owned subsidiary of PEDEVCO formed for the purpose of making this offer.
PEDEVCO is an oil and gas company focused on the acquisition and development of oil and natural gas assets where the latest in
modern drilling and completion techniques and technologies have yet to be applied. In particular, PEDEVCO focuses on legacy proven
properties where there is a long production history, well defined geology and existing infrastructure that can be leveraged when
applying modern field management technologies. PEDEVCO’s current properties are located in the San Andres formation of the
Permian Basin situated in West Texas and Eastern New Mexico, and in the Denver-Julesberg Basin in Colorado.
PEDEVCO’s
principal executive offices are located at 575 N. Dairy Ashford, Energy Center II, Suite 210, Houston, Texas 77079, and its telephone
number is (713) 221-1768.
For
additional information concerning PEDEVCO, please see the section of this offer to exchange titled “Information about PEDEVCO.”
Please also see “Where You Can Find More Information.”
Purchaser
Purchaser
is a Texas limited liability company organized on October 2, 2020, with principal executive offices at 575 N. Dairy Ashford, Energy
Center II, Suite 210, Houston, Texas 77079. The telephone number of Purchaser’s principal executive offices is (713) 221-1768.
Purchaser is a wholly owned subsidiary of PEDEVCO that was formed to facilitate the transactions contemplated by this offer to
exchange. Purchaser has engaged in no activities to date and has no material assets or liabilities of any kind, in each case,
other than those incidental to its formation and its activities and obligations in connection with the offer.
For
additional information concerning the Purchaser, please see the section of this offer to exchange titled “Information about
the Purchaser.” Please also see “Where You Can Find More Information.”
Trust
The
Trust is a statutory trust formed under the Delaware Statutory Trust Act (the “Delaware Trust Act”) pursuant to the
Trust Agreement by and among SandRidge Energy, Inc. (“SandRidge”), as Trustor, The Bank of New York Mellon Trust Company,
N.A., as Trustee (the “Trustee”), and The Corporation Trust Company, as Delaware Trustee (the “Delaware Trustee”).
The
Trust holds royalty interests (the “Royalty Interests”) in specified oil and natural gas properties located in Andrews
County, Texas (the “Underlying Properties”). These Royalty Interests were conveyed by SandRidge to the Trust concurrent
with the initial public offering of the Trust’s Common Units in August 2011 pursuant to the terms set forth in conveyancing
documents effective April 1, 2011 (the “Conveyances”).
The
Trust’s principal executive offices are located at 601 Travis Street, 16th Floor, Houston, Texas, 77002 and its telephone
number is (512) 236-6555.
For
additional information concerning the Trust, please see the section of this offer to exchange titled “Information about
the Trust.” Please also see “Where You Can Find More Information.”
The
Offer (see page 157)
PEDEVCO
is offering to exchange each issued and outstanding Trust Common Unit for the Consideration set forth on the cover page of this
offer to exchange subject, in each case, to the procedures described in this offer to exchange and in the related letter of transmittal.
PEDEVCO will not allot or issue fractional PEDEVCO Common Stock to holders of Trust Common Units who accept the offer. To the
extent that you would be entitled to fractional shares, those fractional entitlements will be aggregated and, if a fractional
share results from such aggregation, you will be entitled to receive, in lieu of such fractional share, an amount in cash determined
by multiplying the fractional share by a price equal to the average of the closing prices of PEDEVCO Common Stock on the NYSE
American on each of the five NYSE American trading days ending on the 10th business day prior to the date of expiration of the
offer, which will be promptly paid following PEDEVCO’s acceptance of Trust Common Units in the offer.
Reasons
for the Offer (see page 156)
PEDEVCO
intends, promptly after consummation of the offer and satisfaction of the conditions in the Trust Agreement, including the Trustee’s
consent which is a condition to this offer, to cause the Trust to merge with Purchaser, after which the Trust would be a direct
or indirect, wholly owned subsidiary of PEDEVCO.
PEDEVCO
believes that the combination of PEDEVCO and the Trust represents a financially and strategically compelling, value-creating opportunity
for both PEDEVCO stockholders and holders of Trust Common Units. PEDEVCO believes that the value that could be created by combining
PEDEVCO and the Trust significantly outweighs—and is incremental to—anything holders of Trust Common Units may realize
by remaining a holder of Trust Common Units. PEDEVCO believes the offer is the best available option for holders of Trust Common
Units to maximize the value of their investment while retaining potential upside.
PEDEVCO
believes the offer is compelling for the following reasons:
|
●
|
Attractive
Exchange Ratio: Based on the closing price of PEDEVCO Common Stock on the NYSE
American on October 12, 2020 ($1.34),
the equivalent market value of the fractional share of PEDEVCO Common Stock to be issued
in the exchange offer would be $0.536.
The closing price of a Trust Common Unit on the OTC Pink Sheets on October 12, 2020 was $0.44.
|
|
●
|
Continuation
of Investment: PEDEVCO believes the continued viability of the Trust as an investment
vehicle appears to be in question given the structural disincentives to further development
of the Underlying Properties, and because the Trust has a finite life that may be coming
to an end. PEDEVCO believes that by joining with PEDEVCO, holders of Trust Common Units
have the opportunity to continue their existing investment, as well as obtain an interest
in PEDEVCO’s current assets, with a stable business partner who will endeavor to
monitor and enhance the value of the Royalty Interests rather than be a passive investment
vehicle like the Trust.
|
|
●
|
Publicly
Traded Stock of a Reporting Company Listed on NYSE American: Upon completion
of the offer and the second-step merger, holders of Trust Common Units will receive free
trading shares of PEDEVCO Common Stock. PEDEVCO Common Stock is listed on the NYSE American,
and may provide a more liquid and developed trading market than the Trust’s Common
Units, which are currently traded on the OTC Pink Market.
|
|
●
|
Geographic
Focus and Familiarity of Underlying Properties: PEDEVCO’s Permian assets
are geologically analogous to the Underlying Properties for which the Trust’s Royalty
Interests are dependent, as they are both assets producing from the San Andres formation.
PEDEVCO’s operations team has significant experience managing San Andres assets
throughout the Permian Basin and managed the offsetting Furman-Mascho field assets that
underlie the Underlying Properties, and it believes it could work with the operator of
the Underlying Properties using its existing knowledge to enhance production.
|
|
●
|
Financially
Supportive Sponsor: As of October 13, 2020, SK Energy, LLC (“SK Energy”),
which is owned and controlled by Dr. Simon Kukes, PEDEVCO’s Chief Executive Officer
and a director, has loaned PEDEVCO an aggregate of $51.7 million since June 2018 to support
PEDEVCO’s operations and for acquisitions, all of which loans were evidenced by
promissory notes on substantially more favorable terms to PEDEVCO than could be obtained
with third parties, and all of which loans have been converted into PEDEVCO Common Stock
on substantially more favorable terms than could be obtained with third parties. Additionally,
pursuant to subscription agreements, SK Energy purchased an additional aggregate of 15.0
million shares of common stock from PEDEVCO in private transactions for $28.0 million,
also on substantially more favorable terms to PEDEVCO than could be obtained with third
parties. SK Energy has verbally advised us that it intends to provide us additional funding
as needed, although it is under no obligation to do so. PEDEVCO believes that holders
of PEDEVCO Common Stock benefit by having a sponsor who has an active role in promoting
PEDEVCO and supporting its operations.
|
|
●
|
No
Significant Hurdles: Assuming satisfaction of the Minimum Tender Condition and
the Trustee Consent Condition, PEDEVCO does not believe there is a substantial risk to
completion of the second-step merger and that it can be completed promptly following
the exchange offer.
|
PEDEVCO
realizes there can be no assurance about future results, including results expected as described in the reasons listed above,
such as assumptions regarding potential synergies or other benefits to be realized following the offer. PEDEVCO’s reasons
for the offer and all other information in this section are forward-looking in nature and, therefore, should be read in light
of the factors discussed in the sections of this offer to exchange titled “Risk Factors” and “Forward-Looking
Statements.”
Conditions
to the Offer (see page 166)
The
offer is conditioned upon satisfaction, in the reasonable judgment of PEDEVCO, of the following conditions:
|
●
|
Minimum
Tender Condition—There shall have been validly tendered and not properly
withdrawn prior to the expiration of the offer, a number of Trust Common Units which,
together with any other Trust Common Units Purchaser then owns or has a right to acquire,
is a majority of the total number of outstanding Trust Common Units as of the date that
we accept Trust Common Units for exchange pursuant to the offer.
|
|
●
|
Trustee
Consent Condition—The Trustee shall have consented, pursuant to the Trust
Agreement, to the second-step merger on the terms and conditions described in this offer
to exchange, and has not required or implemented any conditions to the second-step merger
that, in the reasonable judgment of PEDEVCO, could hinder or delay the second-step merger.
|
|
●
|
PEDEVCO
Shareholder Approval Condition—PEDEVCO has received the approval by a sufficient
number of its shareholders of the issuance of PEDEVCO Common Stock contemplated in connection
with the offer and the second-step merger, in accordance with the rules of the NYSE American,
on which the PEDEVCO Common Stock is listed. PEDEVCO expects to file a preliminary information
statement with respect to the shareholder written consent in lieu of a special meeting
to make the approval effective promptly after the date of this offer to exchange.
|
|
●
|
Government
Approval Condition—Any waiting (or extension thereof) period applicable
to the offer and the second-step merger under any applicable antitrust law shall have
expired or been terminated, and any approvals or clearances determined by PEDEVCO to
be required or advisable thereunder shall have been obtained on terms satisfactory to
PEDEVCO, and any other any other approval, permit, authorization, extension, action or
non-action, waiver or consent of any governmental authority as determined by PEDEVCO
to be required or advisable shall have been obtained on terms satisfactory to PEDEVCO.
|
|
●
|
Stock
Exchange Listing Condition—The PEDEVCO Common Stock issuable to holders
of Trust Common Units in connection with the offer and the second-step merger shall have
been approved for listing on the NYSE American, subject to official notice of issuance.
|
|
●
|
Registration
Statement Condition—The registration statement of which this offer to exchange
is a part shall have become effective under the Securities Act of 1933, as amended (the
“Securities Act”). No stop order suspending the effectiveness of the registration
statement shall have been issued, and no proceedings for that purpose shall have been
initiated or be threatened, by the SEC.
|
|
●
|
No
Injunction Condition—No court or other governmental entity of competent
jurisdiction shall have enacted, issued, promulgated, enforced or entered any law, statute
or ordinance, common law, rule, regulation, standard, judgment, order, writ, injunction,
decree, arbitration award or agency requirement (whether temporary, preliminary or permanent)
that is in effect and restrains, enjoins or otherwise prohibits consummation of the offer
and the second-step merger.
|
|
●
|
No
Trust Material Adverse Effect Condition—There shall not have occurred any
change, event, circumstance or development that has had, or would reasonably be likely
to have, a Trust Material Adverse Effect, as described in the section of this offer to
exchange titled “The Offer—Conditions to the Offer—No Trust Material
Adverse Effect Condition.”
|
The
offer is also subject to additional conditions referred to in the section of this offer to exchange titled “The Offer—Conditions
to the Offer—Other Conditions to the Offer.”
Expiration
of the Offer (see page 157)
The
offer is scheduled to expire at 5:00 p.m., New York City time, on November 30, 2020, unless extended by PEDEVCO. For more information,
you should read the discussion below under the section of this offer to exchange titled “The Offer—Extension, Termination
and Amendment.”
Extension,
Termination and Amendment (see page 158)
Subject
to the applicable rules and regulations of the SEC and the terms and conditions of the offer, PEDEVCO expressly reserves the right
(but will not be obligated): (1) to extend, for any reason, the period of time during which the offer is open; (2) to delay acceptance
for exchange of, or the exchange of, Trust Common Units in order to comply in whole or in part with applicable law (any such delay
shall be effected in compliance with Rule 14e-1(c) under the Securities Exchange Act of 1934, as amended (the “Exchange
Act”), which requires PEDEVCO to pay the consideration offered or to return Trust Common Units deposited by or on behalf
of holders of Trust Common Units promptly after the termination or withdrawal of the offer); (3) to amend or terminate the offer
for any reason without accepting for exchange or exchanging any Trust Common Units, including under circumstances where any of
the conditions referred to in the section of this offer to exchange titled “The Offer—Conditions to the Offer”
have not been satisfied or if PEDEVCO or any of its affiliates enters into a definitive agreement or announces an agreement in
principle with the Trust providing for a merger or other business combination or transaction with or involving the Trust, or the
purchase or exchange of securities or assets of the Trust, or PEDEVCO and the Trust reach any other agreement or understanding,
in either case, pursuant to which it is agreed or provided that the offer will be terminated; and (4) to amend the offer or to
waive any conditions to the offer at any time, except for the Registration Statement Condition, PEDEVCO Shareholder Approval Condition,
Government Approval Condition and Stock Exchange Listing Condition, in each case by giving oral or written notice of such delay,
termination, waiver or amendment to the exchange agent and by making public announcement thereof. Any such extension, delay, termination,
waiver or amendment will be followed as promptly as practicable by a public announcement thereof.
No
subsequent offering period will be available after the offer.
Exchange
of Trust Common Units; Delivery of PEDEVCO Common Stock (see page 158)
Upon
the terms and subject to the conditions of the offer (including, if the offer is extended or amended, the terms and conditions
of any extension or amendment), PEDEVCO will accept for exchange promptly after the expiration time all Trust Common Units validly
tendered and not properly withdrawn. For more information, see the section of this offer to exchange titled “The Offer—Exchange
of Trust Common Units; Delivery of PEDEVCO Common Stock.”
Procedure
for Tendering Trust Common Units (see page 159)
The
procedure for tendering Trust Common Units varies depending on whether you possess physical certificates, a nominee holds your
certificates for you or you or a nominee holds your Trust Common Units in book-entry form. See the section of this offer to exchange
titled “The Offer—Procedure for Tendering,” as well as the transmittal materials, including the letter of transmittal,
for a discussion of the procedure for tendering your Trust Common Units.
Withdrawal
Rights (see page 161)
You
can withdraw tendered Trust Common Units at any time prior to the expiration time and, if PEDEVCO has not accepted your Trust
Common Units for exchange, at any time following 60 days from commencement of the offer. See the section of this offer to exchange
titled “The Offer—Withdrawal Rights.” Withdrawn Trust Common Units may be re-tendered at any time prior to the
expiration time by following one of the procedures described in the section of this offer to exchange titled “The Offer—Procedure
for Tendering.”
Material
U.S. Federal Income Tax Consequences (see page 162)
The
offer and the second-step merger will be taxable transactions for U.S. federal income tax purposes. U.S. holders (as defined in
the section of this offer to exchange titled “The Offer–Material U.S. Federal Income Tax Consequences”) of Trust
Common Units generally will recognize gain or loss equal to the difference, if any, between (1) the sum of the fair market value,
at the time of receipt, of PEDEVCO Common Stock received by such U.S. holder in the offer and the second-step merger and cash
received in lieu of fractional shares and (2) such U.S. holder’s adjusted tax basis in the Trust Common Units surrendered
in exchange therefor.
Any
gain or loss recognized upon the offer or the second-step merger generally will be treated as capital gain or loss. However, a
portion of this gain or loss, which could be substantial, will be separately computed and taxed as ordinary income or loss under
Section 751 of the Code to the extent attributable to “unrealized receivables,” including depreciation recapture,
or to “inventory items” owned by the Trust. Passive losses that were not deductible by a U.S. holder in prior taxable
periods because they exceeded a U.S. holder’s share of the Trust’s income may become available to offset a portion
of the gain recognized by such U.S. holder. For a more complete description of the tax consequences of the offer and the second-step
merger, see the section of this offer to exchange titled “The Offer—Material U.S. Federal Income Tax Consequences.”
Tax
matters are very complicated, and the tax consequences of the offer and second-step merger to a particular Trust Common Unitholder
will depend in part on such person’s circumstances. Accordingly, you are urged to consult your own tax advisor for a full
understanding of the tax consequences to you of the offer and second-step merger, including the applicability and effect of federal,
state, local and foreign income and other tax laws.
Ownership
of PEDEVCO After the Offer (see page 164)
PEDEVCO
estimates that, upon consummation of the offer and the second-step merger, former holders of Trust Common Units will own, in the
aggregate, approximately 22.5% of the issued and outstanding PEDEVCO Common Stock (approximately 22.1% on a fully diluted basis)
as a result of having been holders of Trust Common Units. For a more detailed discussion of the assumptions on which this estimate
is based, see the section of this offer to exchange titled “The Offer—Ownership of PEDEVCO After the Offer.”
No
Appraisal/Dissenters’ Rights (see page 165)
Holders
of Trust Common Units do not have dissenters’ or appraisal rights in connection with the offer or the second-step
merger. See the section of this offer to exchange titled “The Offer—No Appraisal/Dissenters’
Rights.”
Regulatory
Approvals (see page 172)
The
offer and the second-step merger may be subject to review by government authorities and other regulatory agencies, including in
jurisdictions outside the United States. PEDEVCO intends to identify such authorities and jurisdictions as soon as practicable
and to file promptly thereafter all notifications that it determines are necessary or advisable under the applicable laws, rules
and regulations of the respective identified authorities, agencies and jurisdictions for the consummation of the offer and/or
the second-step merger and to file all post-completion notifications that it determines are necessary or advisable as soon as
possible after the offer and the second-step merger have been consummated.
Accounting
Treatment (see page 173)
The
proposed acquisition of the Trust would be accounted for under the acquisition method of accounting under U.S. generally accepted
accounting principles, with PEDEVCO recognizing the allocation of the purchase price to the net identifiable assets acquired from
the date of completion of offer and second-step merger with the Trust’s net identifiable asset being recorded at their fair
values at the same date.
Comparison
of the Rights of Holders (see page 185)
Holders
of Trust Common Units who validly tender their Trust Common Units in the offer and do not withdraw will receive PEDEVCO Common
Stock following consummation of the offer. Because PEDEVCO is a Texas corporation and the Trust is a Delaware statutory trust,
there are a number of differences between the rights of a holder of PEDEVCO Common Stock and the rights of a holder of Trust Common
Units. See the discussion in the section of this offer to exchange titled “Comparison of the Rights of Holders.”
Risk
Factors (see page 20)
In
addition to the risks relating to each of PEDEVCO’s business and ownership of Trust Common Units, the offer and the second-step
merger are, and the combined business of PEDEVCO and the Trust will be, subject to several risks which you should carefully consider
prior to participating in the offer.
Risk
Factors Relating to the Offer and the Second-Step Merger
|
●
|
Because
the market price of PEDEVCO Common Stock that holders of Trust Common Units will receive
in the offer will fluctuate, holders of Trust Common Units cannot be sure of the value
of PEDEVCO Common Stock they will receive.
|
|
●
|
Even
if the offer is completed, there remains a risk that the Trust could liquidate prior
to completion of the second-step merger.
|
|
●
|
The
offer is subject to other conditions that PEDEVCO cannot control.
|
|
●
|
The
prices of PEDEVCO Common Stock and Trust Common Units may be adversely affected if the
offer and the second-step merger are not completed.
|
|
●
|
PEDEVCO
has not negotiated the price or terms of the offer or second-step merger with the Trust.
|
|
●
|
You
may be unable to assert a claim against the Trust’s independent registered public
accounting firm or independent reserve engineers under Section 11 of the Securities Act.
|
|
●
|
If
PEDEVCO completes the exchange offer in accordance with the Minimum Tender Condition
and Trustee Consent Condition, it believes it will be able to approve the second-step
merger without a vote of holders of Trust Common Units who did not accept the exchange
offer.
|
|
●
|
The
Trustee may not consent to the second-step merger, or may impose conditions on its consent
that are unfavorable or cause us to terminate the offer.
|
|
●
|
There
will not be appraisal or dissenters’ rights with respect to the exchange offer
or second-step merger.
|
Risk
Factors Relating to PEDEVCO Following the Offer and the Second-Step Merger
|
●
|
Assuming
completion of the offer and second-step merger, PEDEVCO would own only the Royalty Interests,
and would therefore remain subject to the same risks of the Trust with respect to its
Royalty Interests.
|
|
●
|
If
PEDEVCO acquires less than a majority of the outstanding Trust Common Units, it may be
deemed to be an investment company under the Investment Company Act.
|
|
●
|
PEDEVCO
has only conducted a review of the Trust’s publicly available information and has
not had access to the Trust’s non-public information.
|
|
●
|
Future
results of PEDEVCO may differ materially from the unaudited pro forma condensed combined
financial statements of PEDEVCO and the Trust presented in this offer to exchange.
|
|
●
|
Resales
of PEDEVCO Common Stock following the offer may cause the market price of PEDEVCO Common
Stock to fall.
|
|
●
|
The
trading price of PEDEVCO Common Stock may be affected by factors different from those
affecting the price of Trust Common Units.
|
|
●
|
The
PEDEVCO Common Stock to be received by holders of Trust Common Units as consideration
will have different rights from the Trust Common Units.
|
|
●
|
Holders
of Trust Common Units will have a reduced ownership interest in the Trust’s assets
after the consummation of the offer and the second-step merger.
|
|
●
|
The
combined business of PEDEVCO and the Trust will be geographically concentrated.
|
Tax
Risks Related to the Offer and Second-Step Merger and the Ownership of PEDEVCO Common Stock
|
●
|
The
offer and second-step merger will be a taxable transaction to the holders of Trust Common
Units and the resulting tax liability of a holder of Trust Common Units will depend on
such unitholder’s particular situation. The tax liability of a holder of Trust
Common Units as a result of the offer and second-step merger could be more than expected.
|
|
●
|
The
U.S. federal income tax treatment of owning and disposing of PEDEVCO Common Stock received
in the offer or second-step merger will be different than the U.S. federal income tax
treatment of owning and disposing of the Trust Common Units.
|
Risk
Factors Relating to PEDEVCO
Risk
Factors Related to the Oil, NGL and Natural Gas Industry and PEDEVCO’s Business
|
●
|
Declines
in oil and, to a lesser extent, NGL and natural gas prices, have in the past, and will
continue in the future to, adversely affect PEDEVCO’s business, financial condition
or results of operations and PEDEVCO’s ability to meet its capital expenditure
obligations or targets and financial commitments.
|
|
●
|
PEDEVCO
has a limited operating history and expects to continue to incur losses for an indeterminable
period of time.
|
|
●
|
PEDEVCO
will need additional capital to complete future acquisitions, conduct its operations
and fund its business beyond 2020, and its ability to obtain the necessary funding is
uncertain.
|
|
●
|
PEDEVCO
may not be able to generate sufficient cash flow to meet any future debt service and
other obligations due to events beyond its control.
|
|
●
|
All
of PEDEVCO’s crude oil, natural gas and NGLs production is located in the Permian
Basin and the D-J Basin, making it vulnerable to risks associated with operating in only
two geographic areas. In addition, PEDEVCO has a large amount of proved reserves attributable
to a small number of producing formations.
|
|
●
|
Drilling
for and producing oil and natural gas are highly speculative and involve a high degree
of risk, with many uncertainties that could adversely affect its business. PEDEVCO has
not recorded significant proved reserves, and areas that PEDEVCO decide to drill may
not yield oil or natural gas in commercial quantities or at all.
|
|
●
|
PEDEVCO’s
success is dependent on the prices of oil, NGLs and natural gas. Low oil or natural gas
prices and the substantial volatility in these prices will adversely affect, and is expected
to continue to adversely affect, PEDEVCO’s business, financial condition and results
of operations and its ability to meet PEDEVCO’s capital expenditure requirements
and financial obligations.
|
|
●
|
PEDEVCO’s
business and operations have been adversely affected by, and are expected to continue
to be adversely affected by, the recent COVID-19 outbreak, and may be adversely
affected by other similar outbreaks.
|
|
●
|
Future
conditions might require PEDEVCO to make write-downs in its assets, which would adversely
affect its balance sheet and results of operations.
|
|
●
|
Declining
general economic, business or industry conditions have, and will continue to have, a
material adverse effect on PEDEVCO’s results of operations, liquidity and financial
condition, and are expected to continue having a material adverse effect for the foreseeable
future.
|
|
●
|
PEDEVCO’s
exploration, development and exploitation projects require substantial capital expenditures
that may exceed cash on hand, cash flows from operations and potential borrowings, and
PEDEVCO may be unable to obtain needed capital on satisfactory terms, which could adversely
affect its future growth.
|
|
●
|
PEDEVCO’s
oil and natural gas reserves are estimated and may not reflect the actual volumes of
oil and natural gas PEDEVCO will receive, and significant inaccuracies in these reserve
estimates or underlying assumptions will materially affect the quantities and present
value of its reserves.
|
|
●
|
PEDEVCO
may record impairments of oil and gas properties that would reduce its shareholders’
equity.
|
|
●
|
PEDEVCO
may have accidents, equipment failures or mechanical problems while drilling or completing
wells or in production activities, which could adversely affect its business.
|
|
●
|
PEDEVCO’s
operations are subject to operational hazards and unforeseen interruptions for which
PEDEVCO may not be adequately insured.
|
|
●
|
The
threat and impact of terrorist attacks, cyber-attacks or similar hostilities may adversely
impact PEDEVCO’s operations.
|
|
●
|
Failure
to adequately protect critical data and technology systems could materially affect PEDEVCO’s
operations.
|
|
●
|
PEDEVCO’s
strategy as an onshore resource player may result in operations concentrated in certain
geographic areas and may increase its exposure to many of the risks described in this
offer to exchange.
|
|
●
|
Unless
PEDEVCO replaces its oil and natural gas reserves, its reserves and production will decline,
which will adversely affect its business, financial condition and results of operations.
|
|
●
|
PEDEVCO’s
strategy includes acquisitions of oil and natural gas properties, and its failure to
identify or complete future acquisitions successfully, or not produce projected revenues
associated with the future acquisitions could reduce its earnings and hamper its growth.
|
|
●
|
If
PEDEVCO completes acquisitions or enters into business combinations in the future, they
may disrupt or have a negative impact on its business.
|
|
●
|
PEDEVCO
may incur indebtedness which could reduce its financial flexibility, increase interest
expense and adversely impact its operations and its unit costs.
|
|
●
|
PEDEVCO
may purchase oil and natural gas properties with liabilities or risks that PEDEVCO did
not know about or that PEDEVCO did not assess correctly, and, as a result, PEDEVCO could
be subject to liabilities that could adversely affect its results of operations.
|
|
●
|
PEDEVCO
may incur losses or costs as a result of title deficiencies in the properties in which
PEDEVCO invests.
|
|
●
|
PEDEVCO’s
identified drilling locations are scheduled over several years, making them susceptible
to uncertainties that could materially alter the occurrence or timing of their drilling.
|
|
●
|
Potential
conflicts of interest could arise for certain members of PEDEVCO’s management team
and PEDEVCO Board that hold management positions with other entities and its largest
stockholder.
|
|
●
|
PEDEVCO
currently licenses only a limited amount of seismic and other geological data and may
have difficulty obtaining additional data at a reasonable cost, which could adversely
affect its future results of operations.
|
|
●
|
The
unavailability or high cost of drilling rigs, completion equipment and services, supplies
and personnel, including hydraulic fracturing equipment and personnel, could adversely
affect its ability to establish and execute exploration and development plans within
budget and on a timely basis, which could have a material adverse effect on its business,
financial condition and results of operations.
|
|
●
|
PEDEVCO
has limited control over activities on properties PEDEVCO does not operate.
|
|
●
|
The
marketability of PEDEVCO’s production is dependent upon oil and natural gas gathering,
transportation, and storage facilities owned and operated by third parties, and the unavailability
of satisfactory oil and natural gas transportation arrangements have had a material adverse
effect on PEDEVCO’s revenue.
|
|
●
|
An
increase in the differential between the NYMEX or other benchmark prices of oil and natural
gas and the wellhead price PEDEVCO receives for its production has adversely affected
its business, financial condition and results of operations.
|
|
●
|
PEDEVCO
may have difficulty managing growth in its business, which could have a material adverse
effect on its business, financial condition and results of operations and its ability
to execute its business plan in a timely fashion.
|
|
●
|
Financial
difficulties encountered by PEDEVCO’s oil and natural gas purchasers, third-party
operators or other third parties could decrease its cash flow from operations and adversely
affect the exploration and development of its prospects and assets.
|
|
●
|
The
calculated present value of future net revenues from its proved reserves will not necessarily
be the same as the current market value of its estimated oil and natural gas reserves.
|
|
●
|
Competition
in the oil and natural gas industry is intense, making it difficult for PEDEVCO to acquire
properties, market oil and natural gas and secure trained personnel.
|
|
●
|
PEDEVCO’s
competitors may use superior technology and data resources that PEDEVCO may be unable
to afford or that would require a costly investment by PEDEVCO in order to compete with
them more effectively.
|
|
●
|
If
PEDEVCO does not hedge its exposure to reductions in oil and natural gas prices, PEDEVCO
may be subject to significant reductions in prices. Alternatively, PEDEVCO may use oil
and natural gas price hedging contracts, which involve credit risk and may limit future
revenues from price increases and result in significant fluctuations in its profitability.
|
|
●
|
Changes
in the legal and regulatory environment governing the oil and natural gas industry, particularly
changes in the current Colorado forced pooling system drilling operation set-back rules
and salt water disposal permitting regulations in New Mexico, could have a material adverse
effect on PEDEVCO’s business.
|
|
●
|
SEC
rules could limit PEDEVCO’s ability to book additional proved undeveloped reserves
(“PUDs”) in the future.
|
|
●
|
New
or amended environmental legislation or regulatory initiatives could result in increased
costs, additional operating restrictions, or delays, or have other adverse effects on
PEDEVCO.
|
|
●
|
Proposed
changes to U.S. tax laws, if adopted, could have an adverse effect on PEDEVCO’s
business, financial condition, results of operations, and cash flows.
|
|
●
|
PEDEVCO
may incur substantial costs to comply with the various federal, state, and local laws
and regulations that affect its oil and natural gas operations, including as a result
of the actions of third parties.
|
|
●
|
Part
of PEDEVCO’s strategy involves drilling in existing or emerging oil and gas plays
using some of the latest available horizontal drilling and completion techniques. The
results of its planned exploratory drilling in these plays are subject to drilling and
completion technique risks, and drilling results may not meet its expectations for reserves
or production. As a result, PEDEVCO may incur material write-downs and the value of its
undeveloped acreage could decline if drilling results are unsuccessful.
|
|
●
|
Part
of PEDEVCO’s strategy involves using some of the latest available horizontal drilling
and completion techniques. The results of its drilling in these plays are subject to
drilling and completion technique risks, and results may not meet its expectations for
reserves or production.
|
|
●
|
Uncertainties
associated with enhanced recovery methods may result in PEDEVCO not realizing an acceptable
return on its investments in such projects.
|
|
●
|
A
significant amount of its Permian Basin Asset acreage must be drilled pursuant to governing
agreements and leases, in order to hold the acreage by production. In the highly competitive
market for acreage, failure to drill sufficient wells in order to hold acreage will result
in a substantial lease renewal cost, or if renewal is not feasible, loss of PEDEVCO’s
lease and prospective drilling opportunities.
|
|
●
|
Competition
for hydraulic fracturing services and water disposal could impede its ability to
develop its oil and gas plays.
|
|
●
|
Regulations
could adversely affect its ability to hedge risks associated with its business and its
operating results and cash flows.
|
|
●
|
PEDEVCO’s
operations are substantially dependent on the availability of water. Restrictions on
its ability to obtain water may have an adverse effect on its financial condition, results
of operations and cash flows.
|
|
●
|
Downturns
and volatility in global economies and commodity and credit markets have materially adversely
affected PEDEVCO’s business, results of operations and financial condition.
|
|
●
|
Improvements
in or new discoveries of alternative energy technologies could have a material adverse
effect on PEDEVCO’s financial condition and results of operations.
|
|
●
|
Competition
due to advances in renewable fuels may lessen the demand for PEDEVCO’s products
and negatively impact its profitability.
|
|
●
|
Future
litigation or governmental proceedings could result in material adverse consequences,
including judgments or settlements.
|
|
●
|
PEDEVCO
may be subject in the normal course of business to judicial, administrative or other
third-party proceedings that could interrupt or limit its operations, require expensive
remediation, result in adverse judgments, settlements or fines and create negative publicity.
|
|
●
|
A
substantial percentage of PEDEVCO’s New Mexico properties are undeveloped; therefore,
the risk associated with its success is greater than would be the case if the majority
of such properties were categorized as proved developed producing.
|
|
●
|
Part
of PEDEVCO’s strategy involves using certain of the latest available horizontal
drilling and completion techniques, which involve additional risks and uncertainties
in their application if compared to conventional drilling.
|
|
●
|
Prospects
that PEDEVCO decides to drill may not yield oil or natural gas in commercially viable
quantities.
|
|
●
|
Over
the past approximately two years PEDEVCO has been significantly dependent on capital
provided to PEDEVCO by SK Energy.
|
|
●
|
Negative
public perception regarding PEDEVCO and/or its industry could have an adverse effect
on its operations.
|
|
●
|
PEDEVCO’s
business could be adversely affected by security threats, including cybersecurity threats.
|
|
●
|
Weather
and climate may have a significant and adverse impact on PEDEVCO.
|
|
●
|
PEDEVCO
recently temporarily shut-in all of its operated producing wells in its Permian
Basin Asset and D-J Basin Asset to preserve PEDEVCO’s oil and gas reserves for
production during a more favorable oil price environment, and while PEDEVCO has resumed
full production, PEDEVCO may again shut-in some or all of its operated production, should
market conditions significantly deteriorate.
|
|
●
|
PEDEVCO
may be forced to write-down material portions of its assets if low oil prices continue.
|
Risks
Related to PEDEVCO’s Common Stock
|
●
|
PEDEVCO
currently has an illiquid and volatile market for PEDEVCO Common Stock, and the market
for PEDEVCO Common Stock is and may remain illiquid and volatile in the future.
|
|
●
|
An
active liquid trading market for PEDEVCO Common Stock may not develop in the future.
|
|
●
|
PEDEVCO
does not presently intend to pay any cash dividends on or repurchase any shares of PEDEVCO
Common Stock.
|
|
●
|
Because
PEDEVCO is a small company, the requirements of being a public company, including compliance
with the reporting requirements of the Exchange Act and the requirements of the
Sarbanes-Oxley Act and the Dodd-Frank Act, may strain its resources, increase its costs
and distract management, and PEDEVCO may be unable to comply with these requirements
in a timely or cost-effective manner.
|
|
●
|
Future
sales of PEDEVCO Common Stock could cause its stock price to decline.
|
|
●
|
Its
outstanding options, warrants and convertible securities may adversely affect the
trading price of PEDEVCO Common Stock.
|
|
●
|
PEDEVCO
depends significantly upon the continued involvement of its present management.
|
|
●
|
Dr.
Simon Kukes, PEDEVCO’s Chief Executive Officer and a member of the PEDEVCO Board,
beneficially owns 74.2% of PEDEVCO Common Stock through SK Energy LLC, which gives
him majority voting control over stockholder matters and his interests may be different
from your interests.
|
|
●
|
Provisions
of Texas law may have anti-takeover effects that could prevent a change in control even
if it might be beneficial to its stockholders.
|
|
●
|
The
PEDEVCO Board can authorize the issuance of preferred stock, which could diminish the
rights of holders of PEDEVCO Common Stock and make a change of control of its company
more difficult even if it might benefit its stockholders.
|
|
●
|
Securities
analysts may not cover, or continue to cover, PEDEVCO Common Stock and this may have
a negative impact on PEDEVCO Common Stock’s market price.
|
|
●
|
Stockholders
may be diluted significantly through PEDEVCO’s efforts to obtain financing and
satisfy obligations through the issuance of securities.
|
|
●
|
PEDEVCO
is subject to the Continued Listing Criteria of the NYSE American and its failure to
satisfy these criteria may result in delisting of PEDEVCO Common Stock.
|
|
●
|
Due
to the fact that PEDEVCO Common Stock is listed on the NYSE American, PEDEVCO is subject
to financial and other reporting and corporate governance requirements which increase
its costs and expenses.
|
|
●
|
If
persons engage in short sales of PEDEVCO Common Stock, including sales of shares to be
issued upon exercise of its outstanding warrants, the price of PEDEVCO Common Stock may
decline.
|
Risk
Factors Relating to The Trust
Risks
Related to the Trust Common Units
|
●
|
The
COVID-19 pandemic could materially adversely affect proceeds to the Trust and cash distributions
to holders of Trust Common Units.
|
|
●
|
The
ability or willingness of OPEC and other oil exporting nations to set and maintain production
levels has a significant impact on oil and natural gas commodity prices, which could
reduce the amount of cash available for distribution to holders of Trust Common Units.
|
|
●
|
The
value of the Royalty Interests is highly dependent on the performance and financial condition
of Avalon.
|
|
●
|
The
bankruptcy of operators could impede the operation of oil and gas wells subject to the
Royalty Interests (“Trust Wells”).
|
|
●
|
Producing
oil, natural gas and NGL from the Underlying Properties is a high risk activity with
many uncertainties that could adversely affect future production from the Underlying
Properties. Any such reductions in production could decrease cash that is available for
distribution to holders of Trust Common Units.
|
|
●
|
Oil,
natural gas and NGL prices can fluctuate widely due to a number of factors that are beyond
the control of the Trust and Avalon. Continued volatility in oil, natural gas or NGL
prices could reduce proceeds to the Trust and cash distributions to holders of Trust
Common Units.
|
|
●
|
Actual
petroleum reserves and future production may be less than current estimates, which could
reduce cash distributions by the Trust and the value of the Trust Common Units.
|
|
●
|
The
Trust Common Units have been delisted.
|
|
●
|
Production
of oil, natural gas and NGL on the Underlying Properties could be materially and adversely
affected by severe or unseasonable weather.
|
|
●
|
Due
to the Trust’s lack of industry and geographic diversification, adverse developments
in the location of the Underlying Properties could adversely impact the Trust’s
financial condition, results of operations and cash flows and reduce its ability to make
distributions to the holders of Trust Common Units.
|
|
●
|
The
generation of proceeds for distribution by the Trust depends in part on Avalon’s
access to and the operation of gathering, transportation and processing facilities. Limitations
in the availability of those facilities could interfere with sales of oil, natural gas
and NGL production from the Underlying Properties.
|
|
●
|
The
Trust is passive in nature and has no voting rights in Avalon, no managerial, contractual
or other ability to influence Avalon, and no right to exercise control over the field
operations of, or sale of oil, natural gas and NGL from, the Underlying Properties.
|
|
●
|
The
oil, natural gas and NGL reserves estimated to be attributable to the Royalty Interests
are depleting assets and production from those reserves will diminish over time. Furthermore,
the Trust is precluded from acquiring other oil and natural gas properties or royalty
interests to replace the depleting assets and production.
|
|
●
|
An
increase in the differential between the price realized by Avalon for oil and natural
gas produced from the Underlying Properties and the NYMEX or other benchmark price of
oil or natural gas could reduce the proceeds to the Trust and therefore the cash distributions
by the Trust and the value of Trust Common Units.
|
|
●
|
The
amount of cash available for distribution by the Trust is reduced by Trust expenses,
post-production costs and applicable taxes associated with the Royalty Interests.
|
|
●
|
The
Trust has no hedges in place to protect against the price risk inherent in holding interests
in oil and gas, commodities that are frequently characterized by significant price volatility.
|
|
●
|
The
Trust is administered by a Trustee who cannot be replaced except at a special meeting
of holders of Trust Common Units.
|
|
●
|
Holders
of Trust Common Units have limited ability to enforce provisions of the Royalty Interests,
and Avalon’s liability to the Trust is limited.
|
|
●
|
Courts
outside of Delaware may not recognize the limited liability of the holders of Trust Common
Units provided under Delaware law.
|
|
●
|
The
sale of Trust Common Units by Avalon could have an adverse impact on the trading price
of the Trust Common Units.
|
|
●
|
Avalon
could have interests that conflict with the interests of the Trust and holders of Trust
Common Units.
|
|
●
|
Avalon
may sell all or a portion of the Underlying Properties, subject to and burdened by the
Royalty Interests; any such purchaser could have a weaker financial position and/or be
less experienced in oil and natural gas development and production than Avalon.
|
|
●
|
Oil
and natural gas wells are subject to operational hazards that can cause substantial losses.
Avalon maintains insurance but may not be adequately insured for all such hazards.
|
|
●
|
The
operation of the Underlying Properties is subject to complex federal, state, local and
other laws and regulations that could adversely affect the cost, manner and feasibility
of conducting operations on the properties, which in turn could negatively impact Trust
distributions.
|
|
●
|
Should
Avalon fail to comply with all applicable statutes, rules, regulations and orders of
the Federal Energy Regulatory Commission (“FERC”) or the Federal Trade Commission
(“FTC”), Avalon could be subject to substantial penalties and fines.
|
|
●
|
The
operation of the Underlying Properties is subject to environmental and occupational safety
and health laws and regulations that could adversely affect the cost, manner or feasibility
of conducting operations or result in significant costs and liabilities.
|
|
●
|
Climate
change laws and regulations restricting emissions of greenhouse gasses (“GHGs”)
could result in increased operating costs with respect to the Underlying Properties.
|
|
●
|
The
Trust is subject to the requirements of the Sarbanes-Oxley Act of 2002, which may impose
cost and operating challenges on it.
|
|
●
|
Cyber-attacks
or other failures in telecommunications or IT systems could result in information theft,
data corruption and significant disruption of Avalon’s business operations.
|
|
●
|
Cyber-attacks
or other failures in telecommunications or IT systems could result in information theft,
data corruption and significant disruption of the Trustee’s operations.
|
|
●
|
Legislation
or regulatory initiatives intended to address seismic activity are restricting and could
further restrict Avalon’s ability and the ability of other operators of the
Underlying Properties to dispose of waste water produced alongside hydrocarbons.
|
Tax
Risks Related to the Trust Units
|
●
|
The
Trust’s tax treatment depends on its status as a partnership for U.S. federal income
tax purposes. If the U.S. Internal Revenue Service (“IRS”) were to treat
the Trust as a corporation for U.S. federal income tax purposes, then its cash available
for distribution to its holders of Trust Common Units would be substantially reduced.
|
|
●
|
If
the Trust were subjected to a material amount of additional entity-level taxation by
individual states, it would reduce the Trust’s cash available for distribution
to holders of Trust Common Units.
|
|
●
|
Tax
legislation enacted in 2017 may have a significant impact on the taxation of the Trust
and holders of Trust Common Units.
|
|
●
|
The
tax treatment of an investment in Trust Common Units could be affected by potential legislative
changes, possibly on a retroactive basis.
|
|
●
|
The
Trust has adopted and may continue to adopt positions that may not conform to all aspects
of existing Treasury Regulations. If the IRS contests the tax positions the Trust takes,
the value of the Trust Common Units may be adversely affected, the cost of any IRS contest
will reduce the Trust’s cash available for distribution and income, gains, losses
and deductions may be reallocated among holders of Trust Common Units. The Tax Cut and
Jobs Act alters the procedures for assessing and collecting income taxes due for taxable
years beginning after December 31, 2017, in a manner that could substantially reduce
cash available for distribution to holders of Trust Common Units.
|
|
●
|
Each
holder of Trust Common Units is required to pay taxes on its share of the Trust’s
income even if it does not receive cash distributions from the Trust equal to its share
of the Trust’s taxable income.
|
|
●
|
Tax
gain or loss on the disposition of the Trust Common Units could be more or less than
expected.
|
|
●
|
The
ownership and disposition of Trust Common Units by tax-exempt organizations and non-U.S.
persons may result in adverse tax consequences to them.
|
|
●
|
The
Trust treats each purchaser of Trust Common Units as having the same economic attributes
without regard to the actual Trust Common Units purchased. The IRS may challenge this
treatment, which could adversely affect the value of the Trust Common Units.
|
|
●
|
The
Trust prorates its items of income, gain, loss and deduction between transferors and
transferees of the Trust Common Units each quarter based upon the record ownership of
the Trust Common Units on the quarterly record date, in such quarter, instead of on the
basis of the date a particular Trust Common Unit is transferred. The IRS may challenge
this treatment, which could change the allocation of items of income, gain, loss and
deduction among the holders of Trust Common Units.
|
|
●
|
A
holder of Trust Common Units whose Trust Common Units are loaned to a “short seller”
to cover a short sale of Trust Common Units may be considered as having disposed of those
Trust Common Units. If so, such unitholder would no longer be treated for tax purposes
as a partner (for tax purposes) with respect to those Trust Common Units during the period
of the loan and may recognize gain or loss from the disposition.
|
|
●
|
The
Trust may adopt certain valuation methodologies that may affect the income, gain, loss
and deduction allocable to the holders of Trust Common Units. The IRS may challenge this
treatment, which could adversely affect the value of the Trust Common Units.
|
|
●
|
The
availability and extent of percentage depletion deductions to the holders of Trust Common
Units for any taxable year is uncertain.
|
In
addition to the above risks, in deciding whether to tender your Trust Common Units for exchange pursuant to the offer, you should
read and consider all of the risk factors discussed or referenced in the section of this offer to exchange titled “Risk
Factors.”
RISK
FACTORS
In
deciding whether to tender your Trust Common Units for exchange pursuant to the offer, holders of Trust Common Units should read
carefully this offer to exchange and all other documents to which this offer to exchange refers. If any of the risks described
below actually occur, the respective businesses, financial results, financial conditions, operating results or share prices of
PEDEVCO, the Trust or the combined company could be materially adversely affected.
Risk
Factors Relating to the Offer and the Second-Step Merger
Because
the market price of PEDEVCO Common Stock that holders of Trust Common Units will receive in the offer will fluctuate, holders
of Trust Common Units cannot be sure of the value of PEDEVCO Common Stock they will receive.
Upon
consummation of the offer, each Trust Common Unit tendered and accepted for exchange by PEDEVCO pursuant to the offer will be
converted into the right to receive the Consideration subject to the procedures described in this offer to exchange and in the
related letter of transmittal. Because the number of shares of PEDEVCO Common Stock being offered as consideration will not vary
based on the market value of PEDEVCO Common Stock or the market value of Trust Common Units, the market value of the consideration
holders of Trust Common Units will receive in the offer will be based on the value of PEDEVCO Common Stock and Trust Common Units
at the time the consideration in the offer is received. If the price of PEDEVCO Common Stock declines or the price of Trust Common
Units increases, holders of Trust Common Units could receive less value for their Trust Common Units upon the consummation of
the offer than the value calculated on the date the offer was announced, as of the date of the filing of this offer to exchange
or as of the date such holder of Trust Common Units made his or her election and tendered Trust Common Units into the offer. Changes
in the price of PEDEVCO Common Stock or Trust Common Units may result from a variety of factors that are beyond the companies’
control, including general market and economic conditions, changes in business prospects or in the oil and gas industry, actions
of third parties, catastrophic events, both natural and man-made, regulatory considerations. In addition, the ongoing businesses
of PEDEVCO and the Trust may be adversely affected by actions taken by PEDEVCO or the Trust in connection with the offer, including
payment by the companies of certain costs relating to the offer, including certain legal, accounting, financing and financial
and other advisory fees.
Because
the offer and the second-step merger will not be completed until certain conditions have been satisfied or, where relevant, waived
(see the section of this offer to exchange titled “The Offer—Conditions to the Offer”), a period of time, which
may be significant, may pass between the commencement of the offer and the time that Purchaser accepts Trust Common Units exchanged.
Therefore, at the time when you tender your Trust Common Units pursuant to the offer, you will not know the exact market value
of PEDEVCO Common Stock that you may receive if Purchaser accepts such Trust Common Units for exchange. However, tendered Trust
Common Units may be withdrawn at any time prior to the expiration time of the offer and, unless we have already accepted the tendered
Trust Common Units for exchange, at any time following 60 days from commencement of the offer. See the section of this offer to
exchange titled “The Offer—Withdrawal Rights.”
Holders
of Trust Common Units are urged to obtain current market quotations for Trust Common Units and PEDEVCO Common Stock (and to consider
the equivalent market value of the Consideration based on current market quotations for PEDEVCO Common Stock) when they consider
whether to tender their Trust Common Units pursuant to the offer. See the section of this offer to exchange titled “Comparative
Per Share Market Price and Dividend Information and Related Stockholder Matters” for recent historical high and low closing
prices of PEDEVCO Common Stock and Trust Common Units.
Even
if the offer is completed, there remains a risk that the Trust could liquidate prior to the completion of the second-step merger.
Even
if the exchange offer is completed, there remains substantial risk of the Trust being liquidated prior to the completion of the
second-step merger. Until completion of the second-step merger, provisions of the Trust Agreement (which cannot be amended without
the consent of Avalon) would require the Trust to liquidate upon certain events, including the disposition of all of the Royalty
Interests and other assets (other than cash), tangible or intangible, including accounts receivable and claims or rights to payment,
constituting the trust estate or if the aggregate quarterly cash distribution amounts received by the Trust for distribution to
its holders of Trust Common Units from Avalon for any four consecutive quarters, on a cumulative basis, fall below $5.0 million.
There
is uncertainty regarding Avalon’s ability to pay the quarterly cash distribution amounts to the Trust. For example, the
Trust has disclosed that Avalon failed to pay $4.65 million owed to the Trust for the three-month period ended March 31, 2020
resulting in no quarterly distribution for that quarter. The Trust’s Quarterly Report on Form 10-Q for the period ended
June 30, 2020 indicates that Avalon will make a payment of $1.7 million to the Trust for the three months ended June 30, 2020,
which will result in a quarterly distribution of $652,000.
The
Trust has indicated in SEC filings the possibility for an early termination. In its Quarterly Report on Form 10-Q for the quarter
ended June 30, 2020 filed on August 8, 2020, the Trust stated that based on Avalon’s estimates for the next twelve months
regarding projected production from the Underlying Properties and estimated pricing for WTI crude oil based on futures prices
as of August 1, 2020 readily available in the public market, adjusted for differentials, and assuming that Avalon is unable to
make the quarterly payment to the Trust for the three-month period ended March 31, 2020, cash available for distribution for the
four consecutive quarters ending December 31, 2020, on a cumulative basis, may fall below $5.0 million, which would require the
Trust to commence termination shortly after the required quarterly cash distribution is to be made in February 2021. The Trust
stated that if that occurs, the Trustee would be required to sell all of the Trust’s remaining assets and liquidate the
Trust.
Subsequently,
Avalon and Montare Resources I, LLC (“Montare”) stated in a letter to the Trust dated September 2, 2020 and filed
as Exhibit 99.4 to a jointly filed Schedule 13D on September 8, 2020, that Avalon believes that, based on current and future projections
of oil prices, there will be sufficient cash for the Trust to make distributions exceeding $5 million per 12-month period until
March 31, 2024.
In
response on September 4, 2020, which response is filed as Exhibit 99.1 to the Trust’s Current Report on Form 8-K filed on
September 8, 2020, the Trustee noted that its prior statements included in its Quarterly Report on Form 10-Q for the quarter ended
June 30, 2020 were “disclosure . . . provided to the Trust by Avalon” and that it was “ . . surprised by the
projected distributions to unitholders [in the] September 2 letter and by [Avalon’s] statements regarding [its] belief that
the Trust will be able to make cumulative distributions exceeding $5.0 million during each four-quarter period until March 2024.”
Accordingly,
there is uncertainty regarding payment of future distributions by Avalon. Due to the Trust Agreement requiring liquidation that
depends upon the payments Avalon makes under the Royalty Interests, actions by persons other than the Trust or PEDEVCO may cause
a liquidation of the Trust. Although PEDEVCO intends to complete the second-step merger as promptly as practicable following the
exchange offer, the timing of completing the second-step merger following the exchange offer cannot be estimated with exact certainty.
Accordingly, the Trust could be liquidated after completing the exchange offer but prior to the second-step merger.
If
liquidation of the Trust were to occur following the exchange offer but prior to the second-step merger, the Trustee would sell
the Royalty Interests (subject to Avalon’s right of first refusal) and proceeds of the Trust’s liquidation would be
distributed to holders of Trust Common Units, including PEDEVCO. In such an event, holders that will have exchanged their Trust
Common Units for PEDEVCO Common Stock would not share directly in the liquidating distributions because they would no longer hold
Trust Common Units, and PEDEVCO would receive the liquidating distributions that the exchanging holders of Trust Common Units
would have otherwise received.
The
offer is subject to other conditions that PEDEVCO cannot control.
The
offer is subject to other conditions, including the Minimum Tender Condition, the Trustee Consent Condition, the PEDEVCO Shareholder
Approval Condition, the Government Approval Condition and the No Trust Material Adverse Effect Condition. No assurance can be
given that all of the conditions to the offer will be satisfied or, if they are, as to the timing of such satisfaction. In addition,
the Trust or a third party, such as Avalon or Montare, may seek to take additional actions, or fail to take actions, and put in
place additional obstacles that will delay, or frustrate, the satisfaction of one or more conditions. If the conditions to the
offer are not satisfied, then PEDEVCO may allow the offer to expire, or could amend or extend the offer. See the section of this
offer to exchange titled “The Offer—Conditions to the Offer” for a discussion of the conditions to the offer.
The
prices of PEDEVCO Common Stock and Trust Common Units may be adversely affected if the offer and the second-step merger are not
completed.
If
the offer and the second-step merger are not completed, the prices of PEDEVCO Common Stock and Trust Common Units may decline
to the extent that the current market prices of PEDEVCO Common Stock and Trust Common Units reflect a market assumption that the
offer and the second-step merger will be completed.
PEDEVCO
has not negotiated the price or terms of the offer or second-step merger with the Trust.
In
evaluating the offer, you should be aware that PEDEVCO has not negotiated the price or terms of the offer or the second-step merger
with the Trust and neither the Trust nor the Trustee has approved the offer or the second-step merger. The Trustee has declined
to enter into discussions with PEDEVCO regarding the offer, and has stated that the Trust Agreement does not authorize the Trustee
to enter into an arrangement with an offeror or with respect to a negotiated exchange offer or tender offer for the outstanding
Common Units. In light of the Trustee’s indicated inability to negotiate with PEDEVCO, PEDEVCO is making the offer directly
to holders of Trust Common Units upon the terms and subject to the conditions set forth in this offer to exchange as an alternative
to a negotiated transaction.
The
Trustee is now required under the rules and regulations of the SEC to issue a statement as to whether it recommends acceptance
or rejection of the offer, that it expresses no opinion and remains neutral toward the offer or that it is unable to take a position
with respect to the offer, and to file with the SEC a solicitation/recommendation statement on Schedule 14D-9 describing its position,
if any, and certain related information, no later than ten business days from the date this offer to exchange is first published,
sent or given to stockholders. PEDEVCO recommends that you review this Schedule 14D-9 when it becomes available.
You
may be unable to assert a claim against the Trust’s independent registered public accounting firm or independent reserve
engineers under Section 11 of the Securities Act.
Section
11(a) of the Securities Act provides that if part of a registration statement at the time it becomes effective contains an untrue
statement of a material fact or omits a material fact required to be stated therein or necessary to make the statements therein
not misleading, any person acquiring a security pursuant to such registration statement (unless it is proved that at the time
of such acquisition such person knew of such untruth or omission) may assert a claim against, among others, any accountant or
expert who has consented to be named as having certified any part of the registration statement or as having prepared any report
for use in connection with the registration statement.
Although
audit reports were issued on the Trust’s historical financial statements and are included in the Trust’s filings with
the SEC, the Trust’s independent registered public accounting firm has not permitted the use of its reports in PEDEVCO’s
registration statement of which this offer to exchange forms a part. PEDEVCO is requesting but has not, as of the date hereof,
received the consent of such independent registered public accounting firm. If PEDEVCO does not receive this consent, PEDEVCO
plans to request dispensation pursuant to Rule 437 under the Securities Act from this requirement. If PEDEVCO receives the consent
of the Trust’s independent registered public accounting firm, PEDEVCO will promptly file it as an exhibit to PEDEVCO’s
registration statement of which this offer to exchange forms a part. Accordingly, if PEDEVCO is unable to obtain the consent of
the Trust’s independent registered public accounting firm, you may not be able to assert a claim against the Trust’s
independent registered public accounting firm under Section 11 of the Securities Act.
Similarly,
the information included herein regarding the Trust’s estimated quantities of proved developed producing reserves and future
revenue, as of December 31, 2019, of the Trust’s royalty interest in certain oil and gas properties is based on the proved
reserve report prepared by the Trust’s independent reserve engineers, as set forth in their report included in the Trust’s
Annual Report on Form 10-K for the year ended December 31, 2019. PEDEVCO is requesting but has not, as of the date hereof, received
the consent of such independent reserve engineers to file their report. If PEDEVCO does not receive this consent, PEDEVCO plans
to request dispensation pursuant to Rule 437 under the Securities Act from this requirement. If PEDEVCO receives the consent of
the Trust’s independent reserve engineers, PEDEVCO will promptly file it, and the report, as an exhibit to PEDEVCO’s
registration statement of which this offer to exchange forms a part. Accordingly, if PEDEVCO is unable to obtain the consent of
the Trust’s independent reserve engineers, you may not be able to assert a claim against the Trust’s independent reserve
engineers under Section 11 of the Securities Act.
If
PEDEVCO completes the exchange offer in accordance with the Minimum Tender Condition and Trustee Consent Condition, it believes
it will be able to approve the second-step merger without a vote of holders of Trust Common Units who did not accept the exchange
offer.
Under
Section 3815(a) of the Delaware Trust Act, a statutory trust may merge or consolidate with or into another business entity formed
or organized or existing under the laws of the State of Delaware or any other state or jurisdiction, with either the trust or
other business entity surviving. Section 3815(a) of the Delaware Trust Act further provides that unless otherwise provided in
the governing instrument of a statutory trust that is not a registered investment company, an agreement of merger or consolidation
shall be approved by each such statutory trust which is to merge or consolidate by all of the beneficial owners and all of the
trustees. Section 3806(f)(1) of the Delaware Trust Act provides that unless otherwise provided in the governing instrument of
a statutory trust, on any matter that is to be voted on by the beneficial owners, the beneficial owners may take such action without
a meeting, without a prior notice and without a vote if consented to, in writing, or by electronic transmission by beneficial
owners having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting
at which all interests in the statutory trust entitled to vote thereon were present and voted.
Pursuant
to Section 9.04 of the Trust Agreement, the Trust may merge or consolidate with or into, or convert into, one or more other
corporations, partnerships, limited liability companies, trusts, estates or other entity, organization or association in
accordance with Section 3815 of the Trust Act if such transaction: (1) is agreed to by the Trustee; (2) approved by the vote
of a Unit Majority at a meeting duly called and held in accordance with Article VIII; and (3) is permitted under the Trust
Act and any other applicable law. A “Unit Majority” is defined in the Trust Agreement as (i) a majority of the
Trust Common Units (excluding Trust Common Units owned by Avalon and its Affiliates ) and (ii) a majority of the Trust Common
Units, in each case present in person or by proxy at a meeting at which a quorum is present; provided, that, at any time when
Avalon and its Affiliates collectively own less than 10% of the outstanding Trust Common Units, “Unit Majority”
means a majority of the Trust Common Units present in person or by proxy at a meeting at which a quorum is
present.
Upon
completion of the offer to exchange, assuming the satisfaction of the Minimum Tender Condition, PEDEVCO will have a majority of
the outstanding Trust Common Units. Furthermore, assuming satisfaction of the Trustee Consent Condition, PEDEVCO will have the
approval for the Trustee for the second-step merger. PEDEVCO believes it will be able to, and intends to, approve the second-step
merger acting by written consent under Section 3806(f)(1) of the Delaware Trust Act as a holder of a Unit Majority of the Trust
Common Units because the Trust Agreement does not presently prohibit action by written consent. PEDEVCO intends to file a preliminary
information statement with respect to the shareholder written consent in lieu of a special meeting to approve the second-step
merger prior to, or promptly after, the completion of the offer to exchange.
While
the Trust Agreement does not expressly prohibit action by written consent of a holder of Trust Common Units, parties may challenge
the ability of PEDEVCO to act by written consent, including the Trustee, Avalon or Montare, which may delay or prevent this offer
to exchange or the second-step merger.
The
Trustee may not consent to the second-step merger, or may impose conditions on its consent that are unfavorable or cause us to
terminate the offer.
Pursuant
to Section 9.04 of the Trust Agreement, the Trust may merge or consolidate with or into, or convert into, one or more other corporations,
partnerships, limited liability companies, trusts, estates or other entity, organization or association in accordance with Section
3815 of the Trust Act if, among other conditions, such transaction is agreed to by the Trustee.
PEDEVCO
has conditioned this offer upon the Trustee’s consent to the second-step merger. The Trustee may not consent to the second-step
merger. Additionally, the Trustee may determine to impose conditions on the second-step merger that are unfavorable to PEDEVCO,
or that could have the effect of delaying this offer to exchange or the second-step merger. In the event the Trustee does not
consent to the second-step merger, or the Trustee imposes conditions on the second-step merger, PEDEVCO may terminate the exchange
offer.
There
will not be appraisal or dissenters’ rights with respect to the exchange offer or second-step merger.
Holders
of Trust Common Units do not have dissenters’ or appraisal rights in connection with the offer.
Additionally,
Section 3815(h) of the Delaware Trust Act provides that unless otherwise provided in a governing instrument or an agreement of
merger or consolidation or a plan of division, no appraisal rights are available with respect to a beneficial interest or another
interest in a statutory trust, including in connection with any amendment of a governing instrument, any merger or consolidation
in which the statutory trust is a constituent party to the merger or consolidation, any division of the statutory trust or the
sale of all or substantially all of the statutory trust’s assets. The Trust Agreement does not provide for appraisal rights.
Accordingly, holders of Trust Common Units will not have appraisal rights in the second-step merger.
Risk
Factors Relating to PEDEVCO Following the Offer and the Second-Step Merger
Assuming
completion of the offer and second-step merger, PEDEVCO would own only the Royalty Interests, and would therefore remain subject
to the same risks of the Trust with respect to its Royalty Interests.
Assuming
PEDEVCO completes the offer and the second-step merger, it will only acquire the Royalty Interests. PEDEVCO would not, without
further action, become the operator of the Underlying Properties, a working interest owner, or own any other form of ownership
with respect to the Underlying Properties. Accordingly, all of the risks that are present with respect to the Trust and its Royalty
Interest would continue to apply to PEDEVCO. Although PEDEVCO intends to engage with the operator of the Underlying Properties
to enhance the value of the Royalty Interest, there is no assurance it will be able to do so. Please read “—Risk Factors
Related to the Trust—Risks Related to the Trust Units.” There can be no assurance that PEDEVCO can increase the value
of the Royalty Interests, or that its ownership of the Royalty Interests would be any different from that of the Trust.
If
PEDEVCO acquires less than a majority of the outstanding Trust Common Units, it may be deemed to be an investment company under
the Investment Company Act.
PEDEVCO
has conditioned the exchange offer on the Minimum Tender Condition, which means the exchange offer is conditioned upon PEDEVCO
acquiring a majority of the outstanding Trust Common Units. However, the condition may be waived by PEDEVCO. If the Minimum Tender
Condition is waived by PEDEVCO, and it acquires less than a majority of the outstanding Trust Common Units, it may be deemed to
be an investment company under the Investment Company Act of 1940, as amended (the “Investment Company Act”). If PEDEVCO
is deemed to be an investment company, it will either have to register as an investment company under the Investment Company Act,
obtain exemptive relief from the SEC or modify its organizational structure or contractual rights to fall outside the definition
of an investment company. Registering as an investment company could, among other things, materially limit PEDEVCO’s ability
to engage in transactions with affiliates, including the purchase and sale of certain securities or other property to or from
its affiliates, restrict its ability to borrow funds or engage in other transactions involving leverage, require PEDEVCO to add
additional directors who are independent of PEDEVCO and its affiliates, and adversely affect the price of PEDEVCO’s Common
Stock.
PEDEVCO
has only conducted a review of the Trust’s publicly available information and has not had access to the Trust’s non-public
information.
To
date, PEDEVCO has only conducted a due diligence review of the Trust’s publicly available information. There may be material
non-public information about the Trust, Avalon or Montare that could impact PEDEVCO’s decision, including the Consideration
offered in the exchange. For example, Avalon and Montare referenced an Exhibit A in a letter to the Trust dated September 2, 2020
and filed as Exhibit 99.4 to a jointly filed Schedule 13D on September 8, 2020, which included estimated distributions by quarter
from the third quarter of 2019 to the first quarter of 2023, as forecasted by Avalon. In response on September 4, 2020, which
response is filed as Exhibit 99.1 to the Trust’s Current Report on Form 8-K filed on September 8, 2020, the Trust noted
that it had received supporting documents with respect to the forecast. Financial forecasts and supporting documents regarding
future distributions on the Trust Common Units, if it were available to PEDEVCO, would likely be considered material information
that would be used to determine, among other things, the Consideration offered in the exchange.
As
a result, after the consummation of the offer and the second-step merger, PEDEVCO may be subject to liabilities and risks of the
Trust unknown to PEDEVCO or the Trust, or holders of Trust Common Units, which may have a material adverse effect on the business,
financial condition and results of operations of the combined company and the market value of PEDEVCO Common Stock after the consummation
of the offer and the second-step merger.
The
consummation of the offer or the second-step merger may constitute a breach or default, or an event that, with or without notice
or lapse of time or both, would constitute a breach or default, or result in the acceleration or other change of any right or
obligation (including, without limitation, any payment obligation) or termination of an agreement under agreements of the Trust
that are not publicly available. If this happens, PEDEVCO may have liabilities relating to the breach or default and may have
to seek to replace that agreement with a new agreement. PEDEVCO cannot provide assurance that it will be able to replace a terminated
agreement on comparable terms or at all. Depending on the importance of a terminated agreement to the Trust, failure to replace
that agreement on similar terms or at all may increase the costs to PEDEVCO of acquiring the Trust or prevent PEDEVCO from utilizing
all or a part of the Trust assets. In addition, the Trust may be committed to arrangements or agreements of which PEDEVCO is not
aware.
In
respect of all information relating to the Trust presented in, or omitted from, this offer to exchange, PEDEVCO has relied upon
publicly available information, including information publicly filed by the Trust with the SEC. Although PEDEVCO has no knowledge
that would indicate that any statements contained herein regarding the Trust’s condition, including its financial or operating
condition (based upon such publicly filed reports and documents) are inaccurate, incomplete or untrue, PEDEVCO was not involved
in the preparation of such information and statements. For example, PEDEVCO has made adjustments and assumptions in preparing
the pro forma financial information presented in this offer to exchange that have necessarily involved PEDEVCO’s estimates
with respect to the Trust’s financial information that, given the lack of information received, could be materially different
than currently presented. See the section of this offer to exchange titled “Unaudited Pro Forma Condensed Combined Financial
Statements.” Any financial, operating or other information regarding the Trust that may be detrimental to PEDEVCO following
the consummation of the offer and the second-step merger that has not been publicly disclosed by the Trust, or errors in PEDEVCO’s
estimates due to the lack of cooperation and information from the Trust, may have a material adverse effect on the business, financial
condition and results of operations of the combined company and the market value of PEDEVCO Common Stock after the consummation
of the offer and the second-step merger.
Future
results of PEDEVCO may differ materially from the unaudited pro forma condensed combined financial statements of PEDEVCO and the
Trust presented in this offer to exchange.
The
future results of PEDEVCO following the consummation of the offer and the second-step merger may be materially different from
those shown in the Unaudited Pro Forma Condensed Combined Financial Statements presented in this offer to exchange, which show
only a combination of PEDEVCO’s and the Trust’s standalone historical results after giving effect to the offer and
the second-step merger, subject to the matters noted therein. PEDEVCO has estimated that it will record approximately $0.6 million
in transaction expenses, as described in the notes to the Unaudited Pro Forma Condensed Combined Financial Statements included
in this offer to exchange. In addition, the final amount of any charges relating to acquisition accounting adjustments that PEDEVCO
may be required to record will not be known until following the consummation of the offer and the second-step merger. These and
other expenses and charges may be significantly higher or lower than estimated.
Resales
of PEDEVCO Common Stock following the offer may cause the market price of PEDEVCO Common Stock to fall.
PEDEVCO
expects that it will issue approximately 21,000,000 shares of PEDEVCO Common Stock in connection with the offer and the second-step
merger. The issuance of these new shares and the sale of additional shares (including by way of registration rights Avalon may
have as a result of the second-step merger) that may become eligible for sale in the public market from time to time upon
exercise
of options could have the effect of depressing the market price for PEDEVCO Common Stock. The increase in the number of PEDEVCO
Common Stock may lead to sales of such PEDEVCO Common Stock or the perception that such sales may occur, either of which may adversely
affect the market for, and the market price of, PEDEVCO Common Stock.
The
trading price of PEDEVCO Common Stock may be affected by factors different from those affecting the price of Trust Common Units.
Upon
consummation of the offer and the second-step merger, holders of Trust Common Units will become holders of PEDEVCO Common Stock.
PEDEVCO’s business differs from that of the Trust, and PEDEVCO’s results of operations, as well as the trading price
of PEDEVCO Common Stock, may be affected by factors different from those affecting the Trust’s results of operations and
the price of Trust Common Units.
The
PEDEVCO Common Stock to be received by holders of Trust Common Units as consideration will have different rights from the Trust
Common Units.
Upon
receipt of PEDEVCO Common Stock in the offer, holders of Trust Common Units will become holders of PEDEVCO Common Stock and their
rights as shareholders will be governed by the certificate of formation of PEDEVCO (the “PEDEVCO Certificate of Formation”),
the bylaws of PEDEVCO (the “PEDEVCO Bylaws”), and the Texas Business Organizations Code (the “TBOC”).
Many of the rights associated with PEDEVCO Common Stock are significantly different from those of Trust Common Units. See the
section of this offer to exchange titled “Comparison Rights of Holders” for a discussion of the different rights associated
with PEDEVCO Common Stock and Trust Common Units.
Holders
of Trust Common Units will have a reduced ownership interest in the Trust’s assets after the consummation of the offer and
the second-step merger.
When
the Trust Common Units are tendered in the offer are exchanged and following consummation of the second-step merger, each holder
of Trust Common Units will become a PEDEVCO shareholder with a percentage ownership of the combined company that is smaller than
the Trust Common Unit holder’s interest in the Trust. PEDEVCO estimates that, upon consummation of the offer and the second-step
merger, former holders of Trust Common Units will own, in the aggregate, approximately 22.5% of the issued and outstanding PEDEVCO
Common Stock (approximately 22.1% on a fully diluted basis) as a result of having been holders of Trust Common Units. For a more
detailed discussion of the assumptions on which this estimate is based, see the section of this offer to exchange titled “The
Offer—Ownership of PEDEVCO After the Offer.”
The
combined business of PEDEVCO and the Trust will be geographically concentrated.
Both
PEDEVCO and the Trust are dependent upon oil and gas producing properties in the Permian Basin. This concentration could disproportionately
expose the combined entities to operational and regulatory risk in that area. Due to the lack of diversification in industry type
and location of the combined entities interests, adverse developments in the oil and natural gas market or the area, for example,
transportation or treatment capacity constraints, curtailment of production or treatment plant closures for scheduled maintenance,
could have a significantly greater impact on the combined entities financial condition, results of operations and cash flows than
if it were more diversified.
Tax
Risks Related to the Offer and Second-Step Merger and
the Ownership of PEDEVCO Common Stock
In
addition to reading the following risk factors, you are urged to read “The Offer—Material U.S. Federal Income Tax
Consequences” for a more complete discussion of the expected U.S. federal income tax consequences of the offer and second-step
merger and of owning and disposing of PEDEVCO Common Stock.
The
offer and second-step merger will be a taxable transaction to the holders of Trust Common Units and the resulting tax liability
of a holder of Trust Common Units will depend on such unitholder’s particular situation. The tax liability of a holder of
Trust Common Units as a result of the offer and second-step merger could be more than expected.
Holders
of Trust Common Units will receive PEDEVCO Common Stock in exchange for their Trust Common Units. Although the holders of Trust
Common Units will receive no cash consideration, the offer and second-step merger will be treated as a taxable sale by U.S. Holders
(as defined in “The Offer—Material U.S. Federal Income Tax Consequences”) of the Trust Common Units for U.S.
federal income tax purposes. As a result of the offer and second-step merger, a holder of Trust Common Units that is a U.S. holder
will recognize gain or loss for U.S. federal income tax purposes equal to the difference between such unitholder’s amount
realized and the unitholder’s adjusted tax basis in its Trust Common Units. The amount of gain or loss recognized by such
a U.S. holder in the offer and second-step merger will vary depending on such U.S. holder’s particular situation, including
the value of the shares of PEDEVCO Common Stock received and the adjusted tax basis of the Trust Common Units exchanged by such
U.S. holder in the offer and second-step merger, and the amount of any suspended passive losses that may be available to a particular
U.S. holder to offset a portion of the gain recognized by it.
Because
the value of any PEDEVCO Common Stock received in the offer and second-step merger will not be known until the effective time
of the offer and second-step merger, a holder of Trust Common Units that is a U.S. holder will not be able to determine its amount
realized, and therefore its taxable gain or loss, until such time. In addition, because prior distributions in excess of a U.S.
holder’s allocable share of the Trust’s net taxable income decrease the U.S. holder’s tax basis in its Trust
Common Units, the amount, if any, of the prior excess distributions with respect to such Trust Common Units will, in effect, become
taxable income to a unitholder that is a U.S. holder if the aggregate value of the consideration received in the offer and second-step
merger is greater than the U.S. holder’s adjusted tax basis in its Trust Common Units, even if the aggregate value of the
consideration received in the offer and second-step merger is less than the U.S. holder’s original cost basis in its Trust
Common Units. Furthermore, a portion of this gain or loss, which could be substantial, will be separately computed and taxed as
ordinary income or loss to the extent attributable to “unrealized receivables,” including depreciation recapture,
or to “inventory items” owned by the Trust.
For
a more complete discussion of U.S. federal income tax consequences of the offer and second-step merger, see “The Offer—Material
U.S. Federal Income Tax Consequences.”
The
U.S. federal income tax treatment of owning and disposing of PEDEVCO Common Stock received in the offer or second-step merger
will be different than the U.S. federal income tax treatment of owning and disposing of the Trust Common Units.
The
Trust is classified as a partnership for U.S. federal income tax purposes and, generally, is not subject to entity-level U.S.
federal income taxes. Instead, each holder of Trust Common Units is required to take into account its respective share of the
Trust’s items of income, gain, loss and deduction in computing its federal income tax liability, even if no cash distributions
are made by the Trust to the unitholder. A pro rata distribution of cash by the Trust to a holder of Trust Common Units who is
a U.S. holder is generally not taxable for U.S. federal income tax purposes unless the amount of cash distributed is in excess
of the such unitholder’s adjusted tax basis in its Trust Common Units.
In
contrast, PEDEVCO is classified as a corporation for U.S. federal income tax purposes and is subject to U.S. federal income tax
on its taxable income. A distribution of cash by PEDEVCO to a shareholder who is a U.S. holder will generally be included in such
shareholder’s income as ordinary dividend income to the extent of PEDEVCO’s current or accumulated “earnings
and profits,” as determined under U.S. federal income tax principles. Cash distributions to a PEDEVCO shareholder who is
a U.S. holder in excess of PEDEVCO’s current and accumulated earnings and profits will be treated as a non-taxable return
of capital, reducing the adjusted tax basis in the U.S. holder’s PEDEVCO Common Stock and, to the extent the cash distribution
exceeds the U.S. holder’s adjusted tax basis, as capital gain from the sale or exchange of such PEDEVCO Common Stock. See
“The Offer—Material U.S. Federal
Income Tax Consequences.”
Risk
Factors Relating to PEDEVCO
Risk
Factors Related to the Oil, NGL and Natural Gas Industry and PEDEVCO’s Business
Declines
in oil and, to a lesser extent, NGL and natural gas prices, have in the past, and will continue in the future to, adversely affect
PEDEVCO’s business, financial condition or results of operations and PEDEVCO’s ability to meet its capital expenditure
obligations or targets and financial commitments.
The
price PEDEVCO receives for its oil and, to a lesser extent, natural gas and NGLs, heavily influences PEDEVCO’s revenue,
profitability, cash flows, liquidity, access to capital, present value and quality of its reserves, the nature and scale of its
operations and future rate of growth. Oil, NGL and natural gas are commodities and, therefore, their prices are subject to wide
fluctuations in response to relatively minor changes in supply and demand. In recent years, the markets for oil and natural gas
have been volatile. These markets will likely continue to be volatile in the future. Further, oil prices and natural gas prices
do not necessarily fluctuate in direct relation to each other. Because approximately 88% of PEDEVCO’s estimated proved reserves
as of December 31, 2019 were oil, its financial results are more sensitive to movements in oil prices. The price of crude oil
has experienced significant volatility over the last five years, with the price per barrel of West Texas Intermediate (“WTI”)
crude rising from a low of $27 in February 2016 to a high of $76 in October 2018, then, in 2020, most recently dropping below
$20 per barrel due in part to reduced global demand stemming from the recent global COVID-19 outbreak. A prolonged period of low
market prices for oil and natural gas, or further declines in the market prices for oil and natural gas, will likely result in
capital expenditures being further curtailed and will adversely affect PEDEVCO’s business, financial condition and liquidity
and its ability to meet obligations, targets or financial commitments and could ultimately lead to restructuring or filing for
bankruptcy, which would have a material adverse effect on its stock price and indebtedness. Additionally, lower oil and natural
gas prices have, and may in the future, cause, a decline in PEDEVCO’s stock price. During the year ended December 31, 2019,
the daily NYMEX WTI oil spot price ranged from a high of $66.24 per Bbl to a low of $46.31 per Bbl and the NYMEX natural gas Henry
Hub spot price ranged from a high of $4.25 per MMBtu to a low of $1.75 per MMBtu. During the six months ended June 30, 2020, the
daily NYMEX WTI oil spot price ranged from a high of $63.27 per Bbl to a low of ($36.98) per Bbl and the NYMEX natural gas Henry
Hub spot price ranged from a high of $2.17 per MMBtu to a low of $1.42 per MMBtu.
PEDEVCO
has a limited operating history and expects to continue to incur losses for an indeterminable period of time.
PEDEVCO
has a limited operating history and is engaged in the initial stages of exploration, development and exploitation of its leasehold
acreage and will continue to be so until commencement of substantial production from its oil and natural gas properties, which
will depend upon successful drilling results, additional and timely capital funding, and access to suitable infrastructure. Companies
in their initial stages of development face substantial business risks and may suffer significant losses. PEDEVCO has generated
substantial net losses and negative cash flows from operating activities in the past and expect to continue to incur substantial
net losses as PEDEVCO continues its drilling program. In considering an investment in PEDEVCO Common Stock, you should consider
that there is only limited historical and financial operating information available upon which to base your evaluation of PEDEVCO’s
performance. PEDEVCO has incurred net losses of $102,594,000 from the date of inception (February 9, 2011) through
June 30, 2020. Additionally, PEDEVCO is dependent on obtaining additional debt and/or equity financing to roll-out and scale its
planned principal business operations. Management’s plans in regard to these matters consist principally of seeking additional
debt and/or equity financing combined with expected cash flows from current oil and gas assets held and additional oil and gas
assets that PEDEVCO may acquire. PEDEVCO’s efforts may not be successful and funds may not be available on favorable terms,
if at all.
PEDEVCO
faces challenges and uncertainties in financial planning as a result of the unavailability of historical data and uncertainties
regarding the nature, scope and results of its future activities. New companies must develop successful business relationships,
establish operating procedures, hire staff, install management information and other systems, establish facilities and obtain
licenses, as well as take other measures necessary to conduct their intended business activities. PEDEVCO may not be successful
in implementing its business strategies or in completing the development of the infrastructure necessary to conduct its business
as planned. In the event that one or more of its drilling programs is not completed or is delayed or terminated, its operating
results will be adversely affected and its operations will differ materially from the activities described in its Annual Report
on Form 10-K, Quarterly Reports on Form 10-Q, in this offer to exchange and its subsequent periodic reports. As a result of industry
factors or factors relating specifically to us, PEDEVCO may have to change its methods of conducting business, which may cause
a material adverse effect on its results of operations and financial condition. The uncertainty and risks described in this offer
to exchange may impede its ability to economically find, develop, exploit and acquire oil and natural gas reserves. As a result,
PEDEVCO may not be able to achieve or sustain profitability or positive cash flows provided by its operating activities in the
future.
PEDEVCO
will need additional capital to complete future acquisitions, conduct its operations and fund its business beyond 2020, and its
ability to obtain the necessary funding is uncertain.
PEDEVCO
will need to raise additional funding to complete future potential acquisitions and will be required to raise additional funds
through public or private debt or equity financing or other various means to fund its operations and complete exploration and
drilling operations beyond 2020 (which 2020 plan is fully funded), and acquire assets. In such a case, adequate funds may not
be available when needed or may not be available on favorable terms. If PEDEVCO needs to raise additional funds in the future
by issuing equity securities, dilution to existing stockholders will result, and such securities may have rights, preferences
and privileges senior to those of PEDEVCO Common Stock. If funding is insufficient at any time in the future and PEDEVCO is unable
to generate sufficient revenue from new business arrangements, to complete planned acquisitions or operations, its results of
operations and the value of its securities could be adversely affected.
Additionally,
due to the nature of oil and gas interests, i.e., that rates of production generally decline over time as oil and gas reserves
are depleted, if PEDEVCO is unable to drill additional wells and develop its reserves, either because PEDEVCO is unable to raise
sufficient funding for such development activities, or otherwise, or in the event PEDEVCO is unable to acquire additional operating
properties, PEDEVCO believes that its revenues will continue to decline over time. Furthermore, in the event PEDEVCO is unable
to raise additional required funding in the future, PEDEVCO will not be able to participate in the drilling of additional wells,
will not be able to complete other drilling and/or workover activities, and may not be able to make required payments
on its outstanding liabilities.
If
this were to happen, PEDEVCO may be forced to scale back its business plan, sell or liquidate assets to satisfy outstanding debts,
all of which could result in the value of its outstanding securities declining in value.
PEDEVCO
may not be able to generate sufficient cash flow to meet any future debt service and other obligations due to events beyond its
control.
PEDEVCO’s
ability to generate cash flows from operations, to make payments on or refinance potential future indebtedness and to fund working
capital needs and planned capital expenditures will depend on its future financial performance and its ability to generate cash
in the future. PEDEVCO’s future financial performance will be affected by a range of economic, financial, competitive, business
and other factors that PEDEVCO cannot control, such as general economic, legislative, regulatory and financial conditions in its
industry, the economy generally, the price of oil and other risks described below. A significant reduction in operating cash flows
resulting from changes in economic, legislative or regulatory conditions, increased competition or other events beyond its control
could increase the need for additional or alternative sources of liquidity and could have a material adverse effect on its business,
financial condition, results of operations, prospects and its ability to service future potential debt and other obligations.
If PEDEVCO
is unable to service future potential indebtedness or to fund its other liquidity needs, PEDEVCO may be forced to adopt
an alternative strategy that may include actions such as reducing or delaying capital expenditures, selling assets, restructuring
or refinancing such indebtedness, seeking additional capital, or any combination of the foregoing. If PEDEVCO raises debt, it
would increase its interest expense, leverage and its operating and financial costs. PEDEVCO cannot assure you that any of these
alternative strategies could be affected on satisfactory terms, if at all, or that they would yield sufficient funds to make required
payments on future potential indebtedness or to fund its other liquidity needs. Reducing or delaying capital expenditures or selling
assets could delay future cash flows. In addition, the terms of future debt agreements may restrict PEDEVCO from adopting any
of these alternatives. PEDEVCO cannot assure you that its business will generate sufficient cash flows from operations or that
future borrowings will be available in an amount sufficient to enable it to pay such future potential indebtedness or to fund
its other liquidity needs.
If
for any reason PEDEVCO is unable to meet its future potential debt service and repayment obligations, PEDEVCO may be in default
under the terms of the agreements governing such indebtedness, which could allow its creditors at that time to declare such outstanding
indebtedness to be due and payable. Under these circumstances, its lenders could compel PEDEVCO to apply all of its available
cash to repay its borrowings. In addition, the lenders under its credit facilities or other secured indebtedness could seek to
foreclose on any of its assets that are their collateral. If the amounts outstanding under such indebtedness were to be accelerated,
or were the subject of foreclosure actions, its assets may not be sufficient to repay in full the money owed to the lenders or
to its other debt holders.
All
of PEDEVCO’s crude oil, natural gas and NGLs production is located in the Permian Basin and the D-J Basin, making it vulnerable
to risks associated with operating in only two geographic areas. In addition, PEDEVCO has a large amount of proved reserves attributable
to a small number of producing formations.
PEDEVCO’s
operations are focused solely in the Permian Basin located in Chaves and Roosevelt Counties, New Mexico, and the D-J Basin of
Weld and Morgan Counties, Colorado, which means its current producing properties and new drilling opportunities are geographically
concentrated in those two areas. Because its operations are not as diversified geographically as many of its competitors, the
success of its operations and its profitability may be disproportionately exposed to the effect of any regional events, including:
|
●
|
fluctuations
in prices of crude oil, natural gas and NGLs produced from the wells in these areas;
|
|
●
|
natural
disasters such as the flooding that occurred in the D-J Basin area in September 2013;
|
|
●
|
the
effects of local quarantines;
|
|
●
|
restrictive
governmental regulations; and
|
|
●
|
curtailment
of production or interruption in the availability of gathering, processing or transportation
infrastructure and services, and any resulting delays or interruptions of production
from existing or planned new wells.
|
For
example, bottlenecks in processing and transportation that have occurred in some recent periods in the Permian Basin and D-J Basin
may negatively affect PEDEVCO’s results of operations, and these adverse effects may be disproportionately severe to PEDEVCO
compared to its more geographically diverse competitors. Similarly, the concentration of its assets within a small number of producing
formations exposes PEDEVCO to risks, such as changes in field-wide rules that could adversely affect development activities or
production relating to those formations. Such an event could have a material adverse effect on PEDEVCO’s results of operations
and financial condition. In addition, in areas where exploration and production activities are increasing, as has been the case
in recent years in the Permian Basin and D-J Basin, the demand for, and cost of, drilling rigs, equipment, supplies, personnel
and oilfield services increase. Shortages or the high cost of drilling rigs, equipment, supplies, personnel or oilfield services
could delay or adversely affect its development and exploration operations or cause PEDEVCO to incur significant expenditures
that are not provided for in its capital forecast, which could have a material adverse effect on its business, financial condition
or results of operations. Finally, its operations in New Mexico or Colorado may be negatively affected by quarantines put in place
in New Mexico or Colorado in an effort to slow the spread of the 2019 novel coronavirus or other viruses or diseases.
Drilling
for and producing oil and natural gas are highly speculative and involve a high degree of risk, with many uncertainties that could
adversely affect PEDEVCO’s business. PEDEVCO has not recorded significant proved reserves, and areas that PEDEVCO decide
to drill may not yield oil or natural gas in commercial quantities or at all.
Exploring
for and developing hydrocarbon reserves involves a high degree of operational and financial risk, which precludes PEDEVCO from
definitively predicting the costs involved and time required to reach certain objectives. Its potential drilling locations are
in various stages of evaluation, ranging from locations that are ready to drill, to locations that will require substantial additional
interpretation before they can be drilled. The budgeted costs of planning, drilling, completing and operating wells are often
exceeded, and such costs can increase significantly due to various complications that may arise during the drilling and operating
processes. Before a well is spudded, PEDEVCO may incur significant geological and geophysical (seismic) costs, which are
incurred whether a well eventually produces commercial quantities of hydrocarbons or is drilled at all. Exploration wells bear
a much greater risk of loss than development wells. The analogies PEDEVCO draws from available data from other wells, more fully
explored locations or
producing fields may not be applicable to its drilling locations. If its actual drilling and development
costs are significantly more than its estimated costs, PEDEVCO may not be able to continue its operations as proposed and could
be forced to modify its drilling plans accordingly.
If
PEDEVCO decides to drill a certain location, there is a risk that no commercially productive oil or natural gas reservoirs will
be found or produced. PEDEVCO may drill or participate in new wells that are not productive. PEDEVCO may drill wells that are
productive, but that do not produce sufficient net revenues to return a profit after drilling, operating and other costs. There
is no way to predict in advance of drilling and testing whether any particular location will yield oil or natural gas in sufficient
quantities to recover exploration, drilling or completion costs or to be economically viable. Even if sufficient amounts of oil
or natural gas exist, PEDEVCO may damage the potentially productive hydrocarbon-bearing formation or experience mechanical difficulties
while drilling or completing the well, resulting in a reduction in production and reserves from the well or abandonment of the
well. Whether a well is ultimately productive and profitable depends on a number of additional factors, including the following:
|
●
|
general
economic and industry conditions, including the prices received for oil and natural gas;
|
|
●
|
shortages
of, or delays in, obtaining equipment, including hydraulic fracturing equipment, and
qualified personnel;
|
|
●
|
potential
significant water production, which could make a producing well uneconomic, particularly
in the Permian Basin, where abundant water production is a known risk;
|
|
●
|
potential
drainage by operators on adjacent properties;
|
|
●
|
loss
of, or damage to, oilfield development and service tools;
|
|
●
|
problems
with title to the underlying properties;
|
|
●
|
increases
in severance taxes;
|
|
●
|
adverse
weather conditions that delay drilling activities or cause producing wells to be shut
down;
|
|
●
|
domestic
and foreign governmental regulations; and
|
|
●
|
proximity
to and capacity of transportation facilities.
|
If
PEDEVCO does not drill productive and profitable wells in the future, its business, financial condition and results of operations
could be materially and adversely affected.
PEDEVCO’s
success is dependent on the prices of oil, NGLs and natural gas. Low oil or natural gas prices and the substantial volatility
in these prices will adversely affect, and is expected to continue to adversely affect, PEDEVCO’s business, financial condition
and results of operations and its ability to meet PEDEVCO’s capital expenditure requirements and financial obligations.
The
prices PEDEVCO receives for its oil, NGLs and natural gas heavily influence its revenue, profitability, cash flow available for
capital expenditures, access to capital and future rate of growth. Oil, NGLs and natural gas are commodities and, therefore, their
prices are subject to wide fluctuations in response to relatively minor changes in supply and demand. Historically, the commodities
market has been volatile. For example, the price of crude oil has experienced significant volatility over the last five years,
with the price per barrel of WTI crude rising from a low of $27 in February 2016 to a high of $76 in October 2018, then dropping
below $20 per barrel in April 2020 due in part to reduced global demand stemming from the recent global COVID-19 outbreak, before
recovering to between $40-$45 per barrel more recently. Prices for natural gas and NGLs experienced declines of similar magnitude.
An extended period of continued lower oil prices, or additional price declines, will have further adverse effects on PEDEVCO.
The prices PEDEVCO receives for its production, and the levels of its production, will continue to depend on numerous factors,
including the following:
|
●
|
the
domestic and foreign supply of oil, NGLs and natural gas;
|
|
●
|
the
domestic and foreign demand for oil, NGLs and natural gas;
|
|
●
|
the
prices and availability of competitors’ supplies of oil, NGLs and natural gas;
|
|
●
|
the
actions of the Organization of Petroleum Exporting Countries, or OPEC, and state-controlled
oil companies relating to oil price and production controls;
|
|
●
|
the
price and quantity of foreign imports of oil, NGLs and natural gas;
|
|
●
|
the
impact of U.S. dollar exchange rates on oil, NGLs and natural gas prices;
|
|
●
|
domestic
and foreign governmental regulations and taxes;
|
|
●
|
speculative
trading of oil, NGLs and natural gas futures contracts;
|
|
●
|
localized
supply and demand fundamentals, including the availability, proximity and capacity of
gathering and transportation systems for natural gas;
|
|
●
|
the
availability of refining capacity;
|
|
●
|
the
prices and availability of alternative fuel sources;
|
|
●
|
the
threat, or perceived threat, or results, of viral pandemics, for example, as experienced
with the COVID-19 pandemic in 2020;
|
|
●
|
weather
conditions and natural disasters;
|
|
●
|
political
conditions in or affecting oil, NGLs and natural gas producing regions, including the
Middle East and South America;
|
|
●
|
the
continued threat of terrorism and the impact of military action and civil unrest;
|
|
●
|
public
pressure on, and legislative and regulatory interest within, federal, state and local
governments to stop, significantly limit or regulate hydraulic fracturing activities;
|
|
●
|
the
level of global oil, NGL and natural gas inventories and exploration and production activity;
|
|
●
|
authorization
of exports from the Unites States of liquefied natural gas;
|
|
●
|
the
impact of energy conservation efforts;
|
|
●
|
technological
advances affecting energy consumption; and
|
|
●
|
overall
worldwide economic conditions.
|
Declines
in oil, NGL or natural gas prices will not only reduce PEDEVCO’s revenue, but will reduce the amount of oil, NGL and natural
gas that PEDEVCO can produce economically. Should natural gas, NGL or oil prices remain at current levels for an extended period
of time, PEDEVCO will continue to shut-in its operated wells, delay some or all of its exploration and development plans for its
prospects, and cease exploration or development activities on certain prospects due to the anticipated unfavorable economics from
such activities, and, as a result, PEDEVCO will have to make substantial downward adjustments to its estimated proved reserves,
each of which would have a material adverse effect on its business, financial condition and results of operations.
PEDEVCO’s
business and operations have been adversely affected by, and are expected to continue to be adversely affected by, the recent COVID-19
outbreak, and may be adversely affected by other similar outbreaks.
As
a result of the recent COVID-19 outbreak or other adverse public health developments, including voluntary and mandatory quarantines,
travel restrictions and other restrictions, PEDEVCO’s operations, and those of its subcontractors, customers and suppliers,
have and are anticipated to continue to experience delays or disruptions and temporary suspensions of operations. In addition,
PEDEVCO’s financial condition and results of operations have been and are likely to continue to be adversely affected by
the COVID-19 outbreak.
The
timeline and potential magnitude of the COVID-19 outbreak is currently unknown. The continuation or amplification
of this virus could continue to more broadly affect the United States and global economy, including its business and operations,
and the demand for oil and gas. For example, the outbreak of coronavirus has resulted in a widespread health crisis that
will adversely affect the economies and financial markets of many countries, resulting in an economic downturn that will affect
PEDEVCO’s operating results. Other contagious diseases in the human population could have similar adverse effects. In addition,
the effects of COVID-19 and concerns regarding its global spread have recently negatively impacted the domestic and international
demand for crude oil and natural gas, which has contributed to price volatility, impacted the price PEDEVCO receives for oil and
natural gas and materially and has materially and adversely affected the demand for and marketability of its production, which
production PEDEVCO temporarily shut-in from mid-April 2020 through early June 2020, and is anticipated to continue to adversely
affect the same for the foreseeable future. As the potential impact from COVID-19 is difficult to predict, the extent to which
it will negatively affect PEDEVCO’s operating results, or the duration of any potential business disruption is uncertain.
The magnitude and duration of any impact will depend on future developments and new information that may emerge regarding the
severity and duration of COVID-19 and the actions taken by authorities to contain it or treat its impact, all of which are beyond
its control. These potential impacts, while uncertain, have already negatively affected PEDEVCO’s first and second quarter
results of operations, and are anticipated to have a negative impact on multiple future quarters’ results as well.
Future
conditions might require PEDEVCO to make write-downs in its assets, which would adversely affect its balance sheet and results
of operations.
PEDEVCO
reviews its long-lived tangible and intangible assets for impairment whenever events or changes in circumstances indicate that
the carrying value of an asset may not be recoverable. If conditions in any of the businesses in which PEDEVCO competes were to
deteriorate, PEDEVCO could determine that certain of its assets were impaired and PEDEVCO would then be required to write-off
all or a portion of its costs for such assets. Any such significant write-offs would adversely affect its balance sheet and results
of operations.
Declining
general economic, business or industry conditions have, and will continue to have, a material adverse effect on PEDEVCO’s
results of operations, liquidity and financial condition, and are expected to continue having a material adverse effect for the
foreseeable future.
Concerns
over global economic conditions, the threat of pandemic diseases and the results thereof, energy costs, geopolitical issues, inflation,
and the availability and cost of credit have contributed to increased economic uncertainty and diminished expectations for the
global economy. These factors, combined with volatile prices of oil and natural gas, declining business and consumer confidence
and increased unemployment, have precipitated an economic slowdown and a recession, which could expand to a global depression.
Concerns about global economic growth have had a significant adverse impact on global financial markets and commodity prices and
are expected to continuing having a material adverse effect for the foreseeable future. If the economic climate in the United
States or abroad continues to deteriorate, demand for petroleum products could diminish, which could further impact the price
at which PEDEVCO can sell its oil, natural gas and natural gas liquids, affect the ability of its vendors, suppliers and customers
to continue operations, and ultimately adversely impact PEDEVCO’s results of operations, liquidity and financial condition
to a greater extent that it has already.
PEDEVCO’s
exploration, development and exploitation projects require substantial capital expenditures that may exceed cash on hand, cash
flows from operations and potential borrowings, and PEDEVCO may be unable to obtain needed capital on satisfactory terms, which
could adversely affect its future growth.
PEDEVCO’s
exploration and development activities are capital intensive. PEDEVCO makes and expects to continue to make substantial capital
expenditures in its business for the development, exploitation, production and acquisition of oil and natural gas reserves. Its
cash on hand, its operating cash flows and future potential borrowings may not be adequate to fund its future acquisitions or
future capital expenditure requirements. The rate of its future growth may be dependent, at least in part, on its ability to access
capital at rates and on terms PEDEVCO determine to be acceptable.
PEDEVCO’s
cash flows from operations and access to capital are subject to a number of variables, including:
|
●
|
its
estimated proved oil and natural gas reserves;
|
|
●
|
the
amount of oil and natural gas PEDEVCO produces from existing wells;
|
|
●
|
the
prices at which PEDEVCO sells its production;
|
|
●
|
the
costs of developing and producing its oil and natural gas reserves;
|
|
●
|
its
ability to acquire, locate and produce new reserves;
|
|
●
|
the
general state of the economy;
|
|
●
|
the
ability and willingness of banks to lend to PEDEVCO; and its ability to access the equity
and debt capital markets.
|
In
addition, future events, such as terrorist attacks, wars or combat peace-keeping missions, financial market disruptions, general
economic recessions, oil and natural gas industry recessions, large company bankruptcies, accounting scandals, pandemic diseases,
overstated reserves estimates by major public oil companies and disruptions in the financial and capital markets have caused financial
institutions, credit rating agencies and the public to more closely review the financial statements, capital structures and earnings
of public companies, including energy companies. Such events have constrained the capital available to the energy industry in
the past, and such events or similar events could adversely affect its access to funding for its operations in the future.
If
PEDEVCO’s revenues decrease as a result of lower oil and natural gas prices, operating difficulties, declines in reserves
or for any other reason, PEDEVCO may have limited ability to obtain the capital necessary to sustain its operations at current
levels, further develop and exploit its current properties or invest in additional exploration opportunities. Alternatively, a
significant improvement in oil and natural gas prices or other factors could result in an increase in its capital expenditures
and PEDEVCO may be required to alter or increase its capitalization substantially through the issuance of debt or equity securities,
the sale of production payments, the sale or farm out of interests in its assets, the borrowing of funds or otherwise to meet
any increase in capital needs. If PEDEVCO is unable to raise additional capital from available sources at acceptable terms, its
business, financial condition and results of operations could be adversely affected. Further, future debt financings may require
that a portion of PEDEVCO’s cash flows provided by operating
activities be used for the payment of principal and interest
on its debt, thereby reducing its ability to use cash flows to fund working capital, capital expenditures and acquisitions. Debt
financing may involve covenants that restrict its business activities. If PEDEVCO succeeds in selling additional equity securities
to raise funds, at such time the ownership percentage of its existing stockholders would be diluted, and new investors may demand
rights, preferences or privileges senior to those of existing stockholders. If PEDEVCO chooses to farm-out interests in its prospects,
PEDEVCO may lose operating control over such prospects.
PEDEVCO’s
oil and natural gas reserves are estimated and may not reflect the actual volumes of oil and natural gas PEDEVCO will receive,
and significant inaccuracies in these reserve estimates or underlying assumptions will materially affect the quantities and present
value of its reserves.
The
process of estimating accumulations of oil and natural gas is complex and is not exact, due to numerous inherent uncertainties.
The process relies on interpretations of available geological, geophysical, engineering and production data. The extent, quality
and reliability of this technical data can vary. The process also requires certain economic assumptions related to, among other
things, oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. The
accuracy of a reserves estimate is a function of:
|
●
|
the
quality and quantity of available data;
|
|
●
|
the
interpretation of that data;
|
|
●
|
the
judgment of the persons preparing the estimate; and
|
|
●
|
the
accuracy of the assumptions.
|
The
accuracy of any estimates of proved reserves generally increases with the length of the production history. Due to the limited
production history of PEDEVCO’s properties, the estimates of future production associated with these properties may be subject
to greater variance to actual production than would be the case with properties having a longer production history. As PEDEVCO’s
wells produce over time and more data is available, the estimated proved reserves will be re-determined on at least an annual
basis and may be adjusted to reflect new information based upon its actual production history, results of exploration and development,
prevailing oil and natural gas prices and other factors.
Actual
future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of
recoverable oil and natural gas most likely will vary from its estimates. It is possible that future production declines in its
wells may be greater than PEDEVCO has estimated. Any significant variance to its estimates could materially affect the quantities
and present value of its reserves.
PEDEVCO
may record impairments of oil and gas properties that would reduce its shareholders’ equity.
The
successful efforts method of accounting is used for oil and gas exploration and production activities. Under this method, all
costs for development wells, support equipment and facilities, and proved mineral interests in oil and gas properties are capitalized.
PEDEVCO reviews the carrying value of its long-lived assets annually or whenever events or changes in circumstances indicate
that the historical cost-carrying value of an asset may no longer be appropriate. PEDEVCO assesses the recoverability of the carrying
value of the asset by estimating the future net undiscounted cash flows expected to result from the asset, including eventual
disposition. If the future net undiscounted cash flows are less than the carrying value of the asset, an impairment loss is recorded
equal to the difference between the asset’s carrying value and estimated fair value. This impairment does not impact cash
flows from operating activities but does reduce earnings and its shareholders’ equity. The risk that PEDEVCO will be required
to recognize impairments of its oil and gas properties increases during periods of low oil or gas prices. Impairments would occur
if PEDEVCO were to experience sufficient downward adjustments to its estimated proved reserves or the present value of estimated
future net revenues. An impairment recognized in one period may not be reversed in a subsequent period even if higher oil and
gas prices increase the cost center ceiling applicable to the subsequent period. PEDEVCO has in the past and could in the future
incur additional impairments of oil and gas properties.
PEDEVCO
may have accidents, equipment failures or mechanical problems while drilling or completing wells or in production activities,
which could adversely affect its business.
While
PEDEVCO is drilling and completing wells or involved in production activities, PEDEVCO may have accidents or experience equipment
failures or mechanical problems in a well that cause PEDEVCO to be unable to drill and complete the well or to continue to produce
the well according to its plans. PEDEVCO may also damage a potentially hydrocarbon-bearing formation during drilling and completion
operations. Such incidents may result in a reduction of its production and reserves from the well or in abandonment of the well.
PEDEVCO’s
operations are subject to operational hazards and unforeseen interruptions for which PEDEVCO may not be adequately insured.
There
are numerous operational hazards inherent in oil and natural gas exploration, development, production and gathering, including:
|
●
|
unusual
or unexpected geologic formations;
|
|
●
|
adverse
weather conditions;
|
|
●
|
unanticipated
pressures;
|
|
●
|
loss
of drilling fluid circulation;
|
|
●
|
blowouts
where oil or natural gas flows uncontrolled at a wellhead;
|
|
●
|
cratering
or collapse of the formation;
|
|
●
|
pipe
or cement leaks, failures or casing collapses;
|
|
●
|
releases
of hazardous substances or other waste materials that cause environmental damage;
|
|
●
|
pressures
or irregularities in formations; and equipment failures or accidents.
|
In
addition, there is an inherent risk of incurring significant environmental costs and liabilities in the performance of PEDEVCO’s
operations, some of which may be material, due to its handling of petroleum hydrocarbons and wastes, its emissions to air and
water, the underground injection or other disposal of its wastes, the use of hydraulic fracturing fluids and historical industry
operations and waste disposal practices.
Any
of these or other similar occurrences could result in the disruption or impairment of PEDEVCO’s operations, substantial
repair costs, personal injury or loss of human life, significant damage to property, environmental pollution and substantial revenue
losses. The location of PEDEVCO’s wells, gathering systems, pipelines and other facilities near populated areas, including
residential areas, commercial business centers and industrial sites, could significantly increase the level of damages resulting
from these risks. Insurance against all operational risks is not available to PEDEVCO. PEDEVCO is not fully insured against all
risks, including development and completion risks that are generally not recoverable from third parties or insurance. In addition,
pollution and environmental risks generally are not fully insurable. PEDEVCO maintains $2 million general liability coverage and
$10 million umbrella coverage that covers its and its subsidiaries’ business and operations. With respect to its other non-operated
assets, PEDEVCO may elect not to obtain insurance if PEDEVCO believes that the cost of available insurance is excessive relative
to the perceived risks presented. Losses could, therefore, occur for uninsurable or uninsured risks or in amounts in excess of
existing insurance coverage. Moreover, insurance may not be available in the future at commercially reasonable prices or on commercially
reasonable terms. Changes in the insurance markets due to various factors may make it more difficult for PEDEVCO to obtain certain
types of coverage in the future. As a result, PEDEVCO may not be able to obtain the levels or types of insurance PEDEVCO would
otherwise have obtained prior to these market changes, and the insurance coverage PEDEVCO does obtain may not cover certain hazards
or all potential losses that are currently covered, and may be subject to large deductibles. Losses and liabilities from uninsured
and underinsured events and delay in the payment of insurance proceeds could have a material adverse effect on its business, financial
condition and results of operations.
The
threat and impact of terrorist attacks, cyber-attacks or similar hostilities may adversely impact PEDEVCO’s operations.
PEDEVCO
cannot assess the extent of either the threat or the potential impact of future terrorist attacks on the energy industry in general,
and on PEDEVCO in particular, either in the short-term or in the long-term. Uncertainty surrounding such hostilities may affect
its operations in unpredictable ways, including the possibility that infrastructure facilities, including pipelines and gathering
systems, production facilities, processing plants and refineries, could be targets of, or indirect casualties of, an act of terror,
a cyber-attack or electronic security breach, or an act of war.
Failure
to adequately protect critical data and technology systems could materially affect PEDEVCO’s operations.
Information
technology solution failures, network disruptions and breaches of data security could disrupt PEDEVCO’s operations by causing
delays or cancellation of customer orders, impeding processing of transactions and reporting financial results, resulting in the
unintentional disclosure of customer, employee or its information, or damage to its reputation. There can be no assurance that
a system failure or data security breach will not have a material adverse effect on PEDEVCO’s financial condition, results
of operations or cash flows.
PEDEVCO’s
strategy as an onshore resource player may result in operations concentrated in certain geographic areas and may increase its
exposure to many of the risks described in this offer to exchange.
PEDEVCO’s
current operations are concentrated in the states of New Mexico and Colorado. This concentration may increase the potential
impact of many of the risks described in this offer to exchange. For example, PEDEVCO may have greater exposure to regulatory
actions impacting New Mexico and/or Colorado, natural disasters in New Mexico and/or Colorado, competition for equipment, services
and materials available in, and access to infrastructure and markets in, these states.
Unless
PEDEVCO replaces its oil and natural gas reserves, its reserves and production will decline, which will adversely affect its business,
financial condition and results of operations.
The
rate of production from PEDEVCO’s oil and natural gas properties will decline as its reserves are depleted. Its future oil
and natural gas reserves and production and, therefore, its income and cash flow, are highly dependent on its success in (a) efficiently
developing and exploiting its current reserves on properties owned by PEDEVCO or by other persons or entities and (b) economically
finding or acquiring additional oil and natural gas producing properties. In the future, PEDEVCO may have difficulty acquiring
new properties. During periods of low oil and/or natural gas prices, it will become more difficult to raise the capital necessary
to finance expansion activities. If PEDEVCO is unable to replace its production, its reserves will decrease, and its business,
financial condition and results of operations would be adversely affected.
PEDEVCO’s
strategy includes acquisitions of oil and natural gas properties, and its failure to identify or complete future acquisitions
successfully, or not produce projected revenues associated with the future acquisitions could reduce its earnings and hamper its
growth.
PEDEVCO
may be unable to identify properties for acquisition or to make acquisitions on terms that PEDEVCO considers economically acceptable.
There is intense competition for acquisition opportunities in the oil and gas industry. Competition for acquisitions may increase
the cost of, or cause PEDEVCO to refrain from, completing acquisitions. The completion and pursuit of acquisitions may be dependent
upon, among other things, PEDEVCO’s ability to obtain debt and equity financing and, in some cases, regulatory approvals.
PEDEVCO’s ability to grow through acquisitions will require PEDEVCO to continue to invest in operations, financial and management
information systems and to attract, retain, motivate and effectively manage its employees. The inability to manage the integration
of acquisitions effectively could reduce PEDEVCO’s focus on subsequent acquisitions and current operations, and could negatively
impact its results of operations and growth potential. PEDEVCO’s financial position and results of operations may fluctuate
significantly from period to period as a result of the completion of significant acquisitions during particular periods. If PEDEVCO
is not successful in identifying or acquiring any material property interests, its earnings could be reduced and its growth could
be restricted.
PEDEVCO
may engage in bidding and negotiating to complete successful acquisitions. PEDEVCO may be required to alter or increase substantially
its capitalization to finance these acquisitions through the use of cash on hand, the issuance of debt or equity securities, the
sale of production payments, the sale of non-strategic assets, the borrowing of funds or otherwise. If PEDEVCO were to proceed
with one or more acquisitions involving the issuance of PEDEVCO Common Stock, its stockholders would suffer dilution of their
interests. Furthermore, PEDEVCO’s decision to acquire properties that are substantially different in operating or geologic
characteristics or geographic locations from areas with which its staff is familiar may impact its productivity in such areas.
PEDEVCO
may not be able to produce the projected revenues related to future acquisitions. There are many assumptions related to the projection
of the revenues of future acquisitions including, but not limited to, drilling success, oil and natural gas prices, production
decline curves and other data. If revenues from future acquisitions do not meet projections, this could adversely affect PEDEVCO’s
business and financial condition.
If
PEDEVCO completes acquisitions or enters into business combinations in the future, they may disrupt or have a negative impact
on its business.
If
PEDEVCO completes acquisitions or enters into business combinations in the future, funding permitting, PEDEVCO could have difficulty
integrating the acquired companies’ assets, personnel and operations with its own. Additionally, acquisitions, mergers or
business combinations PEDEVCO may enter into in the future could result in a change of control of PEDEVCO, and a change in the
PEDEVCO Board or officers of PEDEVCO. In addition, the key personnel of the acquired business may not be willing to work for us.
PEDEVCO cannot predict the effect expansion may have on its core business. Regardless of whether PEDEVCO is successful in making
an acquisition or completing a business combination, the negotiations could disrupt its ongoing business, distract its management
and employees and increase its expenses. In addition to the risks described above, acquisitions and business combinations are
accompanied by a number of inherent risks, including, without limitation, the following:
|
●
|
the
difficulty of integrating acquired companies, concepts and operations;
|
|
●
|
the
potential disruption of the ongoing businesses and distraction of PEDEVCO’s management
and the management of acquired companies;
|
|
●
|
change
in PEDEVCO’s business focus and/or management;
|
|
●
|
difficulties
in maintaining uniform standards, controls, procedures and policies;
|
|
●
|
the
potential impairment of relationships with employees and partners as a result of any
integration of new management personnel;
|
|
●
|
the
potential inability to manage an increased number of locations and employees;
|
|
●
|
PEDEVCO’s
ability to successfully manage the companies and/or concepts acquired;
|
|
●
|
the
failure to realize efficiencies, synergies and cost savings; or
|
|
●
|
the
effect of any government regulations which relate to the business acquired.
|
PEDEVCO’s
business could be severely impaired if and to the extent that PEDEVCO is unable to succeed in addressing any of these risks or
other problems encountered in connection with an acquisition or business combination, many of which cannot be presently identified.
These risks and problems could disrupt PEDEVCO’s ongoing business, distract its management and employees, increase its expenses
and adversely affect its results of operations.
Any
acquisition or business combination transaction PEDEVCO enters into in the future could cause substantial dilution to existing
stockholders, result in one party having majority or significant control over PEDEVCO or result in a change in business focus
of PEDEVCO.
PEDEVCO
may incur indebtedness which could reduce its financial flexibility, increase interest expense and adversely impact its operations
and its unit costs.
PEDEVCO
currently has no outstanding indebtedness, but PEDEVCO may incur significant amounts of indebtedness in the future in order to
make acquisitions or to develop its properties. PEDEVCO’s level of indebtedness could affect its operations in several ways,
including the following:
|
●
|
a
significant portion of PEDEVCO’s cash flows could be used to service its indebtedness;
|
|
●
|
a
high level of debt would increase PEDEVCO’s vulnerability to general adverse economic
and industry conditions;
|
|
●
|
any
covenants contained in the agreements governing PEDEVCO’s outstanding indebtedness
could limit its ability to borrow additional funds, dispose of assets, pay dividends
and make certain investments;
|
|
●
|
a
high level of debt may place PEDEVCO at a competitive disadvantage compared to its competitors
that are less leveraged and, therefore, may be able to take advantage of opportunities
that its indebtedness may prevent PEDEVCO from pursuing; and
|
|
●
|
debt
covenants to which PEDEVCO may agree may affect its flexibility in planning for, and
reacting to, changes in the economy and in its industry.
|
A
high level of indebtedness increases the risk that PEDEVCO may default on its debt obligations. PEDEVCO may not be able to generate
sufficient cash flows to pay the principal or interest on its debt, and future working capital, borrowings or equity financing
may not be available to pay or refinance such debt. If PEDEVCO does not have sufficient funds and are otherwise unable to arrange
financing, PEDEVCO may have to sell significant assets or have a portion of its assets foreclosed upon which could have a material
adverse effect on its business, financial condition and results of operations.
PEDEVCO
may purchase oil and natural gas properties with liabilities or risks that PEDEVCO did not know about or that PEDEVCO did not
assess correctly, and, as a result, PEDEVCO could be subject to liabilities that could adversely affect its results of operations.
Before
acquiring oil and natural gas properties, PEDEVCO estimates the reserves, future oil and natural gas prices, operating costs,
potential environmental liabilities and other factors relating to the properties. However, PEDEVCO’s review involves many
assumptions and estimates, and their accuracy is inherently uncertain. As a result, PEDEVCO may not discover all existing or potential
problems associated with the properties PEDEVCO buys. PEDEVCO may not become sufficiently familiar with the properties to assess
fully their deficiencies and capabilities. PEDEVCO does not generally perform inspections on every well or property, and PEDEVCO
may not be able to observe mechanical and environmental problems even when PEDEVCO conducts an inspection. The seller may not
be willing or financially able to give PEDEVCO contractual protection against any identified problems, and PEDEVCO may decide
to assume environmental and other liabilities in connection with properties PEDEVCO acquires. If PEDEVCO acquires properties with
risks or liabilities PEDEVCO did not know about or that PEDEVCO did not assess correctly, its business, financial condition and
results of operations could be adversely affected as PEDEVCO settles claims and incur cleanup costs related to these liabilities.
PEDEVCO
may incur losses or costs as a result of title deficiencies in the properties in which PEDEVCO invests.
If
an examination of the title history of a property that PEDEVCO has purchased reveals an oil and natural gas lease has been purchased
in error from a person who is not the owner of the property, its interest would be worthless. In such an instance, the amount
paid for such oil and natural gas lease as well as any royalties paid pursuant to the terms of the lease prior to the discovery
of the title defect would be lost.
Prior
to the drilling of an oil and natural gas well, it is the normal practice in the oil and natural gas industry for the person or
company acting as the operator of the well to obtain a preliminary title review of the spacing unit within which the proposed
oil and natural gas well is to be drilled to ensure there are no obvious deficiencies in title to the well. Frequently, as a result
of such examinations, certain curative work must be done to correct deficiencies in the marketability of the title, and such curative
work entails expense. Its failure to cure any title defects may adversely impact PEDEVCO’s ability in the future to increase
production and reserves. In the future, PEDEVCO may suffer a monetary loss from title defects or title failure. Additionally,
unproved and unevaluated acreage has greater risk of title defects than developed acreage. If there are any title defects or defects
in assignment of leasehold rights in properties in which PEDEVCO holds an interest, PEDEVCO will suffer a financial loss which
could adversely affect its business, financial condition and results of operations.
PEDEVCO’s
identified drilling locations are scheduled over several years, making them susceptible to uncertainties that could materially
alter the occurrence or timing of their drilling.
PEDEVCO’s
management team has identified and scheduled drilling locations in its operating areas over a multi-year period. Its ability to
drill and develop these locations depends on a number of factors, including the availability of equipment and capital, approval
by regulators, seasonal conditions, oil and natural gas prices, assessment of risks, costs and drilling results. The final determination
on whether to drill any of these locations will be dependent upon the factors described elsewhere in this offer to exchange, as
well as, to some degree, the results of its drilling activities with respect to its established drilling locations. Because of
these uncertainties, PEDEVCO does not know if the drilling locations PEDEVCO has identified will be drilled within its expected
timeframe or at all or if PEDEVCO will be able to economically produce hydrocarbons from these or any other potential drilling
locations. PEDEVCO’s actual drilling activities may be materially different from its current expectations, which could adversely
affect its business, financial condition and results of operations.
Potential
conflicts of interest could arise for certain members of PEDEVCO’s management team and PEDEVCO’s Board that hold management
positions with other entities and its largest stockholder.
Dr.
Simon Kukes, PEDEVCO’s Chief Executive Officer and member of the PEDEVCO Board, J. Douglas Schick, its President, and Clark
R. Moore, its Executive Vice President, General Counsel and Secretary, hold various other management positions with privately-held
companies, some of which are involved in the oil and gas industry, and Dr. Simon Kukes is the principal of SK Energy LLC, PEDEVCO’s
largest stockholder. Dr. Kukes also beneficially owns 74.2% of PEDEVCO’s voting securities. PEDEVCO believes these positions
require only an immaterial amount of each officers’ time and will not conflict with their roles or responsibilities with PEDEVCO.
If any of these companies enter into one or more transactions with PEDEVCO, or if the officers’ position with any such
company requires significantly more time than currently anticipated, potential conflicts of interests could arise from
the officers performing services for PEDEVCO and these other entities.
PEDEVCO
currently licenses only a limited amount of seismic and other geological data and may have difficulty obtaining additional data
at a reasonable cost, which could adversely affect its future results of operations.
PEDEVCO
currently licenses only a limited amount of seismic and other geological data to assist PEDEVCO in exploration and development
activities. PEDEVCO may obtain access to additional data in its areas of interest through licensing arrangements with companies
that own or have access to that data or by paying to obtain that data directly. Seismic and geological data can be expensive to
license or obtain. PEDEVCO may not be able to license or obtain such data at an acceptable cost. In addition, even when properly
interpreted, seismic data and visualization techniques are not conclusive in determining if hydrocarbons are present in economically
producible amounts and seismic indications of hydrocarbon saturation are generally not reliable indicators of productive reservoir
rock.
The
unavailability or high cost of drilling rigs, completion equipment and services, supplies and personnel, including hydraulic fracturing
equipment and personnel, could adversely affect PEDEVCO’s ability to establish and execute exploration and development plans
within budget and on a timely basis, which could have a material adverse effect on its business, financial condition and results
of operations.
Shortages
or the high cost of drilling rigs, completion equipment and services, supplies or personnel could delay or adversely affect PEDEVCO’s
operations. When drilling activity in the United States increases, associated costs typically also increase, including those costs
related to drilling rigs, equipment, supplies and personnel and the services and products of other vendors to the industry. These
costs may increase, and necessary equipment and services may become unavailable to PEDEVCO at economical prices. Should this increase
in costs occur, PEDEVCO may delay drilling activities, which may limit its ability to establish and replace reserves, or PEDEVCO
may incur these higher costs, which may negatively affect its business, financial condition and results of operations.
PEDEVCO
has limited control over activities on properties PEDEVCO does not operate.
PEDEVCO
is not the operator on some of its properties located in its D-J Basin Asset, and, as a result, its ability to exercise influence
over the operations of these properties or their associated costs is limited. PEDEVCO’s dependence on the operators and
other working interest owners of these projects and its limited ability to influence operations and associated costs or control
the risks could materially and adversely affect the realization of its targeted returns on capital in drilling or acquisition
activities. The success and timing of PEDEVCO’s drilling and development activities on properties operated by others therefore
depends upon a number of factors, including:
|
●
|
timing
and amount of capital expenditures;
|
|
●
|
the
operator’s expertise and financial resources;
|
|
●
|
the
rate of production of reserves, if any;
|
|
●
|
approval
of other participants in drilling wells; and
|
|
●
|
selection
of technology.
|
The
marketability of PEDEVCO’s production is dependent upon oil and natural gas gathering, transportation, and storage facilities
owned and operated by third parties, and the unavailability of satisfactory oil and natural gas transportation arrangements have
had a material adverse effect on PEDEVCO’s revenue.
The
unavailability of satisfactory oil and natural gas transportation arrangements has hindered PEDEVCO’s access to oil and
natural gas markets and has delayed production from its wells. The availability of a ready market for PEDEVCO’s oil and
natural gas production depends on a number of factors, including the demand for, and supply of, oil and natural gas and the proximity
of reserves to pipelines, terminal facilities and storage facilities. PEDEVCO’s ability to market its production depends
in substantial part on the availability and capacity of gathering systems, pipelines, processing facilities, and storage facilities
owned and operated by third parties. PEDEVCO’s failure to obtain these services on acceptable terms could materially harm
its business. Furthermore, PEDEVCO is obligated to pay shut-in royalties to certain mineral interest owners in order to maintain
its leases with respect to certain shut-in wells. PEDEVCO does not expect to purchase firm transportation capacity on third-party
facilities. Therefore, PEDEVCO expects the transportation of its production to be generally interruptible in nature and lower
in priority to those having firm transportation arrangements.
The
disruption of third-party facilities due to maintenance and/or weather could negatively impact PEDEVCO’s ability to market
and deliver its products. The third parties' control when or if such facilities are restored after disruption, and what prices
will be charged for products. Federal and state regulation of oil and natural gas production and transportation, tax and energy
policies, changes in supply and demand, pipeline pressures, damage to or destruction of pipelines and general economic conditions
could adversely affect PEDEVCO’s ability to produce, gather and transport oil and natural gas.
An
increase in the differential between the NYMEX or other benchmark prices of oil and natural gas and the wellhead price PEDEVCO
receives for its production has adversely affected its business, financial condition and results of operations.
The
prices that PEDEVCO will receive for its oil and natural gas production sometimes may reflect a discount to the relevant benchmark
prices, such as the New York Mercantile Exchange (NYMEX), that are used for calculating hedge positions. The difference between
the benchmark price and the prices PEDEVCO receives is called a differential. Increases in the differential between the benchmark
prices for oil and natural gas and the wellhead price PEDEVCO receives has recently adversely affected, and is anticipated to
continue to adversely affect, PEDEVCO’s business, financial condition and results of operations. PEDEVCO does not have,
and may not have in the future, any derivative contracts or hedging covering the amount of the basis differentials PEDEVCO experiences
in respect of its production. As such, PEDEVCO will be exposed to any increase in such differentials.
PEDEVCO
may have difficulty managing growth in its business, which could have a material adverse effect on its business, financial condition
and results of operations and its ability to execute its business plan in a timely fashion.
Because
of PEDEVCO’s small size, growth in accordance with its business plans, if achieved, will place a significant strain on its
financial, technical, operational and management resources. As PEDEVCO expands its activities, including its planned increase
in oil exploration, development and production, and increases the number of projects it is evaluating or in which it participates,
there will be additional demands on its financial, technical and management resources. The failure to continue to upgrade its
technical, administrative, operating and financial control systems or the occurrence of unexpected expansion difficulties, including
the inability to recruit and retain experienced managers, geoscientists, petroleum engineers and landmen could have a material
adverse effect on PEDEVCO’s business, financial condition and results of operations and its ability to execute its business
plan in a timely fashion.
Financial
difficulties encountered by PEDEVCO’s oil and natural gas purchasers, third-party operators or other third parties could
decrease PEDEVCO’s cash flow from operations and adversely affect the exploration and development of its prospects and assets.
PEDEVCO
derives and will derive in the future, substantially all of its revenues from the sale of its oil and natural gas to unaffiliated
third-party purchasers, independent marketing companies and mid-stream companies. Any delays in payments from its purchasers caused
by financial problems encountered by them will have an immediate negative effect on its results of operations.
Liquidity
and cash flow problems encountered by PEDEVCO’s working interest co-owners or the third-party operators of its non-operated
properties may prevent or delay the drilling of a well or the development of a project. PEDEVCO’s working interest co-owners
may be unwilling or unable to pay their share of the costs of projects as they become due. In the case of a farmout party, PEDEVCO
would have to find a new farmout party or obtain alternative funding in order to complete the exploration and development of the
prospects subject to a farmout agreement. In the case of a working interest owner, PEDEVCO could be required to pay the working
interest owner’s share of the project costs. PEDEVCO cannot assure you that PEDEVCO would be able to obtain the capital
necessary to fund either of these contingencies or that PEDEVCO would be able to find a new farmout party.
The
calculated present value of future net revenues from its proved reserves will not necessarily be the same as the current market
value of its estimated oil and natural gas reserves.
You
should not assume that the present value of future net cash flows as included PEDEVCO’s public filings is the current market
value of its estimated proved oil and natural gas reserves. PEDEVCO generally bases the estimated discounted future net cash flows
from proved reserves on current costs held constant over time without escalation and on commodity prices using an unweighted arithmetic
average of first-day-of-the-month index prices, appropriately adjusted, for the 12-month period immediately preceding the date
of the estimate. Actual future prices and costs may be materially higher or lower than the prices and costs used for these estimates
and will be affected by factors such as:
|
●
|
actual
prices PEDEVCO receives for oil and natural gas;
|
|
●
|
actual
cost and timing of development and production expenditures;
|
|
●
|
the
amount and timing of actual production; and
|
|
●
|
changes
in governmental regulations or taxation.
|
In
addition, the 10% discount factor that is required to be used to calculate discounted future net revenues for reporting purposes
under Generally Accepted Accounting Principles (“GAAP”) is not necessarily the most appropriate discount factor
based on the cost of capital in effect from time to time and risks associated with PEDEVCO’s business and the oil and natural
gas industry in general.
Competition
in the oil and natural gas industry is intense, making it difficult for PEDEVCO to acquire properties, market oil and natural
gas and secure trained personnel.
PEDEVCO’s
ability to acquire additional prospects and to find and develop reserves in the future will depend on its ability to evaluate
and select suitable properties and to consummate transactions in a highly competitive environment for acquiring properties, marketing
oil and natural gas and securing trained personnel. Also, there is substantial competition for capital available for investment
in the oil and natural gas industry. Many of PEDEVCO’s competitors possess and employ financial, technical and personnel
resources substantially greater than PEDEVCO’s, and many of its competitors have more established presences in the United
States than PEDEVCO has. Those companies may be able to pay more for productive oil and natural gas properties and exploratory
prospects and to evaluate, bid for and purchase a greater number of properties and prospects than PEDEVCO’s financial or
personnel resources permit. In addition, other companies may be able to offer better compensation packages to attract and retain
qualified personnel than PEDEVCO is able to offer. The cost to attract and retain qualified personnel has increased in recent
years due to competition and may increase substantially in the future. PEDEVCO may not be able to compete successfully in the
future in acquiring prospective reserves, developing reserves, marketing hydrocarbons, attracting and retaining quality personnel
and raising additional capital, which could have a material adverse effect on its business, financial condition and results of
operations.
PEDEVCO’s
competitors may use superior technology and data resources that PEDEVCO may be unable to afford or that would require a costly
investment by PEDEVCO in order to compete with them more effectively.
PEDEVCO’s
industry is subject to rapid and significant advancements in technology, including the introduction of new products and services
using new technologies and databases. As PEDEVCO’s competitors use or develop new technologies, PEDEVCO may be placed at
a competitive disadvantage, and competitive pressures may force PEDEVCO to implement new technologies at a substantial cost. In
addition, many of PEDEVCO’s competitors will have greater financial, technical and personnel resources that allow them to
enjoy technological advantages and may in the future allow them to implement new technologies before PEDEVCO can. PEDEVCO cannot
be certain that PEDEVCO will be able to implement technologies on a timely basis or at a cost that is acceptable. One or more
of the technologies that PEDEVCO will use or that PEDEVCO may implement in the future may become obsolete, and PEDEVCO may be
adversely affected.
If
PEDEVCO does not hedge its exposure to reductions in oil and natural gas prices, PEDEVCO may be subject to significant reductions
in prices. Alternatively, PEDEVCO may use oil and natural gas price hedging contracts, which involve credit risk and may limit
future revenues from price increases and result in significant fluctuations in its profitability.
In
the event that PEDEVCO continues to choose not to hedge its exposure to reductions in oil and natural gas prices by purchasing
futures and/or by using other hedging strategies, PEDEVCO may be subject to a significant reduction in prices which could have
a material negative impact on its profitability. Alternatively, PEDEVCO may elect to use hedging transactions with respect to
a portion of its oil and natural gas production to achieve more predictable cash flow and to reduce its exposure to price fluctuations.
While the use of hedging transactions limits the downside risk of price declines, their use also may limit future revenues from
price increases. Hedging transactions also involve the risk that the counterparty may be unable to satisfy its obligations.
Changes
in the legal and regulatory environment governing the oil and natural gas industry, particularly changes in the current Colorado
forced pooling system and drilling operation set-back rules, and salt water disposal permitting regulations in New Mexico, could
have a material adverse effect on PEDEVCO’s business.
PEDEVCO’s
business is subject to various forms of government regulation, including laws and regulations concerning the location, spacing
and permitting of the oil and natural gas wells PEDEVCO drills, among other matters. In particular, its business in the D-J Basin
of Colorado utilizes a methodology available in Colorado known as “forced pooling,” which refers to the ability of
a holder of an oil and natural gas interest in a particular prospective drilling spacing unit to apply to the Colorado Oil and
Gas Conservation Commission for an order forcing all other holders of oil and natural gas interests in such area into a common
pool for purposes of developing that drilling spacing unit. In addition, PEDEVCO’s Permian Basin operations require significant
salt water disposal capacity, with the permitting of necessary salt water disposal wells being regulated by the New Mexico State
Land Office. In recent months, PEDEVCO has encountered significant delays in receiving such permits, and increasing difficulty
in obtaining required permits, from the New Mexico State Land Office, which has delayed completion operations and the bringing
of new wells on to full production. Changes in the legal and regulatory environment governing PEDEVCO’s industry, particularly
any changes to Colorado’s forced pooling procedures that make forced pooling more difficult to accomplish and changes in
minimum set-backs distances for drilling operations from buildings, or increased regulation in New Mexico with respect to salt
water disposal well permitting, could result in increased compliance costs and operational delays, and adversely affect PEDEVCO’s
business, financial condition and results of operations.
In
the event that local or state restrictions or prohibitions are adopted in areas where PEDEVCO conducts operations, that impose
more stringent limitations on the production and development of oil and natural gas, including, among other things, the development
of increased setback distances, PEDEVCO and similarly situated oil and natural exploration and production operators in the state
may incur significant costs to comply with such requirements or may experience delays or curtailment in the pursuit of exploration,
development, or production activities, and possibly be limited or precluded in the drilling of wells or in the amounts that PEDEVCO
and similarly situated operates are ultimately able to produce from its reserves. Any such increased costs, delays, cessations,
restrictions or prohibitions could have a material adverse effect on PEDEVCO’s business, prospects, results of operations,
financial condition, and liquidity. If new or more stringent federal, state or local legal restrictions relating to the hydraulic
fracturing process are adopted in areas where PEDEVCO operates, including, for example, on federal and American Indian lands,
PEDEVCO could incur potentially significant added cost to comply with such requirements, experience delays or curtailment in the
pursuit of exploration, development or production activities, and perhaps even be precluded from drilling wells.
SEC
rules could limit PEDEVCO’s ability to book additional proved undeveloped reserves (“PUDs”) in the future.
SEC
rules require that, subject to limited exceptions, PUDs may only be booked if they relate to wells scheduled to be drilled within
five years after the date of booking. This requirement has limited and may continue to limit PEDEVCO’s ability to book additional
PUDs as PEDEVCO pursues its drilling program. Moreover, PEDEVCO may be required to write down its PUDs if PEDEVCO does not drill
or plan on delaying those wells within the required five-year timeframe.
New
or amended environmental legislation or regulatory initiatives could result in increased costs, additional operating restrictions,
or delays, or have other adverse effects on PEDEVCO.
The
environmental laws and regulations to which PEDEVCO is subject change frequently, often to become more burdensome and/or to increase
the risk that PEDEVCO will be subject to significant liabilities. New or amended federal, state, or local laws or implementing
regulations or orders imposing new environmental obligations on, or otherwise limiting, PEDEVCO’s
operations could make it more difficult and more expensive to complete oil and natural gas
wells, increase its costs of compliance and doing business, delay or prevent the development of resources (especially from shale
formations that are not commercial without the use of hydraulic fracturing), or alter the demand for and consumption of its products.
Any such outcome could have a material and adverse impact on its cash flows and results of operations.
For
example, in 2014, 2016 and 2018, opponents of hydraulic fracturing sought statewide ballot initiatives in Colorado that would
have restricted oil and gas development in Colorado and could have had materially adverse impacts on PEDEVCO.
One of the proposed initiatives would have made the vast majority of the surface area of the state ineligible for drilling, including
substantially all
of PEDEVCO’s planned future drilling locations. By further
example, in April 2019, Colorado Senate Bill 19-181 (the “Bill”) was passed into law, which prioritizes the protection
of public safety, health, welfare, and the environment in the regulation of the oil and gas industry by modifying the State’s
oil and gas statutes and clarifying, reinforcing, and establishing local governments’ regulatory authority over the surface
impacts of oil and gas development in Colorado. This Bill, among other things, gives more power to local government entities in
making land use decisions about oil and gas development and regulation, and directs the Colorado Oil & Gas Conservation Commission
(“COGCC”) to promulgate rules to ensure, among other things, proper wellbore integrity, allow public disclosure
of flowline information, and evaluate when inactive or shut-in wells must be inspected before being put into production or used
for injection. In addition, the Bill requires that owners of more than 50% of the mineral interests in lands to be pooled must
have joined in the application for a pooling order and that the application must include proof that the applicant received approval
for the facilities from the affected local government or that the affected local government does not regulate such facilities.
In addition, the Bill provides that an operator cannot use the surface owned by a nonconsenting owner without permission from
the nonconsenting owner, and increases nonconsenting owners’ royalty rates during a well’s pay-back period from 12.5%
to 13.0%. Pursuant to the Bill, in December 2019 the COGCC proposed new regulatory requirements
to enhance safety and environmental protection during hydraulic fracturing and to enhance wellbore integrity.
PEDEVCO anticipates that the Bill may make it more difficult and more costly for PEDEVCO to undertake oil and gas development
activities in Colorado. In addition, on September 28, 2020, the COGCC voted in favor of a preliminary approval establishing a
new 2,000-foot setback rule from buildings for drilling and fracturing operations statewide, increasing the previous 500-foot
setback rule, which new rule will become effective January 1, 2021, and could likewise make it more difficult for PEDEVCO to undertake
oil and gas development activities in Colorado.
Similar
to the Bill described above, proposals are made from time to time to adopt new, or amend existing, laws and regulations to address
hydraulic fracturing or climate change concerns through further regulation of exploration and development activities. Please
read “Information about PEDEVCO—Business—Regulation of the Oil and Gas Industry” and “—Regulation
of Environmental and Occupational Safety and Health Matters” in for a further description of the laws and regulations that
affect PEDEVCO. PEDEVCO cannot predict the nature, outcome, or effect on PEDEVCO of future
regulatory initiatives, but such initiatives could materially impact its results of operations, production, reserves, and other
aspects of its business.
For
example, in 2019, the EPA increased the state of Colorado’s non-attainment ozone classification for the Denver Metro/North
Front Range NAA area from “moderate” to “serious” under the 2008 NAAQS. This “serious” classification
will trigger significant additional obligations for the state under the CAA and could result in new and more stringent air quality
control requirements, which may in turn result in significant costs, and delays in obtaining necessary permits applicable to its
operations.
Proposed
changes to U.S. tax laws, if adopted, could have an adverse effect on PEDEVCO’s business, financial condition, results of
operations, and cash flows.
From
time to time, legislative proposals are made that would, if enacted, result in the elimination of the immediate deduction for
intangible drilling and development costs, the elimination of the deduction from income for domestic production activities relating
to oil and gas exploration and development, the repeal of the percentage depletion allowance for oil and gas properties, and an
extension of the amortization period for certain geological and geophysical expenditures. Such changes, if adopted, or other similar
changes that reduce or eliminate deductions currently available with respect to oil and gas exploration and development, could
adversely affect its business, financial condition, results of operations, and cash flows.
PEDEVCO
may incur substantial costs to comply with the various federal, state, and local laws and regulations that affect its oil and
natural gas operations, including as a result of the actions of third parties.
PEDEVCO
is affected significantly by a substantial number of governmental regulations relating to, among other things, the release or
disposal of materials into the environment, health and safety, land use, and other matters. A summary of the principal environmental
rules and regulations to which PEDEVCO is currently subject is set forth in “Information
about PEDEVCO—Business —Regulation of the Oil and Gas Industry” and “—Regulation of Environmental
and Occupational Safety and Health Matters”. Compliance with such laws and regulations
often increases its cost of doing business and thereby decreases its profitability. Failure to comply with these laws and regulations
may result in the assessment of administrative, civil, and criminal penalties, the incurrence of investigatory or remedial obligations,
or the issuance of cease and desist orders.
The
environmental laws and regulations to which PEDEVCO is subject may, among other things:
|
●
|
require
PEDEVCO to apply for and receive a permit before drilling commences or certain associated
facilities are developed;
|
|
●
|
restrict
the types, quantities, and concentrations of substances that can be released into the
environment in connection with drilling, hydraulic fracturing, and production activities;
|
|
●
|
limit
or prohibit drilling activities on certain lands lying within wilderness, wetlands and
other “waters of the United States,” threatened and endangered species habitat,
and other protected areas;
|
|
●
|
require
remedial measures to mitigate pollution from former operations, such as plugging abandoned
wells;
|
|
●
|
require
PEDEVCO to add procedures and/or staff in order to comply with applicable laws and regulations;
and
|
|
●
|
impose
substantial liabilities for pollution resulting from its operations.
|
In
addition, PEDEVCO could face liability under applicable environmental laws and regulations as a result of the activities of previous
owners of its properties or other third parties. For example, over the years, PEDEVCO has owned or leased numerous properties
for oil and natural gas activities upon which petroleum hydrocarbons or other materials may have been released by PEDEVCO or by
predecessor property owners or lessees who were not under its control. Under applicable environmental laws and regulations, including
The Comprehensive Environmental Response, Compensation, and Liability Act - otherwise known as CERCLA or Superfund, and state
laws, PEDEVCO could be held liable for the removal or remediation of previously released materials or property contamination at
such locations, or at third-party locations to which PEDEVCO has sent waste, regardless of its fault, whether PEDEVCO was responsible
for the release or whether the operations at the time of the release were lawful.
Compliance
with, or liabilities associated with violations of or remediation obligations under, environmental laws and regulations could
have a material adverse effect on PEDEVCO’s results
of operations and financial condition.
Part
of PEDEVCO’s strategy involves drilling in existing or emerging oil and gas plays using some of the latest available horizontal
drilling and completion techniques. The results of PEDEVCO’s planned exploratory drilling in these plays are subject to
drilling and completion technique risks, and drilling results may not meet its expectations for reserves or production. As a result,
PEDEVCO may incur material write-downs and the value of its undeveloped acreage could decline if drilling results are unsuccessful.
PEDEVCO’s
operations in the Permian Basin in Chaves and Roosevelt Counties, New Mexico, and the D-J Basin in Weld and Morgan Counties, Colorado,
involve utilizing the latest drilling and completion techniques in order to maximize cumulative recoveries and therefore generate
the highest possible returns. Risks that PEDEVCO may face while drilling include, but are not limited to, landing its well bore
in the desired drilling zone, staying in the desired drilling zone while drilling horizontally through the formation, running
its casing the entire length of the well bore and being able to run tools and other equipment consistently through the horizontal
well bore. Risks that PEDEVCO may face while completing its wells include, but are not limited to, being able to fracture stimulate
the planned number of stages, being able to run tools the entire length of the well bore during completion operations and successfully
cleaning out the well bore after completion of the final fracture stimulation stage.
The
results of PEDEVCO’s drilling in new or emerging formations will be more uncertain initially than drilling results in areas
that are more developed and have a longer history of established production. Newer or emerging formations and areas have limited
or no production history and consequently PEDEVCO is less able to predict future drilling results in these areas.
Ultimately,
the success of these drilling and completion techniques can only be evaluated over time as more wells are drilled and production
profiles are established over a sufficiently long time period. If PEDEVCO’s drilling results are less than anticipated or
PEDEVCO is unable to execute its drilling program because of capital constraints, lease expirations, access to gathering systems
and limited takeaway capacity or otherwise, and/or natural gas and oil prices decline, the return on its investment in these areas
may not be as attractive as PEDEVCO anticipates. Further, as a result of any of these developments PEDEVCO could incur material
write-downs of its oil and natural gas properties and the value of its undeveloped acreage could decline in the future.
Part
of PEDEVCO’s strategy involves using some of the latest available horizontal drilling and completion techniques. The results
of PEDEVCO’s drilling in these plays are subject to drilling and completion technique risks, and results may not meet its
expectations for reserves or production.
Many
of PEDEVCO’s operations involve, and are planned to utilize, the latest drilling and completion techniques as developed
by PEDEVCO and its service providers in order to maximize production and ultimate recoveries and therefore generate the highest
possible returns. Risks PEDEVCO faces while completing its wells include, but are not limited to, the inability to fracture stimulate
the planned number of stages, the inability to run tools and other equipment the entire length of the well bore during completion
operations, the inability to recover such tools and other equipment, and the inability to successfully clean out the well bore
after completion of the final fracture stimulation. Ultimately, the success of these drilling and completion techniques can only
be evaluated over time as more wells are drilled and production profiles are established over a sufficiently long time period.
If its drilling results are less than anticipated or PEDEVCO is unable to execute its drilling program because of capital constraints,
lease expirations, limited access to gathering systems and takeaway capacity, and/or prices for crude oil, natural gas, and NGLs
decline, then the return on its investment for a particular project may not be as attractive as PEDEVCO anticipated and PEDEVCO
could incur material write-downs of oil and gas properties and the value of its undeveloped acreage could decline in the future.
Uncertainties
associated with enhanced recovery methods may result in PEDEVCO not realizing an acceptable return on its investments in such
projects.
Production
and reserves, if any, attributable to the use of enhanced recovery methods are inherently difficult to predict. If PEDEVCO’s
enhanced recovery methods do not allow for the extraction of crude oil, natural gas, and associated liquids in a manner or to
the extent that PEDEVCO anticipates, PEDEVCO may not realize an acceptable return on its investments in such projects. In addition,
as proposed legislation and regulatory initiatives relating to hydraulic fracturing become law, the cost of some of these enhanced
recovery methods could increase substantially.
A
significant amount of its Permian Basin asset acreage must be drilled pursuant to governing agreements and leases, in order to
hold the acreage by production. In the highly competitive market for acreage, failure to drill sufficient wells in order to hold
acreage will result in a substantial lease renewal cost, or if renewal is not feasible, loss of PEDEVCO’s lease and prospective
drilling opportunities.
As
of September 30, 2020, 31,036 net acres of PEDEVCO’s Permian Basin Asset are held by production and not subject to lease
expiration, with 6,032 acres subject to lease or governing agreement expiration if these acres are not developed by PEDEVCO prior
to expiration. The loss of substantial leases could have a material adverse effect on PEDEVCO’s assets, operations, revenues
and cash flow and could cause the value of its securities to decline in value.
Competition
for hydraulic fracturing services and water disposal could impede PEDEVCO’s ability to develop its oil and gas plays.
The
unavailability or high cost of high pressure pumping services (or hydraulic fracturing services), chemicals, proppant, water and
water disposal and related services and equipment could limit PEDEVCO’s ability to execute its exploration and development
plans on a timely basis and within its budget. The oil and natural gas industry is experiencing a growing emphasis on the exploitation
and development of shale natural gas and shale oil resource plays, which are dependent on hydraulic fracturing for economically
successful development. Hydraulic fracturing in oil and gas plays requires high pressure pumping service crews. A shortage of
service crews or proppant, chemical, water or water disposal options, especially if this shortage occurred in eastern New Mexico
or eastern Colorado, could materially and adversely affect PEDEVCO’s operations and the timeliness of executing its development
plans within its budget.
Regulations
could adversely affect PEDEVCO’s ability to hedge risks associated with its business and its operating results and cash
flows.
Rules
adopted by federal regulators establishing federal regulation of the over-the-counter (“OTC”) derivatives market
and entities that participate in that market may adversely affect PEDEVCO’s ability to manage certain of its risks on a
cost effective basis. Such laws and regulations may also adversely affect PEDEVCO’s ability to execute its strategies with
respect to hedging its exposure to variability in expected future cash flows attributable to the future sale of its oil and gas.
PEDEVCO
expects that its potential future hedging activities will remain subject to significant and developing regulations and regulatory
oversight. However, the full impact of the various U.S. regulatory developments in connection with these activities will not be
known with certainty until such derivatives market regulations are fully implemented and related market practices and structures
are fully developed.
PEDEVCO’s
operations are substantially dependent on the availability of water. Restrictions on PEDEVCO’s ability to obtain water may
have an adverse effect on its financial condition, results of operations and cash flows.
Water
is an essential component of shale oil and natural gas production during both the drilling and hydraulic fracturing processes.
Historically, PEDEVCO has been able to purchase water from local land owners for use in its operations. When drought conditions
occur, governmental authorities may restrict the use of water subject to their jurisdiction for hydraulic fracturing to protect
local water supplies. Both New Mexico and Colorado have relatively arid climates and experience drought conditions from time to
time. If PEDEVCO is unable to obtain water to use in its operations from local sources or dispose of or recycle water used in
operations, or if the price of water or water disposal increases significantly, PEDEVCO may be unable to produce oil and natural
gas economically, which could have a material adverse effect on its financial condition, results of operations, and cash flows.
Downturns
and volatility in global economies and commodity and credit markets have materially adversely affected PEDEVCO’s business,
results of operations and financial condition.
PEDEVCO’s
results of operations are materially adversely affected by the conditions of the global economies and the credit, commodities
and stock markets. Among other things, PEDEVCO has recently been adversely impacted, and anticipates to continue to be adversely
impacted, due to a global reduction in consumer demand for oil and gas, and consumer lack of access to sufficient capital to continue
to operate their businesses or to operate them at prior levels. In addition, a decline in consumer confidence or changing patterns
in the availability and use of disposable income by consumers can negatively affect the demand for oil and gas and as a result
its results of operations.
Improvements
in or new discoveries of alternative energy technologies could have a material adverse effect on PEDEVCO’s financial condition
and results of operations.
Because
PEDEVCO’s operations depend on the demand for oil and used oil, any improvement in or new discoveries of alternative energy
technologies (such as wind, solar, geothermal, fuel cells and biofuels) that increase the use of alternative forms of energy
and reduce the demand for oil, gas and oil and gas related products could have a material adverse impact on PEDEVCO’s business,
financial condition and results of operations.
Competition
due to advances in renewable fuels may lessen the demand for PEDEVCO’s products and negatively impact its profitability.
Alternatives
to petroleum-based products and production methods are continually under development. For example, a number of automotive, industrial
and power generation manufacturers are developing alternative clean power systems using fuel cells or clean-burning gaseous fuels
that may address increasing worldwide energy costs, the long-term availability of petroleum reserves and environmental concerns,
which if successful could lower the demand for oil and gas. If these non-petroleum based products and oil alternatives continue
to expand and gain broad acceptance such that the overall demand for oil and gas is decreased it could have an adverse effect
on PEDEVCO’s operations and the value of its assets.
Future
litigation or governmental proceedings could result in material adverse consequences, including judgments or settlements.
From
time to time, PEDEVCO is involved in lawsuits, regulatory inquiries and may be involved in governmental and other legal proceedings
arising out of the ordinary course of its business. Many of these matters raise difficult and complicated factual and legal issues
and are subject to uncertainties and complexities. The timing of the final resolutions to these types of matters is often uncertain.
Additionally, the possible outcomes or resolutions to these matters could include adverse judgments or settlements, either of
which could require substantial payments, adversely affecting PEDEVCO’s results of operations and liquidity.
PEDEVCO
may be subject in the normal course of business to judicial, administrative or other third-party proceedings that could interrupt
or limit its operations, require expensive remediation, result in adverse judgments, settlements or fines and create negative
publicity.
Governmental
agencies may, among other things, impose fines or penalties on PEDEVCO relating to the conduct of its business, attempt to revoke
or deny renewal of its operating permits, franchises or licenses for violations or alleged violations of environmental laws or
regulations or as a result of third-party challenges, require PEDEVCO to install additional pollution control equipment or require
PEDEVCO to remediate potential environmental problems relating to any real property that PEDEVCO or its predecessors ever owned,
leased or operated or any waste that PEDEVCO or its predecessors ever collected, transported, disposed of or stored. Individuals,
citizens’ groups, trade associations or environmental activists may also bring actions against PEDEVCO in connection with
its operations that could interrupt or limit the scope of its business. Any adverse outcome in such proceedings could harm PEDEVCO’s
operations and financial results and create negative publicity, which could damage its reputation, competitive position and stock
price. PEDEVCO may also be required to take corrective actions, including, but not limited to, installing additional equipment,
which could require PEDEVCO to make substantial capital expenditures. PEDEVCO could also be required to indemnify its employees
in connection with any expenses or liabilities that they may incur individually in connection with regulatory action against us.
These could result in a material adverse effect on PEDEVCO’s prospects, business, financial condition and its results of
operations.
A
substantial percentage of PEDEVCO’s New Mexico properties are undeveloped; therefore, the risk associated with its success
is greater than would be the case if the majority of such properties were categorized as proved developed producing.
Because
a substantial percentage of PEDEVCO’s New Mexico properties are undeveloped, PEDEVCO will require significant additional
capital to develop such properties before they may become productive. Further, because of the inherent uncertainties associated
with drilling for oil and gas, some of these properties may never be developed to the extent that they result in positive cash
flow. Even if PEDEVCO is successful in its development efforts, it could take several years for a significant portion of its undeveloped
properties to be converted to positive cash flow.
Part
of PEDEVCO’s strategy involves using certain of the latest available horizontal drilling and completion techniques, which
involve additional risks and uncertainties in their application if compared to conventional drilling.
PEDEVCO
plans to utilize some of the latest horizontal drilling and completion techniques as developed by PEDEVCO, other oil and gas exploration
and production companies and its service providers. The additional risks that PEDEVCO faces while drilling horizontally include,
but are not limited to, the following:
|
●
|
drilling
wells that are significantly longer and/or deeper than more conventional wells;
|
|
●
|
landing
its wellbore in the desired drilling zone;
|
|
●
|
staying
in the desired drilling zone while drilling horizontally through the formation;
|
|
●
|
running
its casing the entire length of the wellbore; and
|
|
●
|
being
able to run tools and other equipment consistently through the horizontal wellbore.
|
Risks
that PEDEVCO faces while completing its wells include, but are not limited to, the following:
|
●
|
the
ability to fracture stimulate the planned number of stages in a horizontal or lateral
well bore;
|
|
●
|
the
ability to run tools the entire length of the wellbore during completion operations;
and
|
|
●
|
the
ability to successfully clean out the wellbore after completion of the final fracture
stimulation stage.
|
Prospects
that PEDEVCO decides to drill may not yield oil or natural gas in commercially viable quantities.
PEDEVCO’s
prospects are in various stages of evaluation, ranging from prospects that are currently being drilled to prospects that will
require substantial additional seismic data processing and interpretation. There is no way to predict in advance of drilling and
testing whether any particular prospect will yield oil or natural gas in sufficient quantities to recover drilling or completion
costs or to be economically viable. This risk may be enhanced in PEDEVCO’s situation, due to the fact that a significant
percentage of its reserves is undeveloped. The use of seismic data and other technologies and the study of producing fields in
the same area will not enable PEDEVCO to know conclusively prior to drilling whether oil or natural gas will be present or, if
present, whether oil or natural gas will be present in commercial quantities. PEDEVCO cannot assure you that the analogies PEDEVCO
draws from available data obtained by analyzing other wells, more fully explored prospects or producing fields will be applicable
to its drilling prospects.
Over
the past approximately two years PEDEVCO has been significantly dependent on capital provided to PEDEVCO by SK Energy.
Since
June 2018, SK Energy, which is owned and controlled by Dr. Simon Kukes, PEDEVCO’s Chief Executive Officer and director,
has loaned PEDEVCO an aggregate of $51.7 million to support its operations and for acquisitions, all of which loans were evidenced
by promissory notes. The promissory notes generally had terms which were more favorable to PEDEVCO than PEDEVCO would have been
able to obtain from third parties, including, generally favorable interest rates, no restrictions on further borrowing or financial
covenants and no security interests in PEDEVCO’s assets. All of such notes have to date been converted into 29.5 million
shares of PEDEVCO Common Stock at conversion prices which were above the then-trading prices of PEDEVCO Common Stock. Additionally,
pursuant to subscription agreements, SK Energy purchased an additional aggregate of 15.0 million shares of PEDEVCO Common Stock
from PEDEVCO in private transactions for $28.0 million, also on substantially more favorable terms to PEDEVCO than could be obtained
with third parties. While SK Energy has verbally advised PEDEVCO that it intends to provide PEDEVCO additional funding as needed,
nothing has been documented to date, and such future funding, if any, may not ultimately be provided on favorable terms, if at
all. In the event that PEDEVCO is forced to obtain funding from parties other than SK Energy, such funding terms will likely not
be as favorable to PEDEVCO as the funding provided by SK Energy, and may not be available in such amounts as previously provided
by SK Energy. In the event SK Energy fails to provide PEDEVCO future funding, when and if needed, it could have a material adverse
effect on PEDEVCO’s liquidity, results of operations and could force PEDEVCO to borrow funds from outside sources on less
favorable terms than its prior debt.
Negative
public perception regarding PEDEVCO and/or its industry could have an adverse effect on its operations.
Negative
public perception regarding PEDEVCO and/or its industry resulting from, among other things, concerns raised by advocacy groups
about hydraulic fracturing, waste disposal, oil spills, seismic activity, climate change, explosions of natural gas transmission
lines and the development and operation of pipelines and other midstream facilities may lead to increased regulatory scrutiny,
which may, in turn, lead to new state and federal safety and environmental laws, regulations, guidelines and enforcement interpretations.
Additionally, environmental groups, landowners, local groups and other advocates may oppose PEDEVCO’s operations through
organized protests, attempts to block or sabotage its operations or those of its midstream transportation providers, intervene
in regulatory or administrative proceedings involving its assets or those of its midstream transportation providers, or file lawsuits
or other actions designed to prevent, disrupt or delay the development or operation of its assets and business or those of its
midstream transportation providers. These actions may cause operational delays or restrictions, increased operating costs, additional
regulatory burdens and increased risk of litigation. Moreover, governmental authorities exercise considerable discretion in the
timing and scope of permit issuance and the public may engage in the permitting process, including through intervention in the
courts. Negative public perception could cause the permits PEDEVCO requires to conduct its operations to be withheld, delayed
or burdened by requirements that restrict its ability to profitably conduct its business.
Recently,
activists concerned about the potential effects of climate change have directed their attention towards sources of funding for
fossil-fuel energy companies, which has resulted in certain financial institutions, funds and other sources of capital restricting
or eliminating their investment in energy-related activities. Ultimately, this could make it more difficult to secure funding
for exploration and production activities.
PEDEVCO’s
business could be adversely affected by security threats, including cybersecurity threats.
PEDEVCO
faces various security threats, including cybersecurity threats to gain unauthorized access to its sensitive information or to
render its information or systems unusable, and threats to the security of its facilities and infrastructure or third-party facilities
and infrastructure, such as gathering and processing facilities, refineries, rail facilities and pipelines. The potential for
such security threats subjects PEDEVCO’s operations to increased risks that could have a material adverse effect on its
business, financial condition and results of operations. For example, unauthorized access to PEDEVCO’s seismic data, reserves
information or other proprietary information could lead to data corruption, communication interruptions, or other disruptions
to its operations.
PEDEVCO’s
implementation of various procedures and controls to monitor and mitigate such security threats and to increase security for its
information, systems, facilities and infrastructure may result in increased capital and operating costs. Moreover, there can be
no assurance that such procedures and controls will be sufficient to prevent security breaches from occurring. If any of these
security breaches were to occur, they could lead to losses of, or damage to, sensitive information or facilities, infrastructure
and systems essential to PEDEVCO’s business and operations, as well as data corruption, reputational damage, communication
interruptions or other disruptions to its operations, which, in turn, could have a material adverse effect on its business, financial
position and results of operations.
Weather
and climate may have a significant and adverse impact on PEDEVCO.
Demand
for crude oil and natural gas is, to a degree, dependent on weather and climate, which impacts, among other things, the price
PEDEVCO receives for the commodities PEDEVCO produces and, in turn, its cash flows and results of operations. For example, relatively
warm temperatures during a winter season generally result in relatively lower demand for natural gas (as less natural gas is used
to heat residences and businesses) and, as a result, lower prices for natural gas production.
In
addition, there has been public discussion that climate change may be associated with more frequent or more extreme weather events,
changes in temperature and precipitation patterns, changes to ground and surface water availability, and other related phenomena,
which could affect some, or all, of PEDEVCO’s operations. PEDEVCO’s exploration, exploitation and development activities
and equipment could be adversely affected by extreme weather events, such as winter storms, flooding and tropical storms and hurricanes,
which may cause a loss of production from temporary cessation of activity or damaged facilities and equipment. Such extreme weather
events could also impact other areas of PEDEVCO’s operations, including access to its drilling and production facilities
for routine operations, maintenance and repairs, the installation and operation of gathering, processing, compression, storage
and transportation facilities and the availability of, and its access to, necessary third-party services, such as gathering, processing,
compression, storage and transportation services. Such extreme weather events and changes in weather patterns may materially and
adversely affect PEDEVCO’s business and, in turn, its financial condition and results of operations.
PEDEVCO
recently temporarily shut-in all of its operated producing wells in its Permian Basin Asset and D-J Basin Asset to preserve
PEDEVCO’s oil and gas reserves for production during a more favorable oil price environment, and while PEDEVCO has resumed
full production, PEDEVCO may again shut-in some or all of its operated production, should market conditions significantly deteriorate.
As
a result of the recent COVID-19 outbreak, and the recent sharp decline in oil prices which occurred partially as a result of the
decreased demand for oil caused by such outbreak and the actions taken globally to stop the spread of such virus, in mid-April
2020 PEDEVCO temporarily shut-in all of its operated producing wells in its Permian Basin and D-J Basin to preserve PEDEVCO’s
oil and gas reserves for production during a more favorable oil price environment, noting that most of PEDEVCO’s acreage
is held by production with no drilling obligations, which provides PEDEVCO with flexibility to hold back on production and development
during periods of low oil and gas prices. Following partial recovery in oil prices, commencing in early June 2020, PEDEVCO reactivated
over 90% of its operated wells in the Permian Basin and the D-J Basin that PEDEVCO shut-in in mid-April 2020. PEDEVCO subsequently
resumed full production. However, PEDEVCO may again shut-in some or all of its production, should market conditions deteriorate
into the mid- to low-$20 per barrel realized well head price range in the future. While PEDEVCO’s producing wells are shut-in,
PEDEVCO does not generate revenues from such wells, and would need to use its cash on hand and funds it receives from borrowings
and the sale of equity in order to pay its operating expenses. A continued period of low-priced oil may make it non-economical
for PEDEVCO to operate its wells, which would have a material adverse effect on its operating results and the value of its assets.
PEDEVCO cannot estimate the future price of oil, and as such cannot estimate, when PEDEVCO may again determine to begin producing
oil at its operated wells.
PEDEVCO
may be forced to write-down material portions of its assets if low oil prices continue.
The
recent COVID-19 outbreak has led to an economic downturn resulting in lower oil prices, which has in turn required PEDEVCO to
shut-in all of PEDEVCO’s production from mid-April through early June 2020 as it was uneconomical for PEDEVCO to operate
its producing wells during such time, and PEDEVCO could be required to again shut-in some or all of its production in the future
should market conditions deteriorate. A continued period of low prices may force PEDEVCO to incur material write-downs of its
oil and natural gas properties, which could have a material effect on the value of its properties, and cause the value of its
securities to decline in value.
Risks
Related to PEDEVCO’s Common Stock
PEDEVCO
currently has an illiquid and volatile market for PEDEVCO Common Stock, and the market for PEDEVCO Common Stock is and may remain
illiquid and volatile in the future.
PEDEVCO
currently has a highly sporadic, illiquid and volatile market for PEDEVCO Common Stock, which market is anticipated to remain
sporadic, illiquid and volatile in the future. Factors that
could affect its stock price or result in fluctuations in the market price or trading volume of PEDEVCO Common Stock include:
|
●
|
PEDEVCO’s
actual or anticipated operating and financial performance and drilling locations, including
reserves estimates;
|
|
●
|
quarterly
variations in the rate of growth of PEDEVCO’s financial indicators, such as net
income per share, net income and cash flows, or those of companies that are perceived
to be similar to PEDEVCO;
|
|
●
|
changes
in revenue, cash flows or earnings estimates or publication of reports by equity research
analysts;
|
|
●
|
speculation
in the press or investment community;
|
|
●
|
public
reaction to PEDEVCO’s press releases, announcements and filings with the SEC;
|
|
●
|
sales
of PEDEVCO Common Stock by PEDEVCO or other stockholders, or the perception that such
sales may occur;
|
|
●
|
the
limited amount of PEDEVCO’s freely tradable common stock available in the public
marketplace;
|
|
●
|
general
financial market conditions and oil and natural gas industry market conditions, including
fluctuations in commodity prices;
|
|
●
|
the
realization of any of the risk factors presented in this offer to exchange;
|
|
●
|
the
recruitment or departure of key personnel;
|
|
●
|
commencement
of, or involvement in, litigation;
|
|
●
|
the
prices of oil and natural gas;
|
|
●
|
the
success of PEDEVCO’s exploration and development operations, and the marketing
of any oil and natural gas PEDEVCO produces;
|
|
●
|
changes
in market valuations of companies similar to PEDEVCO; and
|
|
●
|
domestic
and international economic, health, legal and regulatory factors unrelated to PEDEVCO’s
performance.
|
PEDEVCO
Common Stock is listed on the NYSE American under the symbol “PED.” PEDEVCO’s stock price may be impacted by
factors that are unrelated or disproportionate to its operating performance. The
stock markets in general have experienced extreme volatility that has often been unrelated to the operating performance of particular
companies. These broad market fluctuations may adversely affect the trading price of PEDEVCO Common Stock. Additionally, general
economic, political and market conditions, such as recessions, interest rates or international currency fluctuations may adversely
affect the market price of PEDEVCO Common Stock. Due to the limited volume of PEDEVCO Common Stock that trades,
PEDEVCO believes that its stock prices (bid, ask and closing prices) may not be related to its actual value, and not reflect
the actual value of PEDEVCO Common Stock. Stockholders and potential investors in PEDEVCO Common Stock should exercise caution
before making an investment in PEDEVCO.
Additionally,
as a result of the illiquidity of PEDEVCO Common Stock, investors may not be interested in owning PEDEVCO Common Stock because
of the inability to acquire or sell a substantial block of PEDEVCO Common Stock at
one time. Such illiquidity could have an adverse effect on the market price of PEDEVCO Common Stock. In addition, a stockholder
may not be able to borrow funds using PEDEVCO Common Stock as collateral because lenders may be unwilling to accept the pledge
of securities having such a limited market. PEDEVCO cannot assure you that an active trading market for PEDEVCO Common Stock will
develop or, if one develops, be sustained.
An
active liquid trading market for PEDEVCO Common Stock may not develop in the future.
PEDEVCO
Common Stock currently trades on the NYSE American, although PEDEVCO Common Stock’s trading volume is very low. Liquid and
active trading markets usually result in less price volatility and more efficiency in carrying out investors’ purchase and
sale orders. However, PEDEVCO Common Stock may continue to have limited trading volume, and many investors may not be interested
in owning PEDEVCO Common Stock because of the inability to acquire or sell a substantial block of PEDEVCO Common Stock at one
time. Such illiquidity could have an adverse effect on the market price of PEDEVCO Common Stock. In addition, a
stockholder may
not be able to borrow funds using PEDEVCO Common Stock as collateral because lenders may be unwilling to accept the pledge of
securities having such a limited market. PEDEVCO cannot assure you that an active trading market for PEDEVCO Common Stock will
develop or, if one develops, be sustained.
PEDEVCO
does not presently intend to pay any cash dividends on or repurchase any shares of PEDEVCO Common Stock.
PEDEVCO
does not presently intend to pay any cash dividends on PEDEVCO Common Stock or to repurchase any shares of PEDEVCO Common Stock.
Any payment of future dividends will be at the discretion of the PEDEVCO Board and will depend on, among other things, its earnings,
financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions applying to the payment
of dividends and other considerations that the PEDEVCO Board deems relevant. Cash dividend payments in the future may only be
made out of legally available funds and, if PEDEVCO experiences substantial losses, such funds may not be available. Accordingly,
you may have to sell some or all of your PEDEVCO Common Stock in order to generate cash flow from your investment, and there is
no guarantee that the price of PEDEVCO Common Stock that will prevail in the market will ever exceed the price paid by you.
Because
PEDEVCO is a small company, the requirements of being a public company, including compliance with the reporting requirements of
the Exchange Act and the requirements of the Sarbanes-Oxley Act and the Dodd-Frank Act, may strain its resources, increase
its costs and distract management, and PEDEVCO may be unable to comply with these requirements in a timely or cost-effective manner.
As
a public company with listed equity securities, PEDEVCO must comply with the federal securities laws, rules and regulations, including
certain corporate governance provisions of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and the
Dodd-Frank Act, related rules and regulations of the SEC and the NYSE American, with which a private company is not required to
comply. Complying with these laws, rules and regulations will occupy a significant amount of time of the PEDEVCO Board and management
and will significantly increase its costs and expenses, which PEDEVCO cannot estimate accurately at this time. Among other things,
PEDEVCO must:
|
●
|
establish
and maintain a system of internal control over financial reporting in compliance with
the requirements of Section 404 of the Sarbanes-Oxley Act and the related rules and regulations
of the SEC and the Public Company Accounting Oversight Board;
|
|
●
|
comply
with rules and regulations promulgated by the NYSE American;
|
|
●
|
prepare
and distribute periodic public reports in compliance with its obligations under the federal
securities laws;
|
|
●
|
maintain
various internal compliance and disclosures policies, such as those relating to disclosure
controls and procedures and insider trading in PEDEVCO Common Stock;
|
|
●
|
involve
and retain to a greater degree outside counsel and accountants in the above activities;
|
|
●
|
maintain
a comprehensive internal audit function; and
|
|
●
|
maintain
an investor relations function.
|
In
addition, being a public company subject to these rules and regulations may require PEDEVCO to accept less director and officer
liability insurance coverage than PEDEVCO desires or to incur substantial costs to obtain coverage. These factors could also make
it more difficult for PEDEVCO to attract and retain qualified members of the PEDEVCO Board, particularly to serve on its audit
committee, and qualified executive officers.
Future
sales of PEDEVCO Common Stock could cause its stock price to decline.
If
PEDEVCO stockholders sell substantial amounts of PEDEVCO Common Stock in the public market, the market price of PEDEVCO Common
Stock could decrease significantly. The perception in the public market that its stockholders might sell shares of PEDEVCO Common
Stock could also depress the market price of PEDEVCO Common Stock. A decline in the price of shares of PEDEVCO Common Stock
might impede its ability to raise capital through the issuance of additional shares of PEDEVCO Common Stock or other equity securities.
PEDEVCO’s
outstanding options, warrants and convertible securities may adversely affect the trading price of PEDEVCO Common Stock.
As
of June 30, 2020, there are outstanding stock options to purchase 1,234,849 shares of PEDEVCO Common Stock and outstanding warrants
to purchase 150,239 shares of PEDEVCO Common Stock. For the life of the options and warrants, the holders have the opportunity
to profit from a rise in the market price of PEDEVCO Common Stock without assuming the risk of ownership. The issuance of shares
upon the exercise of outstanding securities will also dilute the ownership interests of its existing stockholders.
The
availability of these shares for public resale, as well as any actual resales of these shares, could adversely affect the trading
price of PEDEVCO Common Stock. PEDEVCO previously filed registration statements with the SEC on Form S-8 providing for the registration
of an aggregate of approximately 8,134,915 shares of PEDEVCO Common Stock, issued, issuable or reserved for issuance under its
equity incentive plans. Subject to the satisfaction of vesting conditions, the expiration of lockup agreements, any management
10b5-1 plans and certain restrictions on sales by affiliates, shares registered under registration statements on Form S-8 will
be available for resale immediately in the public market without restriction.
PEDEVCO
cannot predict the size of future issuances of PEDEVCO Common Stock pursuant to the exercise of outstanding options or warrants
or conversion of other securities, or the effect, if any, that future issuances and sales of shares of PEDEVCO Common Stock may
have on the market price of PEDEVCO Common Stock. Sales or distributions of substantial amounts of PEDEVCO Common Stock (including
shares issued in connection with an acquisition), or the perception that such sales could occur, may cause the market price of
PEDEVCO Common Stock to decline.
PEDEVCO
depends significantly upon the continued involvement of its present management.
PEDEVCO
depends to a significant degree upon the involvement of its management, specifically, its Chief Executive Officer, Dr. Simon Kukes
and its President, Mr. J. Douglas Schick. PEDEVCO’s performance and success are dependent to a large extent on the efforts
and continued employment of Dr. Kukes and Mr. Schick. PEDEVCO does not believe that Dr. Kukes or Mr. Schick could be quickly replaced
with personnel of equal experience and capabilities, and their successor(s) may not be as effective. If Dr. Kukes, Mr. Schick,
or any of PEDEVCO’s other key personnel resign or become unable to continue in their present roles and if they are not adequately
replaced, it PEDEVCO’s business operations could be adversely affected. PEDEVCO has no employment or similar agreement in
place with Dr. Kukes. Mr. Schick is party to an employment agreement with PEDEVCO which has no stated term and can be terminated
by either party without cause.
PEDEVCO
has an active PEDEVCO Board that meets several times throughout the year and is intimately involved in PEDEVCO’s business
and the determination of its operational strategies. Members of the PEDEVCO Board work closely with management to identify potential
prospects, acquisitions and areas for further development. If any of PEDEVCO’s directors resign or become unable to continue
in their present role, it may be difficult to find replacements with the same knowledge and experience and as a result, its operations
may be adversely affected.
Dr.
Simon Kukes, PEDEVCO’s Chief Executive Officer and a member of the PEDEVCO Board, beneficially owns 74.2% of PEDEVCO
Common Stock through SK Energy LLC, which gives him majority voting control over stockholder matters and his interests may be
different from your interests.
Dr.
Simon Kukes, PEDEVCO’s Chief Executive Officer and member of the PEDEVCO Board, is the principal and sole owner of SK Energy
LLC, which beneficially owns approximately 71.5% of PEDEVCO’s issued and outstanding common stock and Dr. Kukes, together
with the ownership of SK Energy, beneficially owns approximately 74.2% of PEDEVCO’s issued and outstanding common stock.
As such, Dr. Kukes can control the outcome of all matters requiring a stockholder vote, including the election of directors, matters
requiring approval under the NYSE American Guide, the adoption of amendments to PEDEVCO’s certificate of formation or bylaws
and the approval of mergers and other significant corporate transactions. Subject to any fiduciary duties owed to the stockholders
generally, while Dr. Kukes’ interests may generally be aligned with the interests of PEDEVCO’s stockholders, in some
instances Dr. Kukes may have interests different than the rest of PEDEVCO’s stockholders, including but not limited to,
future potential company financings in which SK Energy may participate, or his leadership at PEDEVCO. Dr. Kukes’ influence
or control of PEDEVCO as a stockholder may have the effect of delaying or preventing a change of control of PEDEVCO
and may adversely affect the voting and other rights of other stockholders. Because Dr. Kukes controls the stockholder vote, investors
may find it difficult to replace Dr. Kukes (and such persons as he may appoint from time to time) as members of PEDEVCO’s
management if they disagree with the way PEDEVCO’s business is being operated. Additionally, the interests of Dr. Kukes
may differ from the interests of the other stockholders and thus result in corporate decisions that are adverse to other stockholders.
Provisions
of Texas law may have anti-takeover effects that could prevent a change in control even if it might be beneficial to PEDEVCO’s
stockholders.
Provisions
of Texas law may discourage, delay or prevent someone from acquiring or merging with PEDEVCO, which may cause the market price
of PEDEVCO Common Stock to decline. Under Texas law, a stockholder who beneficially owns more than 20% of a company’s voting
stock, or any “affiliated stockholder,” cannot acquire PEDEVCO for a period of three years from the date the
person became an affiliated stockholder, unless various conditions are met, such as approval of the transaction by the PEDEVCO
Board before the person became an affiliated stockholder (such as the approval of PEDEVCO Board of Dr. Kukes’ ownership
of PEDEVCO) or approval of the holders of at least two-thirds of the company’s outstanding voting shares not beneficially
owned by the affiliated stockholder.
The
PEDEVCO Board can authorize the issuance of preferred stock, which could diminish the rights of holders of PEDEVCO Common Stock
and make a change of control of PEDEVCO more difficult even if it might benefit its stockholders.
The
PEDEVCO Board is authorized to issue shares of preferred stock in one or more series and to fix the voting powers, preferences
and other rights and limitations of the preferred stock. Shares of preferred stock may be issued by the PEDEVCO Board without
stockholder approval, with voting powers and such preferences and relative, participating, optional or other special rights and
powers as determined by the PEDEVCO Board, which may be greater than the shares of PEDEVCO Common Stock currently outstanding.
As a result, shares of preferred stock may be issued by the PEDEVCO Board which cause the holders to have majority voting power
over PEDEVCO’s shares, provide the holders of the preferred stock the right to convert the shares of preferred stock they
hold into shares of PEDEVCO Common Stock, which may cause substantial dilution to PEDEVCO’s then common stock stockholders
and/or have other rights and preferences greater than those of holders of PEDEVCO Common Stock including having a preference over
PEDEVCO Common Stock with respect to dividends or distributions on liquidation or dissolution.
Investors
should keep in mind that the PEDEVCO Board has the authority to issue additional shares of PEDEVCO Common Stock and preferred
stock, which could cause substantial dilution to PEDEVCO’s existing stockholders. Additionally, the dilutive effect of any
preferred stock which PEDEVCO may issue may be exacerbated given the fact that such preferred stock may have voting rights and/or
other rights or preferences which could provide the preferred stockholders with substantial voting control over PEDEVCO and/or
give those holders the power to prevent or cause a change in control, even if that change in control might benefit PEDEVCO’s
stockholders. As a result, the issuance of shares of PEDEVCO Common Stock and/or preferred stock may cause the value of PEDEVCO’s
securities to decrease.
Securities
analysts may not cover, or continue to cover, PEDEVCO Common Stock and this may have a negative impact on PEDEVCO Common Stock’s
market price.
The
trading market for PEDEVCO Common Stock will depend, in part, on the research and reports that securities or industry analysts
publish about PEDEVCO or its business. PEDEVCO does not have any control over independent analysts (provided that PEDEVCO has
engaged various non-independent analysts). PEDEVCO currently only has a few independent analysts that cover PEDEVCO Common Stock,
and these analysts may discontinue coverage of PEDEVCO Common Stock at any time. Further, PEDEVCO may not be able to obtain additional
research coverage by independent securities and industry analysts. If no independent securities or industry analysts continue
coverage of us, the trading price for PEDEVCO Common Stock could be negatively impacted. If one or more of the analysts who covers
PEDEVCO downgrades PEDEVCO Common Stock, changes their opinion of PEDEVCO’s
shares or publishes inaccurate or unfavorable research about PEDEVCO’s business,
PEDEVCO’s stock price could decline. If one or more of these analysts ceases
coverage of PEDEVCO or fails to publish reports on PEDEVCO regularly, demand for PEDEVCO Common Stock could decrease and PEDEVCO
could lose visibility in the financial markets, which could cause its stock price and trading volume to decline.
Stockholders
may be diluted significantly through PEDEVCO’s efforts to obtain financing and satisfy obligations through the issuance
of securities.
Wherever
possible, the PEDEVCO Board will attempt to use non-cash consideration to satisfy obligations. In many instances, PEDEVCO believes
that the non-cash consideration will consist of shares of PEDEVCO Common Stock, preferred stock or warrants to purchase shares
of PEDEVCO Common Stock. The PEDEVCO
Board has authority, without action or vote of the stockholders, subject to
the requirements of the NYSE American (which generally require stockholder approval for any transactions which would result in
the issuance of more than 20% of its then outstanding shares of PEDEVCO Common Stock or voting rights representing over 20% of
its then outstanding shares of stock, subject to certain exceptions, including sales in a public offering and/or sales which are
undertaken at or above the lower of the closing price immediately preceding the signing of the binding agreement or the average
closing price for the five trading days immediately preceding the signing of the binding agreement), to
issue all or part of the authorized but unissued shares of common stock, preferred stock or warrants to purchase such shares of
common stock. In addition, PEDEVCO may attempt to raise capital by selling shares of PEDEVCO Common Stock, possibly at a discount
to market in the future. These actions will result in dilution of the ownership interests of existing stockholders and may further
dilute PEDEVCO Common Stock book value, and that dilution may be material. Such issuances
may also serve to enhance existing management’s ability to maintain control of PEDEVCO, because the shares may be issued
to parties or entities committed to supporting existing management.
PEDEVCO
is subject to the Continued Listing Criteria of the NYSE American and its failure to satisfy these criteria may result in delisting
of PEDEVCO Common Stock.
PEDEVCO
Common Stock is currently listed on the NYSE American. In order to maintain this listing, PEDEVCO must maintain certain share
prices, financial and share distribution targets, including maintaining a minimum amount of stockholders’ equity and a minimum
number of public stockholders. In addition to these objective standards, the NYSE American may delist the securities of any issuer
if, in its opinion, the issuer’s financial condition and/or operating results appear unsatisfactory; if it appears that
the extent of public distribution or the aggregate market value of the security has become so reduced as to make continued listing
on the NYSE American inadvisable; if the issuer sells or disposes of principal operating assets or ceases to be an operating company;
if an issuer fails to comply with the NYSE American’s listing requirements; if an issuer’s common stock sells at what
the NYSE American
considers a “low selling price” (generally trading below $0.20 per share for an extended period
of time) and the issuer fails to correct this via a reverse split of shares after notification by the NYSE American (provided
that issuers can also be delisted if any shares of the issuer trade below $0.06 per share); or if any other event occurs or any
condition exists which makes continued listing on the NYSE American, in its opinion, inadvisable.
If
the NYSE American delists PEDEVCO Common Stock, investors may face material adverse consequences, including, but not limited to,
a lack of trading market for PEDEVCO’s securities, reduced liquidity, decreased analyst coverage of its securities, and
an inability for PEDEVCO to obtain additional financing to fund its operations.
Due
to the fact that PEDEVCO Common Stock is listed on the NYSE American, PEDEVCO is subject to financial and other reporting and
corporate governance requirements which increase its costs and expenses.
PEDEVCO
is currently required to file annual and quarterly information and other reports with the SEC that are specified in Sections 13
and 15(d) of the Exchange Act. Additionally, due to the fact that PEDEVCO’s Common Stock is listed on the NYSE American,
PEDEVCO is also subject to the requirements to maintain independent directors, comply with other corporate governance requirements
and is required to pay annual listing and stock issuance fees. These obligations require a commitment of additional resources
including, but not limited, to additional expenses, and may result in the diversion of PEDEVCO’s
senior management’s time and attention from its day-to-day operations. These obligations
increase PEDEVCO’s expenses and may make it more complicated or time consuming
for PEDEVCO to undertake certain corporate actions due to the fact that PEDEVCO may require NYSE approval for such transactions
and/or NYSE rules may require PEDEVCO to obtain stockholder approval for such transactions.
If
persons engage in short sales of PEDEVCO Common Stock, including sales of shares to be issued upon exercise of its outstanding
warrants, the price of PEDEVCO Common Stock may decline.
Selling
short is a technique used by a stockholder to take advantage of an anticipated decline in the price of a security. In addition,
holders of options and warrants will sometimes sell short knowing they can, in effect, cover through the exercise of an option
or warrant, thus locking in a profit. A significant number of short sales or a large volume of other sales within a relatively
short period of time can create downward pressure on the market price of a security. Further sales of PEDEVCO Common Stock issued
upon exercise of its outstanding warrants could cause even greater declines in the price of PEDEVCO Common Stock due to the number
of additional shares available in the market upon such exercise, which could encourage short sales that could further undermine
the value of PEDEVCO Common Stock. Stockholders could, therefore, experience a decline in the values of their investment as a
result of short sales of PEDEVCO Common Stock.
Risk
Factors Relating to THE TRUST
All
information concerning the Trust, its businesses, operations, financial condition and management, including the following risk
factors, presented or incorporated by reference in this offer to exchange is taken from publicly available information. Please
see the section of this offer to exchange entitled “Note on Trust Information.”
Risks
Related to the Trust Units
The
COVID-19 pandemic could materially adversely affect proceeds to the Trust and cash distributions to holders of Trust Common Units.
The
recent outbreak of the novel form of coronavirus known as COVID-19 and its development into a global pandemic is negatively impacting
worldwide economic and commercial activity and financial markets, as well as global demand for crude oil and natural gas. The
West Texas Intermediate spot price of crude oil has declined from $61.17 per barrel on January 2, 2020 to $40.77 per barrel on
August 3, 2020, and crude oil reached a closing NYMEX price low of negative $37.63 per barrel of crude oil in April 2020, in response
to the economic effects of the COVID-19 pandemic and the dispute over production levels between Russia and the members of the
Organization of Petroleum Exporting Countries (“OPEC”), which resulted in an oversupply of crude oil and exacerbated
the decline in crude oil prices. COVID-19 and the responses by federal, state and local governmental authorities to the pandemic
have also resulted in significant business and operational disruptions, including business closures, supply chains disruptions,
travel restrictions, stay-at-home orders and limitations on the availability of workforces. The full impact of COVID-19 is unknown
and is rapidly evolving.
Continued
low oil and natural gas prices may ultimately reduce the amount of oil and natural gas that is economically viable to produce
from the Underlying Properties. As a result, Avalon could determine during periods of low commodity prices to shut-in or curtail
production from Wells on the Underlying Properties, or even plug and abandon marginal Wells that otherwise may have been allowed
to continue to produce for a longer period under conditions of higher prices. Specifically, Avalon may abandon any well or property
if it reasonably believes that the well or property can no longer produce oil or natural gas in commercially paying quantities,
which could result in termination of the portion of the Royalty Interest relating to the abandoned well, and Avalon has no obligation
to drill a replacement well. If commodity prices for crude oil and natural gas remain at reduced levels, cash distributions to
holders of Trust Common Units will be substantially lower than historical distributions, and in certain periods there may be no
distribution to holders of Trust Common Units.
To
the extent COVID-19 adversely affects production from the Underlying Properties or Avalon’s business, results of operations
and financial condition, it may also have the effect of heightening many of the other risks described below.
The
ability or willingness of OPEC and other oil exporting nations to set and maintain production levels has a significant impact
on oil and natural gas commodity prices, which could reduce the amount of cash available for distribution to holders of Trust
Common Units.
OPEC
is an intergovernmental organization that seeks to manage the price and supply of oil on the global energy market. Actions taken
by OPEC members, including those taken alongside other oil exporting nations, have a significant impact on global oil supply and
pricing. For example, OPEC and certain other oil exporting nations have previously agreed to take measures, including production
cuts, to support crude oil prices. In March 2020, members of OPEC and Russia considered extending and potentially increasing these
oil production cuts. However, those negotiations were unsuccessful. As a result, Saudi Arabia announced an immediate reduction
in export prices and Russia announced that all previously agreed upon oil production cuts would expire on April 1, 2020. These
actions led to an immediate and steep decrease in oil prices, which reached a closing NYMEX price low of negative $37.63 per Bbl
of crude oil in April 2020. There can be no assurance that OPEC members and other oil exporting nations will agree to future production
cuts or other actions to support and stabilize oil prices, nor can there be any assurance that they will not further reduce oil
prices or increase production. Uncertainty regarding future actions to be taken by OPEC members or other oil exporting countries
could lead to increased volatility in the price of oil, which could adversely affect the financial condition and economic performance
of the operators of the Underlying Properties and may reduce the net proceeds to which the Trust is entitled, which could materially
reduce or completely eliminate the amount of cash available for distribution to holders of Trust Common Units.
The
value of the Royalty Interests is highly dependent on the performance and financial condition of Avalon.
As
of November 1, 2018, Avalon is the operator of all Wells. The Conveyances provide that Avalon is obligated to market, or cause
to be marketed, the oil, natural gas and NGL produced by such Wells (to the extent such Wells are capable of producing marketable
hydrocarbons in paying quantities) from the Underlying Properties. If Avalon were to default on its obligation, the cash distributions
to holders of Trust Common Units may be materially reduced. The Trust is highly dependent on its Trustor, Avalon, for multiple
services, including the operation of the Wells, remittance of net proceeds from the sale of associated production to the Trust,
administrative services such as accounting, tax preparation, bookkeeping and informational services performed on behalf of the
Trust. Due to the Trust’s reliance on Avalon to fulfill these obligations, the value of the Royalty Interests and its ultimate
cash available for distribution is highly dependent on Avalon’s performance. Avalon has notified the Trustee that current
reductions in production of crude oil and the current low prices for crude oil have adversely impacted Avalon’s financial
condition. This negative impact could affect Avalon’s ability to operate the Wells and provide services to the Trust. In
addition, Avalon has informed the Trustee that Avalon’s independent public accounting firm included a going concern qualification
in its audit report on Avalon’s financial statements for the fiscal year ended December 31, 2019.
Avalon
has informed the Trustee that during 2020 it has shut in additional Wells that are not capable of producing oil and natural gas
in paying quantities, as permitted under the Conveyances, in an effort to further reduce LOE. These Wells were not necessary to
hold the leasehold interests burdened by the Trust’s Royalty Interests. Avalon shut in 23 Trust Wells and 79 Trust Wells
during the first and second quarters of 2020, respectively.
Avalon
has informed the Trustee that Avalon is using its commercially reasonable efforts to preserve the oil and gas leases on which
the Wells are located so that in the future, assuming that crude oil prices return to a profitable level, the Trust will still
hold its Royalty Interests, and holders of Trust Common Units may have the opportunity to receive future quarterly distributions.
Avalon also has informed the Trustee that Avalon believes that continuing production from the Wells required to preserve such
leases is preferable to stopping production, as the failure to continue production would result in a termination of Avalon’s
working interest in such Wells and, therefore, the Royalty Interests, which would have a material adverse effect on the Trust’s
financial condition. Avalon has reported to the Trustee that Avalon therefore used revenues it received during the production
period from December 1, 2019 to February 29, 2020 to pay the operating expenses necessary to maintain production from the Wells
and to pay oil and gas lessor royalties, as the proceeds attributable to Avalon’s net revenue interest in the Underlying
Properties was insufficient to cover all such costs. Avalon had anticipated that revenues from current period production would
be sufficient to fund the quarterly payment to the Trust; however, revenues from current period production have been insufficient
to generate the cash needed to make the quarterly payment to the Trust for the quarter ended March 31, 2020 due to the sharp drop
in crude oil prices during the first quarter of 2020. In April 2020, Avalon informed the Trustee that due to Avalon’s decision
to prioritize the preservation of oil and gas leases burdened by the Royalty Interests, coupled with the sharp decline in oil
and gas prices since the beginning of 2020, at that time Avalon did not believe that it would be able to generate sufficient cash
for quarterly payments to the Trust for the foreseeable future. However, with the recovery of crude oil prices since the end of
April 2020 and with increased cost-cutting efforts, Avalon has informed the Trust that it will make a payment of approximately
$1.7 million to the Trust for the three-month period ended June 30, 2020 (which primarily relates to production attributable to
the Trust’s Royalty Interests from March 1, 2020 to May 31,2020), and the Trust has announced a quarterly distribution to
holders of Trust Common Units of $652,000 for that period. As the COVID pandemic continues to show no signs of abating and has
recently resurged in the United States, Avalon has informed the Trust that it believes crude oil prices will continue to fluctuate
dramatically and cannot assure the Trust of its ability to generate sufficient cash to make all future quarterly payments to the
Trust on a timely basis.
In
connection with the Sales Transaction, Avalon obtained the WaFed Loan from WaFed pursuant to the terms of a Loan Agreement and
related security documents. Avalon used the proceeds of the WaFed Loan to fund a portion of the purchase price for the interests
in the Underlying Properties and Trust Common Units acquired in the Sale Transaction. The WaFed Loan is secured by the WaFed Collateral
consisting of a first lien mortgage on Avalon’s interest in the Underlying Properties and a pledge of the Avalon’s
Trust Common Units. The Royalty Interests are not part of the WaFed Collateral. Due to the reduction in the number of producing
wells (both Trust Wells and other wells owned by Avalon) and the resulting expected reduction in the proved reserves attributable
to Avalon’s net revenue interest in the Underlying Properties and other oil and gas assets, Avalon notified the Trust in
April 2020 that it expected WaFed to notify Avalon (concurrent with WaFed’s redetermination of the borrowing base under
the terms of the WaFed Loan) that the borrowing base would be reduced to less than the outstanding principal amount of the WaFed
Loan. As Avalon has indicated to the Trust that Avalon does not presently have sufficient cash available to pay down the principal
amount of the WaFed Loan to come into compliance with any adjustment to the borrowing base, it is possible that WaFed could foreclose
on the collateral securing the WaFed Loan or take other steps to protect its interest in such collateral. Since April 2020, Avalon
has been in discussions with WaFed regarding forbearance of certain breached financial covenants and an extension of the WaFed
Loan. On July 30, 2020, Avalon and WaFed entered into an amendment to the WaFed Loan that, among other things (i) extends the
date on which Avalon is obligated to provide a reserve report to WaFed (regarding the redetermination of the borrowing base) to
September 15, 2020, (ii) provides for additional collateral for the WaFed Loan, (iii) requires increased financial and operations
reporting, and (iv) requires Avalon to pay off the WaFed Loan by October 15, 2020. In addition, WaFed and a third party entered
into a Participation Agreement with respect to the WaFed Loan where such third party has the right to purchase the WaFed Loan
in the event Avalon does not meet the conditions of the amended WaFed Loan. Avalon has informed the Trust that if it is unsuccessful
in its efforts to recapitalize and pay off the WaFed Loan, it anticipates that WaFed will call the WaFed Loan and foreclose on
its collateral, which could occur as early as late October 2020. If such foreclosure were to occur, Avalon would lose its working
interest in the Underlying Properties and could be replaced as operator of the Underlying Properties. See “—The value
of the Royalty Interests is highly dependent on the performance and financial condition of Avalon” for a discussion of additional
risks relating to the WaFed Loan and Avalon’s financial condition.
The
bankruptcy of operators could impede the operation of Trust Wells.
The
value of the Royalty Interests and the Trust’s ultimate cash available for distribution is highly dependent on the financial
condition of the operator of the Wells. Avalon has not agreed with the Trust to maintain a certain net worth or to be restricted
by other similar covenants. The ability to operate the Underlying Properties depends on an operator’s future financial condition,
economic performance and access to capital, which in turn will depend upon the supply and demand for oil, natural gas and NGL,
prevailing economic conditions and financial, business and other factors, many of which are beyond the control of such operators,
including Avalon.
Avalon
is not a reporting company and is not required to file periodic reports with the SEC pursuant to the Exchange Act. Therefore,
as a holder of Trust Common Units, you do not have access to financial information about Avalon. Avalon has informed the Trustee
that Avalon’s independent public accounting firm included a going concern qualification in its audit report on Avalon’s
financial statements for the fiscal year ended December 31, 2019. In the event of any future bankruptcy of Avalon or any other
future operator of the Underlying Properties, the value of the Royalty Interests could be adversely affected by, among other things,
delay or cessation of payments under the Royalty Interests, business disruptions or cessation of operations by the operator, replacements
of operators, inability to find a replacement operator where necessary, reduced production of petroleum reserves. Any of such
events would likely result in decreased distributions to holders of Trust Common Units.
Producing
oil, natural gas and NGL from the Underlying Properties is a high risk activity with many uncertainties that could adversely affect
future production from the Underlying Properties. Any such reductions in production could decrease cash that is available for
distribution to holders of Trust Common Units.
Production
operations on the Underlying Properties may be curtailed, delayed or canceled as a result of various factors, including the following:
|
●
|
reductions
in oil, natural gas and NGL prices;
|
|
●
|
unusual
or unexpected geological formations and miscalculations;
|
|
●
|
equipment
malfunctions, failures or accidents;
|
|
●
|
lack
of available gathering facilities or delays in construction of gathering facilities;
|
|
●
|
lack
of available capacity on interconnecting transmission pipelines;
|
|
●
|
lack
of adequate electrical infrastructure and water disposal capacity;
|
|
●
|
unexpected
operational events;
|
|
●
|
pipe
or cement failures and casing collapses;
|
|
●
|
pressures,
fires, blowouts and explosions;
|
|
●
|
uncontrollable
flows of oil, NGL, natural gas, brine, water or drilling fluids;
|
|
●
|
environmental
hazards, such as oil spills, natural gas and NGL leaks, pipeline or tank ruptures, encountering naturally occurring radioactive
materials, and unauthorized discharges of brine, well stimulation and completion fluids, toxic gases or other pollutants into
the surface and subsurface environment;
|
|
●
|
high
costs, shortages or delivery delays of equipment, labor or other services, or water used in hydraulic fracturing;
|
|
●
|
compliance
with environmental and other governmental requirements;
|
|
●
|
adverse
weather conditions, such as extreme cold, fires caused by extreme heat or lack of rain and severe storms or tornadoes; and
|
|
●
|
market
limitations for oil, natural gas and NGL.
|
If
production from the Trust wells is lower than anticipated due to one or more of the foregoing factors or for any other reason,
cash distributions to holders of Trust Common Units may be reduced.
Oil,
natural gas and NGL prices can fluctuate widely due to a number of factors that are beyond the control of the Trust and Avalon.
Continued volatility in oil, natural gas or NGL prices could reduce proceeds to the Trust and cash distributions to holders of
Trust Common Units.
The
value of the petroleum reserves attributable to the Royalty Interests and the amount of revenue available for quarterly cash distributions
to holders of Trust Common Units are highly dependent upon the prices realized from the sale of oil, natural gas and NGL produced
from the Underlying Properties. Historically, the markets for these hydrocarbons have been very volatile. Prices for oil, natural
gas and NGL can move quickly and fluctuate widely in response to a variety of factors that are beyond the control of the Trust
or Avalon. These factors include, among others:
|
●
|
changes
in regional, domestic and foreign supply of, and demand for, oil, natural gas and NGL, as well as perceptions of supply of, and
demand for, oil, natural gas and NGL generally;
|
|
●
|
the
price and quantity of foreign imports;
|
|
●
|
the
ability of other companies to complete and commission liquefied natural gas export facilities in the U.S.;
|
|
●
|
U.S.
and worldwide political and economic conditions;
|
|
●
|
the
occurrence or threat of epidemic or pandemic diseases, including the recent outbreak of coronavirus, or any government response
to such occurrence or threat;
|
|
●
|
weather
conditions and seasonal trends;
|
|
●
|
future
prices of oil, natural gas and NGL, alternative fuels and other commodities;
|
|
●
|
technological
advances affecting energy consumption and energy supply;
|
|
●
|
the
proximity, capacity, cost and availability of pipeline infrastructure, treating, transportation and refining capacity;
|
|
●
|
natural
disasters and other extraordinary events;
|
|
●
|
domestic
and foreign governmental regulations and taxation;
|
|
●
|
energy
conservation and environmental measures; and
|
|
●
|
the
price and availability of alternative fuels.
|
These
factors and the volatility of the energy markets, which is expected to continue, make it extremely difficult to predict future
oil, natural gas and NGL price movements with any certainty. For crude oil, from January 2018 through December 2019, the highest
spot price for West Texas Intermediate (WTI) was $76.41 per Bbl and the lowest was $42.53 per Bbl. For natural gas, from January
2018 through December 2019, the highest Henry Hub natural gas spot price was $4.25 per MMBtu and the lowest was $1.75 per MMBtu.
In addition, the market price of oil and natural gas is generally lower in the summer months than during the winter months of
the year due to decreased demand for oil and natural gas for heating purposes during the summer season.
Oil,
natural gas and NGL prices experienced substantial fluctuations during 2019 ending the year at $61.06/Bbl (spot price for WTI
crude oil), or up approximately 31.2% from the January 2, 2019 spot price of $46.54/Bbl. A buildup in inventories, lower global
demand, or other factors, including one or more factors listed above, have caused prices for U.S. oil to weaken further, and could
result in additional declines from current levels. The spot price for WTI crude oil has decreased a further 50.6% from $61.17
on January 2, 2020 to $30.24 on March 9, 2020. Continued low oil, natural gas and NGL prices will reduce proceeds to which the
Trust is entitled and may ultimately reduce the amount of oil, natural gas and NGL that is economic to produce from the Underlying
Properties causing the Trust to make substantial downward adjustments to its estimated proved reserves. As a result, Avalon could
determine during periods of low oil, natural gas or NGL prices to shut in or curtail production from wells that are not producing
in paying quantities (using the Reasonably Prudent Operator Standard) on the Underlying Properties. Furthermore, pursuant to the
terms of the Conveyances, Avalon has the right to abandon, at its cost, any well if it reasonably believes that the well can no
longer produce oil, natural gas and NGL in paying quantities. This could result in termination of the portion of the Royalty Interest
relating to the abandoned well, and Avalon has no obligation to drill a replacement well.
Actual
petroleum reserves and future production may be less than current estimates, which could reduce cash distributions by the Trust
and the value of the Common Units.
The
value of the Trust Common Units and the amount of future cash distributions to the holders of Trust Common Units will depend upon,
among other things, the accuracy of the reserves estimated to be attributable to the Royalty Interests. It is not possible to
accurately measure underground accumulations of oil, natural gas and NGL in an exact way and estimating reserves is inherently
uncertain. As discussed below, the process of estimating oil, natural gas and NGL reserves requires interpretations of available
technical data and many assumptions. Any significant inaccuracies in these interpretations or assumptions could materially affect
the estimated quantities and present value of the reserves attributable to the Royalty Interests. This could result in actual
production and revenues for the Underlying Properties being materially less than estimated amounts.
In
order to prepare the estimates of reserves attributable to the Underlying Properties and the Royalty Interests, production rates
must be projected. In so doing, available geological, geophysical, production and engineering data must be analyzed. The extent,
quality and reliability of this data can vary. In addition, petroleum engineers are required to make subjective estimates of underground
accumulations of oil, natural gas and NGL based on factors and assumptions that include:
|
●
|
historical
production from the area compared with production rates from other producing areas;
|
|
●
|
oil,
natural gas and NGL prices, production levels, Btu content, production expenses, transportation
costs, severance and excise taxes and capital expenditures; and
|
|
●
|
the
assumed effect of governmental regulation.
|
A
material and adverse variance of actual production, revenues and expenditures from those underlying reserve estimates would have
a material adverse effect on the financial condition, results of operations and cash flows of the Trust and would reduce cash
distributions to holders of Trust Common Units. As a result, the Trust may not receive the benefit of the total amount of reserves
reflected in the reserve report.
The
Trust Common Units have been delisted.
Under
the continued listing requirements of NYSE, a company will be considered to be out of compliance with the exchange’s minimum
price requirement if the company’s average closing price over a consecutive 30 trading day period (“Average Closing
Price”) is less than $1.00 (the “Minimum Price Requirement”). Under NYSE rules, a company that is out of compliance
with the Minimum Price Requirement has a cure period of six months to regain compliance if it notifies the NYSE within 10 business
days of receiving a deficiency notice of its intention to cure the deficiency. A company may regain compliance if on the last
trading day of any calendar month during the cure period the company has a closing share price of at least $1.00 and an average
closing share price of at least $1.00 over the 30-trading-day period ending on the last trading day of that month. If at the expiration
of the cure period, both a $1.00 closing share price on the last trading day of the cure period and a $1.00 average closing share
price over the 30-trading-day period ending on the last trading day of the cure period are not attained, the NYSE will commence
suspension and delisting procedures. If delisted by the NYSE, a company’s shares may be transferred to the over-the-counter
(“OTC”) market, a significantly more limited market than the NYSE, which could affect the market price, trading volume,
liquidity and resale price of such shares. Securities that trade on the OTC markets also typically experience more volatility
compared to securities that trade on a national securities exchange. During the cure period, the company’s shares would
continue to trade on the NYSE, subject to compliance with other continued listing requirements.
On
December 27, 2019, the Trust received written notification from the NYSE that the Trust was not in compliance with the Minimum
Price Requirement. Neither the Trust nor the Trustee has any control over the trading price of the Trust Common Units, and neither
the Trust nor the Trustee intends to attempt to cause a reverse split of the Trust Common Units or other action in an effort to
affect the trading price of the Trust Common Units. Even if the Trust does regain compliance, it might be unable to maintain compliance,
and would again become subject to the NYSE delisting procedures.
As
the Trust was unable to regain compliance with the applicable standards within a cure period that concluded on September 5, 2020,
the NYSE announced the suspension of trading of the Trust Common Units due to non-compliance with Rule 802.01C of the NYSE
Listed Company Manual, effective as of the close of trading on September 8, 2020, and announced that it was initiating proceedings
to delist the Trust Common Units. The NYSE filed a Form 25 on September 28, 2020.
As
a result of the suspension, the Trust Common Units begin trading on September 9, 2020 under the symbol “PERS” on the
OTC Pink Market, which is operated by OTC Markets Group Inc. To be quoted on OTC Pink Market, a market maker must sponsor the
security and comply with SEC Rule 15c2-11 before it can initiate a quote in a specific security. OTC Pink Market is a significantly
more limited market than the NYSE, and the quotation of the Trust Common Units on OTC Pink Market may result in a less liquid
market available for existing and potential holders of Trust Common Units and could further depress the trading price of the Trust
Common Units. There is no assurance that an active market in the Trust Common Units will develop on the OTC Pink Market, or whether
broker-dealers will continue to provide public quotes of the Trust Common Units on this market, whether the trading volume of
the Trust Common Units will be sufficient to provide for an efficient trading market or whether quotes for the Trust Common Units
may be blocked by OTC Markets Group in the future.
Production
of oil, natural gas and NGL on the Underlying Properties could be materially and adversely affected by severe or unseasonable
weather.
Production
of oil, natural gas and NGL on the Underlying Properties could be materially and adversely affected by severe weather. Repercussions
of severe weather conditions may include:
|
●
|
changes
in oil viscosity as a result of extremely cold weather conditions;
|
|
●
|
evacuation
of personnel and curtailment of operations;
|
|
●
|
weather-related
damage to facilities, resulting in suspension of operations;
|
|
●
|
inability
to deliver materials to worksites; and
|
|
●
|
weather-related
damage to pipelines and other transportation facilities.
|
Interruptions
in production could have a material adverse effect on the Trust’s financial condition, results of operations and cash flows,
and could reduce the amount of cash distributions to holders of Trust Common Units.
Due
to the Trust’s lack of industry and geographic diversification, adverse developments in the location of the Underlying Properties
could adversely impact the Trust’s financial condition, results of operations and cash flows and reduce its ability to make
distributions to the holders of Trust Common Units.
The
Underlying Properties are being and will be operated for oil, natural gas and NGL production only and are focused exclusively
in the Permian Basin in Andrews County, Texas. This concentration could disproportionately expose the Trust’s interests
to operational and regulatory risk in that area. Due to the lack of diversification in industry type and location of the Trust’s
interests, adverse developments in the oil and natural gas market or the area of the Underlying Properties, including, for example,
transportation or treatment capacity constraints, curtailment of production or treatment plant closures for scheduled maintenance,
could have a significantly greater impact on the Trust’s financial condition, results of operations and cash flows than
if the Royalty Interests were more diversified.
The
generation of proceeds for distribution by the Trust depends in part on Avalon’s access to and the operation of gathering,
transportation and processing facilities. Limitations in the availability of those facilities could interfere with sales of oil,
natural gas and NGL production from the Underlying Properties.
The
amount of oil, natural gas and NGL that may be produced and sold from any well to which the Underlying Properties relate is subject
to (a) curtailment of production in certain circumstances, such as by reason of weather, pump failure, down-hole issues or other
operating risks common to the production of hydrocarbons, and (b) the availability of adequate transportation services or the
curtailment of transportation services, including pipeline interruptions due to scheduled and unscheduled maintenance, failure
of tendered oil, natural gas and NGL to meet quality specifications of gathering lines or downstream transporters, excessive line
pressure which prevents delivery, physical damage to the gathering system or transportation system or lack of contracted capacity
on such systems. The curtailments may vary from a few days to several months. In many cases, Avalon is provided limited notice,
if any, as to when production will be curtailed and the duration of such curtailments. If Avalon is forced to reduce production
due to such a curtailment or other interruption of transportation services, the revenues of the Trust and the amount of cash distributions
to the holders of Trust Common Units would similarly be reduced due to the reduction of proceeds from the sale of production.
The
Trust is passive in nature and has no voting rights in Avalon, no managerial, contractual or other ability to influence Avalon,
and no right to exercise control over the field operations of, or sale of oil, natural gas and NGL from, the Underlying Properties.
Neither
the Trust nor any holder of Trust Common Units has any voting rights with respect to Avalon and, therefore, has no managerial,
contractual or other ability to influence Avalon’s activities or operations of the Underlying Properties. In addition, some
of the Underlying Properties may, in the future, be operated by third parties unrelated to Avalon. Such third-party operators
may not have the operational expertise of Avalon. Oil and natural gas properties are typically managed pursuant to an operating
agreement among the working interest owners in the properties. The typical operating agreement contains procedures whereby the
owners of the aggregate working interest in the property designate one of the interest owners to be the operator of the property.
Under these arrangements, the operator is typically responsible for making all decisions relating to sale of production, compliance
with regulatory requirements and other matters that affect the property. The failure of an operator to adequately perform operations
could reduce production from the Underlying Properties and cash available for distribution to holders of Trust Common Units. Neither
the Trustee nor the holders of Trust Common Units has any contractual or other ability to influence or control the field operations
of, sale of oil, natural gas and NGL from, or future development of, the Underlying Properties.
The
oil, natural gas and NGL reserves estimated to be attributable to the Royalty Interests are depleting assets and production from
those reserves will diminish over time. Furthermore, the Trust is precluded from acquiring other oil and natural gas properties
or royalty interests to replace the depleting assets and production.
The
proceeds payable to the Trust from the Royalty Interests are derived from the sale of oil, natural gas and NGLs produced from
the Underlying Properties. The oil, natural gas and NGL reserves attributable to the Royalty Interests are depleting assets, which
means that the reserves of oil, natural gas and NGL attributable to the Royalty Interests will decline over time as will the quantity
of oil, natural gas and NGL produced from the Underlying Properties.
Future
maintenance of the wells burdened by the Royalty Interests may affect the quantity of proved reserves that can be economically
produced from the Underlying Properties. The timing and size of these projects will depend on, among other factors, the market
prices of oil, natural gas and NGL. Pursuant to the terms of the Conveyances, Avalon is obligated to operate and maintain the
Underlying Properties in good faith and in accordance with the Reasonably Prudent Operator Standard. However, Avalon has no contractual
obligation to make capital expenditures on the Underlying Properties in the future. If Avalon does not implement maintenance projects
when warranted, the future rate of production decline of proved reserves may be higher than the rate currently expected by Avalon
or estimated in the Trust’s reserve report.
The
Trust Agreement generally limits the Trust’s business activities to owning the Royalty Interests and activities reasonably
related to such ownership, including activities required or permitted by the terms of the Conveyances related to the Royalty Interests.
As a result, the Trust is not permitted to acquire other oil and natural gas properties or royalty interests to replace the depleting
assets (the Underlying Properties) and production attributable thereto.
An
increase in the differential between the price realized by Avalon for oil and natural gas produced from the Underlying Properties
and the NYMEX or other benchmark price of oil or natural gas could reduce the proceeds to the Trust and therefore the cash distributions
by the Trust and the value of Trust Common Units.
The
prices received for oil and natural gas production usually fall below benchmark prices such as NYMEX. The difference between the
price received and the benchmark price is called a differential. The amount of the differential depends on a variety of factors,
including discounts based on the quality and location of hydrocarbons produced, Btu content and post-production costs, including
transportation. These factors can cause differentials to be volatile from period to period. Sellers of production have little
or no control over the factors that determine the amount of the differential, and cannot accurately predict differentials for
natural gas or crude oil. Increases in the differential between the realized price of oil or natural gas and the benchmark price
for oil or natural gas in the area where the Underlying Properties are located (Andrews County, Texas) could reduce the proceeds
to the Trust and therefore the cash distributions made by the Trust and the value of the Trust Common Units. Due to the cost of
transportation in the Permian Basin (in part caused by a lack of pipeline capacity in certain fields), the differential may fluctuate
significantly from period to period.
The
amount of cash available for distribution by the Trust is reduced by Trust expenses, post-production costs and applicable taxes
associated with the Royalty Interests.
The
Royalty Interests and the Trust bear certain costs and expenses that reduce the amount of cash received by or available for distribution
by the Trust to the holders of Trust Common Units. These costs and expenses include the following:
|
●
|
the
Trust’s share of the costs incurred by Avalon to gather, store, compress, transport, process, treat, dehydrate and market
the oil, natural gas and NGL (excluding costs of marketing services provided by Avalon);
|
|
●
|
the
Trust’s share of applicable taxes, including property taxes and taxes on the production of oil, natural gas and NGL;
|
|
●
|
the
Trust’s liability for Texas franchise tax; and
|
|
●
|
Trust
administrative expenses, including fees paid to the Trustee and the Delaware Trustee, the annual administrative services fee payable
to Avalon, tax return and Schedule K-1 preparation and mailing costs, independent auditor fees, registrar and transfer agent fees,
and costs associated with compliance with federal securities laws and NYSE listing requirements, including the preparation of
annual and quarterly reports to holders of Trust Common Units and current reports announcing the amount of quarterly distributions
by the Trust.
|
In
addition, the amount of funds available for distribution to holders of Trust Common Units is reduced by the amount of any cash
reserves maintained by the Trustee in respect of anticipated future Trust administrative expenses. Commencing with the distribution
to holders of Trust Common Units paid in the first quarter of 2019, the Trustee has withheld, and in the future intends to withhold,
the greater of $190,000 or 3.5% of the funds otherwise available for distribution each quarter to gradually increase cash reserves
for the payment of future known, anticipated or contingent expenses or liabilities by a total of approximately $2,275,000. In
2019, the Trustee withheld $760,000 from the funds otherwise available for distribution to holders of Trust Common Units. In February
2020, the Trustee withheld approximately $190,000 from the funds otherwise available for distribution. In July 2020, the Trustee
withheld approximately $190,000 from funds otherwise available for distribution.
The
amount of post-production costs, taxes and expenses borne by the Trust may vary materially from quarter-to-quarter. The extent
by which the costs are lower in any quarter will directly decrease revenues received by the Trust from Avalon and such amount
will be further decreased by expenses of the Trust. As a result, distributions available to holders of Trust Common Units may
vary significantly quarter to quarter. Meanwhile, historical post-production costs, taxes and expenses are not indicative of future
post-production costs, taxes and expenses.
The
Trust has no hedges in place to protect against the price risk inherent in holding interests in oil and gas, commodities that
are frequently characterized by significant price volatility.
The
Trust and SandRidge were parties to a derivatives agreement that provided the Trust with the economic effect of certain derivative
contracts between SandRidge and a third party for production through March 31, 2015. From inception through the termination of
the hedging arrangements, the Trust received approximately $47.5 million that it would not have received without the hedging arrangements.
The last of the hedging arrangements expired on March 31, 2015. Consequently, holders of Trust Common Units no longer have the
benefit of any hedging arrangements, and all production after March 31, 2015 is subject to the price risks inherent in holding
interests in oil and natural gas, both commodities that are frequently characterized by significant price volatility.
The
Trust is administered by a Trustee who cannot be replaced except at a special meeting of holders of Trust Common Units.
The
business and affairs of the Trust are administered by the Trustee. A holder of Trust Common Units voting rights are more limited
than those of stockholders of most public corporations. For example, there is no requirement for annual meetings of holders of
Trust Common Units or for an annual or other periodic re-election of the Trustee. The Trust Agreement provides that the Trustee
may only be removed and replaced by the holders of a majority of the outstanding Trust Common Units, excluding Trust Common Units
held by Avalon (until such time as the total number of Trust Common Units held by Avalon is less than 10% of all issued and outstanding
Trust Common Units), voting in person or by proxy at a special meeting of holders of Trust Common Units at which a quorum is present
called by either the Trustee or holders of not less than 10% of the outstanding Trust Common Units. As a result, it may be difficult
for holders of Trust Common Units to remove or replace the Trustee without the cooperation of holders of a substantial percentage
of the outstanding Trust Common Units.
Holders
of Trust Common Units have limited ability to enforce provisions of the Royalty Interests, and Avalon’s liability to the
Trust is limited.
The
Trust Agreement permits the Trustee and the Trust to sue Avalon or any other future owner of the Underlying Properties to enforce
the terms of the Conveyances creating the Royalty Interests. If the Trustee does not take appropriate action to enforce provisions
of the Conveyances, a holder of Trust Common Units recourse would be limited to bringing a lawsuit against the Trustee to compel
the Trustee to take specified actions. The Trust Agreement expressly limits a holder of Trust Common Units ability to directly
sue Avalon or any other party other than the Trustee. As a result, holders of Trust Common Units will not be able to sue Avalon
or any future owner of the Underlying Properties to enforce the Trust’s rights under the Conveyances. Furthermore, the Conveyances
provide that, except as set forth in the Conveyances, Avalon will not be liable to the Trust for the manner in which it performs
its duties in operating the Underlying Properties, the wells burdened by the Royalty Interests or the minerals in or under the
Underlying Properties as long as it acts in good faith and in accordance with the Reasonably Prudent Operator Standard. Furthermore,
the Trust Agreement provides (a) that Avalon (as successors to SandRidge) may exercise their rights and discharge their obligations
fully, without hindrance or regard to conflict of interest principles, duty of loyalty principles or other breach of fiduciary
duties, all of which defense, claims or assertions are expressly waived by the other parties to the Trust Agreement and the holders
of Trust Common Units, (b) neither Avalon nor its affiliates shall be a fiduciary to the Trust or the holders of Trust Common
Units, and (c) to the extent that, at law or in equity, Avalon has duties (including fiduciary duties) and liabilities to the
Trust and holders of Trust Common Units, such duties and liabilities are eliminated to the fullest extent permitted by law.
Courts
outside of Delaware may not recognize the limited liability of the holders of Trust Common Units provided under Delaware law.
Under
the Delaware Statutory Trust Act, holders of Trust Common Units are entitled to the same limitation of personal liability extended
to stockholders of private corporations for profit under the General Corporation Law of the State of Delaware. However, courts
in jurisdictions outside of Delaware may not give effect to such limitation.
The
sale of Trust Common Units by Avalon could have an adverse impact on the trading price of the Trust Common Units.
As
of March 10, 2020, Avalon owned 13,125,000 Trust Common Units, all of which are pledged as collateral on Avalon’s secured
revolving line of credit. So long as the line of credit is outstanding, Avalon does not have the right to sell any or all of such
Trust Common Units without the prior consent of its lender. In the event Avalon could obtain the permission of its lender to sell
Trust Common Units, any such sale could have an adverse impact on the price of the Trust Common Units depending on the number
and manner in which the Trust Common Units are sold by Avalon.
Avalon
could have interests that conflict with the interests of the Trust and holders of Trust Common Units.
As
a working interest owner in the Underlying Properties, Avalon could have interests that conflict with the interests of the Trust
and the holders of Trust Common Units. For example:
|
●
|
Avalon’s
interests may conflict with those of the Trust and the holders of Trust Common Units in situations involving the maintenance,
operation or abandonment of the Underlying Properties. Additionally, Avalon may, consistent with its obligation to act in good
faith and in accordance with the Reasonably Prudent Operator Standard, abandon a well that is uneconomic or not generating revenues
from production in excess of its operating costs, even though such well is still generating revenue for the holders of Trust Common
Units. Avalon may make decisions with respect to expenditures and decisions to allocate resources on projects that adversely affect
the Underlying Properties, including reducing expenditures on these properties, which could cause oil, natural gas and NGL production
to decline at a faster rate and thereby result in lower cash distributions by the Trust in the future.
|
|
●
|
Avalon
may, without the consent or approval of the holders of Trust Common Units, sell all or any part of its retained interest in the
Underlying Properties, if the Underlying Properties are sold subject to and burdened by the Royalty Interests. Such sale may not
be in the best interests of the Trust and holders of Trust Common Units. For example, any purchaser may lack Avalon’s experience
in the Permian Basin or its creditworthiness.
|
|
●
|
Avalon
may, without the consent or approval of holders of Trust Common Units, require the Trust to release Royalty Interests with an
aggregate value of up to $5.0 million during any 12-month period in connection with a sale by Avalon of a portion of its retained
interest in the Underlying Properties. The value received by the Trust for such Royalty Interests may not fully compensate the
Trust for the value of future production attributable to the Royalty Interests burdening such Underlying Properties.
|
|
●
|
Avalon
is permitted under the Conveyances creating the Royalty Interests to enter into new processing and transportation contracts without
obtaining bids from or otherwise negotiating with any independent third parties, and Avalon will deduct from the Trust’s
proceeds any charges under such contracts attributable to production from the Underlying Properties.
|
|
●
|
Avalon
can sell its Trust Common Units regardless of the effects such sale may have on the market price of Trust Common Units or on the
Trust itself. Additionally, Avalon can vote its Trust Common Units in its sole discretion.
|
In
addition, Avalon has agreed that, if at any time the Trust’s cash on hand (including available cash reserves) is not sufficient
to pay the Trust’s ordinary course administrative expenses as they become due, Avalon will, at the Trustee’s request,
loan funds to the Trust necessary to pay such expenses. Any such loan will be on an unsecured basis, and the terms of such loan
will be substantially the same as those which would be obtained in an arms’ length transaction between Avalon and an unaffiliated
third party. If Avalon provides such funds to the Trust, it would become a creditor of the Trust and its interests as a creditor
could conflict with the interests of holders of Trust Common Units since it is entitled to receive a return of the principal amount
of such loan and interest earned thereon prior to any further distributions to the holders of Trust Common Units.
Avalon
may sell all or a portion of the Underlying Properties, subject to and burdened by the Royalty Interests; any such purchaser could
have a weaker financial position and/or be less experienced in oil and natural gas development and production than Avalon.
Holders
of Trust Common Units will not be entitled to vote on any sale of the Underlying Properties if the Underlying Properties are sold
subject to and burdened by the Royalty Interests, and the Trust will not receive any proceeds from any such sale. The purchaser
would be responsible for all of Avalon’s obligations relating to the Royalty Interests on the portion of the Underlying
Properties sold, and Avalon would have no continuing obligation to the Trust for those properties. Additionally, Avalon may enter
into farmout or joint venture arrangements with respect to the wells burdened by the Royalty Interests. Any purchaser, farmout
counterparty or joint venture partner could have a weaker financial position, or could be less experienced in oil and natural
gas development and production than Avalon, or both.
Oil
and natural gas wells are subject to operational hazards that can cause substantial losses. Avalon maintains insurance but may
not be adequately insured for all such hazards.
There
are a variety of operating risks inherent in oil, natural gas and NGL production and associated activities, such as fires, leaks,
explosions, mechanical problems, major equipment failures, uncontrollable flow of oil, natural gas, NGL, water or drilling fluids,
casing collapses, abnormally pressurized formations and natural disasters. The occurrence of any of these or similar accidents
that temporarily or permanently halt the production and sale of oil, natural gas and NGL at any of the Underlying Properties will
reduce Trust distributions by reducing the amount of proceeds available for distribution.
Additionally,
if any of such risks or similar accidents occur, Avalon could incur substantial losses as a result of injury or loss of life,
severe damage or destruction of property, natural resources and equipment, regulatory investigation and penalties and environmental
damage and clean-up responsibilities. If Avalon were to experience any of these problems, its ability to conduct operations and
perform its obligations to the Trust could be adversely affected. Although Avalon maintains insurance coverage it deems appropriate
for these risks with respect to the Underlying Properties, Avalon’s operations may result in liabilities exceeding such
insurance coverage or liabilities not covered by insurance. If a well is damaged, Avalon would have no obligation to drill a replacement
well or make the Trust whole for the loss. The Trust does not maintain any type of insurance against any of the risks of conducting
oil and gas exploration and production and related activities.
The
operation of the Underlying Properties is subject to complex federal, state, local and other laws and regulations that could adversely
affect the cost, manner and feasibility of conducting operations on the properties, which in turn could negatively impact Trust
distributions.
Oil,
natural gas and NGL production, transportation and treatment operations are subject to complex and stringent laws and regulations.
In order to conduct operations in compliance with these laws and regulations, numerous permits, approvals and certificates are
required from various federal, state and local governmental authorities. Compliance with these existing laws and regulations may
require the incurrence of substantial costs by Avalon or other future operators of the Underlying Properties. Additionally, there
has been a variety of regulatory initiatives at the federal and state levels to further regulate oil and natural gas operations
in certain locations. Any increased regulation or suspension of oil and natural gas operations, or revision or reinterpretation
of existing laws and regulation, could result in delays and higher operating costs. Such costs or significant delays could have
a material adverse effect on the operation of the Underlying Properties, which in turn could negatively impact Trust distributions.
Laws
and regulations governing oil and natural gas exploration and production may also affect production levels. Avalon is required
to comply with federal and state laws and regulations governing conservation matters, including: (i) provisions related to the
unitization or pooling of the oil and natural gas properties; (ii) the establishment of maximum rates of production from wells;
(iii) the spacing of wells; and (iv) the plugging and abandonment of wells. These and other laws and regulations can limit the
amount of oil, natural gas and NGL Avalon can produce from the wells which it owns and operates, including those wells burdened
by the Royalty Interests, which in turn could negatively impact Trust distributions.
New
laws or regulations, or changes to existing laws or regulations may unfavorably impact Avalon, could result in increased operating
costs and could have a material adverse effect on Avalon’s financial condition and results of operations. Additionally,
federal and state regulatory authorities may expand or alter applicable pipeline safety laws and regulations, compliance with
which may require increased capital expenditures by Avalon and third-party downstream oil, natural gas and NGL transporters. These
and other potential regulations could increase Avalon’s operating costs, reduce Avalon’s liquidity, delay Avalon’s
operations, increase direct and third-party post production costs associated with the Trust’s interests or otherwise alter
the way Avalon conducts its business, which could have a material adverse effect on Avalon’s financial condition, results
of operations and cash flows and which could reduce cash received by or available for distribution, including any amounts paid
by Avalon for transportation on downstream interstate pipelines.
Please
see the section titled “Regulation” under “Information About the Trust—Business” for a more complete
discussion of applicable federal and state laws impacting the Underlying Properties and their operation.
Should
Avalon fail to comply with all applicable statutes, rules, regulations and orders of FERC or the FTC, Avalon could be subject
to substantial penalties and fines.
Under
the Energy Policy Act of 2005 and implementing regulations, FERC prohibits market manipulation in connection with the purchase
or sale of natural gas. The FTC also prohibits manipulative or fraudulent conduct in the wholesale petroleum market with respect
to sales of commodities, including crude oil, condensate and natural gas liquids. These agencies have substantial enforcement
authority, including the ability to impose penalties for current violations in excess of $1 million per day for each violation.
FERC has also imposed requirements related to reporting of natural gas sales volumes that may impact the formation of prices indices.
Additional rules and legislation pertaining to these and other matters may be considered or adopted from time to time. Failure
to comply with these or other laws and regulations administered by these agencies could subject Avalon to criminal and civil penalties,
as described in “Information about the Trust—Business—Regulation —Oil and Natural Gas Regulations.”
The
operation of the Underlying Properties is subject to environmental and occupational safety and health laws and regulations that
could adversely affect the cost, manner or feasibility of conducting operations or result in significant costs and liabilities.
The
oil, natural gas and NGL production operations on the Underlying Properties are subject to stringent and complex federal, state,
regional and local laws and regulations governing worker safety and health, the discharge and disposal of materials into the environment
or otherwise relating to environmental protection. Failure to comply with these laws and regulations may result in litigation;
the assessment of sanctions, including administrative, civil and criminal penalties; the imposition of investigatory, remedial
or corrective action obligations; the occurrence of delays or restrictions in permitting or performance of projects; and the issuance
of orders and injunctions limiting or preventing some or all operations relating to the Underlying Properties in affected areas.
Under
certain environmental laws and regulations, an owner or operator of the Underlying Properties could be subject to joint and several
liability for the investigation, removal or remediation of previously released materials or property contamination, regardless
of whether the owner or operator was responsible for such release or contamination or whether the operations were in compliance
with all applicable laws at the time the release or contamination occurred. Private parties, including the owners of properties
upon which wells are drilled or facilities where petroleum hydrocarbons or wastes are taken for reclamation or disposal may also
have the right to pursue legal actions to enforce compliance, to seek damages for contamination, or for personal injury or property
damage.
Changes
in environmental laws and regulations occur frequently, and any changes that result in delays or restrictions in permitting or
development of projects or more stringent or costly construction, drilling, water management, or completion activities or waste
handling, storage, transport, remediation or disposal, emission or discharge requirements could require significant expenditures
by Avalon to attain and maintain compliance and may otherwise have a material adverse effect on the results of operations, competitive
position or financial condition of Avalon. In addition, delays or restrictions in permitting or development of projects that reduce
or temporarily or permanently halt the production of oil, natural gas and natural gas liquids at any of the Underlying Properties
will reduce Trust distributions by reducing the amount of proceeds available for distribution.
Climate
change laws and regulations restricting emissions of GHGs could result in increased operating costs with respect to the Underlying
Properties.
In
2009, the EPA published its findings that emissions of carbon dioxide, methane and certain other “greenhouse gases”
(collectively, “GHGs”) present an endangerment to public health and the environment because emissions of such gases
are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. The EPA has taken
a number of steps aimed at gathering information about, and reducing the emissions of, GHGs from industrial sources, including
oil and natural gas sources. The EPA has adopted rules requiring the reporting of GHG emissions from oil, natural gas and NGL
production and processing facilities on an annual basis, as well as reporting GHG emissions from gathering and boosting systems,
oil well completions and workovers using hydraulic fracturing, as well as rules adopting New Source Performance Standards (“NSPS”)
for new, modified, or reconstructed oil and gas facilities that require control of the GHG methane from affected facilities, including
requirements to find and repair fugitive leaks of methane emissions at well sites (“Methane Rule”). Following the
2016 presidential election and change in administrations, in 2017 the EPA proposed to delay implementation of the Methane Rule,
and also convened a reconsideration proceeding that resulted in two 2018 rulemaking projects aimed at rolling back certain Methane
Rule requirements. In 2019, the EPA proposed to eliminate the obligation to control methane emissions under the NSPS, while maintaining
the rule’s substantive emissions control requirements because they serve to control emissions of other, non-methane pollutants.
These actions, like the Methane Rule itself, have been (or are likely to be) challenged in courts. The ultimate fate of the Methane
Rule requirements is unclear. Nevertheless, regulations promulgated under the CAA may require Avalon to incur development expenses
to install and utilize specific equipment, technologies, or work practices to control emissions from its operations.
A
number of state and regional efforts also are aimed at tracking and/or reducing GHG emissions by means of cap-and-trade programs
that typically require major sources of GHG emissions to acquire and surrender emission allowances in return for emitting those
GHGs. On an international level, the United States is one of almost 200 nations that in December 2015 entered into the Paris Agreement,
which calls for countries to set their own GHG emissions targets and maintain transparency regarding the measures each country
will use to achieve its GHG emissions targets. However, the Paris Agreement does not impose any binding obligations on the United
States. Moreover, in June 2017, President Trump announced that the United States would withdraw from the Paris Agreement but may
enter into a future international agreement related to GHGs. In August 2017, the U.S. State Department officially informed the
United Nations of the intent of the United States to withdraw from the Paris Agreement and such withdrawal has been finalized.
Further, several states and local governments remain committed to the principles of the Paris Agreement in their effectuation
of policy and regulations. It is not possible at this time to predict how or when the United States might impose restrictions
on GHGs as a result of the Paris Agreement.
For
a more detailed discussion of applicable federal and state laws regarding air emission and climate change regulation, please see
the section titled “Information about the Trust—Business—Regulation – Air Emissions and Climate Change.”
The
adoption and implementation of any laws or regulations imposing reporting obligations on, or limiting emissions of GHGs from,
the equipment and operations of Avalon or other operators of the Underlying Properties could require additional expenditures to
monitor, report and potentially reduce emissions of GHGs associated with their operations or could adversely affect demand for
the oil, natural gas and NGL produced from the Underlying Properties. Recently, activists concerned about the potential effects
of climate change have directed their attention at sources of funding for fossil-fuel energy companies, which has resulted in
certain financial institutions, funds and other sources of capital restricting or eliminating their investment in oil and natural
gas activities. Ultimately, this could make it more difficult to secure funding for exploration and production activities. Notwithstanding
potential risks related to climate change, the International Energy Agency estimates that global energy demand will continue to
rise and will not peak until after 2040, and that oil and gas will continue to represent a substantial percentage of global energy
use over that time. Finally, to the extent increasing concentrations of GHGs in the Earth’s atmosphere may produce climate
changes that could have significant physical effects, such as increased frequency and severity of storms, droughts, floods and
other climatic events, such events could have a material adverse effect on the Underlying Properties, and potentially subject
the Underlying Properties and the operations of Avalon or other operators of the Underlying Properties to greater regulation.
The occurrence of any of these events that reduce or temporarily or permanently halt the production of oil, natural gas and natural
gas liquids at any of the Underlying Properties will reduce Trust distributions by reducing the amount of proceeds available for
distribution.
The
Trust is subject to the requirements of the Sarbanes-Oxley Act of 2002, which may impose cost and operating challenges on it.
The
Trust is subject to certain of the requirements of the Sarbanes-Oxley Act of 2002 which requires, among other things, maintenance
by the Trust of, and reports regarding the effectiveness of, a system of internal control over financial reporting. Complying
with these requirements may pose operational challenges and may cause the Trust to incur unanticipated expenses. Any failure by
the Trust to comply with these requirements could lead to a loss of public confidence in the Trust’s internal controls and
in the accuracy of the Trust’s publicly reported results.
Cyber-attacks
or other failures in telecommunications or IT systems could result in information theft, data corruption and significant disruption
of Avalon’s business operations.
Avalon
relies on information technology (“IT”) systems and networks in connection with its business activities, including
certain of its development and production activities. Avalon relies on digital technology, including information systems and related
infrastructure, as well as cloud applications and services, to, among other things, estimate quantities of oil, natural gas and
NGL reserves, analyze seismic and drilling information, process and record financial and operating data and communicate with employees
and third parties. As dependence on digital technologies has increased in the oil and gas industry, cyber incidents, including
deliberate attacks and attempts to gain unauthorized access to computer systems and networks, have increased in frequency and
sophistication. These threats pose a risk to the security of Avalon’s systems and networks, the confidentiality, availability
and integrity of its data and the physical security of its employees and assets. Avalon has not experienced any attempts by hackers
and other third parties to gain unauthorized access to its IT systems and networks. However, if any such attempt were to occur,
there is no assurance that Avalon would be successful in preventing a cyber-attack or adequately mitigating the effect of such
cyber-attack. Any cyber-attack could have a material adverse effect on Avalon’s reputation, competitive position, business,
financial condition and results of operations, and could have a material adverse effect on the Trust. Cyber-attacks or security
breaches also could result in litigation or regulatory action, as well as significant additional expense to Avalon to implement
further data protection measures.
In
addition to the risks presented to Avalon’s systems and networks, cyber-attacks affecting oil and natural gas distribution
systems maintained by third parties, or the networks and infrastructure on which they rely, could delay or prevent delivery to
markets. A cyber-attack of this nature would be outside Avalon’s ability to control but could have a material adverse effect
on Avalon’s business, financial condition and results of operations, and could have a material adverse effect on the Trust.
Cyber-attacks
or other failures in telecommunications or IT systems could result in information theft, data corruption and significant disruption
of the Trustee’s operations.
The
Trustee depends heavily upon IT systems and networks in connection with its business activities. Despite a variety of security
measures implemented by the Trustee, events such as the loss or theft of back-up tapes or other data storage media could occur,
and the Trustee’s computer systems could be subject to physical and electronic break-ins, cyber-attacks and similar disruptions
from unauthorized tampering, including threats that may come from external factors, such as governments, organized crime, hackers
and third parties to whom certain functions are outsourced, or may originate internally from within the respective companies.
If a cyber-attack were to occur, it could potentially jeopardize the confidential, proprietary and other information processed
and stored in, and transmitted through, the Trustee’s computer systems and networks, or otherwise cause interruptions or
malfunctions in the operations of the Trust, which could result in litigation, increased costs and regulatory penalties. Although
steps are taken to prevent and detect such attacks, it is possible that a cyber incident will not be discovered for some time
after it occurs, which could increase exposure to these consequences.
Legislation
or regulatory initiatives intended to address seismic activity are restricting and could further restrict Avalon’s ability
and the ability of other operators of the Underlying Properties to dispose of waste water produced alongside hydrocarbons.
Large
volumes of waste water produced alongside Avalon’s and other operators’ oil, natural gas and NGL on the Underlying
Properties in connection with drilling and production operations are disposed of pursuant to permits issued by governmental authorities
overseeing such disposal activities. While these permits are issued pursuant to existing laws and regulations, these legal requirements
are subject to change, which could result in the imposition of more stringent operating constraints or new monitoring and reporting
requirements, owing to, among other things, concerns of the public or governmental authorities regarding such gathering or disposal
activities.
Furthermore,
in response to recent seismic events near underground disposal wells used for the disposal by injection of produced water resulting
from oil and natural gas activities, federal and some state agencies are investigating whether such wells have caused increased
seismic activity, and some states have restricted, suspended or shut down the use of such disposal wells. For example, in October
2014, the Texas Railroad Commission, or TRC, published a new rule governing permitting or re-permitting of disposal wells that
would require, among other things, the submission of information on seismic events occurring within a specified radius of the
disposal well location, as well as logs, geologic cross sections and structure maps relating to the disposal area in question.
If the permittee or an applicant of a disposal well permit fails to demonstrate that the saltwater or other fluids are confined
to the disposal zone or if scientific data indicates such a disposal well is likely to be or determined to be contributing to
seismic activity, then the TRC may deny, modify, suspend or terminate the permit application or existing operating permit for
that well. Evaluation of seismic incidents and whether or to what extent those events are induced by the injection of saltwater
into disposal wells continues to evolve, as governmental authorities consider new and/or past seismic incidents in areas where
salt water disposal activities occur or are proposed to be performed. The adoption of any new laws, regulations, or directives
that restrict Avalon’s ability to dispose of saltwater generated by production and development activities on the Underlying
Properties, whether by plugging back the depths of disposal wells, reducing the volume of salt water disposed in such wells, restricting
disposal well locations or otherwise, or by requiring Avalon to shut down disposal wells, which could negatively affect the economic
lives of the Underlying Properties and have a material adverse effect on the Trust.
Tax
Risks Related to the Trust Units
The
Trust’s tax treatment depends on its status as a partnership for U.S. federal income tax purposes. If the U.S. Internal
Revenue Service (“IRS”) were to treat the Trust as a corporation for U.S. federal income tax purposes, then its cash
available for distribution to its holders of Trust Common Units would be substantially reduced.
The
anticipated after-tax economic benefit of an investment in the Trust Common Units depends largely on the Trust being treated as
a partnership for U.S. federal income tax purposes. The Trust has not requested, and does not plan to request, a ruling from the
IRS, on this or any other tax matter affecting it. It is possible in certain circumstances for a publicly traded trust otherwise
treated as a partnership, such as the Trust, to be treated as a corporation for U.S. federal income tax purposes. In addition,
a change in current law could cause the Trust to be treated as a corporation for U.S. federal income tax purposes or otherwise
subject it to federal taxation as an entity.
If
the Trust were treated as a corporation for U.S. federal income tax purposes, it would pay federal income tax on its taxable income
at the corporate tax rate, which after December 31, 2017 is a maximum of 21%, and likely would be required to also pay state income
tax on its taxable income at the corporate tax rate of such state. Distributions to holders of Trust Common Units generally would
be taxed again as corporate distributions, and no income, gains, losses, deductions or credits would flow through to holders of
Trust Common Units. Because additional tax would be imposed upon the Trust as a corporation, its cash available for distribution
to holders of Trust Common Units would be substantially reduced. Therefore, treatment of the Trust as a corporation would result
in a material reduction in the anticipated cash flow and after-tax return to the holders of Trust Common Units, likely causing
a substantial reduction in the value of the Trust Common Units.
If
the Trust were subjected to a material amount of additional entity-level taxation by individual states, it would reduce the Trust’s
cash available for distribution to holders of Trust Common Units.
The
Trust is required to pay Texas franchise tax each year at a maximum effective rate (subject to changes in the statutory rate)
of 0.525% of its gross income. This rate of tax is subject to change by new legislation at any time. Changes in current Texas
state law may subject the Trust to additional entity-level taxation. Because of widespread state budget deficits and other reasons,
Texas is evaluating ways to subject partnerships to entity-level taxation through the imposition of state franchise and other
forms of taxation. Additional imposition of such taxes may substantially reduce the cash available for distribution to holders
of Trust Common Units and, therefore, negatively impact the value of an investment in Trust Common Units.
Upon
examination, the state of Texas may contest any of the tax positions the Trust has taken. Audit adjustments to an entity-level
state tax, such as Texas franchise tax (including any applicable penalties and interest), are collected directly from the Trust
upon completion of the examination.
Tax
legislation enacted in 2017 may have a significant impact on the taxation of the Trust and holders of Trust Common Units.
The
Tax Cuts and Jobs Act (“TCJA”) enacted in December 2017 provides the most substantial tax reform in over thirty years.
In general, the TCJA lowers tax rates, eliminates or limits numerous deductions and other tax benefits, and significantly changes
international tax rules. Given the complexity of the TCJA and the significant changes to prior tax law, and the significant amount
of regulations that the Treasury Department and the IRS have yet to issue, propose and finalize to interpret and implement TCJA
changes, the impact and effect of the legislation on the Trust and holders of Trust Common Units in respect of income and loss
of the Trust remains uncertain.
The
foregoing is not a complete summary of all of the changes in law that may apply to or impact the Trust or a holders of Trust Common
Units with respect to income of the Trust (or otherwise), holders of Trust Common Units strongly are urged to consult with their
own tax advisors to determine how they might be affected by the TCJA, both generally and specifically with respect to their ownership
of Trust Common Units.
The
tax treatment of an investment in Trust Common Units could be affected by potential legislative changes, possibly on a retroactive
basis.
Current
law may change so as to cause the Trust to be treated as a corporation for U.S. federal income tax purposes or otherwise subject
the Trust to entity-level taxation. Specifically, the present U.S. federal income tax treatment of publicly-traded partnerships,
including the Trust, or an investment in Trust Common Units may be modified by administrative, legislative or judicial interpretation
at any time. For example, from time to time, members of the U.S. Congress propose and consider substantive changes to existing
federal income tax laws that could affect publicly traded partnerships. Such proposals, if adopted, could eliminate the qualifying
income exception for publicly traded partnerships deriving qualifying income from activities relating to fossil fuels thus treating
such partnerships as corporations. The Trust currently relies upon this qualifying income exemption for treatment of the Trust
as a partnership for U.S. federal income tax purposes.”
Any
modification to the U.S. federal income tax laws may be applied retroactively and could make it more difficult or impossible for
the Trust to meet the exception for certain publicly traded partnerships to be treated as partnerships for U.S. federal income
tax purposes. The Trust is unable to predict whether any of these changes or other proposals ultimately will be enacted. Any such
changes could have a material adverse effect on the value of the Trust Common Units.
The
Trust has adopted and may continue to adopt positions that may not conform to all aspects of existing Treasury Regulations. If
the IRS contests the tax positions the Trust takes, the value of the Trust Common Units may be adversely affected, the cost of
any IRS contest will reduce the Trust’s cash available for distribution and income, gains, losses and deductions may be
reallocated among holders of Trust Common Units. The TCJA alters the procedures for assessing and collecting income taxes due
for taxable years beginning after December 31, 2017, in a manner that could substantially reduce cash available for distribution
to holders of Trust Common Units.
If
the IRS contests any of the U.S. federal income tax positions the Trust takes or has taken, the value of the Trust Common Units
may be adversely affected, because the cost of any IRS contest will reduce the Trust’s cash available for distribution and
income, gain, loss and deduction may be reallocated among holders of Trust Common Units. For example, the Trust generally prorates
its items of income, gain, loss and deduction between transferors and transferees of the Trust Common Units each quarter based
upon the record ownership of the Trust Common Units on the quarterly record date in such quarter, instead of on the basis of the
date a particular Trust Common Unit is transferred. Although simplifying conventions are contemplated by the Internal Revenue
Code, and most publicly-traded partnerships use similar simplifying conventions, the use of these methods may not be permitted
under existing Treasury Regulations, and, accordingly, Avalon’s counsel is unable to opine as to the validity of this method.
If the IRS were to challenge the Trust’s proration method, the Trust may be required to change its allocation of items of
income, gain, loss and deduction among the holders of Trust Common Units and the costs to the Trust of implementing and reporting
under any such changed method may be significant.
The
Trust has not requested a ruling from the IRS with respect to its treatment as a partnership for U.S. federal income tax purposes
or any other tax matter affecting the Trust. The IRS may adopt positions that differ from the conclusions of Avalon’s counsel
or from the positions the Trust takes. It may be necessary to resort to administrative or court proceedings to attempt to sustain
some or all of the conclusions of Avalon’s counsel or the positions the Trust takes. A court may not agree with some or
all of the conclusions of Avalon’s counsel or positions the Trust takes. Any contest with the IRS may materially and adversely
impact the market for the Trust Common Units and the price at which they trade. In addition, the Trust’s costs of any contest
with the IRS will be borne indirectly by the holders of Trust Common Units, because the costs will reduce the Trust’s cash
available for distribution.
The
TCJA enacted in 2017 and applicable to the Trust for taxable years beginning after December 31, 2017, alters the procedures for
auditing large partnerships and also alters the procedures for assessing and collecting income taxes due (including applicable
penalties and interest) as a result of an audit. Unless the Trust is eligible to (and chooses to) elect to issue revised Schedules
K-1 to holders of Trust Common Units with respect to an audited and adjusted return, the IRS may assess and collect income taxes
(including any applicable penalties and interest) directly from the Trust in the year in which the audit is completed under the
new rules, which effectively would impose an entity level tax on the Trust. If the Trust is required to pay income taxes, penalties
and interest as the
result of audit adjustments, cash available for distribution to holders of Trust Common Units may be substantially
reduced. In addition, because payment would be due for the taxable year in which the audit is completed, holders of Trust Common
Units during that taxable year would bear the expense of the adjustment even if they were not holders of Trust Common Units during
the audited taxable year.
Each
holder of Trust Common Units is required to pay taxes on its share of the Trust’s income even if it does not receive cash
distributions from the Trust equal to its share of the Trust’s taxable income.
Because
the holders of Trust Common Units are treated as partners to whom the Trust allocates taxable income that could be different in
amount than the cash the Trust distributes, each holder of Trust Common Units may be required to pay any federal income taxes
and, in some cases, state and local income taxes on the unitholder’s share of the Trust’s taxable income even if the
unitholder does not receive cash distributions from the Trust equal to the unitholder’s share of the Trust’s taxable
income or even equal to the actual tax liability that results from that income.
Tax
gain or loss on the disposition of the Trust Common Units could be more or less than expected.
If
a holder of Trust Common Units sells its Trust Common Units, such unitholder will recognize a gain or loss equal to the difference
between the amount realized and the unitholder’s tax basis in those Trust Common Units. Because distributions in excess
of a unitholder’s allocable share of the Trust’s net taxable income decrease the unitholder’s adjusted tax basis
in its Trust Common Units, the amount, if any, of such prior excess distributions with respect to the Trust Common Units sold
by a unitholder will, in effect, become taxable income to such unitholder if the unitholder sells such Trust Common Units at a
price greater than the unitholder’s tax basis in those Trust Common Units, even if the price the unitholder receives is
less than the unitholder’s original cost. Furthermore, a substantial portion of the amount realized, whether or not representing
gain, may be taxed as ordinary income due to potential recapture items, including depletion recapture.
The
ownership and disposition of Trust Common Units by tax-exempt organizations and non-U.S. persons may result in adverse tax consequences
to them.
Tax-Exempt
Organizations. Employee benefit plans and most other organizations exempt from U.S. federal income tax including individual retirement
accounts (known as IRAs) and other retirement plans are subject to U.S. federal income tax on “unrelated business taxable
income”. Because all of the income of the Trust is royalty income, interest income, and gain from the sale of real property,
none of which is expected to be unrelated business taxable income, any such organization exempt from U.S. federal income tax is
not expected to be taxed on income generated by ownership of Trust Common Units so long as neither the property held by the Trust
nor the Trust Common Units are debt-financed property within the meaning of Section 514(b) of the Internal Revenue Code (“IRC”).
However, such investors should consult their own tax advisors as to the treatment of income from the Trust.
Non-U.S.
Persons. Pursuant to Section 1446 of the IRC, withholding tax on income effectively connected to a United States trade or business
allocated to non-U.S. persons (“ECI”) should be made at the highest marginal rate. Under Section 1441 of the IRC,
withholding tax on fixed, determinable, annual, periodic income from United States sources allocated to non-U.S. persons should
be made at 30% of gross income unless the rate is reduced by treaty. Nominees and brokers should withhold at the highest marginal
rate on the distribution made to non-U.S. persons. The TCJA, discussed above, treats a non-U.S. holder’s gain on the sale
of Trust Common Units as ECI to the extent such holder would have had ECI if the Trust had sold all of its assets at fair market
value on the date of the sale of such Trust Common Units. The TCJA also requires the transferee of Trust Common Units to withhold
10% of the amount realized on the sale or exchange of such Trust Common Units (generally, the purchase price) unless the transferor
certifies that it is not a non-resident alien individual or foreign corporation. Pending the finalization of proposed regulations
under Section 1446 of the IRC, the IRS has suspended this new withholding obligation with respect to publicly traded partnerships
such as the Trust, which is classified as a partnership for federal and state income tax purposes.
The
Trust treats each purchaser of Trust Common Units as having the same economic attributes without regard to the actual Trust Common
Units purchased. The IRS may challenge this treatment, which could adversely affect the value of the Trust Common Units.
Due
to a number of factors, including the Trust’s inability to match transferors and transferees of Trust Common Units, the
Trust may adopt positions that may not conform to all aspects of existing Treasury Regulations. A successful IRS challenge to
those positions could adversely alter the tax effects of an investment in Trust Common Units. It also could affect the timing
of tax benefits or the amount of gain from a unitholder’s sale of Trust Common Units and could have a negative impact on
the value of the Trust Common Units or result in audit adjustments to a unitholder’s tax returns.
The
Trust prorates its items of income, gain, loss and deduction between transferors and transferees of the Trust Common Units each
quarter based upon the record ownership of the Trust Common Units on the quarterly record date, in such quarter, instead of on
the basis of the date a particular Trust Common Unit is transferred. The IRS may challenge this treatment, which could change
the allocation of items of income, gain, loss and deduction among the holders of Trust Common Units.
The
Trust generally prorates its items of income, gain, loss and deduction between transferors and transferees of the Trust Common
Units based upon the record ownership of the Trust Common Units on the quarterly record date in such quarter instead of on the
basis of the date a particular Trust Common Unit is transferred. The use of this proration method may not be permitted under existing
Treasury Regulations, and, accordingly, the Trust’s counsel is unable to opine as to the validity of this method. If the
IRS were to challenge the Trust’s proration method, the Trust may be required to change its allocation of items of income,
gain, loss and deduction among the holders of Trust Common Units and the costs to the Trust of implementing and reporting under
any such changed method may be significant.
A
holder of Trust Common Units whose Trust Common Units are loaned to a “short seller” to cover a short sale of Trust
Common Units may be considered as having disposed of those Trust Common Units. If so, such unitholder would no longer be treated
for tax purposes as a partner (for tax purposes) with respect to those Trust Common Units during the period of the loan and may
recognize gain or loss from the disposition.
Because
a holder of Trust Common Units whose Trust Common Units are loaned to a “short seller” to cover a short sale of Trust
Common Units may be considered as having disposed of the loaned Trust Common Units, he or she may no longer be treated for tax
purposes as a partner with respect to those Trust Common Units during the period of the loan to the short seller and the unitholder
may recognize gain or loss from such disposition. Moreover, during the period of the loan to the short seller, any of the Trust’s
income, gains, losses or deductions with respect to those Trust Common Units may not be reportable by the unitholder and any cash
distributions received by the unitholder as to those Trust Common Units could be fully taxable as ordinary income. Holders of
Trust Common Units desiring to assure their status as partners (for tax purposes) and avoid the risk of gain recognition from
a loan to a short seller are urged to modify any applicable brokerage account agreements to prohibit their brokers from loaning
their Trust Common Units.
The
Trust may adopt certain valuation methodologies that may affect the income, gain, loss and deduction allocable to the holders
of Trust Common Units. The IRS may challenge this treatment, which could adversely affect the value of the Trust Common Units.
The
U.S. federal income tax consequences of the ownership and disposition of Trust Common Units will depend in part on the Trust’s
estimates of the relative fair market values, and the initial tax basis of the Trust’s assets. Although the Trust may from
time to time consult with professional appraisers regarding valuation matters, the Trust will make many of the relative fair market
value estimates itself. These estimates and determinations of basis are subject to challenge and will not be binding on the IRS
or the courts. If the estimates of fair market value or basis are later found to be incorrect, the character and amount of items
of income, gain, loss or deductions previously reported by holders of Trust Common Units might change, and holders of Trust Common
Units might be required to adjust their tax liability for prior years and incur interest and penalties with respect to those adjustments.
The
availability and extent of percentage depletion deductions to the holders of Trust Common Units for any taxable year is uncertain.
The
payments received by the Trust with respect to the perpetual portion of the Royalty Interests are treated as mineral royalty interests
for U.S. federal income tax purposes and taxable as ordinary income. Holders of Trust Common Units are entitled to deductions
for the greater of either cost depletion or (if otherwise allowable) percentage depletion with respect to such income. Although
the Internal Revenue Code requires each holder of Trust Common Units to compute its own depletion allowance and maintain records
of its share of the adjusted tax basis of the underlying royalty interest for depletion and other purposes, the Trust will furnish
each of the holders of Trust Common Units with information relating to this computation for U.S. federal income tax purposes.
Each holder of Trust Common Units, however, remains responsible for calculating its own depletion allowance and maintaining records
of its share of the adjusted tax basis of the perpetual royalties for depletion and other purposes. The rules with respect to
this depletion allowance are complex and must be computed separately by each holder of Trust Common Units and not by the Trust
for each oil or natural gas property. As a result, the availability or extent of percentage depletion deductions to the holders
of Trust Common Units for any taxable year is uncertain.
COMPARATIVE
PER SHARE MARKET PRICE AND DIVIDEND INFORMATION AND
RELATED STOCKHOLDER MATTERS
Market
Information
Since
September 10, 2013, PEDEVCO’s Common Stock has traded on the NYSE American under the ticker symbol “PED.” As
of October 13, 2020, there are 72,463,340 shares of PEDEVCO Common Stock issued and outstanding.
Prior
to September 9, 2020, the Trust Common Units traded on the New York Stock Exchange under the symbol “PER”. On and
after September 9, 2020, the Trust Common Units are traded on the OTC Pink Market under the symbol “PERS.” As of July
30, 2020, as reported in the Trust’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, there are 52,500,000
Trust Common Units issued and outstanding.
Stockholders
As
of October 9, 2020, there were approximately 737 holders of record of PEDEVCO Common Stock. On March 10, 2020, there were ten
record holders of Trust Common Units. Actual number of holders of PEDEVCO Common Stock and holders of Trust Common Units likely
exceeds the number of holders of record.
Distributions
PEDEVCO
does not presently intend to pay any cash dividends on PEDEVCO Common Stock Any payment of future dividends will be at the discretion
of the PEDEVCO Board and will depend on, among other things, PEDEVCO’s earnings, financial condition, capital requirements,
level of indebtedness, statutory and contractual restrictions applying to the payment of dividends and other considerations that
the PEDEVCO Board deems relevant.
The
Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s
administrative expenses, property tax and Texas franchise tax and cash reserves withheld by the Trustee, on or about the 60th
day following the completion of each quarter.
Market
Value of Securities
The
tables below set forth, for the respective calendar quarters indicated, the high and low sale prices reported on the NYSE American
for PEDEVCO Common Stock, and on the NYSE and the OTC Pink Market for Trust Common Units.
|
|
PEDEVCO Common Stock
|
|
|
|
High
|
|
|
Low
|
|
2020
|
|
|
|
|
|
|
|
|
Fourth Quarter (through October 12, 2020)
|
|
$
|
1.75
|
|
|
$
|
1.31
|
|
Third Quarter
|
|
$
|
2.50
|
|
|
$
|
0.74
|
|
Second Quarter
|
|
$
|
1.23
|
|
|
$
|
0.66
|
|
First Quarter
|
|
$
|
1.82
|
|
|
$
|
0.74
|
|
2019
|
|
|
|
|
|
|
|
|
Fourth Quarter
|
|
$
|
2.00
|
|
|
$
|
1.06
|
|
Third Quarter
|
|
$
|
2.08
|
|
|
$
|
1.05
|
|
Second Quarter
|
|
$
|
2.90
|
|
|
$
|
1.82
|
|
First Quarter
|
|
$
|
2.90
|
|
|
$
|
0.68
|
|
2018
|
|
|
|
|
|
|
|
|
Fourth Quarter
|
|
$
|
2.30
|
|
|
$
|
0.48
|
|
Third Quarter
|
|
$
|
3.43
|
|
|
$
|
1.36
|
|
Second Quarter
|
|
$
|
4.44
|
|
|
$
|
0.30
|
|
First Quarter
|
|
$
|
0.45
|
|
|
$
|
0.26
|
|
|
|
Trust Common Units
|
|
|
|
High
|
|
|
Low
|
|
2020
|
|
|
|
|
|
|
|
|
Fourth Quarter (through October 12, 2020)
|
|
$
|
0.54
|
|
|
$
|
0.41
|
|
Third Quarter
|
|
$
|
0.55
|
|
|
$
|
0.30
|
|
Second Quarter
|
|
$
|
0.75
|
|
|
$
|
0.42
|
|
First Quarter
|
|
$
|
1.14
|
|
|
$
|
0.25
|
|
2019
|
|
|
|
|
|
|
|
|
Fourth Quarter
|
|
$
|
1.70
|
|
|
$
|
0.80
|
|
Third Quarter
|
|
$
|
1.94
|
|
|
$
|
1.52
|
|
Second Quarter
|
|
$
|
2.55
|
|
|
$
|
1.45
|
|
First Quarter
|
|
$
|
2.50
|
|
|
$
|
1.86
|
|
2018
|
|
|
|
|
|
|
|
|
Fourth Quarter
|
|
$
|
2.85
|
|
|
$
|
1.70
|
|
Third Quarter
|
|
$
|
3.00
|
|
|
$
|
2.40
|
|
Second Quarter
|
|
$
|
2.61
|
|
|
$
|
1.80
|
|
First Quarter
|
|
$
|
2.55
|
|
|
$
|
1.80
|
|
The
following table presents trading information for PEDEVCO Common Stock and Trust Common Units on August 26, 2020, the last trading
day before the public announcement of the proposed combination of PEDEVCO and the Trust.
|
|
|
PEDEVCO Common Stock
|
|
|
Trust Common Units
|
|
|
|
|
High
|
|
|
Low
|
|
|
Close
|
|
|
High
|
|
|
Low
|
|
|
Close
|
|
August 26, 2020
|
|
|
$
|
0.79
|
|
|
$
|
0.78
|
|
|
$
|
0.785
|
|
|
$
|
0.36
|
|
|
$
|
0.32
|
|
|
$
|
0.35
|
|
The
value of PEDEVCO Common Stock that is the offer consideration will change as the market price of PEDEVCO Common Stock fluctuates
during the pendency of the offer and thereafter, and therefore will likely be different from the prices set forth above at the
time you receive your PEDEVCO Common Stock. See the section in this offer to exchange titled “Risk Factors.” You are
encouraged to obtain current market quotations for PEDEVCO Common Stock and Trust Common Units prior to making any decision with
respect to the offer.
Equity
Compensation Plan Information
The
Trust does not have any employees and, therefore, does not maintain any equity compensation plans.
The
following table sets forth information, as of December 31, 2019, with respect to PEDEVCO compensation plans under which PEDEVCO
Common Stock is authorized for issuance.
Plan Category
|
|
Number of
securities to be
issued upon
exercise of
outstanding
options,
warrants and
rights
(A)
|
|
|
Weighted-
average exercise
price of
outstanding
options,
warrants and
rights
(B)
|
|
|
Number of
securities
remaining
available for
future issuance
under equity compensation
plans (excluding securities
reflected in
Column A)
(C)
|
|
Equity compensation plans approved by stockholders(1)
|
|
|
699,635
|
|
|
$
|
2.76
|
|
|
|
3,341,870
|
(2)
|
Equity compensation plans not approved by stockholders(3)
|
|
|
204,043
|
|
|
$
|
1.58
|
|
|
|
—
|
|
Total
|
|
|
903,678
|
|
|
$
|
2.50
|
|
|
|
3,341,870
|
|
|
(1)
|
Consists
of (i) options to purchase 21,635 shares of PEDEVCO Common Stock issued and outstanding
under the Pacific Energy Development Corp. 2012 Amended and Restated Equity Incentive
Plan, and (ii) options to purchase 678,000 shares of PEDEVCO Common Stock issued and
outstanding under the PEDEVCO Corp. 2012 Amended and Restated Equity Incentive Plan.
|
|
(2)
|
Consists
of 3,341,870 shares of PEDEVCO Common Stock reserved and available for issuance under
the PEDEVCO Corp. 2012 Amended and Restated Equity Incentive Plan.
|
|
(3)
|
Consists
of (i) options to purchase 53,714 shares of PEDEVCO Common Stock granted by Pacific Energy
Development Corp. to employees and consultants of the company in October 2011 and June
2012, and (ii) warrants to purchase 150,329 shares of PEDEVCO Common Stock granted by
PEDEVCO Corp. to lenders in June 2018.
|
INFORMATION
ABOUT PEDEVCO
Description
of Business
History
PEDEVCO
was originally incorporated in September 2000 as Rocker & Spike Entertainment, Inc. In January 2001 PEDEVCO changed its name
to Reconstruction Data Group, Inc., and in April 2003 PEDEVCO changed its name to Verdisys, Inc. and was engaged in the business
of providing satellite services to agribusiness. In June 2005, PEDEVCO changed its name to Blast Energy Services, Inc. to reflect
its new focus on the energy services business, and in 2010 PEDEVCO changed its direction to focus on the acquisition of oil and
gas producing properties.
On
July 27, 2012, PEDEVCO acquired, through a reverse acquisition, Pacific Energy Development Corp., a privately held Nevada corporation
(“Pacific Energy Development”). As described below, pursuant to the acquisition, the stockholders of Pacific Energy
Development gained control of approximately 95% of the then voting securities of PEDEVCO. Since the transaction resulted in a
change of control, Pacific Energy Development was the acquirer for accounting purposes. In connection with the merger, Pacific
Energy Development became PEDEVCO’s wholly-owned subsidiary and PEDEVCO changed its name from Blast Energy Services, Inc.
to PEDEVCO Corp. Following the merger, PEDEVCO refocused its business plan on the acquisition, exploration, development and production
of oil and natural gas resources in the United States.
PEDEVCO’s
corporate headquarters are located in approximately 5,200 square feet of office space at 575 N. Dairy Ashford, Energy Center II,
Suite 210, Houston, Texas 77079. PEDEVCO leases that space pursuant to a lease that expires in August 2023.
Overview
PEDEVCO
is an oil and gas company focused on the acquisition and development of oil and natural gas assets where the latest in modern
drilling and completion techniques and technologies have yet to be applied. In particular, PEDEVCO focuses on legacy proven properties
where there is a long production history, well defined geology and existing infrastructure that can be leveraged when applying
modern field management technologies. PEDEVCO’s current properties are located in the San Andres formation of the Permian
Basin situated in West Texas and eastern New Mexico (the “Permian Basin”) and in the Denver-Julesberg Basin (“D-J
Basin”) in Colorado. As of September 30, 2020, PEDEVCO held approximately 37,069 net Permian Basin acres located in Chaves
and Roosevelt Counties, New Mexico, through its wholly-owned operating subsidiary, Pacific Energy Development Corp. (“PEDCO”)
(the “Permian Basin Asset”) and approximately 11,948 net D-J Basin acres located in Weld and Morgan Counties, Colorado,
through PEDEVCO’s wholly-owned operating subsidiary, Red Hawk Petroleum, LLC (“Red Hawk”) (the “D-J Basin
Asset”). As of September 30, 2020, PEDEVCO held interests in 378 gross (298 net) wells in the Permian Basin Asset, of which
26 are active producers, 13 are active injectors and two wells are active Saltwater Disposal Wells (“SWDs”), all of
which are held by PEDCO and operated by its wholly-owned operating subsidiaries, and interests in 75 gross (21.9 net) wells in
the D-J Basin Asset, of which 18 gross (16.2 net) wells are operated by Red Hawk and currently producing, 36 gross (5.6 net) wells
are non-operated, and 21 wells have an after-payout interest.
As
a result of the recent COVID-19 outbreak, and the recent sharp decline in oil prices which occurred partially as a result of the
decreased demand for oil caused by such outbreak and the actions taken globally to stop the spread of such virus, in mid-April
2020, PEDEVCO temporarily shut-in all of its operated producing wells in its Permian Basin Asset and D-J Basin Asset to preserve
PEDEVCO’s oil and gas reserves for production during a more favorable oil price environment, noting that most of PEDEVCO’s
acreage is held by production with no drilling obligations, which provides PEDEVCO with flexibility to hold back on production
and development during periods of low oil and gas prices. Following the partial recovery in oil prices, commencing in early June
2020, PEDEVCO resumed full production from its operated wells in the Permian Basin and the D-J Basin that PEDEVCO shut-in in mid-April
2020, and is now working to complete several carryover projects from 2019’s Phase II Permian Basin Asset development plan
which it had put on hold due to the COVID-19 outbreak. PEDEVCO will continue to monitor oil prices with a view to reactivating
all of its shut-in production and fully completing its 2019 carryover development plan.
Business
Strategy
PEDEVCO
believes that horizontal development and exploitation of conventional assets in the Permian Basin and development of the Wattenberg
and Wattenberg Extension in the D-J Basin represent among the most economic oil and natural gas plays in the U.S. PEDEVCO plans
to optimize its existing assets and opportunistically seek additional acreage proximate to its currently held core acreage, as
well as other attractive onshore U.S. oil and gas assets that fit its acquisition criteria, that PEDEVCO management believes can
be developed using its technical and operating expertise and be accretive to stockholder value.
Specifically,
PEDEVCO seeks to increase stockholder value through the following strategies:
|
●
|
Grow
production, cash flow and reserves by developing its operated drilling inventory and
participating opportunistically in non-operated projects. PEDEVCO believes its extensive
inventory of drilling locations in the Permian Basin and the D-J Basin, combined with
its operating expertise, will enable PEDEVCO to continue to deliver accretive production,
cash flow and reserves growth. PEDEVCO has identified approximately 150 gross drilling
locations across its Permian Basin acreage based on 20-acre spacing. PEDEVCO believes
the location, concentration and scale of its core leasehold positions, coupled with its
technical understanding of the reservoirs will allow PEDEVCO to efficiently develop its
core areas and to allocate capital to maximize the value of its resource base.
|
|
●
|
Apply
modern drilling and completion techniques and technologies. PEDEVCO owns and intends
to own additional properties that have been historically underdeveloped and underexploited.
PEDEVCO believes its attention to detail and application of the latest industry advances
in horizontal drilling, completions design, frac intensity and locally optimal frac fluids
will allow PEDEVCO to successfully develop its properties.
|
|
●
|
Optimization
of well density and configuration. PEDEVCO owns properties that are legacy conventional
oil fields characterized by widespread vertical development and geological well control.
PEDEVCO utilizes the extensive petrophysical and production data of such legacy properties
to confirm optimal well spacing and configuration using modern reservoir evaluation methodologies.
|
|
●
|
Maintain
a high degree of operational control. PEDEVCO believes that by retaining high operational
control, PEDEVCO can efficiently manage the timing and amount of its capital expenditures
and operating costs, and thus key in on the optimal drilling and completions strategies,
which PEDEVCO believes will generate higher recoveries and greater rates of return per
well.
|
|
●
|
Leverage
extensive deal flow, technical and operational experience to evaluate and execute accretive
acquisition opportunities. PEDEVCO’s management and technical teams have an
extensive track record of forming and building oil and gas businesses. PEDEVCO also has
significant expertise in successfully sourcing, evaluating and executing acquisition
opportunities. PEDEVCO believes its understanding of the geology, geophysics and reservoir
properties of potential acquisition targets will allow it to identify and acquire highly
prospective acreage in order to grow its reserve base and maximize stockholder value.
|
|
●
|
Preserve
financial flexibility to pursue organic and external growth opportunities. PEDEVCO
intends to maintain a disciplined financial profile that will provide it flexibility
across various commodity and market cycles. PEDEVCO intends to utilize its strategic
partners and public currency to continuously fund development and operations.
|
PEDEVCO’s
strategy is to be the operator and/or a significant working interest owner, directly or through its subsidiaries and joint ventures,
in the majority of its acreage so that PEDEVCO can dictate the pace of development in order to execute its business plan. Prior
to the COVID-19 outbreak, PEDEVCO’s 2020 development plan included several carryover projects from 2019’s Phase II
Permian Basin Asset development plan, including the drilling of an SWD well in the Chaveroo field (Chaves and Roosevelt Counties,
New Mexico) and production hookup and commencement on five horizontal San Andres wells drilled in 2019, with PEDEVCO’s plan
for the later part of 2020 contemplating the drilling of two horizontal San Andres wells on its Permian Basin Asset, several potential
San Andres well reactivation projects, and several enhancement and facilities projects throughout all of its operated assets.
However,
due to the COVID-19 outbreak, in April 2020 the SWD well completion was put on hold, resulting in only two of 2019’s Phase
II carryover producing wells being placed online at reduced rates due to water disposal constraints, and all drilling, reactivation,
enhancement and facilities projects contemplated under the 2020 development plan being halted. With the recent partial recovery
in oil prices, PEDEVCO is now working to complete several carryover projects from 2019’s Phase II Permian Basin Asset development
plan, including the planned completion of the SWD well and production hookup and commencement on three horizontal San Andres wells
drilled in 2019. For the remainder of 2020, PEDEVCO anticipates deploying an estimated $950,000 to complete the SWD and put on
production the three new wells in the Permian Basin in the coming months, and spending approximately $1 million to participate
in non-operated well projects on the D-J Basin Asset pursuant to well proposals recently received from third party operators on
lands in which PEDEVCO shares a leasehold interest. This revised 2020 development plan is based upon PEDEVCO’s current outlook
for the remainder of the year and is subject to further revision due to the significant volatility in market conditions and historically
high levels of uncertainty affecting the oil and gas exploration sector. PEDEVCO plans to further revise its development plans
as necessary to react to market conditions in the best interest of its shareholders, while prioritizing its financial strength
and liquidity.
PEDEVCO
expects that it will have sufficient cash available to meet its needs over the foreseeable future, which cash it anticipates being
available from (i) its projected cash flow from operations, (ii) its existing cash on hand, (iii) equity infusions or loans (which
may be convertible) made available from SK Energy, which is 100% owned and controlled by Dr. Simon Kukes, PEDEVCO’s Chief
Executive Officer and director, which funding SK Energy is under no obligation to provide, and (iv) funding through credit or
loan facilities. In addition, PEDEVCO may seek additional funding through asset sales, farm-out arrangements, lines of credit,
or public or private debt or equity financings to fund potential acquisitions in 2020.
The
following chart reflects PEDEVCO’s current organizational structure, prior to the completion of the exchange offer and second-step
merger:
*Represents
percentage of total voting power based on 72,463,340 shares of common stock outstanding
as of October 13, 2020, with beneficial ownership calculated in accordance with Rule 13d-3 of the Exchange Act. Holdings
of SK Energy LLC are also included in holdings of Senior Management and Board. See “Information about PEDEVCO—Security
Ownership of Certain Beneficial Owners and Management.” Ownership of Mr. Tkachev is based solely on his filings with the
Securities and Exchange Commission.
Competition
The
oil and natural gas industry is highly competitive. PEDEVCO competes, and will continue to compete, with major and independent
oil and natural gas companies for exploration and exploitation opportunities, acreage and property acquisitions. PEDEVCO also
competes for drilling rig contracts and other equipment and labor required to drill, operate and develop its properties. Many
of its competitors have substantially greater financial resources, staffs, facilities and other resources than PEDEVCO has. In
addition, larger competitors may be able to absorb the burden of any changes in federal, state and local laws and regulations
more easily than PEDEVCO can, which would adversely affect its competitive position. These competitors may be able to pay more
for drilling rigs or exploratory prospects and productive oil and natural gas properties and may be able to define, evaluate,
bid for and purchase a greater number of properties and prospects than PEDEVCO can. PEDEVCO’s competitors may also be able
to afford to purchase and operate their own drilling rigs.
PEDEVCO’s
ability to exploit, drill and explore for oil and natural gas and to acquire properties will depend upon its ability to conduct
operations, to evaluate and select suitable properties and to consummate transactions in this highly competitive environment.
Many of PEDEVCO’s competitors have a longer history of operations than PEDEVCO has, and many of them have also demonstrated
the ability to operate through industry cycles.
Competitive
Strengths
PEDEVCO
believes it is well positioned to successfully execute its business strategies and achieve its business objectives because of
the following competitive strengths:
|
●
|
Legacy
Conventional Focus. Legacy conventional oil fields that have seen large-scale vertical
development. Vertical production confirms moveable hydrocarbons ideal for horizontal
development that may have been technologically or economically limited or missed.
|
|
●
|
Technical
Engineering and Operations Expertise. Lateral landing decisions incorporate log analysis,
fracture-geometry modeling and an understanding of local porosity and saturation distributions.
PEDEVCO’s team are creative problem solvers with expertise in wellbore mechanics,
completion design, production enhancement, artificial lift design, water handling, facilities
optimization, and production down-time reduction.
|
|
●
|
Low
Cost Development. Shallow conventional reservoirs (<8,000 feet) and short to mid-range
laterals (1.0 mile and 1.5 mile, respectively) allow for efficient full-scale development
without the requirement for extended reach laterals and large fracs to meet economic
thresholds.
|
|
●
|
Management.
PEDEVCO has assembled a management team with extensive experience in the fields of business
development, petroleum engineering, geology, field development and production, operations,
planning and corporate finance. PEDEVCO’s management team is headed by its Chief
Executive Officer, Dr. Simon Kukes, who was formerly the CEO at Samara-Nafta, a Russian
oil company partnering with Hess Corporation, President and CEO of Tyumen Oil Company,
and Chairman of Yukos Oil. Its President, J. Douglas Schick, has over 20 years of experience
in the oil and gas industry, having co-founded American Resources, Inc., and formerly
serving in executive, management and operational planning, strategy and finance roles
at Highland Oil and Gas, Mariner Energy, Inc., The Houston Exploration Co., ConocoPhillips
and Shell Oil Company. In addition, PEDEVCO’s Executive Vice President and General
Counsel, Clark R. Moore, has over 14 years of energy industry experience, and formerly
served as acting general counsel of Erin Energy Corp. Several other members of the management
team have also successfully helped develop similar companies with like kind asset profiles
and technical operations at Sheridan Production Company, Trinity Operating LLC, Baker
Hughes and Halliburton. PEDEVCO believes that its management team is highly qualified
to identify, acquire and exploit energy resources in the U.S.
|
PEDEVCO’s
operations team has extensive experience in horizontal development of conventional assets in the Permian Basin at Sheridan Production
Company and experience drilling and completing unconventional wells in the D-J Basin at Baker Hughes and Halliburton.
The
PEDEVCO Board also brings extensive oil and gas industry experience, headed by PEDEVCO’s Chairman, John J. Scelfo, who brings
40 years of experience in oil and gas management, finance and accounting, and who served in numerous executive-level capacities
at Hess Corporation, including as Senior Vice President, Finance and Corporate Development, Chief Financial Officer, Worldwide
Exploration & Producing, and as a member of Hess’ Executive Committee. In addition, the PEDEVCO Board includes Ivar
Siem, who brings over 50 years of broad experience from both the upstream and the service segments of the oil and gas industry,
including serving as Chairman of Blue Dolphin Energy Company (OTCQX: BDCO), as Chairman and interim CEO of DI Industries/Grey
Wolf Drilling, as Chairman and CEO of Seateam Technology ASA, and in various executive roles at multiple E&P and oil field
service companies. Furthermore, the PEDEVCO Board includes H. Douglas Evans, who brings over 50 years of experience in executive
management positions with Gulf Interstate Engineering Company, one of the world’s top pipeline design and engineering firms,
including as its Honorary Chairman and previously its Chairman and President and Chief Executive Officer, and who is a past President
and current Board member of the International Pipe Line and Offshore Contractors Association, current Chairman of its Strategy
Committee, and an active member of the Pipeline Contractors Association.
|
●
|
Significant
acreage positions and drilling potential. As of September 30, 2020, PEDEVCO has accumulated
interests in a total of 37,069 net acres in the core Permian Basin Asset operating area,
and 11,948 net acres in the core D-J Basin Asset operating area, both of which PEDEVCO
believes represent significant upside potential. The majority of PEDEVCO’s Interests
are in or near areas of considerable activity by both major and independent operators,
although such activity may not be indicative of its future operations. Based on its current
acreage position, PEDEVCO believes the Permian Basin Asset could contain 185 potential
net wells, comprised of 170 net 1.0-mile lateral wells and 15 net 1.5-mile lateral wells,
on 120-acre spacing and 180-acre spacing, respectively. PEDEVCO believes the D-J Basin
Asset could contain approximately 90 potential net wells, comprised of 49 net 1.0-mile
lateral wells, 40 net 2.0-mile lateral wells, and 1 net 1.5-mile lateral well, on 80-acre
spacing, 160-acre spacing, and 120-acre spacing, respectively, providing PEDEVCO with
a substantial drilling inventory for future years.
|
Marketing
PEDEVCO
generally sells a significant portion of its oil and gas production to a relatively small number of customers, and during the
year ended December 31, 2019, sales to two customers comprised 54% and 13%, respectively, of PEDEVCO’s total oil and gas
revenues. No other customer accounted for more than 10% of PEDEVCO’s revenue during these periods. PEDEVCO is not dependent
upon any one purchaser and believes that, if its primary customers are unable or unwilling to continue to purchase PEDEVCO’s
production, there are a substantial number of alternative buyers for its production at comparable prices.
Oil
PEDEVCO’s
crude oil is generally sold under short-term, extendable and cancellable agreements with unaffiliated purchasers. Crude oil prices
realized from production sales are indexed to published posted refinery prices, and to published crude indexes with adjustments
on a contract basis. Transportation costs related to moving crude oil are also deducted from the price received for crude oil.
Natural
Gas
PEDEVCO’s
natural gas is sold under both long-term and short-term natural gas purchase agreements, which include two gas purchase agreements
for the DJ Basin Asset that are in effect until December 1, 2021 and April 1, 2032, respectively. However, natural gas sales related
to these agreements only represent a nominal (3%) of PEDEVCO’s total revenues as of December 31, 2019, and PEDEVCO believes
that this trend will continue in the DJ Basin Asset. Natural gas produced by PEDEVCO is sold at various delivery points at or
near producing wells to both unaffiliated independent marketing companies and unaffiliated mid-stream companies. PEDEVCO receives
proceeds from prices that are based on various pipeline indices less any associated fees for processing, location or transportation
differentials.
Oil
and Gas Properties
PEDEVCO
believes that the Permian Basin and D-J Basin assets represent among the most economic oil and natural gas plays in the U.S. PEDEVCO
plans to opportunistically seek additional acreage proximate to its currently held core acreage located in the Northwest Shelf
of the Permian Basin in Chaves and Roosevelt Counties, New Mexico, and the Wattenberg and Wattenberg Extension areas of Weld County,
Colorado in the D-J Basin. PEDEVCO’s strategy is to be the operator and/or a significant working interest owner, directly
or through its subsidiaries and joint ventures, in the majority of its acreage so PEDEVCO can dictate the pace of development
in order to execute its business plan. The majority of its capital expenditure budget for 2020 will be focused on the development
of its Permian Basin Asset, and secondarily on development of its D-J Basin Asset.
Unless
otherwise noted, the following table presents summary data for PEDEVCO’s leasehold acreage in the core Permian Basin Asset
and D-J Basin Asset as of September 30, 2020 and its revised 2020 development capital budget with respect to this acreage from
January 1, 2020 to December 31, 2020. This revised 2020 development plan is based upon PEDEVCO’s current outlook for the
remainder of the year and is subject to further revision due to the significant volatility in market conditions and historically
high levels of uncertainty affecting the oil and gas exploration sector, with the ultimate amount of capital PEDEVCO
will expend subject to material fluctuations based on, among other things, market conditions,
commodity prices, asset monetizations, non-operated project proposals, and availability of capital. PEDEVCO will further revise
its development plans as necessary to react to market conditions in the best interest of its shareholders, while prioritizing
its financial strength and liquidity.
|
|
|
|
|
Revised Development Capital Budget
January 1, 2020 - December 31, 2020
|
|
Current Core Assets:
|
|
Net Acres
|
|
|
Gross Wells(1)
|
|
|
Gross Costs
per Well
|
|
|
Capital Cost to PEDEVCO(2)
|
|
Permian Basin Asset
|
|
|
37,069
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
D-J Basin Asset
|
|
|
11,948
|
|
|
|
2.0
|
|
|
|
5,000,000
|
|
|
$
|
1,050,000
|
|
Enhancements(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
Facilities and Infrastructure(4)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
2019 Carryover(5)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
5,800,000
|
|
Total
|
|
|
49,017
|
|
|
|
2.0
|
|
|
|
|
|
|
$
|
6,850,000
|
|
|
(1)
|
Includes
planned participation on a non-operated basis in the drilling and completion of two gross
horizontal wells in the D-J Basin Asset at an estimated 8.5% and 12.3% working interest
net to PEDEVCO. None of this estimated capital amount has been spent to date.
|
|
(2)
|
PEDEVCO
anticipates that it can fund the entire $6.9 million capital cost to it through cash
from operations and existing cash on the balance sheet.
|
|
(3)
|
Due
to the COVID-19 outbreak, anticipated 2020 reactivation and enhancement projects were
halted.
|
|
(4)
|
Due
to the COVID-19 outbreak, anticipated 2020 facilities and infrastructure projects were
halted.
|
|
(5)
|
Carryover
capital expenditures from the 2019 development plan. Includes a SWD well and cleanouts,
hookups, flowback and associated costs on five (2019 Phase II) wells. These projects
have been completed, and substantially all of this estimated capital expenditure has
been paid to date.
|
PEDEVCO
Core Areas
Permian
Basin Asset
PEDEVCO
holds the Permian Basin Assets through its wholly-owned subsidiary, PEDCO, with operations conducted through PEDCO’s wholly-owned
operating subsidiaries, EOR Operating Company and Ridgeway Arizona Oil Corp. The Permian Basin Asset was assembled through three
acquisitions completed between 2018 and 2019. In the first acquisition, PEDEVCO acquired 100% of the assets of Hunter Oil Company,
with an effective date of September 1, 2018, which created its core Permian position. In 2019, PEDEVCO acquired additional assets
in two bolt-on acquisitions from private operators. These interests are all located in Chaves and Roosevelt Counties, New Mexico,
where PEDEVCO currently operates 378 gross (298 net) wells, of which 26 wells are active producers, 13 wells are active injectors,
and two wells are active SWDs. As of September 30, 2020, the Permian Basin Asset acreage is located in the areas shaded in yellow
in the sectional map following the State of New Mexico map below.
It
is estimated that there are approximately 110 billion barrels of oil-in-place in San Andres reservoirs across the Permian Basin
(Research Partnership to Secure Energy for America (“RPSEA”) report dated December 21, 2015). The San Andres oilfields
of the Northwest Shelf, Central Basin Platform and the Eastern Shelf are some of the largest oilfields within the Permian Basin.
According to the U.S. Energy Information Administration (“EIA”), as of December 31, 2013, three oil fields that have
produced from the San Andres formation were amongst the top 50 largest oilfields by reserves in the United States. The San Andres
has been historically under-developed due to technological and economic limitations during early development. The San Andres is
a dolomitic carbonate reservoir characterized as being highly-heterogenous with a multi-porosity system that typically shows significant
oil saturation, but primary production often yields higher than normal water cut. While existing San Andres operators may ascribe
different drivers for the water cut, San Andres production requires sufficient fluid removal, transportation and disposal, in
order to achieve higher oil cuts, through a network of on-site fluid storage and saltwater disposal systems.
Oil
was originally trapped in the San Andres by three types of pre-Tertiary traps: Structural, Stratigraphic and Structurally enhanced
Stratigraphic. Legacy fields exist where oil accumulated in these traps to form thick oil columns, referred to as Main Pay Zones
(“MPZ”). Legacy San Andres fields lack sharp oil-water contacts creating secondary zones of increasing water saturation
beneath the MPZ known as Transitional Oil Zones (“TOZ”) and Residual Oil Zones (“ROZ”). TOZs and ROZs
also extend outside the historical boundaries of the legacy fields downdip to their structural limits. The vast majority of horizontal
San Andres wells have been drilled in these TOZ and ROZ areas where vertical development is uneconomic.
PEDEVCO’s
37,069 net acres within the Chaveroo and Milnesand fields of Chaves and Roosevelt Counties, New Mexico offer a rare opportunity
to drill infill horizontal wells targeting the higher oil-saturations of the MPZs. The Chaveroo NE field is an extension of the
Chaveroo field that was not originally developed vertically. There are currently 378 wellbores within the leasehold, of which
26 are active producers and 13 are active injectors, and two are active SWDs. The remainder are shut-in wellbores with future
potential utility for additional water injection, production reactivations, and behind-pipe recompletions. PEDEVCO currently owns
and operates three water handling facilities, one in each field, that have a current combined capacity of approximately 60,000
barrels of water per day (bbl/d).
D-J
Basin Asset
PEDEVCO
has grown the legacy D-J Basin Asset position to 11,948 net acres in Weld and Morgan Counties, Colorado. PEDEVCO directly holds
all of its interests in the D-J Basin Asset through its wholly-owned subsidiary, Red Hawk. These interests are all located in
Weld County, Colorado. Red Hawk has an interest in 75 gross (21.9 net) wells and is currently the operator of 18 gross (16.2 net)
wells located in the D-J Basin Asset. The D-J Basin Asset acreage is located in the areas circled in the map below. The D-J Basin
has seen a tremendous amount of growth in drilling activity in the past 12 months. D-J Basin operators are now drilling 16 to
24 horizontal wells per section in the Niobrara and Codell formations, utilizing the latest advances in completion design, frac
stages, and frac intensity to obtain favorable well results. Notable non-operated partners leading the Niobrara revival are Noble
Energy, Extraction Oil & Gas, SRC Energy (merged with PDC Energy in January 2020), and Bonanza Creek Energy.
Production,
Sales Price and Production Costs
PEDEVCO
has listed below the total production volumes and total revenue net to PEDEVCO for the years ended December 31, 2019, 2018, and
2017:
|
|
2019
|
|
|
2018
|
|
|
2017
|
|
Total Revenues
|
|
$
|
12,972,000
|
|
|
$
|
4,523,000
|
|
|
$
|
3,015,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil:
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Production (Bbls)
|
|
|
234,378
|
|
|
|
70,395
|
|
|
|
52,260
|
|
Average sales price (per Bbl)
|
|
$
|
53.41
|
|
|
$
|
59.00
|
|
|
$
|
47.15
|
|
Natural Gas:
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Production (Mcf)
|
|
|
153,251
|
|
|
|
89,769
|
|
|
|
100,254
|
|
Average sales price (per Mcf)
|
|
$
|
2.43
|
|
|
$
|
2.56
|
|
|
$
|
2.97
|
|
NGL:
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Production (Bbls)
|
|
|
6,150
|
|
|
|
7,629
|
|
|
|
12,209
|
|
Average sales price (per Bbl)
|
|
$
|
13.28
|
|
|
$
|
18.32
|
|
|
$
|
20.73
|
|
Oil Equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Production (Boe)(1)
|
|
|
266,070
|
|
|
|
92,985
|
|
|
|
81,178
|
|
Average Daily Production (Boe/d)
|
|
|
729
|
|
|
|
255
|
|
|
|
222
|
|
Average Production Costs (per Boe)(2)
|
|
$
|
15.32
|
|
|
$
|
19.77
|
|
|
$
|
13.62
|
|
|
(1)
|
Assumes
6 Mcf of natural gas equivalents to 1 barrel of oil.
|
|
(2)
|
Excludes
workover costs, marketing, ad valorem and severance taxes.
|
As
of December 31, 2019, and 2018, the Chaveroo and Milnesand fields are the fields that each comprise 15% or more of PEDEVCO’s
total proved reserves. As of December 31, 2017, the Wattenberg field comprised 15% or more of PEDEVCO’s total proved reserves
for that year. The applicable production volumes from these fields for the years ended December 31, 2019, 2018, and 2017, is represented
in the table below in total barrels (Bbls):
|
|
|
|
2019
|
|
|
|
2018(1)
|
|
|
|
2017
|
|
Chaveroo
|
|
|
|
120,765
|
|
|
|
3,631
|
|
|
|
—
|
|
Milnesand
|
|
|
|
11,295
|
|
|
|
2,917
|
|
|
|
—
|
|
Wattenberg
|
|
|
|
—
|
|
|
|
—
|
|
|
|
46,198
|
|
|
(1)
|
In
2018, production from the acquisition of the Chaveroo and Milnesand fields in the third
quarter 2018 are the fields that each comprised 15% or more of PEDEVCO’s total
proved reserves at December 31, 2018. The data above only includes production for these
fields since the date of the acquisition.
|
The
following table summarizes PEDEVCO’s gross and net developed and undeveloped leasehold and mineral fee acreage at December
31, 2019:
|
|
Total
|
|
|
Developed(1)
|
|
|
Undeveloped(2)
|
|
|
|
Gross
|
|
|
Net
|
|
|
Gross
|
|
|
Net
|
|
|
Gross
|
|
|
Net
|
|
D-J Basin
|
|
|
205,994
|
|
|
|
11,948
|
|
|
|
183,370
|
|
|
|
9,388
|
|
|
|
22,624
|
|
|
|
2,560
|
|
Permian Basin
|
|
|
40,648
|
|
|
|
38,258
|
|
|
|
31,813
|
|
|
|
31,036
|
|
|
|
8,835
|
|
|
|
7,222
|
|
Total
|
|
|
246,642
|
|
|
|
50,206
|
|
|
|
215,183
|
|
|
|
40,424
|
|
|
|
31,459
|
|
|
|
9,782
|
|
|
(1)
|
Developed
acreage is the number of acres that are allocated or assignable to producing wells or
wells capable of production.
|
|
(2)
|
Undeveloped
acreage is lease acreage on which wells have not been drilled or completed to a point
that would permit the production of commercial quantities of oil and natural gas regardless
of whether such acreage includes proved reserves.
|
PEDEVCO
believes it has satisfactory title, in all material respects, to substantially all of its producing properties in accordance with
standards generally accepted in the oil and natural gas industry.
Total
Net Undeveloped Acreage Expiration
In
the event that production is not established or PEDEVCO takes no action to extend or renew the terms of its leases, its net undeveloped
acreage that will expire over the next three years as of December 31, 2019 is 1,758, 3,545 and 1,395 for the years ending December
31, 2020, 2021 and 2022, respectively. PEDEVCO expects to retain substantially all of its expiring acreage either through drilling
activities, renewal of the expiring leases or through the exercise of extension options.
Well
Summary
The
following table presents PEDEVCO’s ownership in productive crude oil and natural gas wells at December 31, 2019. This summary
includes crude oil wells in which PEDEVCO has a working interest:
|
|
Gross
|
|
|
Net
|
|
Crude oil
|
|
|
122.0
|
|
|
|
88.1
|
|
Natural gas
|
|
|
—
|
|
|
|
—
|
|
Total(1)
|
|
|
122.0
|
|
|
|
88.1
|
|
|
(1)
|
Total
percentage of gross operated wells is 69.7%.
|
Drilling
Activity
PEDEVCO
drilled wells or participated in the drilling of wells as indicated in the table below:
|
|
|
2019
|
|
|
2018
|
|
|
2017
|
|
|
|
|
Gross
|
|
|
Net
|
|
|
Gross
|
|
|
Net
|
|
|
Gross
|
|
|
Net
|
|
Development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Productive
|
|
|
|
20
|
|
|
|
9.6
|
|
|
|
—
|
|
|
|
—
|
|
|
|
3
|
|
|
|
0.2
|
|
Dry
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Exploratory
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Productive
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Dry
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Oil
and Natural Gas Reserves
Reserve
Information
For
estimates of PEDEVCO’s net proved producing reserves of crude oil and natural gas, as well as discussion of PEDEVCO’s
proved and probable undeveloped reserves, please see “PEDEVCO Corp. Supplemental Oil and Gas Disclosures (Unaudited)”
appearing in the Financial Statements to this offer to exchange. At December 31, 2019, PEDEVCO’s total estimated proved
reserves were 14.0 million Boe, of which 12.4 million Bbls were crude oil and NGL reserves, and 9.7 million Mcf were natural gas
reserves.
Internal
Controls
Clayton
Riddle, PEDEVCO’s former Vice President of Development (a non-executive position), was the technical person primarily responsible
for its internal reserves estimation process (which are based upon the best available production, engineering and geologic data)
and provided oversight of the annual audit of PEDEVCO’s previous year end reserves by its independent third party engineers.
Mr. Riddle left PEDEVCO in August 2020. He has a Bachelor of Science degree in Petroleum Engineering, and in excess of five years
as a reserves estimator and is a member of the Society of Petroleum Engineers.
The
preparation of PEDEVCO’s reserve estimates is in accordance with its prescribed procedures that include verification of
input data into a reserve forecasting and economic software, as well as management review. PEDEVCO’s reserve analysis includes,
but is not limited to, the following:
|
●
|
Research
of operators near PEDEVCO’s lease acreage. Review operating and technological techniques,
as well as reserve projections of such wells.
|
|
●
|
The
review of internal reserve estimates by well and by area by a qualified petroleum engineer.
A variance by well to the previous year-end reserve report is used as a tool in this
process.
|
|
●
|
SEC-compliant
internal policies to determine and report proved reserves.
|
|
●
|
The
discussion of any material reserve variances among management to ensure the best estimate
of remaining reserves.
|
Qualifications
of Third Party Engineers
The
technical person primarily responsible for the audit of PEDEVCO’s reserves estimates at Cawley, Gillespie & Associates,
Inc. is W. Todd Brooker, who meets the requirements regarding qualifications, independence, objectivity, and confidentiality set
forth in the Standards Pertaining to the Estimating and Auditing of Oil and Gas Reserves Information promulgated by the Society
of Petroleum Engineers. Cawley, Gillespie & Associates, Inc. is an independent firm and does not own an interest in its properties
and is not employed on a contingent fee basis. Reserve estimates are imprecise and subjective and may change at any time as additional
information becomes available. Furthermore, estimates of oil and gas reserves are projections based on engineering data. There
are
uncertainties inherent in the interpretation of this data as well as the projection of future rates of production. The accuracy
of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment.
A copy of the report issued by Cawley, Gillespie & Associates, Inc. is incorporated by reference into the Registration Statement
for which this offer to exchange is a part as Exhibit 99.5.
For
more information regarding its oil and gas reserves, please refer “PEDEVCO Corp. Supplemental Oil and Gas Disclosures (Unaudited)”
appearing in the Financial Statements to the offer to exchange.
Recent
Events
January
2019 SK Energy Convertible Note
On
January 11, 2019, PEDEVCO borrowed $15.0 million from SK Energy, through the issuance of a convertible promissory note in the
amount of $15.0 million (the “January 2019 Convertible Note”). The January 2019 Convertible Note accrues interest
monthly at 8.5% per annum, which is payable on the maturity date, unless otherwise converted into shares of PEDEVCO Common Stock
as described below. The January 2019 Convertible Note and all accrued interest thereon are convertible into shares of PEDEVCO
Common Stock, at the option of the holder thereof, at a conversion price equal to $1.50 per share. Further, the conversion of
the January 2019 Convertible Note is subject to a 49.9% conversion limitation which prevents the conversion of any portion thereof
into PEDEVCO Common Stock if such conversion would result in SK Energy or any of its affiliates beneficially owning more than
49.9% of outstanding shares of PEDEVCO Common Stock. The January 2019, Convertible Note is due and payable on January 11, 2022
but may be prepaid at any time without penalty. In February 2019, the January 2019 Convertible Note was converted into common
stock as discussed below.
Convertible
Notes Amendment and Conversion
On
February 15, 2019, PEDEVCO and SK Energy agreed to amend the terms of $23.6 million in Convertible Promissory Notes sold in August
2018 (including $22 million acquired by SK Energy) and a $7 million Convertible Note sold to SK Energy in October 2018, each described
in further detail in “Note 8 - Notes Payable” to the PEDEVCO audited financial statements included in this offer to
exchange, as well as the January 2019 Convertible Note, whereby each of the notes were amended to remove the conversion limitation
that previously prevented SK Energy from converting any portion of the notes into PEDEVCO Common Stock if such conversion would
have resulted in SK Energy beneficially owning more than 49.9% of outstanding shares of PEDEVCO Common Stock
Immediately
following the entry into the Amendment, on February 15, 2019, SK Energy elected to convert (i) all $15,000,000 of the outstanding
principal and all $126,000 of accrued interest under the January 2019 Convertible Notes into PEDEVCO Common Stock at a conversion
price of $1.50 per share as set forth in the January 2019 Convertible Notes into 10,083,819 shares of restricted PEDEVCO Common
Stock, and (ii) all $7,000,000 of the outstanding principal and all $18,700 of accrued interest under the October 2018 note into
PEDEVCO Common Stock at a conversion price of $1.79 per share as set forth in the October 2018 note into 4,014,959 shares of restricted
common stock of PEDEVCO, which shares in aggregate represented approximately 47.1% of PEDEVCO’s then 29,907,223 shares of
issued and outstanding PEDEVCO Common Stock after giving effect to the conversions.
SK
Energy Note Amendment; Note Purchases and Conversion
On
March 1, 2019, PEDEVCO and SK Energy entered into a First Amendment to Promissory Note (the “SK Energy Note Amendment”)
which amended the note dated June 25, 2018, evidencing $7.7 million of principal owed to SK Energy (the “SK Energy Note”),
to provide SK Energy the right, at any time, at its option, to convert the principal and interest owed under such SK Energy Note,
into shares of PEDEVCO Common Stock, at a conversion price of $2.13 per share. The SK Energy Note previously only included a conversion
feature whereby PEDEVCO had the option to pay quarterly interest payments on the SK Energy Note in shares of PEDEVCO Common Stock
instead of cash, at a conversion price per share calculated based on the average closing sales price of PEDEVCO Common Stock on
the NYSE American for the ten trading days immediately preceding the last day of the calendar quarter immediately prior to the
quarterly payment date.
In
addition, on March 1, 2019, the holders of $1,500,000 in aggregate principal amount of Convertible Notes issued by PEDEVCO on
August 1, 2018 (the “August 2018 Notes”) sold their August 2018 Notes at face value plus accrued and unpaid interest
through March 1, 2019 to SK Energy (the “August 2018 Note Sale”). Holders which sold their August 2018 Notes pursuant
to the August 2018 Note Sale to SK Energy include an executive officer of SK Energy ($200,000 in principal amount of August 2018
Notes); a trust affiliated with John J. Scelfo, a director of PEDEVCO ($500,000 in principal amount of August 2018 Notes); an
entity affiliated with Ivar Siem, a director of PEDEVCO, and J. Douglas Schick the President of PEDEVCO ($500,000 in principal
amount of August 2018 Notes); and Harold Douglas Evans, a director of PEDEVCO ($200,000 in principal amount of August 2018 Notes).
Following
the August 2018 Note Sale, PEDEVCO’s sole issued and outstanding debt was the (i) $7,700,000 in principal, plus accrued
interest, under the SK Energy Note held by SK Energy, (ii) an aggregate of $23,500,000 in principal, plus accrued interest, under
the August 2018 Notes and Convertible Note held by SK Energy, and (iii) $100,000 in principal, plus accrued interest, under an
August 2018 Note held by an unaffiliated holder (the “Unaffiliated Holder”).
Immediately
following the effectiveness of the SK Energy Note Amendment and August 2018 Note Sale, on March 1, 2019, SK Energy and the Unaffiliated
Holder elected to convert all $31,300,000 of outstanding principal and an aggregate of $1,462,818 of accrued interest under the
SK Energy Note, Convertible Note held by SK Energy, and August 2018 Notes, into PEDEVCO Common Stock at a conversion price of
$2.13 per share (the “Conversion Price” and the “Conversions”) as set forth in the SK Energy Note, as
amended, and the August 2018 Notes and the Convertible Note held by SK Energy (collectively, the “Notes”), into an
aggregate of 15,381,605 shares of restricted PEDEVCO Common Stock (the “Conversion Shares”).
Manzano
Acquisition
On
February 1, 2019, for consideration of $700,000, PEDEVCO completed an asset purchase from Manzano, LLC and Manzano Energy Partners
II, LLC, whereby PEDEVCO purchased approximately 18,000 net leasehold acres, ownership and operated production from one horizontal
well currently producing from the San Andres play in the Permian Basin, ownership of three additional shut-in wells, and ownership
of one saltwater disposal well. PEDEVCO subsequently drilled one Manzano well in Phase Two of its 2019 development plan, which
was completed in the fourth quarter of 2019.
Red
Hawk Property Rights Sale
On
March 7, 2019, Red Hawk sold rights to 85.5 net acres of oil and gas leases located in Weld County, Colorado, to a third party,
for aggregate proceeds of $1.2 million. The sale agreement included a provision whereby the purchaser was required to assign Red
Hawk 85 net acres of leaseholds in an area located where PEDEVCO already owns other leases in Weld County, Colorado, within nine
months from the date of the sale, or to repay PEDEVCO up to $200,000 (proportionally adjusted for the amount of leasehold delivered).
In December 2019, the purchaser assigned Redhawk 121 net acres of leaseholds with a value of $121,000, thereby satisfying in full
its obligations to Red Hawk under the sale agreement.
Drilling
and Workover Activities
In
December 2018, PEDEVCO commenced drilling four San Andres horizontal wells in the Permian Basin Asset acreage acquired from Hunter
Oil Company in September 2018, which wells were completed in March 2019. Also, in February 2019, PEDEVCO completed workover operations
to reactivate a San Andres horizontal well, and in March 2019 w PEDEVCO e completed the drilling of its fifth San Andres horizontal
well, both of which operations were conducted on the Permian Basin acreage acquired from Manzano in February 2019. In July 2019,
PEDEVCO also commenced drilling four additional San Andres horizontal wells in the Permian Basin Asset, for which drilling operations
were completed in September 2019, and for which recompletion operations were completed in November and December of 2019. Also,
PEDEVCO participated in the drilling and completion of two horizontal wells in August of 2019 and nine horizontal wells in October
of 2019 in the DJ-Basin Asset, which are operated by third-party operators.
Additional
San Andres Acquisition
Effective
June 10, 2019, for consideration of $350,000, PEDEVCO completed an asset purchase from a private operator, whereby PEDEVCO purchased
approximately 2,076 net leasehold acres, ownership and operated production from 22 horizontal wells currently producing from the
San Andres play in the Permian Basin and ownership of three injection wells.
Regulation
of the Oil and Gas Industry
All
of PEDEVCO’s oil and gas operations are substantially affected by federal, state and local laws and regulations. Failure
to comply with applicable laws and regulations can result in substantial penalties. The regulatory burden on the industry increases
the cost of doing business and affects profitability. Historically, PEDEVCO’s compliance costs have not had a material adverse
effect on its results of operations; however, PEDEVCO is unable to predict the future costs or impact of compliance.
Additional
proposals and proceedings that affect the oil and natural gas industry are regularly considered by Congress, the states, the Federal
Energy Regulatory Commission (the “FERC”) and the courts. PEDEVCO cannot predict when or whether any such proposals
may become effective. PEDEVCO does not believe that PEDEVCO would be affected by any such action materially differently than similarly
situated competitors.
At
the state level, PEDEVCO’s operations in Colorado are regulated by the Colorado Oil & Gas Conservation Commission (“COGCC”)
and its New Mexico operations are regulated by the Conservation Division of the New Mexico Energy, Minerals, and Natural Resources
Department (regulates oil and gas operations), New Mexico Environment Department (administers environmental protection laws),
and the New Mexico State Land Office (oversees surface and mineral acres and development). The Oil Conservation Division of the
New Mexico Energy, Minerals, Natural Resources Department, and New Mexico State Land Office require the posting of financial assurance
for owners and operators on privately owned or state land within New Mexico in order to provide for abandonment restoration and
remediation of wells, and for the drilling of salt water disposal wells.
The
COGCC regulates oil and gas operators through rules, policies, written guidance, orders, permits, and inspections. Among other
things, the COGCC enforces specifications regarding drilling, development, production, reclamation, enhanced recovery, safety,
aesthetics, noise, waste, flowlines, and wildlife. In recent years, the COGCC has amended its existing regulatory requirements
and
adopted new requirements with increased frequency. For example, in January 2016, the COGCC approved new rules that require
local government consultation and certain best management practices for large-scale oil and natural gas facilities in certain
urban mitigation areas. These rules also require operator registration and/or notifications to local governments with respect
to future oil and natural gas drilling and production facility locations. In February 2018, the COGCC comprehensively amended
its regulations for oil, gas, and water flowlines to expand requirements addressing flowline registration and safety, integrity
management, leak detection, and other matters. The COGCC has also adopted or amended numerous other rules in recent years, including
rules relating to safety, flood protection, and spill reporting. In December 2018, the COGCC approved new rules that require new
oil and gas sites to be situated at least 1,000 feet away from school properties such as playgrounds and athletic fields. Most
recently, in 2019, Colorado enacted Senate Bill 19-181 (“SB 19-181”), which changes the mission of the COGCC from
fostering responsible and balanced development to regulating development to protect public health and the environment and directs
the COGCC to undertake rulemaking on various operational matters including environmental protection, facility siting and wellbore
integrity. Pursuant to this directive, in December 2019, the COGCC proposed new regulatory requirements to enhance safety and
environmental protection during hydraulic fracturing and to enhance wellbore integrity.
PEDEVCO
anticipates that the COGCC, the Conservation Division of the New Mexico Energy, Minerals, Natural Resources Department, the New
Mexico State Land Office, the New Mexico Environment Department and other federal, state and local authorities will continue to
adopt new rules and regulations moving forward which will likely affect its oil and gas operations, and could make it more costly
for its operations or limit its activities. PEDEVCO routinely monitors its operations and new rules and regulations which may
affect its operations, to ensure that PEDEVCO maintains compliance.
Regulation
Affecting Production
The
production of oil and natural gas is subject to United States federal and state laws and regulations, and orders of regulatory
bodies under those laws and regulations, governing a wide variety of matters. All of the jurisdictions in which PEDEVCO owns or
operates producing oil and natural gas properties have statutory provisions regulating the exploration for and production of oil
and natural gas, including provisions related to permits for the drilling of wells, bonding requirements to drill or operate wells,
the location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells
are drilled, sourcing and disposal of water used in the drilling and completion process, and the abandonment of wells. PEDEVCO’s
operations are also subject to various conservation laws and regulations. These include the regulation of the size of drilling
and spacing units or proration units, the number of wells which may be drilled in an area, and the unitization or pooling of oil
or natural gas wells, as well as regulations that generally prohibit the venting or flaring of natural gas, and impose certain
requirements regarding the ratability or fair apportionment of production from fields and individual wells. These laws and regulations
may limit the amount of oil and gas wells PEDEVCO can drill. Moreover, each state generally imposes a production or severance
tax with respect to the production and sale of oil, NGL and gas within its jurisdiction.
States
do not regulate wellhead prices or engage in other similar direct regulation, but there can be no assurance that they will not
do so in the future. The effect of such future regulations may be to limit the amounts of oil and gas that may be produced from
PEDEVCO’s wells, negatively affect the economics of production from these wells or limit the number of locations PEDEVCO
can drill.
The
failure to comply with the rules and regulations of oil and natural gas production and related operations can result in substantial
penalties. PEDEVCO’s competitors in the oil and natural gas industry are subject to the same regulatory requirements and
restrictions that affect its operations.
Regulation
Affecting Sales and Transportation of Commodities
Sales
prices of gas, oil, condensate and NGL are not currently regulated and are made at market prices. Although prices of these energy
commodities are currently unregulated, the United States Congress historically has been active in their regulation. PEDEVCO cannot
predict whether new legislation to regulate oil and gas, or the prices charged for these commodities might be proposed, what proposals,
if any, might actually be enacted by the United States Congress or the various state legislatures and what effect, if any, the
proposals might have on its operations. Sales of oil and natural gas may be subject to certain state and federal reporting requirements.
The
price and terms of service of transportation of the commodities, including access to pipeline transportation capacity, are subject
to extensive federal and state regulation. Such regulation may affect the marketing of oil and natural gas produced by PEDEVCO,
as well as the revenues received for sales of such production. Gathering systems may be subject to state ratable take and common
purchaser statutes. Ratable take statutes generally require gatherers to take, without undue discrimination, oil and natural gas
production that may be tendered to the gatherer for handling. Similarly, common purchaser statutes generally require gatherers
to purchase, or accept for gathering, without undue discrimination as to source of supply or producer. These statutes are designed
to prohibit discrimination in favor of one producer over another producer or one source of supply over another source of supply.
These statutes may affect whether and to what extent gathering capacity is available for oil and natural gas production, if any,
of the drilling program and the cost of such capacity. Further state laws and regulations govern rates and terms of access to
intrastate pipeline systems, which may similarly affect market access and cost.
The
FERC regulates interstate natural gas pipeline transportation rates and service conditions. The FERC is continually proposing
and implementing new rules and regulations affecting interstate transportation. The stated purpose of many of these regulatory
changes is to ensure terms and conditions of interstate transportation service are not unduly discriminatory or unduly preferential,
to promote competition among the various sectors of the natural gas industry and to promote market transparency. PEDEVCO does
not believe that its drilling program will be affected by any such FERC action in a manner materially differently than other similarly
situated natural gas producers.
In
addition to the regulation of natural gas pipeline transportation, FERC has additional jurisdiction over the purchase or sale
of gas or the purchase or sale of transportation services subject to FERC’s jurisdiction pursuant to the Energy Policy Act
of 2005 (“EPAct 2005”). Under the EPAct 2005, it is unlawful for “any entity,” including producers such
as PEDEVCO, that are otherwise not subject to FERC’s jurisdiction under the Natural Gas Act of 1938 (“NGA”)
to use any deceptive or manipulative device or contrivance in connection with the purchase or sale of gas or the purchase or sale
of transportation services subject to regulation by FERC, in contravention of rules prescribed by FERC. FERC’s rules implementing
this provision make it unlawful, in connection with the purchase or sale of gas subject to the jurisdiction of FERC, or the purchase
or sale of transportation services subject to the jurisdiction of FERC, for any entity, directly or indirectly, to use or employ
any device, scheme or artifice to defraud; to make any untrue statement of material fact or omit to make any such statement necessary
to make the statements made not misleading; or to engage in any act or practice that operates as a fraud or deceit upon any person.
EPAct 2005 also gives FERC authority to impose civil penalties for violations of the NGA and the Natural Gas Policy Act of 1978
up to $1.2 million per day, per violation. The anti-manipulation rule applies to activities of otherwise non-jurisdictional entities
to the extent the activities are conducted “in connection with” gas sales, purchases or transportation subject to
FERC jurisdiction, which includes the annual reporting requirements under FERC Order No. 704 (defined below).
In
December 2007, FERC issued a final rule on the annual natural gas transaction reporting requirements, as amended by subsequent
orders on rehearing (“Order No. 704”). Under Order No. 704, any market participant, including a producer that engages
in certain wholesale sales or purchases of gas that equal or exceed 2.2 trillion BTUs of physical natural gas in the previous
calendar year, must annually report such sales and purchases to FERC on Form No. 552 on May 1 of each year. Form No. 552 contains
aggregate volumes of natural gas purchased or sold at wholesale in the prior calendar year to the extent such transactions utilize,
contribute to the formation of price indices. Not all types of natural gas sales are required to be reported on Form No. 552.
It is the responsibility of the reporting entity to determine which individual transactions should be reported based on the guidance
of Order No. 704. Order No. 704 is intended to increase the transparency of the wholesale gas markets and to assist FERC in monitoring
those markets and in detecting market manipulation.
The
FERC also regulates rates and terms and conditions of service on interstate transportation of liquids, including oil and NGL,
under the Interstate Commerce Act, as it existed on October 1, 1977 (“ICA”). Prices received from the sale of liquids
may be affected by the cost of transporting those products to market. The ICA requires that certain interstate liquids pipelines
maintain a tariff on file with FERC. The tariff sets forth the established rates as well as the rules and regulations governing
the service. The ICA requires, among other things, that rates and terms and conditions of service on interstate common carrier
pipelines be “just and reasonable.” Such pipelines must also provide jurisdictional service in a manner that is not
unduly discriminatory or unduly preferential. Shippers have the power to challenge new and existing rates and terms and conditions
of service before FERC.
The
rates charged by many interstate liquids pipelines are currently adjusted pursuant to an annual indexing methodology established
and regulated by FERC, under which pipelines increase or decrease their rates in accordance with an index adjustment specified
by FERC. For the five-year period beginning July 1, 2016, FERC established an annual index adjustment equal to the change in the
producer price index for finished goods plus 1.23%. This adjustment is subject to review every five years. Under FERC’s
regulations, a liquids pipeline can request a rate increase that exceeds the rate obtained through application of the indexing
methodology by obtaining market-based rate authority (demonstrating the pipeline lacks market power), establishing rates by settlement
with all existing shippers, or through a cost-of-service approach (if the pipeline establishes that a substantial divergence exists
between the actual costs experienced by the pipeline and the rates resulting from application of the indexing methodology). Increases
in liquids transportation rates may result in lower revenue and cash flows for PEDEVCO.
In
addition, due to common carrier regulatory obligations of liquids pipelines, capacity must be prorated among shippers in an equitable
manner in the event there are nominations in excess of capacity or for new shippers. Therefore, new shippers or increased volume
by existing shippers may reduce the capacity available to PEDEVCO. Any prolonged interruption in the operation or curtailment
of available capacity of the pipelines that PEDEVCO relies upon for liquids transportation could have a material adverse effect
on its business, financial condition, results of operations and cash flows. However, PEDEVCO believes that access to liquids pipeline
transportation services generally will be available to PEDEVCO to the same extent as to its similarly situated competitors.
Rates
for intrastate pipeline transportation of liquids are subject to regulation by state regulatory commissions. The basis for intrastate
liquids pipeline regulation, and the degree of regulatory oversight and scrutiny given to intrastate liquids pipeline rates, varies
from state to state. PEDEVCO believes that the regulation of liquids pipeline transportation rates will not affect its operations
in any way that is materially different from the effects on its similarly situated competitors.
In
addition to FERC’s regulations, PEDEVCO is required to observe anti-market manipulation laws with regard to its physical
sales of energy commodities. In November 2009, the Federal Trade Commission (“FTC”) issued regulations pursuant to
the Energy Independence and Security Act of 2007, intended to prohibit market manipulation in the petroleum industry. Violators
of the regulations face civil penalties of up to $1 million per violation per day. In July 2010, Congress passed the Dodd-Frank
Act, which incorporated an expansion of the authority of the Commodity Futures Trading Commission (“CFTC”) to prohibit
market manipulation in the markets regulated by the CFTC. This authority, with respect to oil swaps and futures contracts, is
similar to the anti-manipulation authority granted to the FTC with respect to oil purchases and sales. In July 2011, the CFTC
issued final rules to implement their new anti-manipulation authority. The rules subject violators to a civil penalty of up to
the greater of $1.1 million or triple the monetary gain to the person for each violation.
Regulation
of Environmental and Occupational Safety and Health Matters
PEDEVCO’s
operations are subject to stringent federal, state and local laws and regulations governing occupational safety and health aspects
of its operations, the discharge of materials into the environment and environmental protection. Numerous governmental entities,
including the U.S. Environmental Protection Agency (“EPA”) and analogous state agencies have the power to enforce
compliance with these laws and regulations and the permits issued under them, often requiring difficult and costly actions. These
laws and regulations may, among other things (i) require the acquisition of permits to conduct drilling and other regulated activities;
(ii) restrict the types, quantities and concentration of various substances that can be released into the environment or injected
into formations in connection with oil and natural gas drilling and production activities; (iii) limit or prohibit drilling activities
on certain lands lying within wilderness, wetlands and other protected areas; (iv) require remedial measures to mitigate pollution
from former and ongoing operations, such as requirements to close pits and plug abandoned wells; (v) apply specific health and
safety criteria addressing worker protection; and (vi) impose substantial liabilities for pollution resulting from drilling and
production operations. Any failure to comply with these laws and regulations may result in the assessment of administrative, civil
and criminal penalties, the imposition of corrective or remedial obligations, the occurrence of delays or restrictions in permitting
or performance of projects, and the issuance of orders enjoining performance of some or all of PEDEVCO’s operations.
These
laws and regulations may also restrict the rate of oil and natural gas production below the rate that would otherwise be possible.
The regulatory burden on the oil and natural gas industry increases the cost of doing business in the industry and consequently
affects profitability. The trend in environmental regulation is to place more restrictions and limitations on activities that
may affect the environment, and thus any changes in environmental laws and regulations or re-interpretation of enforcement policies
that result in more stringent and costly well drilling, construction, completion or water management activities, or waste handling,
storage transport, disposal, or remediation requirements could have a material adverse effect on PEDEVCO’s financial position
and results of operations. PEDEVCO may be unable to pass on such increased compliance costs to its customers. Moreover, accidental
releases or spills may occur in the course of its operations, and PEDEVCO cannot assure you that it will not incur significant
costs and liabilities as a result of such releases or spills, including any third-party claims for damage to property, natural
resources or persons. Continued compliance with existing requirements is not expected to materially affect PEDEVCO. However, there
is no assurance that PEDEVCO will be able to remain in compliance in the future with such existing or any new laws and regulations
or that such future compliance will not have a material adverse effect on its business and operating results.
Additionally,
on January 14, 2019, in Martinez v. Colorado Oil and Gas Conservation Commission, the Colorado Supreme Court overturned
a ruling by the Colorado Court of Appeals that held that the Colorado Oil & Gas Conservation Commission (“COGCC”)
had held that the COGCC concluded that it lacked statutory authority to undertake a proposed rulemaking “to suspend the
issuance of permits that allow hydraulic fracturing until it can be done without adversely impacting human health and safety and
without impairing Colorado’s atmospheric resource and climate system, water, soil, wildlife, or other biological resources.”
The Colorado Court of Appeals concluded that Colorado’s Oil and Gas Conservation Act mandated that oil and gas development
“be regulated subject to the protection of public health, safety, and welfare, including protection of the environment and
wildlife resources.” In the Colorado Supreme Court’s majority opinion, Justice Richard L. Gabriel wrote the COGCC
is required first to “foster the development of oil and gas resources” and second “to prevent and mitigate significant
environmental impacts to the extent necessary to protect public health, safety and welfare, but only after taking into consideration
cost-effectiveness and technical feasibility.”
The
following is a summary of the more significant existing and proposed environmental and occupational safety and health laws, as
amended from time to time, to which its business operations are or may be subject and for which compliance may have a material
adverse impact on PEDEVCO’s capital expenditures, results of operations or financial position.
Hazardous
Substances and Wastes
The
Resource Conservation and Recovery Act (“RCRA”), and comparable state statutes, regulate the generation, transportation,
treatment, storage, disposal and cleanup of hazardous and non-hazardous wastes. Pursuant to rules issued by the EPA, the individual
states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements.
Drilling fluids, produced waters, and most of the other wastes associated with the exploration, development, and production of
oil or natural gas, if properly handled, are currently exempt from regulation as hazardous waste under RCRA and, instead, are
regulated under RCRA’s less stringent non-hazardous waste provisions, state laws or other federal laws. However, it is possible
that certain oil
and natural gas drilling and production wastes now classified as non-hazardous could be classified as hazardous
wastes in the future. Stricter regulation of wastes generated during PEDEVCO’s operations could result in an increase in
PEDEVCO’s, as well as the oil and natural gas exploration and production industry’s costs to manage and dispose of
wastes, which could have a material adverse effect on PEDEVCO’s results of operations and financial position.
In
December 2016, the U.S. District Court for the District of Columbia approved a consent decree between the EPA and a coalition
of environmental groups. The consent decree requires the EPA to review and determine whether it will revise the RCRA regulations
for exploration and production waste to treat such waste as hazardous waste. In April 2019, the EPA, pursuant to the consent decree,
determined that revision of the regulations is not necessary. Information comprising the EPA’s review and decision is contained
in a document entitled “Management of Exploration, Development and Production Wastes: Factors Informing a Decision on the
Need for Regulatory Action”. The EPA indicated that it will continue to work with states and other organizations to identify
areas for continued improvement and to address emerging issues to ensure that exploration, development and production wastes continue
to be managed in a manner that is protective of human health and the environment. Environmental groups, however, expressed dissatisfaction
with the EPA’s decision and will likely continue to press the issue at the federal and state levels.
The
Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), also known as the Superfund law,
and comparable state laws impose joint and several liability, without regard to fault or legality of conduct, on classes of persons
who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the
current and former owners and operators of the site where the release occurred and anyone who disposed or arranged for the disposal
of a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the
costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and
for the costs of certain health studies. CERCLA also authorizes the EPA and, in some instances, third parties to act in response
to threats to the public health or the environment and to seek to recover from the responsible classes of persons the costs they
incur. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and
property damage allegedly caused by the hazardous substances released into the environment. PEDEVCO generates materials in the
course of its operations that may be regulated as hazardous substances.
PEDEVCO
currently leases or operates numerous properties that have been used for oil and natural gas exploration, production and processing
for many years. Although PEDEVCO believes that it has utilized operating and waste disposal practices that were standard in the
industry at the time, hazardous substances, wastes, or petroleum hydrocarbons may have been released on, under or from the properties
owned or leased by PEDEVCO, or on, under or from other locations, including off-site locations, where such substances have been
taken for treatment or disposal. In addition, some of its properties have been operated by third parties or by previous owners
or operators whose treatment and disposal of hazardous substances, wastes, or petroleum hydrocarbons was not under PEDEVCO’s
control. These properties and the substances disposed or released on, under or from them may be subject to CERCLA, RCRA and analogous
state laws. Under such laws, PEDEVCO could be required to undertake response or corrective measures, which could include removal
of previously disposed substances and wastes, cleanup of contaminated property or performance of remedial plugging or pit closure
operations to prevent future contamination, the costs of which could be substantial.
Water
Discharges
The
federal Clean Water Act (“CWA”) and analogous state laws impose strict controls concerning the discharge of pollutants
and fill material, including spills and leaks of crude oil and other substances. The CWA also requires approval and/or permits
prior to construction, where construction will disturb certain wetlands or other waters of the U.S. In June 2015, the EPA issued
a final rule that attempted to clarify the CWA’s jurisdictional reach over “waters of the United States” (“2015
Clean Water Rule”) and replace the pre-existing 1986 rule and guidance. In February 2018, the EPA issued a rule to delay
the applicability of the 2015 Clean Water Rule until February 2020, but this delay rule was struck following a court challenge.
Other federal district courts, however, issued rulings temporarily enjoining the applicability of the 2015 Clean Water Rule itself
in several states. Taken together, the 2015 Clean Water Rule has been in effect in 22 states, including Colorado, and temporarily
stayed in 27 states (the 2015 Clean Water Rule was in effect in certain counties in New Mexico and not in others). In those remaining
states, the 1986 rule and guidance remained in effect. In October 2019, the EPA and the USACE issued a final rule to repeal the
2015 Clean Water Rule (the “2019 Repeal Rule”). With the 2019 Repeal Rule, the agencies report that they will implement
the pre-2015 Clean Water Rule regulations and guidance nationwide. The 2019 Repeal Rule became effective on December 23, 2019;
accordingly, the 2015 Clean Water Rule is no longer in effect in any state. However, numerous legal challenges to the 2019 Repeal
Rule have already been filed in federal court.
In
February 2019, the EPA and the USACE published a proposed new rule that would differently revise the definition of “waters
of the United States” and essentially replace both the 1986 rule and the 2015 Clean Water Rule. On January 23, 2020, the
EPA and USACE announced the final new rule, titled the Navigable Waters Protection Rule (“2020 Rule”). The 2020 Rule
became effective on June 22, 2020. The 2020 Rule generally regulates four categories of “jurisdictional” waters: (i)
territorial seas and traditional navigable waters (i.e., large rivers); (ii) perennial and intermittent tributaries of these waters;
(iii) certain lakes, ponds and impoundments; and (iv) wetlands to jurisdictional waters. The 2020 Rule also includes 12 categories
of exclusions, or “non-jurisdictional” waters, including groundwater, ephemeral features and diffuse stormwater run-off
over upland areas. The 2020 Rule likely regulates fewer wetlands areas than were regulated under the 1986 rule and the 2015 Clean
Water Rule because it does not
regulate wetlands that are not adjacent to jurisdictional waters. This new definition of “waters
of the United States” has been challenged and sought to be enjoined in federal court. On June 19, 2020 the U.S. District
Court for the District of Colorado issued an administrative stay that enjoined the effectiveness of the 2020 Rule within Colorado.
State of Colorado v. U.S. Environmental Protection Agency, et al., Civil Action No. 20-cv-1461-WJM-NRN. (D.C. Colo. Jun.
19, 2020). With this stay in place, EPA and USACE jurisdiction is pursuant to the 1986 rule and subsequent guidance. The 2020
Rule changes the scope of the CWA’s jurisdiction, in every state except Colorado, which could result in increased costs
and delays with respect to obtaining permits for discharges of pollutants or dredge and fill activities in waters of the U.S.,
including regulated wetland areas.
In
January 2017, the USACE issued revised and renewed streamlined general nationwide permits that are available to satisfy permitting
requirements for certain work in streams, wetlands and other waters of the U.S. under Section 404 of the CWA and the Rivers and
Harbors Act. The new nationwide permits took effect in March 2017, or when certified by each state, whichever was later. The oil
and gas industry broadly utilizes nationwide permits 12 (“nwp 12”), 14 and 39 for the construction, maintenance and
repair of pipelines, roads and drill pads, respectively, and related structures in waters of the U.S. that impact less than a
half-acre of waters of the U.S. and meet the other criteria of each nationwide permit. There has been challenges to the NWP 12
on Endangered Species Act grounds in the United States District Court for the District of Montana that initially resulted in the
NWP 12 being vacated thoughout the United States. The Supreme Court of the United States ultimately limited to the vacatur to
just the Keystone XL pipeline. This suit is currently before the United States Ninth Circuit Court of Appeals. Northern Plains
v. United States Army Corps of Engineers, No. 20-35432 (9th Cir. May 20, 2020). However a recent suit in in the
Fourth Circuit Court of Appeals by environmental groups have raised the same Endangered Species Act challenges to a NWP 12 authorization
issued for the Mountain Valley Pipeline. Sierra Club v. United States Army Corps of Engineers., No. 20-2039, (4th
Cir. Oct. 5, 2020).
The
CWA also regulates storm water run-off from crude oil and natural gas facilities and requires storm water discharge permits for
certain activities. Spill Prevention, Control and Countermeasure (“SPCC”) requirements of the CWA require appropriate
secondary containment, load out controls, piping controls, berms and other measures to help prevent the contamination of navigable
waters in the event of a petroleum hydrocarbon spill, rupture or leak.
Subsurface
Injections
In
the course of its operations, PEDEVCO produces water in addition to oil and natural gas. Water that is not recycled may be disposed
of in disposal wells, which inject the produced water into non-producing subsurface formations. Underground injection operations
are regulated pursuant to the Underground Injection Control (“UIC”) program established under the federal Safe Drinking
Water Act (“SDWA”) and analogous state laws. The UIC program requires permits from the EPA or an analogous state agency
for the construction and operation of disposal wells, establishes minimum standards for disposal well operations, and restricts
the types and quantities of fluids that may be disposed. A change in UIC disposal well regulations or the inability to obtain
permits for new disposal wells in the future may affect PEDEVCO’s ability to dispose of produced water and ultimately increase
the cost of its operations. For example, in response to recent seismic events near belowground disposal wells used for the injection
of oil and natural gas-related wastewaters, regulators in some states, including Colorado, have imposed more stringent permitting
and operating requirements for produced water disposal wells. In Colorado, permit applications are reviewed specifically to evaluate
seismic activity and, as of 2011, the state has required operators to identify potential faults near proposed wells, if earthquakes
historically occurred in the area, and to accept maximum injection pressures and volumes based on fracture gradient as conditions
to permit approval. Additionally, legal disputes may arise based on allegations that disposal well operations have caused damage
to neighboring properties or otherwise violated state or federal rules regulating waste disposal. These developments could result
in additional regulation, restriction on the use of injection wells by PEDEVCO or by commercial disposal well vendors whom it
may use from time to time to dispose of wastewater, and increased costs of compliance, which could have a material adverse effect
on its capital expenditures and operating costs, financial condition, and results of operations.
Air
Emissions
PEDEVCO’s
operations are subject to the Clean Air Act (the “CAA”) and comparable state and local requirements. The CAA contains
provisions that may result in the gradual imposition of certain pollution control requirements with respect to air emissions from
its operations. The EPA and state governments continue to develop regulations to implement these requirements. PEDEVCO may be
required to make certain capital investments in the next several years for air pollution control equipment in connection with
maintaining or obtaining operating permits and approvals addressing other air emission-related issues.
In
June 2016, the EPA implemented new requirements focused on achieving additional methane and volatile organic compound reductions
from the oil and natural gas industry. The rules imposed, among other things, new requirements for leak detection and repair,
control requirements for oil well completions, replacement of certain pneumatic pumps and controllers and additional control requirements
for gathering, boosting and compressor stations. In September 2018, the EPA proposed revisions to the 2016 rules. The proposed
amendments address certain technical issues raised in administrative petitions and include proposed changes to, among other things,
the frequency of monitoring for fugitive emissions at well sites and compressor stations. In August of 2020, the EPA finalized
two rules that revised the 2016 rules that would remove all sources in the transmission and storage segment of the oil and natural
gas industry from regulation. The final rules also rescinded the methane requirements in the 2016 rules that apply to sources
in the
production and processing segments of the industry. The final rules also effectively rescinded the methane requirements
that apply to existing sources in the oil and natural gas industry, without removing any sources from the current source category.
Several environmental groups and the States of New York and California have challenged these final rules in the United States
District Court for the District of Columbia.
In
November 2016, the BLM finalized rules to further regulate venting, flaring and leaks during oil and natural gas production activities
on onshore federal and Indian leases. The rules require additional controls and impose new emissions and other standards on certain
operations on applicable leases, including committed state or private tracts in a federally approved unit or communitized agreement
that drains federal minerals. In September 2018, the BLM published a final rule (“the Revision Rule”) that revises
the 2016 rules. The Revision Rule, among other things, rescinds the 2016 rule requirements related to waste-minimization plans,
gas-capture percentages, well drilling, well completion and related operations, pneumatic controllers, pneumatic diaphragm pumps,
storage vessels and leak detection and repair. The RevisionRule also revised provisions related to venting and flaring. Environmental
groups and the States of California and New Mexico have filed challenges to the 2018 rule in the United States District Court
for the Northern District of California who, on July 15, 2020 the court vacated the Revision Rule. Because of the vacatur, on
July 21, 2020, the District of Wyoming revived a previous challenge to the 2016 rule levied by the States of Wyoming Montant,
North Dakota, Texas, and industry groups, who paused this litigation when the Revision Rule was challenged in California. As of
today, the 2016 rule is in effect for Colorado and New Mexico.
In
2016, the EPA increased the state of Colorado’s non-attainment ozone classification for the Denver Metro North Front Range
Ozone Eight-Hour Non-Attainment (“Denver Metro/North Front Range NAA”) area from “marginal” to “moderate”
under the 2008 national ambient air quality standard (“NAAQS”). This increase in non-attainment status triggered significant
additional obligations for the state under the CAA and resulted in Colorado adopting new and more stringent air quality control
requirements in November 2017 that are applicable to PEDEVCO’s operations. In 2019, the EPA increased the state of Colorado’s
non-attainment ozone classification for the Denver Metro/North Front Range NAA area from “moderate” to “serious”
under the 2008 NAAQS. This “serious” classification will trigger significant additional obligations for the state
under the CAA and could result in new and more stringent air quality control requirements, which may in turn result in significant
costs, and delays in obtaining necessary permits applicable to PEDEVCO’s operations.
SB
19-181 also requires, among other things, that the Air Quality Control Commission (“AQCC”) adopt additional rules
to minimize emissions of methane and other hydrocarbons and nitrogen oxides from the entire oil and gas fuel cycle. The AQCC anticipates
holding several rulemakings over the next several years to implement the requirements of SB 19-181, including a rulemaking to
require continuous emission monitoring equipment at oil and gas facilities. In December 2019, the AQCC held the first of several
rulemakings that are anticipated as a result of SB 19-181. As part of that rulemaking, the AQCC adopted significant additional
and new emission control requirements applicable to oil and gas operations, including, for example, hydrocarbon liquids unloading
control requirements and increased LDAR frequencies for facilities in certain proximity to occupied areas.
State-level
rules applicable to PEDEVCO’s operations include regulations imposed by the Colorado Department of Public Health and Environment’s
(“CDPHE”) Air Quality Control Commission, including stringent requirements relating to monitoring, recordkeeping and
reporting matters. In October 2019, the CDPHE published a human health risk assessment for oil and gas operations in Colorado,
which used oil and gas emission data to model possible human exposure and found a possibility of negative health impacts at distances
up to 2,000 feet away under worst case conditions. In response, the COGCC announced that it will more rigorously scrutinize permit
applications for wells within 2,000 feet of a building unit, work with CDPHE to obtain better site-specific data on oil and gas
emissions, and consider the resulting data for possible future rulemaking.
Regulation
of GHG Emissions
The
EPA has published findings that emissions of carbon dioxide, methane and other greenhouse gases (“GHGs”) present an
endangerment to public health and the environment because such emissions are, according to the EPA, contributing to warming of
the earth’s atmosphere and other climatic changes. These findings provide the basis for the EPA to adopt and implement regulations
that would restrict emissions of GHGs under existing provisions of the CAA. In June 2010, the EPA began regulating GHG emissions
from stationary sources.
In
the past, Congress has considered proposed legislation to reduce emissions of GHGs. To date, Congress has not adopted any such
significant legislation, but could do so in the future. In addition, many states and regions have taken legal measures to reduce
emissions of GHGs, primarily through the planned development of GHG emission inventories and/or regional GHG cap and trade programs.
In February 2014, November 2017 and December 2019, Colorado adopted rules regulating methane emissions from the oil and gas sector.
The
Obama administration reached an agreement during the December 2015 United Nations climate change conference in Paris pursuant
to which the U.S. initially pledged to make a 26 percent to 28 percent reduction in its GHG emissions by 2025, against a 2005
baseline, and committed to periodically update this pledge every five years starting in 2020 (the “Paris Agreement”).
In June 2017, President Trump announced that the U.S. would initiate the formal process to withdraw from the Paris Agreement.
In November 2019, the U.S. formally notified the United Nations of its intentions to withdraw from the Paris Agreement. The notification
begins a one-year process to complete the withdrawal.
Regulation
of methane and other GHG emissions associated with oil and natural gas production could impose significant requirements and costs
on PEDEVCO’s operations.
Regulation
of Flowlines
In
February 2018, the COGCC comprehensively amended its regulations for oil, gas and water flowlines in Colorado to expand requirements
addressing flowline registration and safety, integrity management, leak detection and other matters. In November 2019, the COGCC
further amended its flowline regulations pursuant to SB 19-181 to impose additional requirements regarding flowline mapping, operational
status, certification and abandonment, among other things. The COGCC has also adopted or amended numerous other rules in recent
years, including rules relating to safety, flood protection and spill reporting.
Hydraulic
Fracturing Activities
Hydraulic
fracturing is an important and common practice that is used to stimulate production of natural gas and/or oil from dense subsurface
rock formations. PEDEVCO regularly uses hydraulic fracturing as part of its operations. Hydraulic fracturing involves the injection
of water, sand or alternative proppant and chemicals under pressure into targeted geological formations to fracture the surrounding
rock and stimulate production. Hydraulic fracturing is typically regulated by state oil and natural gas commissions. However,
several federal agencies have asserted regulatory authority over certain aspects of the process. For example, in December 2016,
the EPA released its final report on the potential impacts of hydraulic fracturing on drinking water resources, concluding that
“water cycle” activities associated with hydraulic fracturing may impact drinking water resources under certain circumstances.
Additionally, the EPA published in June 2016 an effluent limitations guideline final rule pursuant to its authority under the
SDWA prohibiting the discharge of wastewater from onshore unconventional oil and natural gas extraction facilities to publicly
owned wastewater treatment plants; asserted regulatory authority in 2014 under the SDWA over hydraulic fracturing activities involving
the use of diesel and issued guidance covering such activities; and issued in 2014 a prepublication of its Advance Notice of Proposed
Rulemaking regarding Toxic Substances Control Act reporting of the chemical substances and mixtures used in hydraulic fracturing.
Also, the BLM published a final rule in March 2015 establishing new or more stringent standards for performing hydraulic fracturing
on federal and American Indian lands including well casing and wastewater storage requirements and an obligation for exploration
and production operators to disclose what chemicals they are using in fracturing activities. However, following years of litigation,
the BLM rescinded the rule in December 2017. Additionally, from time to time, legislation has been introduced, but not enacted,
in Congress to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in the fracturing
process. In the event that a new, federal level of legal restrictions relating to the hydraulic fracturing process is adopted
in areas where PEDEVCO operates, it may incur additional costs to comply with such federal requirements that may be significant
in nature, and also could become subject to additional permitting requirements and experience added delays or curtailment in the
pursuit of exploration, development, or production activities.
At
the state level, Colorado, where PEDEVCO conducts significant operations, is among the states that has adopted, and other states
are considering adopting, regulations that could impose new or more stringent permitting, disclosure or well-construction requirements
on hydraulic fracturing operations. Moreover, states could elect to prohibit high volume hydraulic fracturing altogether, following
the approach taken by the State of New York in 2015. Also, certain interest groups in Colorado opposed to oil and natural gas
development generally, and hydraulic fracturing in particular, have from time to time advanced various options for ballot initiatives
that, if approved, would allow revisions to the state constitution in a manner that would make such exploration and production
activities in the state more difficult in the future. However, during the November 2016 voting process, one proposed amendment
placed on the Colorado state ballot making it relatively more difficult to place an initiative on the state ballot was passed
by the voters. As a result, there are more stringent procedures now in place for placing an initiative on a state ballot. In addition
to state laws, local land use restrictions may restrict drilling or the hydraulic fracturing process and cities may adopt local
ordinances allowing hydraulic fracturing activities within their jurisdictions but regulating the time, place and manner of those
activities.
For
example, on November 6, 2018, registered voters in the State of Colorado cast their ballots and rejected Proposition 112 (“Prop.
112”), with 55% of ballots cast against the measure. Prop. 112 would have created a rigid 2,500-foot setback from oil and
gas facilities to the nearest occupied structure and other “vulnerable areas,” which included parks, ball fields,
open space, streams, lakes and intermittent streams. It would have dramatically increased the amount of surface area off-limits
to new energy development by 26 times and put 94% of private land in the top five oil and gas producing counties in the State
of Colorado off-limits to new development. See further discussion in “Risk Factors—Risk Factors Relating to PEDEVCO.”
Passed
in Colorado in 2019, SB 19-181, which gives local governmental authorities increased authority to
regulate oil and gas development. The authors of the legislation were clear that SB 19-181 was not intended to allow an outright
ban on oil and gas development. However, anti-industry activists in Longmont, Colorado, have argued in court that SB 19-181 permits
a local governmental authority to impose such a ban. PEDEVCO primarily operates in the rural
areas of the Wattenberg Field in Weld and Morgan Counties, jurisdictions in which there has historically been significant support
for the oil and gas industry.
If
new or more stringent federal, state or local legal restrictions relating to the hydraulic fracturing process are adopted in areas
where PEDEVCO operates, including, for example, on federal and American Indian lands, PEDEVCO could incur potentially significant
added costs to comply with such requirements, experience delays or curtailment in the pursuit of exploration, development or production
activities, and perhaps even be precluded from drilling wells.
In
the event that local or state restrictions or prohibitions are adopted in areas where PEDEVCO conducts operations, that impose
more stringent limitations on the production and development of oil and natural gas, including, among other things, the development
of increased setback distances, PEDEVCO and similarly situated oil and natural exploration and production operators in the state
may incur significant costs to comply with such requirements or may experience delays or curtailment in the pursuit of exploration,
development, or production activities, and possibly be limited or precluded in the drilling of wells or in the amounts that PEDEVCO
and similarly situated operates are ultimately able to produce from its reserves. Any such increased costs, delays, cessations,
restrictions or prohibitions could have a material adverse effect on PEDEVCO’s business, prospects, results of operations,
financial condition, and liquidity. If new or more stringent federal, state or local legal restrictions relating to the hydraulic
fracturing process are adopted in areas where PEDEVCO operates, including, for example, on federal and American Indian lands,
PEDEVCO could incur potentially significant added cost to comply with such requirements, experience delays or curtailment in the
pursuit of exploration, development or production activities, and perhaps even be precluded from drilling wells.
Moreover,
because most of PEDEVCO’s operations are conducted in two particular areas, the Permian Basin in New Mexico and the D-J
Basin in Colorado, legal restrictions imposed in that area will have a significantly greater adverse effect than if PEDEVCO had
its operations spread out amongst several diverse geographic areas. Consequently, in the event that local or state restrictions
or prohibitions are adopted in the Permian Basin in New Mexico and/or the D-J Basin in Colorado that impose more stringent limitations
on the production and development of oil and natural gas, PEDEVCO may incur significant costs to comply with such requirements
or may experience delays or curtailment in the pursuit of exploration, development, or production activities, and possibly be
limited or precluded in the drilling of wells or in the amounts that PEDEVCO is ultimately able to produce from its reserves.
Any such increased costs, delays, cessations, restrictions or prohibitions could have a material adverse effect on PEDEVCO’s
business, prospects, results of operations, financial condition, and liquidity.
Activities
on Federal Lands
Oil
and natural gas exploration, development and production activities on federal lands, including American Indian lands and lands
administered by the BLM, are subject to the National Environmental Policy Act (“NEPA”). NEPA requires federal agencies,
including the BLM, to evaluate major agency actions having the potential to significantly impact the environment. In the course
of such evaluations, an agency will prepare an Environmental Assessment that assesses the potential direct, indirect and cumulative
impacts of a proposed project and, if necessary, will prepare a more detailed Environmental Impact Statement that may be made
available for public review and comment. While PEDEVCO currently has no exploration, development and production activities on
federal lands, its future exploration, development and production activities may include leasing of federal mineral interests,
which will require the acquisition of governmental permits or authorizations that are subject to the requirements of NEPA. This
process has the potential to delay or limit, or increase the cost of, the development of oil and natural gas projects. Authorizations
that under NEPA review are also subject to protest, appeal or litigation, any or all of which may delay or halt projects. Moreover,
depending on the mitigation strategies recommended in Environmental Assessments or Environmental Impact Statements, PEDEVCO could
incur added costs, which may be substantial.
Endangered
Species and Migratory Birds Considerations
The
federal Endangered Species Act (“ESA”), and comparable state laws were established to protect endangered and threatened
species. Pursuant to the ESA, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely
affecting that species or that species’ habitat. Similar protections are offered to migrating birds under the Migratory
Bird Treaty Act. PEDEVCO may conduct operations on oil and natural gas leases in areas where certain species that are listed as
threatened or endangered are known to exist and where other species, such as the sage grouse, that potentially could be listed
as threatened or endangered under the ESA may exist. Moreover, as a result of one or more agreements entered into by the U.S.
Fish and Wildlife Service, the agency is required to make a determination on listing of numerous species as endangered or threatened
under the ESA pursuant to specific timelines. The identification or designation of previously unprotected species as threatened
or endangered in areas where underlying property operations are conducted could cause PEDEVCO to incur increased costs arising
from species protection measures, time delays or limitations on its exploration and production activities that could have an adverse
impact on its ability to develop and produce reserves. If PEDEVCO were to have a portion of its leases designated as critical
or suitable habitat, it could adversely impact the value of its leases.
OSHA
PEDEVCO
is subject to the requirements of the Occupational Safety and Health Administration (“OSHA”) and comparable state
statutes whose purpose is to protect the health and safety of workers. In addition, the OSHA hazard communication standard, the
Emergency Planning and Community Right-to-Know Act and comparable state statutes and any implementing regulations require that
PEDEVCO organizes and/or discloses information about hazardous materials used or produced in its operations and that this information
be provided to employees, state and local governmental authorities and citizens.
Private
Lawsuits
Lawsuits
have been filed against other operators in several states, including Colorado, alleging contamination of drinking water as a result
of hydraulic fracturing activities.
Related
Permits and Authorizations
Many
environmental laws require PEDEVCO to obtain permits or other authorizations from state and/or federal agencies before initiating
certain drilling, construction, production, operation, or other oil and natural gas activities, and to maintain these permits
and compliance with their requirements for on-going operations. These permits are generally subject to protest, appeal, or litigation,
which can in certain cases delay or halt projects and cease production or operation of wells, pipelines, and other operations.
PEDEVCO
is not able to predict the timing, scope and effect of any currently proposed or future laws or regulations regarding hydraulic
fracturing, but the direct and indirect costs of such laws and regulations (if enacted) could materially and adversely affect
its business, financial conditions and results of operations. See further discussion in “Risk Factors—Risk Factors
Relating to PEDEVCO.”
Insurance
PEDEVCO’s
oil and gas properties are subject to hazards inherent in the oil and gas industry, such as accidents, blowouts, explosions, implosions,
fires and oil spills. These conditions can cause:
|
●
|
damage
to or destruction of property, equipment and the environment;
|
|
●
|
personal
injury or loss of life; and
|
|
●
|
suspension
of operations.
|
PEDEVCO
maintains insurance coverage that PEDEVCO believes to be customary in the industry against these types of hazards. However, PEDEVCO
may not be able to maintain adequate insurance in the future at rates it considers reasonable. In addition, PEDEVCO’s insurance
is subject to coverage limits and some policies exclude coverage for damages resulting from environmental contamination. The occurrence
of a significant event or adverse claim in excess of the insurance coverage that PEDEVCO maintains or that is not covered by insurance
could have a material adverse effect on its financial condition and results of operations.
Employees
At
September 30, 2020, PEDEVCO employed 15 people and also utilizes the services of independent contractors to perform various field
and other services. PEDEVCO’s future success will depend partially on its ability to attract, retain and motivate qualified
personnel. PEDEVCO is not a party to any collective bargaining agreements and have not experienced any strikes or work stoppages.
PEDEVCO considers its relations with its employees to be satisfactory.
Description
of Property
The
information regarding the Company’s oil and gas properties is included in “Information about PEDEVCO—Description
of Business—Oil and Gas Properties”, above and incorporated in this Description of Property by reference.
Office
Leases
In
June 2018, the Company assumed the lease for its corporate office space located in Houston, Texas from American Resources, Inc.,
an entity beneficially owned and controlled by Ivar Siem, a director of the Company, and J. Douglas Schick, the Company’s
President. The term of the lease ended on August 31, 2019.
Effective
September 1, 2019, the Company moved its corporate headquarters from 1250 Wood Branch Park Dr., Suite 400, Houston, Texas 77079
to 575 N. Dairy Ashford, Energy Center II, Suite 210, Houston, Texas 77079 in connection with the expiration of its former office
space lease. The Company entered into a sublease on approximately 5,200 square feet of office space that expires on August 31,
2023, and has a base monthly rent of approximately $10,000 with the first month rent due beginning on January 1, 2020. The Company
paid a security deposit of $9,600.
On
November 1, 2019, the Company subleased approximately 300 square feet of office space at its current headquarters to SK Energy,
which is owned and controlled by Dr. Kukes, our Chief Executive Officer and a member of the Board of Directors. The lease renews
on a monthly basis, may be terminated by either party at any time upon prior written notice delivered to the other party, and
has a monthly base rent of $1,200.
The
Company also leased space for its former corporate headquarters in Danville, California that was scheduled to expire on July 31,
2019, but was terminated in January 2019, without penalty or other amounts due. In February 2019, the Company entered into a six-month
lease agreement for 187 square feet of new office space located in Danville, California for the Company’s General Counsel.
The monthly rent is $1,200, and the Company paid a $1,200 security deposit. In August 2019, the lease was extended for an additional
six months on the same terms. The lease was subsequently extended for an additional six months in February 2020 at the same rate,
expiring at the end of August 2020. The total current obligation for the remainder of this lease through July 2020 is $8,400.
For
the year ended December 31, 2019 and 2018, the Company incurred lease expense of $139,000 and $98,000, respectively, for the combined
leases.
Legal
Proceedings
From
time to time, PEDEVCO may become party to litigation or other legal proceedings that it considers to be a part of the ordinary
course of business. PEDEVCO is not currently involved in any legal proceedings that it believes could reasonably be expected to
have a material adverse effect on its business, prospects, financial condition or results of operations. PEDEVCO may become involved
in material legal proceedings in the future.
Management’s
Discussion and Analysis of Financial Information and Results of Operations
The
following is management’s discussion and analysis of the significant factors that affected PEDEVCO’s financial position
and results of operations during the periods included in the accompanying consolidated financial statements.
General
Overview
PEDEVCO
is an oil and gas company focused on the acquisition and development of oil and natural gas assets where the latest in modern
drilling and completion techniques and technologies have yet to be applied. In particular, PEDEVCO focuses on legacy proven properties
where there is a long production history, well defined geology and existing infrastructure that can be leveraged when applying
modern field management technologies. PEDEVCO’s current properties are located in the San Andres formation of the Permian
Basin situated in West Texas and eastern New Mexico and in the Denver-Julesberg Basin in Colorado. As of September 30, 2020, PEDEVCO
held 37,069 net Permian Basin acres located in Chaves and Roosevelt Counties, New Mexico, through its wholly-owned operating subsidiary,
PEDCO, which is referred to as PEDEVCO’s Permian Basin Asset, and approximately 11,948 net D-J Basin acres located in Weld
and Morgan Counties, Colorado, through its wholly-owned operating subsidiary, Red Hawk, which asset is referred to as the D-J
Basin Asset. As of September 30, 2020, PEDEVCO held interests in 378 gross (298 net) wells in its Permian Basin Asset, of which
26 were active producers, 13 were active injectors and two wells were active Saltwater Disposal Wells (“SWDs”), all
of which are held by PEDCO and operated by its wholly-owned operating subsidiaries, and interests in 75 gross (21.9 net) wells
in its D-J Basin Asset, of which 18 gross (16.2 net) wells are operated by Red Hawk and were producing, 36 gross (5.6 net) wells
are non-operated, and 21 wells have an after-payout interest.
As
a result of the recent COVID-19 outbreak, and the recent sharp decline in oil prices which occurred partially as a result of the
decreased demand for oil caused by such outbreak and the actions taken globally to stop the spread of such virus, in mid-April
2020, PEDEVCO temporarily shut-in all of its operated producing wells in its Permian Basin Asset and D-J Basin Asset to preserve
PEDEVCO’s oil and gas reserves for production during a more favorable oil price environment, noting that most of PEDEVCO’s
acreage is held by production with no drilling obligations, which provides PEDEVCO with flexibility to hold back on production
and development during periods of low oil and gas prices. Following the partial recovery in oil prices, commencing in early June
2020, PEDEVCO resumed full production from its operated wells in the Permian Basin and the D-J Basin that PEDEVCO shut-in in mid-April
2020, and is now working to complete several carryover projects from 2019’s Phase II Permian Basin Asset development plan
which it had put on hold due to the COVID-19 outbreak. PEDEVCO will continue to monitor oil prices with a view to reactivating
all of its shut-in production and fully completing its 2019 carryover development plan.
How
PEDEVCO Conducts Its Business and Evaluates Its Operations
PEDEVCO’s
use of capital for acquisitions and development allows it to direct its capital resources to what it believes to be the most attractive
opportunities as market conditions evolve. PEDEVCO has historically acquired properties that it believes had significant appreciation
potential. PEDEVCO intends to continue to acquire both operated and non-operated properties to the extent it believes they meet
its return objectives.
PEDEVCO
will use a variety of financial and operational metrics to assess the performance of its oil and natural gas operations, including:
|
●
|
realized
prices on the sale of oil and natural gas, including the effects of PEDEVCO’s commodity
derivative contracts;
|
|
●
|
oil
and natural gas production and operating expenses;
|
|
●
|
general
and administrative expenses;
|
|
●
|
net
cash provided by operating activities; and
|
Reserves
PEDEVCO’s
estimated net proved crude oil and natural gas reserves at December 31, 2019 and 2018 were approximately 14.0 million Boe and
12.4 million Boe, respectively. This reserve level increased approximately 1.6 million Boe or 13%, from 2018 to 2019. In 2019,
PEDEVCO had an increase in reserves primarily due to the drilling and completion of nine new productive wells in the Permian Basin,
as well as PEDEVCO’S participation (non-operated working interest), in 11 productive wells in the DJ-Basin.
Using
the average monthly crude oil price of $55.69 per Bbl and natural gas price of $2.58 per thousand cubic feet (Mcf) for the twelve
months ended December 31, 2019, PEDEVCO’S estimated discounted future net cash flow (PV-10) before tax expenses for its
proved reserves was approximately $122.7 million, of which approximately $82.8 million are proved undeveloped reserves. Total
reserve value at December 31, 2019 represents a decrease of approximately $58.6 million or 32% from a year earlier using the same
SEC pricing and reserves methodology. The decrease can be attributed to a $69.1 million reduction due to changes in commodity
prices, coupled with a $21.5 million reduction due to increases in capital costs for proved undeveloped reserves and operating
expenses, offset by a $32.0 million increase in proved developed reserves from PEDEVCO’s drilling and completion activity
during the period which is noted above.
The
reserves as of December 31, 2019 were determined in accordance with standard industry practices and SEC regulations by the licensed
independent petroleum engineering firm of Cawley, Gillespie & Associates, Inc. A large portion of the proved undeveloped crude
oil reserves are associated with the Permian Basin formation. Although these hydrocarbon quantities have been determined in accordance
with industry standards, they are prepared using the subjective judgments of the independent engineers and may actually be more
or less.
Oil
and Natural Gas Sales Volumes
During
the year ended December 31, 2019, PEDEVCO’s net crude oil, natural gas and NGLs sales volumes increased to 266,070 Bbls
or 729 Bopd from 92,985 Bbls, or 255 Bopd, a 186% increase over the previous fiscal year. The production increase is primarily
related to PEDEVCO’s acquisition of oil and gas properties in third quarter of 2018, which in turn increased production
for 2019, and the drilling and completion of five new productive wells, four of which began production in the first quarter of
2019, in the Permian Basin, as well as PEDEVCO’s participation (non-operated working interest) in 11 productive wells in
the DJ-Basin.
Although
PEDEVCO shut-in all of its operated wells for 42 days during the 2020 period as a result of the severe reduction in pricing from
the decreased demand in oil and gas related to the COVID-19 outbreak, production during the six months ended June 30, 2020 increased
compared to the prior six-month period primarily from five new productive wells in its Permian Basin Asset, as well as PEDEVCO’s
participation (non-operated working interest) in the drilling and completion of 11 productive wells in its D-J Basin Asset, which
occurred in the latter part of the 2019 fiscal year and are now being realized. However, the 31% increase in production was not
able to overcome the significant price declines.
Significant
Capital Expenditures
The
table below sets out the significant components of capital expenditures for the year ended December 31, 2019 (in thousands):
|
|
2019
|
|
Capital Expenditures
|
|
|
|
|
Leasehold Acquisitions(1)
|
|
$
|
468
|
|
Property Acquisitions (1)
|
|
|
652
|
|
Drilling and Facilities(2)
|
|
|
41,810
|
|
Total
|
|
$
|
42,930
|
|
|
(1)
|
Consists
of amounts related to the acquisition of certain oil and gas properties during 2019 (discussed
in greater detail at “Note 6 - Oil and Gas Properties” in the notes to the
audited consolidated financial statements of PEDEVCO included in this offer to exchange.
|
|
(2)
|
Consists
of amounts primarily related to the drilling and completion of nine wells in the Permian
and PEDEVCO’s participation in the drilling and completion of 11 wells in the DJ-Basin
by a third-party operator.
|
The
table below sets out the significant components of capital expenditures for the six months ended June 30, 2020 (in thousands):
Capital Expenditures
|
|
June 30,
2020
|
|
Leasehold Acquisitions
|
|
$
|
73
|
|
Drilling and Facilities
|
|
|
5,329
|
|
Total(1)
|
|
$
|
5,402
|
|
|
(1)
|
See
“Note 6 - Oil and Gas Properties” in the notes to the unaudited consolidated
financial statements of PEDEVCO included in this offer to exchange.
|
Market
Conditions and Commodity Prices
PEDEVCO’s
financial results depend on many factors, particularly the price of natural gas and crude oil and its ability to market its production
on economically attractive terms. Commodity prices are affected by many factors outside of PEDEVCO’s control, including
changes in market supply and demand, which are impacted by weather conditions, inventory storage levels, basis differentials and
other factors. As a result, PEDEVCO cannot accurately predict future commodity prices and, therefore, PEDEVCO cannot determine
with any degree of certainty what effect increases or decreases in these prices will have on its production volumes or revenues.
In addition to production volumes and commodity prices, finding and developing sufficient amounts of natural gas and crude oil
reserves at economical costs are critical to its long-term success. PEDEVCO expect prices to remain volatile for the remainder
of the year. For information about the impact of realized commodity prices on PEDEVCO’s natural gas and crude oil and condensate
revenues, refer to “Results of Operations” below.
Results
of Operations and Financial Condition
The
following discussion and analysis of the results of operations for the years ended December 31, 2018 and 2019 should be read in
conjunction with PEDEVCO’s audited consolidated financial statements and the notes thereto included in this offer to exchange.
The following discussion and analysis of the results of operations for the three and six-month periods ended June 30, 2020 and
2019, should be read in conjunction with PEDEVCO’s unaudited consolidated financial statements and notes thereto included
in this offer to exchange. The majority of the numbers presented below are rounded numbers and should be considered as approximate.
Results
for the Years Ended December 31, 2019 and 2018
PEDEVCO
reported a net loss for the year ended December 31, 2019 of $11.1 million, or ($0.22) per share, compared to net income for the
year ended December 31, 2018 of $53.6 million or $4.80 per share. The decrease in net income of $64.7 million was primarily due
to the recognition of a one-time $70.3 million gain on debt restructuring in June 2018. Excluding this significant non-recurring
transaction, PEDEVCO’s net loss decreased by $5.6 million, due to a reduction in interest expense incurred of $6.9 million,
as a result of its 2018 debt restructuring, coupled with $8.4 million in additional revenue and a $1.0 million gain on asset sale,
offset by a $0.5 million loss on the settlement of Asset Retirement Obligations (“ARO”) and additional operating expenses
of $10.2 million, from PEDEVCO’s production increases, as well as the hiring of additional staff and consultants, when comparing
the current period to the prior period.
Net
Revenues
The
following table sets forth the revenue and production data for the years ended December 31, 2019 and 2018:
|
|
2019
|
|
|
2018
|
|
|
Increase
(Decrease)
|
|
|
%
Increase
(Decrease)
|
|
Sale Volumes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil (Bbls)
|
|
|
234,378
|
|
|
|
70,395
|
|
|
|
163,983
|
|
|
|
233
|
%
|
Natural Gas (Mcf)
|
|
|
153,251
|
|
|
|
89,769
|
|
|
|
63,482
|
|
|
|
71
|
%
|
NGL (Bbls)
|
|
|
6,150
|
|
|
|
7,629
|
|
|
|
(1,479
|
)
|
|
|
(19
|
%)
|
Total (Boe)
|
|
|
266,070
|
|
|
|
92,985
|
|
|
|
173,085
|
|
|
|
186
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil (Bbls per day)
|
|
|
642
|
|
|
|
193
|
|
|
|
449
|
|
|
|
233
|
%
|
Natural Gas (Mcf per day)
|
|
|
420
|
|
|
|
246
|
|
|
|
174
|
|
|
|
71
|
%
|
NGL (Bbls per day)
|
|
|
17
|
|
|
|
21
|
|
|
|
(4
|
)
|
|
|
(19
|
%)
|
Total (Boe per day)
|
|
|
729
|
|
|
|
255
|
|
|
|
474
|
|
|
|
186
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Sale Price:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil ($/Bbl)
|
|
$
|
53.41
|
|
|
$
|
59.00
|
|
|
$
|
(5.59
|
)
|
|
|
(9
|
%)
|
Natural Gas($/Mcf)
|
|
|
2.43
|
|
|
|
2.56
|
|
|
|
(0.13
|
)
|
|
|
(5
|
%)
|
NGL ($/Bbl)
|
|
|
13.28
|
|
|
|
18.32
|
|
|
|
(5.04
|
)
|
|
|
(28
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Operating Revenues (In thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil
|
|
$
|
12,518
|
|
|
$
|
4,153
|
|
|
$
|
8,365
|
|
|
|
201
|
%
|
Natural Gas
|
|
|
372
|
|
|
|
230
|
|
|
|
142
|
|
|
|
62
|
%
|
NGL
|
|
|
82
|
|
|
|
140
|
|
|
|
(58
|
)
|
|
|
(41
|
%)
|
Total Revenues
|
|
$
|
12,972
|
|
|
$
|
4,523
|
|
|
$
|
8,449
|
|
|
|
187
|
%
|
|
(1)
|
Assumes
6 Mcf of natural gas equivalents to 1 barrel of oil.
|
Total
crude oil and natural gas revenues for the year ended December 31, 2019 increased $8.5 million, or 187%, to $13.0 million, compared
to $4.5 million for the same period a year ago due primarily to a favorable crude oil volume variance of $8.9 million, offset
by an unfavorable crude oil price variance of $0.4 million. Production increases are primarily from PEDEVCO drilling and completing
five productive wells in its Permian Basin, as well as its participation (non-operated working interest) in the drilling and completion
of 11 productive wells in its DJ-Basin and additional workover activities during the period.
Net
Operating and Other (Income) Expenses
The
following table sets forth operating and other expenses for the years ended December 31, 2019 and 2018 (In thousands):
|
|
2019
|
|
|
2018
|
|
|
Increase
(Decrease)
|
|
|
% Increase
(Decrease)
|
|
Direct Lease Operating Expenses
|
|
$
|
4,077
|
|
|
$
|
1,839
|
|
|
$
|
2,238
|
|
|
|
122
|
%
|
Workovers
|
|
|
1,421
|
|
|
|
695
|
|
|
|
726
|
|
|
|
104
|
%
|
Other*
|
|
|
1,319
|
|
|
|
287
|
|
|
|
1,032
|
|
|
|
360
|
%
|
Total Lease Operating Expenses
|
|
|
6,817
|
|
|
|
2,821
|
|
|
|
3,996
|
|
|
|
142
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exploration Expenses
|
|
|
110
|
|
|
|
47
|
|
|
|
63
|
|
|
|
134
|
%
|
Depreciation, Depletion, Amortization and Accretion
|
|
|
11,031
|
|
|
|
6,519
|
|
|
|
4,512
|
|
|
|
69
|
%
|
Loss on settlement of ARO
|
|
|
496
|
|
|
|
—
|
|
|
|
496
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and Administrative (Cash)
|
|
$
|
4,228
|
|
|
$
|
3,278
|
|
|
$
|
950
|
|
|
|
29
|
%
|
Share-Based Compensation (Non-Cash)
|
|
|
1,557
|
|
|
|
862
|
|
|
|
695
|
|
|
|
81
|
%
|
Total General and Administrative Expense
|
|
|
5,785
|
|
|
|
4,140
|
|
|
|
1,645
|
|
|
|
40
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on Sale of Oil and Gas Properties
|
|
$
|
1,040
|
|
|
$
|
—
|
|
|
$
|
1,040
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense
|
|
$
|
824
|
|
|
$
|
7,699
|
|
|
$
|
(6,875
|
)
|
|
|
(89
|
%)
|
Interest Income
|
|
$
|
55
|
|
|
$
|
1
|
|
|
$
|
54
|
|
|
|
5,400
|
%
|
Gain on Debt Extinguishment
|
|
$
|
—
|
|
|
$
|
70,309
|
|
|
$
|
(70,309
|
)
|
|
|
(100
|
%)
|
Other Expense
|
|
$
|
106
|
|
|
$
|
—
|
|
|
$
|
106
|
|
|
|
100
|
%
|
|
*
|
Includes
severance, ad valorem taxes and marketing costs.
|
Lease
Operating Expenses. The increase of $4.0 million in lease operating expenses was primarily due to $0.7 million in increased
workover expenses coupled with higher direct and variable lease operating expenses associated with the higher oil volume resulting
from the increased number of wells and increased oil production during the current year’s period, compared to the prior
year’s period, due to the Permian Basin Asset acquisition in September 2018, as well as production from PEDEVCO’s
completed wells in 2019.
Exploration
Expense. There was a minimal change in exploration expenses for 2019 compared to 2018, as there was a minimal increase in
exploration activity undertaken by PEDEVCO in the current year’s period compared to the prior year’s period.
Depreciation,
Depletion, Amortization and Accretion. The $4.5 million increase in depreciation, depletion, amortization and accretion was
primarily the result of higher oil volume resulting from the increased number of wells and increased oil production from PEDEVCO’s
four new producing wells during the current year’s period, compared to the prior year’s period.
Loss
on Settlement of ARO. During 2019, PEDEVCO incurred a $0.5 million loss on the plugging and abandonment of seven wells located
in the Permian Asset. PEDEVCO experienced unforeseen fishing and cleanout costs, in addition to a lack of available service providers,
which resulted in additional premium charges.
General
and Administrative Expenses (excluding share-based compensation). The increase of $1.0 million in general and administrative
expenses (excluding share-based compensation) was primarily due to increases in payroll, as well as other cost increases, resulting
from the hiring of additional personnel and consultants during the current year’s period, compared to the prior year’s
period.
Share-Based
Compensation. Share-based compensation, which is included in general and administrative expenses in the Statements of Operations,
increased by $0.7 million primarily due to an increase in the awarding of employee stock-based options and compensation. Share-based
compensation is utilized for the purpose of conserving cash resources for use in field development activities and operations.
Gain
on Sale of Oil and Gas Properties. PEDEVCO sold rights to 85.5 net acres and acquired 121 net acres of oil and gas leases
located in Weld County, Colorado, to a third party during 2019, for aggregate proceeds of $1.2 million and recognized a gain on
sale of oil and gas properties of $1.0 million.
Interest
Expense. The decrease of $6.9 million in interest expense was due primarily to the conversion of all of PEDEVCO’s outstanding
debt in the first quarter of 2019, coupled with PEDEVCO’s June 2018 debt restructuring, noted above, when comparing the
current period to the prior period.
Gain
on Debt Extinguishment. During 2018, PEDEVCO recognized a one-time gain of $70.3 million on PEDEVCO’s debt restructuring,
which occurred in June 2018.
Interest
Income and Other Expense. Includes interest earned from PEDEVCO’s interest-bearing cash accounts, and the write-off
of a $0.1 million third party option related to the option to acquire shares of Caspian Energy, described in greater detail under
“Note 7 – Other Current Assets” in the notes to PEDEVCO audited consolidated financial statements included in
this offer to exchange.
Three
Months Ended June 30, 2020 vs. Three Months Ended June 30, 2019
PEDEVCO
reported a net loss for the three-month period ended June 30, 2020 of $2.7 million, or ($0.04) per share, compared to a net loss
for the three-month period ended June 30, 2019 of $2.5 million or ($0.05) per share. The increase in net loss of $0.2 million
was due to a decrease in production as PEDEVCO had shut-in all of its operated producing wells in the Permian Basin Asset and
D-J Basin Asset in late April 2020, as a result of the COVID-19 outbreak, and the sharp decline in oil prices which occurred partially
as a result of the decreased demand for oil caused by such outbreak. In early June 2020, as prices began to partially recover,
PEDEVCO resumed full production from its previously producing operated wells. In total, PEDEVCO shut-in all its operated wells
for a period of 42 days during the three months ended June 30, 2020.
Net
Revenues
The
following table sets forth the revenue and production data for the three months ended June 30, 2020 and 2019:
|
|
Three
Months Ended
June 30,
|
|
|
Increase
|
|
|
%
Increase
|
|
|
|
2020
|
|
|
2019
|
|
|
(Decrease)
|
|
|
(Decrease)
|
|
Sale Volumes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil (Bbls)
|
|
|
35,889
|
|
|
|
71,443
|
|
|
|
(35,554
|
)
|
|
|
(50
|
%)
|
Natural Gas (Mcf)
|
|
|
44,500
|
|
|
|
13,792
|
|
|
|
30,708
|
|
|
|
223
|
%
|
NGL (Bbls)
|
|
|
3,224
|
|
|
|
478
|
|
|
|
2,746
|
|
|
|
574
|
%
|
Total (Boe)(1)
|
|
|
46,530
|
|
|
|
74,220
|
|
|
|
(27,690
|
)
|
|
|
(37
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil (Bbls per day)
|
|
|
394
|
|
|
|
785
|
|
|
|
(391
|
)
|
|
|
(50
|
%)
|
Natural Gas (Mcf per day)
|
|
|
489
|
|
|
|
152
|
|
|
|
337
|
|
|
|
222
|
%
|
NGL (Bbls per day)
|
|
|
35
|
|
|
|
5
|
|
|
|
30
|
|
|
|
600
|
%
|
Total (Boe per day)(1)
|
|
|
511
|
|
|
|
816
|
|
|
|
(305
|
)
|
|
|
(37
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Sale Price:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil ($/Bbl)
|
|
$
|
16.85
|
|
|
$
|
56.50
|
|
|
$
|
(39.65
|
)
|
|
|
(70
|
%)
|
Natural Gas ($/Mcf)
|
|
|
0.93
|
|
|
|
1.85
|
|
|
|
(0.92
|
)
|
|
|
(50
|
%)
|
NGL ($/Bbl)
|
|
|
3.20
|
|
|
|
16.07
|
|
|
|
(12.87
|
)
|
|
|
(80
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Operating Revenues (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil
|
|
$
|
605
|
|
|
$
|
4,037
|
|
|
$
|
(3,432
|
)
|
|
|
(85
|
%)
|
Natural Gas
|
|
|
41
|
|
|
|
26
|
|
|
|
15
|
|
|
|
58
|
%
|
NGL
|
|
|
10
|
|
|
|
7
|
|
|
|
3
|
|
|
|
43
|
%
|
Total Revenues
|
|
$
|
656
|
|
|
$
|
4,070
|
|
|
$
|
(3,414
|
)
|
|
|
(84
|
%)
|
|
(1)
|
Assumes
6 Mcf of natural gas equivalents to 1 barrel of oil.
|
Total
crude oil and natural gas revenues for the three-month period ended June 30, 2020 decreased $3.4 million, or 84%, to $0.7 million,
compared to $4.1 million for the same period a year ago, due to an unfavorable price variance of $2.8 million, coupled with an
unfavorable volume variance of $0.6 million. As noted above, PEDEVCO shut-in all of its operated wells for 42 days during the
2020 period due to the severe reduction in pricing, coupled with significantly widened differentials from the decreased demand
related to the COVID-19 outbreak.
Operating
Expenses and Other Income (Expense)
The
following table summarizes PEDEVCO’s production costs and operating expenses for the three months ended June 30, 2020 and
2019 (in thousands):
|
|
Three
Months Ended
June 30,
|
|
|
Increase
|
|
|
%
Increase
|
|
|
|
2020
|
|
|
2019
|
|
|
(Decrease)
|
|
|
(Decrease)
|
|
Direct Lease Operating Expenses
|
|
$
|
650
|
|
|
$
|
1,123
|
|
|
$
|
(473
|
)
|
|
|
(42
|
%)
|
Workovers
|
|
|
(29
|
)
|
|
|
595
|
|
|
|
(624
|
)
|
|
|
(105
|
%)
|
Gain on settlement of ARO
|
|
|
(19
|
)
|
|
|
—
|
|
|
|
(19
|
)
|
|
|
100
|
%
|
Other*
|
|
|
148
|
|
|
|
377
|
|
|
|
(229
|
)
|
|
|
(61
|
%)
|
Total Lease Operating Expenses
|
|
|
750
|
|
|
|
2,095
|
|
|
|
(1,345
|
)
|
|
|
(64
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exploration Expenses
|
|
|
—
|
|
|
|
13
|
|
|
|
(13
|
)
|
|
|
(100
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation, Depletion, Amortization and Accretion
|
|
|
1,912
|
|
|
|
2,784
|
|
|
|
(872
|
)
|
|
|
(31
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and Administrative (Cash)
|
|
$
|
703
|
|
|
$
|
1,246
|
|
|
$
|
(543
|
)
|
|
|
(44
|
%)
|
Share-Based Compensation (Non-Cash)
|
|
|
719
|
|
|
|
398
|
|
|
|
321
|
|
|
|
81
|
%
|
Total General and Administrative Expense
|
|
|
1,422
|
|
|
|
1,644
|
|
|
|
(222
|
)
|
|
|
(14
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Income
|
|
$
|
8
|
|
|
$
|
9
|
|
|
$
|
(1
|
)
|
|
|
(11
|
%)
|
Other Income (Expense)
|
|
$
|
679
|
|
|
$
|
(3
|
)
|
|
$
|
682
|
|
|
|
22,733
|
%
|
|
*
|
Includes
severance, ad valorem taxes and marketing costs
|
Lease
Operating Expenses. The decrease of $1.3 million was primarily due to the shut-in all of its operated wells for 42 days during
the 2020 period related to the severe reduction in pricing from the decreased demand related to the COVID-19 outbreak. Additionally,
there were cost adjustments related to workovers and a gain on the settlement of an asset retirement obligations (“ARO”)
liability when comparing the prior period to the current period.
Exploration
Expense. There was minimal change in exploration activity undertaken by PEDEVCO in the current year’s period compared
to the prior year’s period, with PEDEVCO conducting no exploration activities in the 2020 period as PEDEVCO sought to conserve
its operating cash in response to falling oil and gas prices resulting from decreased demand due to the COVID-19 pandemic.
Depreciation,
Depletion, Amortization and Accretion. As noted above, the $0.9 million decrease was primarily the result of lower oil volumes
related to the production decreases from all of its operated wells being shut-in over a 42-day period during the 2020 period.
General
and Administrative Expenses (“G&A”) (excluding share-based compensation). The decrease of $0.5 million in
general and administrative expenses (excluding share-based compensation) was primarily due to decreases in payroll, as well as
other cost decreases, resulting from a 20% reduction in salary for all of PEDEVCO’s salaried employees and officers implemented
on April 1, 2020, which was put in place in order to reduce costs at the time that oil and gas prices were falling as a result
of decreased demand due to the COVID-19 pandemic, and a reduction of non-essential contractors.
Share-Based
Compensation. Share-based compensation, which is included in general and administrative expenses in the Statements of Operations,
increased by $0.3 million primarily due to an increase in the awarding of employee share-based options and restricted shares as
compensation during the 2020 period. Share-based compensation is utilized for the purpose of conserving cash resources for use
in field development activities and operations.
Interest
Income and Other Income (Expense). Includes interest earned from PEDEVCO’s interest-bearing cash accounts, and represented
the settlement of accounts payables of $0.6 million and the settlement of a dated $88,000 accounts receivable for the 2020 period.
Six
Months Ended June 30, 2020 vs. Six Months Ended June 30, 2019
PEDEVCO
reported a net loss for the six-month period ended June 30, 2020 of $7.0 million, or ($0.10) per share, compared to a net loss
for the six-month period ended June 30, 2019 of $5.5 million or ($0.14) per share. The increase in net loss of $1.5 million was
primarily due to a decrease in revenue of $2.2 million when comparing the current period to the prior period as result of the
of the COVID-19 outbreak, and its decision to shut-in its wells during the 2020 period, as noted above, resulting in lower production
and pricing, offset by $0.7 million in other income items related to accounts receivable and payable settlements.
Net
Revenues
The
following table sets forth the revenue and production data for the six months ended June 30, 2020 and 2019:
|
|
Six
Months Ended
June 30,
|
|
|
Increase
|
|
|
%
Increase
|
|
|
|
2020
|
|
|
2019
|
|
|
(Decrease)
|
|
|
(Decrease)
|
|
Sale Volumes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil (Bbls)
|
|
|
118,381
|
|
|
|
101,650
|
|
|
|
16,731
|
|
|
|
16
|
%
|
Natural Gas (Mcf)
|
|
|
105,366
|
|
|
|
37,756
|
|
|
|
67,610
|
|
|
|
179
|
%
|
NGL (Bbls)
|
|
|
7,103
|
|
|
|
1,389
|
|
|
|
5,714
|
|
|
|
411
|
%
|
Total (Boe)(1)
|
|
|
143,045
|
|
|
|
109,332
|
|
|
|
33,713
|
|
|
|
31
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil (Bbls per day)
|
|
|
650
|
|
|
|
562
|
|
|
|
88
|
|
|
|
16
|
%
|
Natural Gas (Mcf per day)
|
|
|
579
|
|
|
|
209
|
|
|
|
370
|
|
|
|
177
|
%
|
NGL (Bbls per day)
|
|
|
39
|
|
|
|
8
|
|
|
|
31
|
|
|
|
388
|
%
|
Total (Boe per day)(1)
|
|
|
786
|
|
|
|
605
|
|
|
|
181
|
|
|
|
30
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Sale Price:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil ($/Bbl)
|
|
$
|
27.93
|
|
|
$
|
54.00
|
|
|
$
|
(26.07
|
)
|
|
|
(48
|
%)
|
Natural Gas ($/Mcf)
|
|
|
1.24
|
|
|
|
3.57
|
|
|
|
(2.33
|
)
|
|
|
(65
|
%)
|
NGL ($/Bbl)
|
|
|
7.09
|
|
|
|
9.44
|
|
|
|
(2.35
|
)
|
|
|
(25
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Operating Revenues (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Crude Oil
|
|
$
|
3,307
|
|
|
$
|
5,490
|
|
|
$
|
(2,183
|
)
|
|
|
(40
|
%)
|
Natural Gas
|
|
|
131
|
|
|
|
135
|
|
|
|
(4
|
)
|
|
|
(3
|
%)
|
NGL
|
|
|
50
|
|
|
|
13
|
|
|
|
37
|
|
|
|
285
|
%
|
Total Revenues
|
|
$
|
3,488
|
|
|
$
|
5,638
|
|
|
$
|
(2,150
|
)
|
|
|
(38
|
%)
|
|
(1)
|
Assumes
6 Mcf of natural gas equivalents to 1 barrel of oil.
|
Total
crude oil and natural gas revenues for the six-month period ended June 30, 2020 decreased $2.1 million, or 38%, to $3.5 million,
compared to $5.6 million for the same period a year ago, due primarily to an unfavorable price variance of $2.7 million, partially
offset by a favorable volume variance of $0.6 million. Although PEDEVCO shut-in all of its operated wells for 42 days during the
2020 period as a result of the severe reduction in pricing from the decreased demand in oil and gas related to the COVID-19 outbreak,
production amounts did increase overall in the current six-month period compared to the prior six-month period primarily from
five new productive wells in the Permian Basin Asset, as well as PEDEVCO’s participation (non-operated working interest)
in the drilling and completion of 11 productive wells in the D-J Basin Asset, which occurred in the latter part of the 2019 fiscal
year and are now being realized in the current period. However, the 31% increase in production was not able to overcome the significant
price declines.
Operating
Expenses and Other Income (Expense)
The
following table summarizes PEDEVCO’s production costs and operating expenses for the periods indicated (in thousands):
|
|
Six
Months Ended
June 30,
|
|
|
Increase
|
|
|
%
Increase
|
|
|
|
2020
|
|
|
2019
|
|
|
(Decrease)
|
|
|
(Decrease)
|
|
Direct Lease Operating Expenses
|
|
$
|
1,739
|
|
|
$
|
1,894
|
|
|
$
|
(155
|
)
|
|
|
(8
|
%)
|
Workovers
|
|
|
137
|
|
|
|
681
|
|
|
|
(544
|
)
|
|
|
(80
|
%)
|
Gain on settlement of ARO
|
|
|
(19
|
)
|
|
|
—
|
|
|
|
(19
|
)
|
|
|
100
|
%
|
Other*
|
|
|
415
|
|
|
|
490
|
|
|
|
(75
|
)
|
|
|
(15
|
%)
|
Total Lease Operating Expenses
|
|
|
2,272
|
|
|
|
3,065
|
|
|
|
(793
|
)
|
|
|
(26
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exploration Expenses
|
|
|
30
|
|
|
|
23
|
|
|
|
7
|
|
|
|
30
|
%
|
Depreciation, Depletion,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization and Accretion
|
|
|
5,349
|
|
|
|
5,033
|
|
|
|
316
|
|
|
|
6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and Administrative (Cash)
|
|
$
|
1,973
|
|
|
$
|
2,275
|
|
|
$
|
(302
|
)
|
|
|
(13
|
%)
|
Share-Based Compensation (Non-Cash)
|
|
|
1,572
|
|
|
|
697
|
|
|
|
875
|
|
|
|
126
|
%
|
Total General and Administrative Expense
|
|
|
3,545
|
|
|
|
2,972
|
|
|
|
573
|
|
|
|
19
|
%
|
|
|
Six
Months Ended
June 30,
|
|
|
Increase
|
|
|
%
Increase
|
|
|
|
2020
|
|
|
2019
|
|
|
(Decrease)
|
|
|
(Decrease)
|
|
Gain on sale of oil and gas properties
|
|
$
|
—
|
|
|
$
|
920
|
|
|
$
|
(920
|
)
|
|
|
(100
|
%)
|
Interest Expense
|
|
$
|
—
|
|
|
$
|
826
|
|
|
$
|
(826
|
)
|
|
|
(100
|
%)
|
Interest Income
|
|
$
|
32
|
|
|
$
|
9
|
|
|
$
|
23
|
|
|
|
256
|
%
|
Other Income (Expense)
|
|
$
|
678
|
|
|
$
|
(103
|
)
|
|
$
|
781
|
|
|
|
(758
|
%)
|
|
*
|
Includes
severance, ad valorem taxes and marketing costs
|
Lease
Operating Expenses. The decrease of $0.8 million was due to the shut-in all of PEDEVCO’s operated wells for 42 days
during the 2020 period related to the severe reduction in pricing from the decreased demand related to the COVID-19 outbreak.
Additionally, direct operating lease expenses decreased relative to the overall production increase due to the existing infrastructure
and tank batteries already in place for the recently completed wells in in the Permian Basin Asset and from PEDEVCO’s participation
in the completion of wells in the D-J Basin Asset by outside operators in the latter part of 2019. Additional workover activities
were also down during the 2020 period due to the economic downturn.
Exploration
Expense. There was minimal change in exploration activity undertaken by PEDEVCO in the current year’s period compared
to the prior year’s period.
Depreciation,
Depletion, Amortization and Accretion. The $0.3 million increase was primarily the result of higher oil volume from the increased
number of wells and increased oil production from PEDEVCO new producing wells during the current year’s period, compared
to the prior year’s period.
General
and Administrative Expenses (excluding share-based compensation). The decrease of $0.3 million in general and administrative
expenses (excluding share-based compensation) was primarily due to decreases in payroll, as well as other cost decreases, in the
2020 period, resulting from a 20% reduction in salary for all of PEDEVCO’s salaried employees and officers implemented on
April 1, 2020, and a reduction of non-essential contractors.
Share-Based
Compensation. Share-based compensation, which is included in general and administrative expenses in the Statements of Operations,
increased by $0.9 million primarily due to an increase in the awarding of employee share-based options and restricted shares as
compensation during the 2020 period. Share-based compensation is utilized for the purpose of conserving cash resources for use
in field development activities and operations.
Gain
on Sale of Oil and Gas Properties. In the prior period, PEDEVCO sold rights to 85.5 net acres of oil and gas leases located
in Weld County, Colorado, to a third party, for aggregate proceeds of $1.2 million and recognized a gain on sale of oil and gas
properties of $0.9 million.
Interest
Expense. The decrease of $0.8 million was due primarily to PEDEVCO having no debt in the current period, compared to the prior
year’s period.
Interest
Income and Other Income (Expense). Includes interest earned from PEDEVCO’s interest-bearing cash accounts, and for the
2020 period includes the settlement of accounts payables for $0.6 million and the settlement of a dated $88,000 accounts receivable,
compared to the prior period which included the write-off of a $0.1 million third party option related to an option to acquire
shares of Caspian Energy, which expired unexercised.
Liquidity
and Capital Resources
The
primary sources of cash for PEDEVCO during the year ended December 31, 2019 were funds borrowed pursuant to convertible promissory
notes (which were subsequently converted into PEDEVCO Common Stock) and the sale of restricted PEDEVCO Common Stock, which funds
primarily came from SK Energy, which is owned and controlled by Dr. Kukes, PEDEVCO’s Chief Executive Officer and a member
of the PEDEVCO Board, and Mr. Viktor Tkachev, an unrelated investor who purchased $12.0 million of restricted PEDEVCO Common Stock,
and sales of crude oil and natural gas. The primary uses of cash were funds used for development costs and operations.
The
primary sources of cash for PEDEVCO during the six-month period ended June 30, 2020 were from the sales of crude oil and natural
gas and funds provided by its entry into a PPP loan (see “Note 7 – PPP Loan” in the notes to PEDEVCO’s
unaudited consolidated financial statements included in this offer to exchange). The primary uses of cash were funds used for
development costs and operations. To help conserve its operating cash, effective April 1, 2020, PEDEVCO implemented a 20% reduction
in salary for all of its salaried employees and officers, to continue until the oil markets have recovered to acceptable levels,
which PEDEVCO has determined has not occurred to date.
Impact
of COVID-19
In
December 2019, a novel strain of coronavirus, which causes the infectious disease known as COVID-19, was reported in Wuhan, China.
The World Health Organization declared COVID-19 a “Public Health Emergency of International Concern” on January 30,
2020 and a global pandemic on March 11, 2020. COVID-19 has, since the early part of 2020, reduced worldwide economic activity.
Due to COVID-19 PEDEVCO or its employees, suppliers, and other partners may be prevented from conducting business activities at
full capacity for an indefinite period of time, including due to spread of the disease within these groups or due to shutdowns
that may be requested or mandated by governmental authorities. While it is not possible at this time to estimate the full impact
that COVID-19 will have on PEDEVCO’s business, the continued spread of COVID-19 and the measures taken by the governments
of countries affected and in which PEDEVCO operates has disrupted, and may continue to disrupt, the operation of PEDEVCO’s
business for a prolonged period of time. The COVID-19 outbreak and mitigation measures has also had an adverse impact on global
economic conditions, as well as an adverse effect on PEDEVCO’s business and financial condition, and may continue to have
an adverse effect on PEDEVCO, including on its potential to conduct financings on terms acceptable to PEDEVCO, if at all. In addition,
PEDEVCO has taken temporary precautionary measures intended to help minimize the risk of the virus to its employees, vendors and
guests, including limiting the number of occupants at PEDEVCO’s Houston headquarters and requiring all others to work remotely,
and discouraging employee attendance at in-person work-related meetings, which could negatively affect PEDEVCO’s business.
The extent to which the COVID-19 outbreak will continue to impact PEDEVCO’s results will depend on future developments that
are highly uncertain and cannot be predicted, including new information that may emerge concerning the severity of the virus,
the availability and efficacy of vaccines, and the actions to contain its impact. However, any further decrease in the price of
oil, or the demand for oil and gas, will likely have a negative impact on PEDEVCO’s results of operations and cash flows.
As
discussed above, PEDEVCO shut-in
its operated production from mid-April through early June 2020, which directly contributed to a decrease in production volumes
from 96,515 Boe for the three months ended March 31, 2020 to 46,530 Boe for the three months ended June 30, 2020, representing
a decrease of 52%. Similarly, PEDEVCO’s crude oil, natural gas and NGLs sales revenues decreased from $2,832,000 for the
three months ended March 31, 2020 to $656,000 for the three months ended June 30, 2020, representing a decrease of 77%, largely
due to PEDEVCO’s decreased production, as well as decreases in NYMEX pricing and significantly widened differentials, largely
due to the global COVID-19 pandemic, and the sharp decline in the demand for, and price of, oil and gas, in connection therewith.
In
response to the effects of COVID-19, PEDEVCO has adopted policies, procedures and practices both in its Houston office headquarters
and across its field operations to protect its employees, contractors and guests from COVID-19, including the adoption of a COVID-19
Response Plan, implementation of contractor questionnaires to assess COVID-19 risk and exposure prior to entering PEDEVCO facility
or worksite, adopting best practices, guidelines and protocols recommended by the Centers for Disease Control (the “CDC”)
and the Office of the Texas Governor for the prevention of exposure and spread of COVID-19, and instituting weekly management
calls discussing PEDEVCO’s ongoing response to the COVID-19 pandemic and effectiveness thereof. Consistent with the Office
of the Texas Governor’s executive orders, PEDEVCO has limited occupancy at PEDEVCO’s Houston headquarters; however,
given PEDEVCO’s robust online systems and workflow practices and procedures, PEDEVCO has not experienced any material challenges
or reductions in efficiency or effectiveness of its office-based workforce, while its field personnel continue to attend to their
daily field operations uninterrupted, while mindful of social distancing and other preventative measures and safeguards recommended
by the CDC.
Further,
to help conserve its operating cash, in April 2020 PEDEVCO initiated significant G&A cost-reduction measures, including reducing
all employee and officer salaries by 20%, until market conditions significantly improve, cutting all discretionary spending, undertaking
additional actions resulting in a nearly 20% cash G&A reduction in the second quarter of 2020, from PEDEVCO’s original
G&A budget, and negotiating reductions of approximately $1 million in vendor accounts payable, with further meaningful discounts
going forward. Additionally, PEDEVCO has taken cost-reduction measures anticipated to reduce lease operating expenses (“LOE”)
by over 25% in 2020. PEDEVCO plans to pause its planned 2020 development plan, with the only anticipated significant capital expenditures
remaining in 2020 being those related to (i) 2019 carryover capital commitments to complete an SWD and the cost to put on production
three new wells previously drilled on the Permian Basin Asset in the coming months, for an aggregate estimated expense of $950,000,
and (ii) approximately $1 million earmarked for participation in non-operated D-J Basin Asset development projects, representing
a reduction to its originally projected 2020 development plan budget from $14.5 million, to approximately $7 million (of which
PEDEVCO have deployed $5 million in 2020 to date). This revised 2020 development plan is based upon
PEDEVCO’s current outlook for the remainder of the year and is subject to further revision due to the significant volatility
in market conditions and historically high levels of uncertainty affecting the oil and gas exploration sector. PEDEVCO
will further revise its development plans as necessary to react to market conditions in the best
interest of its shareholders, while prioritizing its financial strength and liquidity.
Working
Capital
At
December 31, 2019, PEDEVCO’s total current assets of $27.1 million exceeded its total current liabilities of $15.2 million,
resulting in a working capital surplus of $11.9 million, which included a reclassification of $3.3 million of restricted cash
from current to other assets, as it was determined that the restricted cash, which is used as collateral for surety bonds in PEDEVCO’s
New Mexico operations, would be long-term in nature. See “Note 4 – Cash” in the notes to PEDEVCO’s audited
consolidated financial statements included in this offer to exchange. At December 31, 2018, PEDEVCO’s total current liabilities
of $8.9 million exceeded its total current assets of $6.8 million, resulting in a working capital deficit of $2.1 million. The
$14.0 million increase in PEDEVCO’s working capital surplus is primarily related to cash borrowed under convertible notes
(subsequently converted into PEDEVCO Common Stock) and the sale of PEDEVCO Common Stock during the period, which amounts were
in excess of amounts used to fund payables and accrued expenses related to PEDEVCO’s capital drilling projects.
At
June 30, 2020, PEDEVCO’s total current assets of $10.9 million exceeded its total current liabilities of $4.1 million, resulting
in a working capital surplus of $6.8 million, compared to $11.9 million at December 31, 2019. The $5.1 million decrease in PEDEVCO’s
working capital surplus is primarily related to cash used to fund payables and accrued expenses related to its earlier capital
drilling projects and current operational expenses.
Financing
A
summary of PEDEVCO’s financing transactions and other recent funding transactions for the year ended December 31, 2019 can
be found above under “Information about PEDEVCO—Description of Business—Recent Events,” “Note 8
– Notes Payable”, “Note 11 – Stockholders’ Equity – Common Stock” and “Note 14
– Related Party Transactions” in the notes to PEDEVCO’s audited consolidated financial statements included in
this offer to exchange.
Other
than obtaining the $370,000 PPP loans and repayment of the Original PPP loan (see “Note 7 – PPP Loan” in the
notes to PEDEVCO’s unaudited consolidated financial statements included in this offer to exchange), PEDEVCO did not engage
in any financing transactions during the three-month period ended June 30, 2020. PEDEVCO expects that it will have sufficient
cash available to meet its needs over the foreseeable future, which cash it anticipates being available from (i) its projected
cash flow from operations, (ii) its existing cash on hand, (iii) equity infusions or loans (which may be convertible) made available
from SK Energy LLC, which is 100% owned and controlled by Dr. Simon Kukes, PEDEVCO’s Chief Executive Officer and director,
which funding SK Energy is under no obligation to provide, and (iv) funding through credit or loan facilities. In addition, PEDEVCO
may seek additional funding through asset sales, farm-out arrangements, lines of credit, or public or private debt or equity financings
to fund 2020 capital expenditures and/or acquisitions. If market conditions are not conducive to raising additional funds, PEDEVCO
may choose to delay or extend the drilling program and associated capital expenditures into 2021. Furthermore, as a result of
the recent COVID-19 outbreak, and the recent sharp decline in oil prices which occurred partially as a result of the decreased
demand for oil caused by such outbreak and the actions taken globally to stop the spread of such virus, in mid-April 2020, PEDEVCO
shut-in all of its operated producing wells in its Permian Basin Asset and D-J Basin Asset to preserve PEDEVCO’s oil and
gas reserves for production during a more favorable oil price environment, 90% of which wells were brought back on production
in early June 2020 and now with all wells back on full production, with the partial recovery of oil prices. If oil prices deteriorate
significantly from current levels, PEDEVCO expects to again shut-in some or all of its oil and gas production, which would result
in reduced or no cash flow being generated from operations during the period such wells are shut-in, have a material adverse effect
on PEDEVCO’s projected cash flow from operations, and, once its cash on hand is depleted, eventually require additional
infusions of capital through debt and/or equity financings, asset sales, farm-out arrangements, lines of credit, or other means,
which may not be available on favorable terms, if at all.
Cash
Flows (in thousands)
|
|
Year
Ended December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Cash flows provided by (used in) operating activities
|
|
$
|
1,669
|
|
|
$
|
(1,494
|
)
|
Cash flows used in investing activities
|
|
|
(39,736
|
)
|
|
|
(23,118
|
)
|
Cash flows provided by financing activities
|
|
|
58,000
|
|
|
|
29,474
|
|
Net increase in cash and restricted cash
|
|
$
|
19,933
|
|
|
$
|
4,862
|
|
Cash
Flows provided by (used in) Operating Activities. Net cash provided by operating activities increased by $3.2 million for
the year ended December 31, 2019, when compared to the prior year, primarily due to a decrease in PEDEVCO’s net loss of
$6.4 million, when not factoring in PEDEVCO’s $70.3 million gain on debt restructuring which occurred in the prior period,
coupled with a $4.0 million decrease in capitalized and deferred interest expense, a $1.0 million gain on asset sales and net
increases to PEDEVCO’s other components of working capital, which are related to PEDEVCO’s increased revenue and production
levels from its drilling and completion activity in the year ended December 31, 2019.
Cash
Flows used in Investing Activities. Net cash used in investing activities increased by $16.6 million for the year ended December
31, 2019, when compared to the prior year, primarily due to an increase of $39.6 million in drilling and completion activities
in the year ended December 31, 2019, offset by a $1.2 million property sale in the current period and $21.8 million in additional
acquisition and equipment costs in the prior year compared to the year ended December 31, 2019.
Cash
Flows provided by Financing Activities. Net cash provided by financing activities increased by $28.5 million primarily due
to $43.0 million in proceeds from the sale of common stock in the year ended December 31, 2019, offset by a decrease in net proceeds
from the sale of notes payable from the prior year compared to the current year of $22.9 million. There was also $7.8 million
of repayment of notes payable and a $1.1 million warrant repurchase, offset by $0.4 million in proceeds from the issuance of a
note payable in the prior year, which contributed to the increase in the year ended December 31, 2019, when compared to the prior
year.
|
|
Six
Months Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Cash flows provided by operating activities
|
|
$
|
87
|
|
|
$
|
2,085
|
|
Cash flows used in investing activities
|
|
|
(12,663
|
)
|
|
|
(24,197
|
)
|
Cash flows provided by financing activities
|
|
|
370
|
|
|
|
33,000
|
|
Net (decrease) increase in cash and restricted cash
|
|
$
|
(12,206
|
)
|
|
$
|
10,888
|
|
Cash
Flows provided by Operating Activities. Net cash provided by operating activities decreased by $2.0 million for the current
year’s period, when compared to the prior year’s period, primarily due to an increase in PEDEVCO’s net loss
of $1.5 million, which was primarily commodity price driven, coupled with net increases in operating activities of $2.0 million
offset by net decreases to certain of its other components of working capital of $2.5 million.
Cash
Flows used in Investing Activities. There was a decrease in net cash used in investing activities of $11.5 million due to
a reduction in capital spending related to drilling and completion costs when comparing the current period to the prior period,
mainly due to reductions and delays in spending associated with the decline in oil prices caused by COVID-19.
Cash
Flows provided by Financing Activities. There was $0.4 million in cash flows provided by obtaining PPP Loan financing in the
current period, compared to $33.0 million in proceeds from financing in the prior period from the issuance of a related party
note payable, which has since been converted to PEDEVCO Common Stock, and the sale of PEDEVCO Common Stock.
Off-Balance
Sheet Arrangements
PEDEVCO
does not participate in financial transactions that generate relationships with unconsolidated entities or financial partnerships.
As of December 31, 2019 and June 30, 2020, PEDEVCO did not have any off-balance sheet arrangements.
Critical
Accounting Policies
PEDEVCO’s
discussion and analysis of its financial condition and results of operations is based on its financial statements, which have
been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial
statements requires PEDEVCO to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues
and expenses. PEDEVCO bases its estimates on historical experience and on various other assumptions that it believes to be reasonable
under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or
conditions. PEDEVCO believes the following critical accounting policies affect its most significant judgments and estimates used
in preparation of its financial statements.
Oil
and Gas Properties, Successful Efforts Method
The
successful efforts method of accounting is used for oil and gas exploration and production activities. Under this method, all
costs for development wells, support equipment and facilities, and proved mineral interests in oil and gas properties are capitalized.
Geological and geophysical costs are expensed when incurred. Costs of exploratory wells are capitalized as exploration and evaluation
assets pending determination of whether the wells find proved oil and gas reserves. Proved oil and gas reserves are the estimated
quantities of crude oil and natural gas which geological and engineering data demonstrate with reasonable certainty to be recoverable
in future years from known reservoirs under existing economic and operating conditions, (i.e., prices and costs as of the date
the estimate is made). Prices include consideration of changes in existing prices provided only by contractual arrangements, but
not on escalations based upon future conditions.
Exploratory
wells in areas not requiring major capital expenditures are evaluated for economic viability within one year of completion of
drilling. The related well costs are expensed as dry holes if it is determined that such economic viability is not attained. Otherwise,
the related well costs are reclassified to oil and gas properties and subject to impairment review. For exploratory wells that
are found to have economically viable reserves in areas where major capital expenditure will be required before production can
commence, the related well costs remain capitalized only if additional drilling is under way or firmly planned. Otherwise the
related well costs are expensed as dry holes.
Exploration
and evaluation expenditures incurred subsequent to the acquisition of an exploration asset in a business combination are accounted
for in accordance with the policy outlined above.
Depreciation,
depletion and amortization of capitalized oil and gas properties is calculated on a field by field basis using the unit of production
method. Lease acquisition costs are amortized over the total estimated proved developed and undeveloped reserves and all other
capitalized costs are amortized over proved developed reserves. Costs specific to developmental wells for which drilling is in
progress or uncompleted are capitalized as wells in progress and not subject to amortization until completion and production commences,
at which time amortization on the basis of production will begin.
Revenue
Recognition
ASU
2014-09, “Revenue from Contracts with Customers (Topic 606)”, supersedes the revenue recognition requirements
and industry-specific guidance under Revenue Recognition (Topic 605). Topic 606 requires an entity to recognize revenue
when it transfers promised goods or services to customers in an amount that reflects the consideration the entity expects to be
entitled to in exchange for those goods or services. PEDEVCO adopted Topic 606 on January 1, 2018, using the modified retrospective
method applied to contracts that were not completed as of January 1, 2018. Under the modified retrospective method, prior period
financial positions and results will not be adjusted. The cumulative effect adjustment recognized in the opening balances included
no significant changes as a result of this adoption. Topic 606 requires certain changes to the presentation of revenues and related
expenses beginning January 1, 2018. Refer to “Note 5 – Revenue from Contracts with Customers” in the notes to
PEDEVCO’s audited consolidated financial statements included in this offer to exchange for additional information.
PEDEVCO’s
revenue is comprised entirely of revenue from exploration and production activities. PEDEVCO’s oil is sold primarily to
marketers, gatherers, and refiners. Natural gas is sold primarily to interstate and intrastate natural-gas pipelines, direct end-users,
industrial users, local distribution companies, and natural-gas marketers. NGLs are sold primarily to direct end-users, refiners,
and marketers. Payment is generally received from the customer in the month following delivery.
Contracts
with customers have varying terms, including month-to-month contracts, and contracts with a finite term. PEDEVCO recognizes sales
revenues for oil, natural gas, and NGLs based on the amount of each product sold to a customer when control transfers to the customer.
Generally, control transfers at the time of delivery to the customer at a pipeline interconnect, the tailgate of a processing
facility, or as a tanker lifting is completed. Revenue is measured based on the contract price, which may be index-based or fixed,
and may include adjustments for market differentials and downstream costs incurred by the customer, including gathering, transportation,
and fuel costs.
Revenues
are recognized for the sale of PEDEVCO’s net share of production volumes. Sales on behalf of other working interest owners
and royalty interest owners are not recognized as revenues.
Stock-Based
Compensation
Pursuant
to the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”)
718, Compensation – Stock Compensation, which establishes accounting for equity instruments exchanged for employee service,
PEDEVCO utilizes the Black-Scholes option pricing model to estimate the fair value of employee stock option awards at the date
of grant, which requires the input of highly subjective assumptions, including expected volatility and expected life. Changes
in these inputs and assumptions can materially affect the measure of estimated fair value of PEDEVCO’s share-based compensation.
These assumptions are subjective and generally require significant analysis and judgment to develop. When estimating fair value,
some of the assumptions will be based on, or determined from, external data and other assumptions may be derived from PEDEVCO’s
historical experience with stock-based payment arrangements. The appropriate weight to place on historical experience is a matter
of judgment, based on relevant facts and circumstances. PEDEVCO estimates volatility by considering historical stock volatility.
PEDEVCO has opted to use the simplified method for estimating expected term, which is equal to the midpoint between the vesting
period and the contractual term.
Recently
Adopted Accounting Pronouncements
Refer
to “Note 3—Summary of Significant Accounting Policies” in the notes to PEDEVCO’s audited and unaudited
consolidated financial statements included in this offer to exchange for a discussion of recently adopted accounting pronouncements.
Changes
in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Security
Ownership of Management and Certain Beneficial Owners
To
PEDEVCO’s knowledge, except as indicated in the footnotes to this table and pursuant to applicable community property laws,
the persons named in the table have sole voting and investment power with respect to all shares of PEDEVCO Common Stock shown
as beneficially owned by them. Unless otherwise stated, the address of each stockholder is c/o PEDEVCO Corp., 575 N. Dairy Ashford,
Energy Center II, Suite 210, Houston, Texas 77079.
|
|
PEDEVCO Common Stock
|
|
|
|
Number of
PEDEVCO
Common
Stock Shares
Beneficially
Owned(1)
|
|
|
Percent of
PEDEVCO
Common
Stock(1)
|
|
Named
Executive Officers and Directors
|
|
|
|
|
|
|
|
|
Simon G. Kukes(2)
|
|
|
53,760,368
|
|
|
|
74.2
|
%
|
Clark R. Moore(3)
|
|
|
450,144
|
|
|
|
*
|
|
Ivar Siem(4)
|
|
|
357,100
|
|
|
|
*
|
|
J. Douglas Schick(5)
|
|
|
259,000
|
|
|
|
*
|
|
John J. Scelfo(6)
|
|
|
269,500
|
|
|
|
*
|
|
Paul A. Pinkston(7)
|
|
|
115,000
|
|
|
|
*
|
|
H. Douglas Evans(8)
|
|
|
250,000
|
|
|
|
*
|
|
Michael L. Peterson(9)**
|
|
|
205,000
|
|
|
|
*
|
|
Gregory Overholtzer(10)**
|
|
|
182,326
|
|
|
|
*
|
|
Frank C. Ingriselli(11)**
|
|
|
131,740
|
|
|
|
*
|
|
All Current Named Executive Officers and Directors as a group (seven persons)
|
|
|
55,461,112
|
|
|
|
76.3
|
%
|
|
|
|
|
|
|
|
|
|
Greater than 5% Stockholders
|
|
|
|
|
|
|
|
|
SK Energy, LLC(12)
|
|
|
51,791,325
|
|
|
|
71.5
|
%
|
|
|
|
|
|
|
|
|
|
Viktor Tkachev(13)
|
|
|
8,570,000
|
|
|
|
11.8
|
%
|
Arhitektora Vlasova Street 22
Apt 93
Moscow, Russia 117393
|
|
|
|
|
|
|
|
|
|
(1)
|
Ownership
voting percentages are based on 72,463,340 total shares of PEDEVCO Common Stock which
were outstanding as October 13, 2020, provided that shares of PEDEVCO Common Stock subject
to options, warrants or other convertible securities (including the PEDEVCO Common Stock
issuable upon exercise of convertible promissory notes) that are currently exercisable
or convertible, or exercisable or convertible within 60 days of the applicable date of
determination, are deemed to be outstanding and to be beneficially owned by the person
or group holding such options, warrants or other convertible securities for the purpose
of computing the percentage ownership of such person or group, but are not treated as
outstanding for the purpose of computing the percentage ownership of any other person
or group. Beneficial ownership is determined in accordance with the rules of the SEC
and includes voting and/or investing power with respect to securities. PEDEVCO believes
that, except as otherwise noted and subject to applicable community property laws, each
person named in the following table has sole investment and voting power with respect
to the securities shown as beneficially owned by such person.
|
|
(2)
|
Consisting
of the following: (a) 51,791,325 shares of PEDEVCO Common Stock held by SK Energy LLC,
an entity which Dr. Simon G. Kukes is deemed to beneficially own; (b) 100,000 shares
of fully-vested PEDEVCO Common Stock held by Dr. Kukes; (c) 710,000 unvested shares of
PEDEVCO Common Stock held by Dr. Kukes, 100,000 of which vest on each of December 12,
2020 and December 12, 2021, and 170,000 of which vest on each of January 13, 2021, January
13, 2022 and January 13, 2023, provided that Dr. Kukes remains employed by us, or is
a consultant to us, on such vesting dates; and (d) 1,000 shares of fully-vested PEDEVCO
Common Stock held by the spouse of Dr. Kukes, and 2,000 unvested shares of PEDEVCO Common
Stock of which 1,000 shares vest on each of December 12, 2021 and December 12, 2022,
provided that his spouse remains an employee of, or consultant to, PEDEVCO on such vesting
dates. Dr. Kukes has voting control over his unvested shares of PEDEVCO Common Stock.
|
|
(3)
|
Consisting
of the following: (a) 197,076 fully-vested shares of PEDEVCO Common Stock held by Mr.
Moore; (b) 2,867 fully-vested shares of PEDEVCO Common Stock held by each of Mr. Moore’s
two children, which he is deemed to beneficially own; (c) 196,000 unvested shares of
PEDEVCO Common Stock held by Mr. Moore, 17,000 of which vest on each of December 12,
2020 and December 12, 2021, and 54,000 of which vest on each of January 13, 2021, January
13, 2022 and January 13, 2023, provided that Mr. Moore remains employed by us, or is
a consultant to us, on such vesting dates; (d) options to purchase 23,334 shares of PEDEVCO
Common Stock exercisable by Mr. Moore at an exercise price of $5.10 per share; and (e)
options to purchase 4,447 shares of PEDEVCO Common Stock exercisable by Mr. Moore at
an exercise price of $2.20 per share. Mr. Moore has voting control over his unvested
shares of PEDEVCO Common Stock.
|
|
(4)
|
Consisting
of the following: (a) 187,100 shares of PEDEVCO Common Stock held by American Resources
Offshore Inc., which shares Mr. Siem is deemed to beneficially own (Mr. Siem disclaims
beneficial ownership of the securities held by American Resources Offshore Inc., except
to the extent of his pecuniary interest therein); (b) 100,000 fully-vested shares of
PEDEVCO Common Stock held by Mr. Siem; and (c) 70,000 unvested shares of PEDEVCO Common
Stock held by Mr. Siem, which vest on July 12, 2021, provided that Mr. Siem remains a
director, employee of, or consultant to PEDEVCO on such vesting date. Mr. Siem has voting
control over his unvested shares of PEDEVCO Common Stock.
|
|
(5)
|
Consisting
of the following: (a) 22,333 shares of fully-vested PEDEVCO Common Stock held by Mr.
Schick; and (b) 236,667 unvested shares of PEDEVCO Common Stock, 37,333 of which vest
on each of December 12, 2021, and 37,334 which vest on December 12, 2022, and 54,000
of which vest on each of January 13, 2021, January 13, 2022 and January 13, 2023, provided
that Mr. Schick remains employed by PEDEVCO, or is a consultant to us, on such vesting
dates. Mr. Schick has voting control over his unvested shares of PEDEVCO Common Stock.
|
|
(6)
|
Consisting
of the following: (a) 49,500 shares of fully-vested PEDEVCO Common Stock held by Mr.
Scelfo; (b) 100,000 unvested shares of PEDEVCO Common Stock, which vest on July 12, 2021,
provided that Mr. Scelfo remains a director, employee of, or consultant to the Company
on such vesting date; and (c) options to purchase 120,000 shares of PEDEVCO Common Stock
exercisable by Mr. Scelfo at an exercise price of $2.19 per share. Mr. Scelfo has voting
control over his unvested shares of PEDEVCO Common Stock.
|
|
(7)
|
Consisting
of the following: (a) 10,000 shares of fully-vested PEDEVCO Common Stock held by Mr.
Pinkston; and (b) 105,000 unvested shares of PEDEVCO Common Stock, 15,000 of which vest
on December 12, 2020, and 30,000 of which vest on each of January 13, 2021, January 13,
2022 and January 13, 2023, provided that Mr. Pinkston remains employed by PEDEVCO, or
is a consultant to PEDEVCO, on such vesting dates. Mr. Pinkston has voting control over
his unvested shares of PEDEVCO Common Stock.
|
|
(8)
|
Consisting
of the following: (a) 80,000 shares of fully-vested PEDEVCO Common Stock held by Mr.
Evans; (b) 70,000 unvested shares of PEDEVCO Common Stock, which vest on September 27,
2021, provided that Mr. Evans remains a director, employee of, or consultant to the Company
on such vesting date; and (c) options to purchase 100,000 shares of PEDEVCO Common Stock
exercisable by Mr. Evans at an exercise price of $2.19 per share. Mr. Evans has voting
control over his unvested shares of PEDEVCO Common Stock.
|
|
(9)
|
Consisting
of 205,000 shares of PEDEVCO Common Stock, including shares held by a family trust which
Mr. Peterson is deemed to beneficially own. The information presented with respect to
the holder’s beneficial ownership is based solely on PEDEVCO’s record stockholder
list and securities which the holder beneficially owns, to the best of PEDEVCO’s
knowledge, which information has not been independently verified or confirmed.
|
|
(10)
|
Consisting
of the following: (a) 14,559 fully-vested shares of PEDEVCO Common Stock; (b) options
to purchase 11,667 shares of PEDEVCO Common Stock exercisable by Mr. Overholtzer at an
exercise price of $5.10 per share; (c) options to purchase 5,000 shares of PEDEVCO Common
Stock exercisable by Mr. Overholtzer at an exercise price of $3.70 per share; (d) options
to purchase 15,000 shares of PEDEVCO Common Stock exercisable by Mr. Overholtzer at an
exercise price of $2.20 per share; (e) options to purchase 1,100 shares of PEDEVCO Common
Stock exercisable by Mr. Overholtzer at an exercise price of $3.00 per share; (f) options
to purchase 60,000 shares of PEDEVCO Common Stock exercisable by Mr. Overholtzer at an
exercise price of $1.10 per share; and (g) options to purchase 75,000 shares of PEDEVCO
Common Stock exercisable by Mr. Overholtzer at an exercise price of $0.3088 per share.
The information presented with respect to the holder’s beneficial ownership is
based solely on PEDEVCO’s record stockholder list and securities which the holder
beneficially owns, to the best of PEDEVCO’s knowledge, which information has not
been independently verified or confirmed.
|
|
(11)
|
Consisting
of the following: (a) 55,659 shares of PEDEVCO Common Stock; (b) options to purchase
39,081 shares of PEDEVCO Common Stock exercisable by Mr. Ingriselli at an exercise price
of $5.10 per share; and (c) options to purchase 37,000 shares of common stock exercisable
by Mr. Ingriselli at an exercise price of $3.70 per share. The information presented
with respect to the holder’s beneficial ownership is based solely on the Company’s
record stockholder list and securities which the holder beneficially owns, to the best
of the Company’s knowledge, which information has not been independently verified
or confirmed.
|
|
(12)
|
Consisting
of 51,791,325 shares of PEDEVCO Common Stock held by SK Energy LLC, an entity which Dr.
Simon G. Kukes is deemed to beneficially own due to his position as the Chief Executive
Officer and 100% owner of SK Energy.
|
|
(13)
|
Consisting
of the following: (a) 8,500,000 shares of PEDEVCO Common Stock held by Mr. Tkachev; and
(b) 70,000 unvested shares of PEDEVCO Common Stock, which vested on February 27, 2021.
Mr. Tkachev has voting control over his unvested shares of PEDEVCO Common Stock. The
information presented with respect to the holder’s beneficial ownership is based
solely on the PEDEVCO’s record stockholder list and securities which the holder
beneficially owns, to the best of PEDEVCO’s knowledge, which information has not
been independently verified or confirmed.
|
Changes
in Control
PEDEVCO
is not currently aware of any arrangements which may at a subsequent date result in a change of control of PEDEVCO.
Directors
and Executive Officers
The
name, age, business address, present principal occupation or employment and five-year employment history of each of the directors
and executive officers of PEDEVCO are set forth below. Unless otherwise indicated, the business address of each individual in
this schedule is c/o PEDEVCO Corp., 575 N. Dairy Ashford, Energy Center II, Suite 210, Houston, Texas 77079 and their business
telephone number is (713) 221-1768. Unless otherwise indicated, each position set forth opposite an individual’s name refers
to employment with PEDEVCO.
Directors
of PEDEVCO (Including Executive Officers Who Are Directors)
Name
|
|
Age
|
|
Citizenship
|
|
Present
Principal Occupation or Employment;
Five-Year Employment History
|
John J. Scelfo
|
|
62
|
|
USA
|
|
Mr.
Scelfo brings 40 years of experience in oil and gas management, finance and accounting to
the PEDEVCO Board. Mr. Scelfo currently serves as principal and owner of JJS Capital Group,
a Fort Lauderdale, Florida-based family investment company that he formed in April 2014. Prior
to forming JJS Capital, Mr. Scelfo was Senior Vice President, Finance and Corporate Development
(from February 2004 to March 2014), and Chief Financial Officer, Worldwide Exploration &
Producing (from April 2003 to January 2004) of New York, New York-based Hess Corporation,
a large integrated oil and gas company, where he served as one of eight members of the company’s
Executive Committee and was responsible for the company’s corporate treasury, strategy
and upstream commercial activities. Prior to joining Hess Corporation, Mr. Scelfo served as
Executive Vice President and Chief Financial Officer of publicly listed Sirius Satellite Radio
(from April 2001 to March 2003), as Vice President and Chief Financial Officer of Asia Pacific
& Japan for Dell Computer (November 1999 to March 2001), and in various roles of increasing
responsibility with Mobil Corporation (from June 1980 to October 1999).
Mr.
Scelfo holds a bachelor’s degree and an M.B.A. from Cornell University. In 2011, he was awarded Cornell ILR School’s
Alpern Award given to those who “have been exceedingly generous in their support of the ILR School in general and
in support of Off-Campus Credit Programs in particular.”
The
board of directors believes that Mr. Scelfo’s over 30 years’ experience in management, finance and accounting
in the energy industry working at major oil and gas and other publicly traded companies, and the insights he has gained
from these experiences, will provide crucial guidance for PEDEVCO’s future operations, capital raising efforts,
and financial accounting and reporting functions.
|
Simon Kukes
|
|
73
|
|
USA
|
|
Dr.
Simon Kukes is a globally renowned consultant for oil and gas businesses in both the United
States and Russia.
Holding
various positions over the years, Kukes has served as the principal of his personal investment company, SK Energy LLC,
since April 2013. From January 2005 to April 2013, Dr. Kukes was the CEO at Samara-Nafta, a Russian oil company that partnered
with US-based international oil company, Hess Corporation. He was also the President and Chief Executive of Tyumen Oil
Company (TNK) from 1998 until it combined with British Petroleum in 2003 to create TNK-BP. Following his time at TNK,
Dr. Kukes joined Yukos Oil Company in Moscow presiding as the CEO and Chairman. From 1979 to 1987 he was the Technical
Director of oil-refining and petro-chemistry for Phillips Petroleum and in 1987 became Vice-President over marketing and
business development for Amoco.
Dr.
Kukes boasts several awards and achievements over his lifespan. In 1999, the Wall Street Journal voted Kukes as one of
the Top 10 Central European Executives. He is also the recipient of the Medal of the Ministry for Natural Resources of
the Russian Federation, as well as the American Society of Competition Development Award for Leadership. In 2003, he was
named by The Financial Times and PricewaterhouseCoopers as one of the 64 most respected business leaders in the world.
Dr.
Kukes attended several prestigious universities all over the globe, receiving his Bachelor of Science in Chemical Engineering
from the University for Chemical Technology in Moscow, where he graduated with Honors. From there, he pursued his PhD
in Physical Chemistry at the Academy of Sciences in Moscow, where he would later be a Research Associate for Nuclear and
Electronic Resonance. Kukes then attended Rice University in Houston, Texas, where he was a Postdoctoral
|
Name
|
|
Age
|
|
Citizenship
|
|
Present
Principal Occupation or Employment;
Five-Year Employment History
|
|
|
|
|
|
|
Fellow. Dr. Kukes
has also served as an Adjunct Professor at the University of Delaware and on the Editorial Board of Fuel Magazine.
His
commitment to the oil and gas industry has inspired Dr. Kukes to publish more than 60 scientific
papers and two books on the oil and gas industry of Russia and the United States. Dr. Kukes
is also the holder of more than 130 patents, primarily in Oil and Petrochemical Processing.
Dr.
Kukes brings to the board of directors decades of leadership and experience in the global energy industry. The board of
directors believes that Dr. Kukes’ experience and strategic leadership and vision will provide crucial guidance
for PEDEVCO’s management and operations, and provide key insights and guidance in the evaluation of oil and gas
acquisition and development opportunities.
|
Ivar Siem
|
|
74
|
|
Norway
|
|
Mr.
Siem has broad experience from both the upstream and the service segments of the oil and gas
industry, has been the founder of several companies, and has been involved in several roll-ups
and restructuring processes throughout his career. He currently serves as the Chairman of
American Resources, Inc., and as a Managing Partner of its affiliated investment vehicle,
Norexas, LLC, both privately held Houston, Texas-based companies active in oil and gas investment,
acquisition and development and has served in that capacity since 2013. Previously, Mr. Siem
served as Chairman and Chief Executive Officer of American Resources, Inc. (from 2013 through
July 2017) and Chairman of Blue Dolphin Energy Company (OTCQX: BDCO), Houston, Texas after
taking the company out of bankruptcy in 1990. Blue Dolphin was an offshore Gulf of Mexico
operator until a merger in 2012 with an independent refiner and marketer of petroleum products.
Mr. Siem’s role as CEO ended with the merger and he left the board in 2014. From January
2007 to present, Mr. Siem served as President of Drillmar Oil and Gas, Inc. (“Drillmar
Oil”), a subsidiary of Drillmar Energy, Inc. In 1999, Mr. Siem acquired a small distressed
public company, American Resources Offshore, Inc. and worked with creditors and existing management
to achieve a voluntary reorganization. From 1995 to 2000, Mr. Siem served as Chairman and
interim CEO of DI Industries/Grey Wolf Drilling while restructuring the company financially
and operationally. Through several mergers and acquisitions, the company emerged as one of
the leading land drilling contractors in the US. The company was subsequently acquired by
Precision Drilling in 2008. From 1996 to 1997 Mr. Siem served as the initial Chairman and
CEO of Seateam Technology ASA when it was spun off from DSND ASA and listed on the Oslo exchange.
Prior to Seateam, Mr. Siem held various executive roles at multiple E&P and oil field
service companies. Mr. Siem started his career at Amoco working as an engineer in various
segments of upstream operations.
Mr.
Siem is currently on the Board of Directors at Siem Industries, Inc., the Drillmar Energy Group of companies, and Petrolia
Energy Corporation (OTCQB: BBLS), and has served on the board of several privately held and publicly traded companies
including Frupor SA, Avenir ASA, and DSND ASA. Siem Industries is a holding company which invests in shipping and offshore
oil and gas construction services. Frupor SA, is a Portuguese agricultural business, which Mr. Siem cofounded with his
brother O. M. Siem in 1988.
Mr.
Siem holds a Bachelor of Science in Mechanical Engineering with a minor in Petroleum from the University of California,
Berkeley and an Executive MBA from the Amos Tuck School of Business, Dartmouth University.
The
board of directors believes that Mr. Siem’s broad experience from both the upstream and the service segments of
the oil and gas industry, and executive management, technical and operating experience at publicly-traded oil and gas
companies, and the insights he has gained from these experiences, will provide crucial guidance for PEDEVCO’s future
management and operations, and provide key insights and guidance in the evaluation of oil and gas acquisition and development
opportunities.
|
Name
|
|
Age
|
|
Citizenship
|
|
Present
Principal Occupation or Employment;
Five-Year Employment History
|
H. Douglas
Evans
|
|
72
|
|
USA
|
|
Mr.
Evans has 50 years of oil and gas industry experience, 40 years of which have been spent
in various executive management positions with Gulf Interstate Engineering Company (“GIE”),
a privately-held Houston, Texas-based firm specializing in the engineering of oil, gas
and liquid pipeline systems, where he has served as Honorary Chairman since November
2017, and previously served as President and Chief Executive Officer (July 2004-November
2017), President (February 2003-November 2017), Senior Vice President (September 1994-July
2004), and in various other roles since he joined the company in 1978. During Mr. Evans’
tenure as an executive at GIE, he has successfully overseen the company’s organic
growth from $25 million in sales in 1996 to over $250 million in sales in recent years,
with GIE involved in almost every major onshore oil and gas pipeline in the world over
the last 20 years.
Mr.
Evans holds a B.S. Civil Engineering and Master of Business Administration from Queen’s University at Kingston,
Ontario, and is a registered Professional Engineer in Ontario and Alberta, Canada. Mr. Evans currently serves as Honorary
Chairman of GIE (since November 2017), and previously a member of the Board of Directors of Gulf Interstate Field Services,
a GIE affiliate engaged in providing oil and gas pipeline construction inspection services, and a number of other GIE
affiliated companies, the Board of Directors and Chairman of the Strategy Committee for the International Pipe Line and
Offshore Contractors Association (IPLOCA) (through September 2019), a member of the Board of Houston, Texas-based
Crossroads School, Inc. (since 2004), and a former member of the Board of the Cystic Fibrosis Foundation – Texas
Gulf Coast Chapter.
The
board of directors believes that Mr. Evans’ over 45 years’ experience in management and operations in the
energy industry, and the insights he has gained from his experiences, will provide crucial guidance for PEDEVCO’s
management and operations.
|
Executive
Officers of PEDEVCO Who Are Not Directors
Name
|
|
Age
|
|
Citizenship
|
|
Executive
Position
|
|
Present
Principal Occupation or Employment;
Five-Year Employment History
|
J. Douglas Schick
|
|
45
|
|
USA
|
|
President
|
|
Mr.
Schick has over twenty years of experience in the oil and gas industry. Prior to joining PEDEVCO
as President on August 1, 2018, Mr. Schick was employed by American Resources, Inc., a Houston,
Texas-based privately-held oil and gas investment, development and operating company which
he co-founded and continues to serve as Chief Executive Officer (from August 2017 to the present) and
formerly as Chief Financial Officer and Vice President of Business Development (from August
2013 to August 2017), provided that Mr. Schick’s service to American Resources requires
only minimal time commitment from Mr. Schick that does not conflict with his duties and responsibilities
to PEDEVCO. Prior to starting American Resources, Mr. Schick served as the founder, owner
and principal of J. Douglas Enterprises, a Houston, Texas-based energy industry focused business
development and financial consulting firm (from June 2011 to August 2013) as Vice President
of Finance (from January 2011 until its sale in June 2011) for Highland Oil and Gas,
a private equity-backed E&P company headquartered in Houston, Texas, as Manager of Planning
and then Director of Planning at Houston, Texas-based Mariner Energy, Inc. (from December
2006 until its merger with Apache Corp. in December 2010), and in various roles of increasing
responsibility in finance, planning, M&A, treasury and accounting at The Houston Exploration
Company, ConocoPhillips and Shell Oil Company (from 1998 to 2006). Mr. Schick current serves
on the Board of Directors of Rockdale Marcellus, LLC, a Houston, Texas-based subsidiary of
Rockdale Energy, LLC engaged in the development of natural gas in
|
Name
|
|
Age
|
|
Citizenship
|
|
Executive
Position
|
|
Present
Principal Occupation or Employment;
Five-Year Employment History
|
|
|
|
|
|
|
|
|
Northeastern Pennsylvania.
Mr. Schick holds a BBA in Finance from New Mexico State University and an MBA with a specialization in Finance from Tulane University.
|
|
|
|
|
|
|
|
|
|
Paul
Pinkston
|
|
53
|
|
USA
|
|
Chief
Accounting Officer
|
|
Mr.
Pinkston brings over 20 years of accounting, compliance, and financial reporting expertise
to PEDEVCO, with extensive experience in handling and managing corporate compliance,
financial reporting and audits, and other regulatory functions for companies engaged
in the oil and gas industry in the U.S. Prior to joining PEDEVCO on December 1, 2018,
from August 2017 to February 2018, Mr. Pinkston served as Corporate Controller and Secretary
for Trecora Resources (NYSE: TREC), a Sugar Land, Texas-based petrochemical manufacturing
and customer processing service company. Prior to joining Trecora Resources, from May
2013 to June 2017, Mr. Pinkston served in various roles of increasing authority and responsibility
at Camber Energy, Inc. (NYSE American: CEI), a Houston, Texas-based oil and gas exploration
and production company, including as Camber Energy’s Chief Accounting Officer,
Secretary and Treasurer (August 2016 to June 2017), and as its Director of Financial
Reporting (May 2013 to August 2016). Before joining Camber Energy, Mr. Pinkston served
as a Senior Consultant with Sirius Solutions LLLP, where he performed accounting, audit
and finance consulting services (January 2006 to May 2013), as a Corporate Auditor performing
internal audits for Baker Hughes, Inc. (January 2002 to November 2005), and as a Senior
Auditor, conducting public and private audits, at Arthur Andersen LLP (from September
1998 to November 2001).
Mr.
Pinkston received a Bachelor of Business Administration (Finance and Marketing) degree from the University of Texas and
earned a Master of Business Administration (Accounting) degree from the University of Houston. Mr. Pinkston is a Certified
Public Accountant registered in the State of Texas.
|
Clark R. Moore
|
|
47
|
|
USA
|
|
Executive
Vice President,
General Counsel
and Secretary
|
|
Mr.
Moore has served as the Executive Vice President, General Counsel, and Secretary of PEDEVCO
since its acquisition of Pacific Energy Development in July 2012 and has served as the Executive
Vice President, General Counsel, and Secretary of PEDEVCO since its inception in February
2011. Mr. Moore began his career in 2000 as a corporate attorney at the law firm of Venture
Law Group located in Menlo Park, California, which later merged into Heller Ehrman LLP in
2003. In 2004, Mr. Moore left Heller Ehrman LLP and launched a legal consulting practice focused
on representation of private and public company clients in the energy and high-tech industries.
In September 2006, Mr. Moore joined Erin Energy Corporation (OTCMKTS:ERN) (formerly CAMAC
Energy, Inc.), an independent energy company headquartered in Houston, Texas, as its acting
General Counsel and continued to serve in that role through February 2011. In addition, since
June 1, 2018, Mr. Moore has served as a partner at Foundation Law Group, LLP.
Mr.
Moore received his J.D. with Distinction from Stanford Law School and his B.A. with Honors from the University of Washington.
|
Ownership
of Trust Common Units by PEDEVCO Directors and Officers
None.
Executive
Compensation
The
following table sets forth the compensation for services paid in all capacities for the two fiscal years ended December 31, 2019
and 2018 to (a) Dr. Simon Kukes, PEDEVCO’s current Chief Executive Officer and Director, (b) J. Douglas Schick,
PEDEVCO’s current President, (c) Clark R. Moore, PEDEVCO’s Executive Vice President, General Counsel and Secretary,
(d) Paul A Pinkston, PEDEVCO’s current Chief Accounting Officer, (e) Frank C. Ingriselli, PEDEVCO’s former
Chairman, former President and former Chief Executive Officer, (f) Michael L. Peterson, PEDEVCO’s former President
and Chief Executive Officer, and (g) Gregory Overholtzer, PEDEVCO’s former Chief Financial Officer (collectively, the
“Named Executive Officers”). There were no other executive officers who received compensation in excess of $100,000
in either 2019 or 2018.
Summary
Compensation Table
Name and Principal Position
|
|
Fiscal Year
|
|
|
Salary
($)
|
|
|
Bonus
($)
|
|
|
Option
Awards
($)
|
|
|
Stock
Awards
($)
|
|
|
All Other
Compensation
($)
|
|
|
Total
($)
|
|
Simon Kukes
|
|
2019
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Chief Executive Officer
|
|
2018
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
399,000
|
(1)
|
|
—
|
|
|
399,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
J. Douglas Schick
|
|
2019
|
|
|
250,000
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
250,000
|
|
President
|
|
2018
|
|
|
104,167
|
|
|
—
|
|
|
—
|
|
|
148,960
|
(2)
|
|
—
|
|
|
253,127
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Clark R. Moore
|
|
2019
|
|
|
250,000
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
250,000
|
|
Executive Vice President, General Counsel and Secretary
|
|
2018
|
|
|
250,000
|
|
|
—
|
|
|
—
|
|
|
141,830
|
(3)
|
|
—
|
|
|
391,830
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paul A. Pinkston
|
|
2019
|
|
|
140,000
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
140,000
|
|
Chief Accounting Officer
|
|
2018
|
|
|
11,667
|
|
|
—
|
|
|
—
|
|
|
39,900
|
(4)
|
|
—
|
|
|
51,567
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Frank C. Ingriselli(5)
|
|
2018
|
|
|
66,346
|
|
|
—
|
|
|
—
|
|
|
116,000
|
(6)
|
|
350,000
|
(7)
|
|
532,346
|
|
Former Chairman of the Board,
Chief Executive Officer and President
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Michael L. Peterson(8)
|
|
2018
|
|
|
125,000
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
125,000
|
|
Former Chief Executive Officer
and President
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gregory Overholtzer(9)
|
|
2018
|
|
|
190,000
|
|
|
—
|
|
|
—
|
|
|
26,600
|
(10)
|
|
—
|
|
|
216,600
|
|
Former Chief Financial Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Consists
of the value of 300,000 shares of restricted PEDEVCO Common Stock granted in December 2018 at $1.33 per share.
|
(2)
|
Consists
of the value of 112,000 shares of restricted PEDEVCO Common Stock granted in December 2018 at $1.33 per share.
|
(3)
|
Consists
of the value of 50,000 shares of restricted PEDEVCO Common Stock granted in July 2018 at $1.48 per share and the value of 51,000
shares of restricted PEDEVCO Common Stock granted in December 2018 at $1.33 per share.
|
(4)
|
Consists
of the value of 30,000 shares of restricted PEDEVCO Common Stock granted in December 2018 at $1.33 per share.
|
(5)
|
Mr.
Ingriselli served as Chief Executive Officer of PEDEVCO until his retirement effective May 1, 2016, after which date he continued
to serve as Chairman of the PEDEVCO Board until September 27, 2018, and again served as its Chief Executive Officer from April
2018 to July 2018, and served as President from April 2018 to August 1, 2018.
|
(6)
|
Consists
of the value of 80,000 shares of restricted PEDEVCO Common Stock granted in May 2018 at $0.34 per share and the value of 60,000
shares of restricted PEDEVCO Common Stock granted in July 2018 at $1.48 per share.
|
(7)
|
Consists
of cash severance amount paid to Mr. Ingriselli pursuant to the Separation and General Release Agreement, dated September 6, 2018,
entered into by and between Mr. Ingriselli and PEDEVCO.
|
(8)
|
Mr.
Peterson resigned as Chief Executive Officer and President effective May 31, 2018, and pursuant to a consulting agreement entered
into with him, he received $5,000 per month through May 2019 for debt restructuring, strategic planning, and capital markets consulting
services.
|
(9)
|
Mr.
Overholtzer resigned as Chief Financial Officer effective December 31, 2018, and pursuant to a consulting agreement entered into
with him, he received $15,000 per month through April 7, 2019 for transitional consulting services, and was paid an additional
amount of cash severance and accrued vacation (totaling $37,755) pursuant to the Separation and General Release Agreement,
dated December 31, 2018, entered into by and between Mr. Overholtzer and PEDEVCO.
|
(10)
|
Consists
of the value of 20,000 shares of restricted PEDEVCO Common Stock granted in December 2018 at $1.33 per share.
|
The
table above does not include perquisites and other personal benefits or property, unless the aggregate amount of such compensation
is more than $10,000. No executive officer earned any non-equity incentive plan compensation or nonqualified deferred compensation
during the periods reported above. Stock Awards represent the aggregate grant date fair value of awards computed in
accordance
with Financial Accounting Standards Board Accounting Standard Codification Topic 718. For additional information on the valuation
assumptions with respect to the option grants, refer to “Note 11 – Stockholders’ Equity – Common Stock”
in PEDEVCO’s audited consolidated financial statements included in this offer to exchange. These amounts do not correspond
to the actual value that will be recognized by the named individuals from these awards.
Outstanding
Equity Awards at Fiscal Year-End
The
following table sets forth information as of December 31, 2019 concerning outstanding equity awards for the executive officers
named in the Summary Compensation Table.
|
|
Option Awards
|
|
|
Stock Awards
|
|
Name
|
|
Number of
securities
underlying
unexercised
options (#)
exercisable
|
|
|
Number of
securities
underlying
unexercised
options (#)
unexercisable
|
|
|
Option
Exercise
price ($)
|
|
|
Option
expiration
date
|
|
|
Number of
shares or units
of stock
that have
not vested (#)
|
|
|
Market value
of shares or
units of stock
that have
not vested ($)
|
|
Dr. Simon Kukes
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
200,000
|
(1)
|
|
$
|
266,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
J. Douglas Schick
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
74,677
|
(1)
|
|
$
|
99,320
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Clark R. Moore
|
|
|
18,887
|
|
|
|
—
|
|
|
$
|
5.10
|
|
|
|
6/18/2022
|
|
|
|
34,000
|
(1)
|
|
$
|
6,720
|
|
|
|
|
4,447
|
|
|
|
—
|
|
|
$
|
5.10
|
|
|
|
6/18/2022
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
27,000
|
*
|
|
|
—
|
|
|
$
|
3.70
|
|
|
|
1/7/2020
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
28,000
|
|
|
|
—
|
|
|
$
|
2.20
|
|
|
|
1/7/2021
|
|
|
|
—
|
|
|
|
—
|
|
Paul A. Pinkston
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
15,000
|
(2)
|
|
|
19,950
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Frank C. Ingriselli**
|
|
|
34,827
|
|
|
|
—
|
|
|
$
|
5.10
|
|
|
|
5/30/2021
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
4,254
|
|
|
|
—
|
|
|
$
|
5.10
|
|
|
|
5/30/2021
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
37,000
|
|
|
|
—
|
|
|
$
|
3.70
|
|
|
|
5/30/2021
|
|
|
|
—
|
|
|
|
—
|
|
Gregory Overholtzer**
|
|
|
11,667
|
|
|
|
—
|
|
|
$
|
5.10
|
|
|
|
6/18/2022
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
5,000
|
|
|
|
—
|
|
|
$
|
3.70
|
|
|
|
12/31/2021
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
15,000
|
|
|
|
—
|
|
|
$
|
2.20
|
|
|
|
12/31/2021
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
1,100
|
|
|
|
—
|
|
|
$
|
3.00
|
|
|
|
2/8/2022
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
60,000
|
|
|
|
—
|
|
|
$
|
1.10
|
|
|
|
12/31/2021
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
75,000
|
|
|
|
—
|
|
|
$
|
0.3088
|
|
|
|
12/28/2022
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Michael L. Peterson**
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
—
|
|
|
|
—
|
|
(1)
|
Stock
award vests 50% on December 12, 2020 and December 12, 2021, subject to the holder remaining an employee of or consultant to the
Company on such vesting dates.
|
(2)
|
Stock
award vests on December 1, 2020, subject to the holder remaining an employee of or consultant to PEDEVCO on such vesting date.
|
*
|
Since
expired unexercised.
|
Issuances
of Equity to Executive Officers
Restricted
Stock
During
the year ended December 31, 2018, PEDEVCO issued shares of PEDEVCO Common Stock and restricted PEDEVCO Common Stock as follows:
600,000 shares of PEDEVCO Common Stock issued to SK Energy, which is 100% owned and controlled by Dr. Simon Kukes, PEDEVCO’s
Chief Executive Officer and director with a fair value of $185,000 based on the market price on the date of issuance, 80,000 shares
of restricted stock were issued to PEDEVCO’s former CEO (Mr. Ingriselli) with a fair value of $27,000 based on the
market price on the date of issuance, and 30,848 shares were issued to employees for the cashless exercise of options. The
80,000 shares of restricted stock were issued in consideration for Mr. Ingriselli rejoining PEDEVCO as its President and Chief
Executive Officer in May 2018. Mr. Ingriselli subsequently resigned as President and Chief Executive Officer on September 27,
2018 and the shares of restricted stock fully vested on October 1, 2018 pursuant to a separation agreement entered into with him.
Also,
restricted stock awards were granted to Messrs. Frank C. Ingriselli (then President) and Clark R. Moore (Executive Vice President,
General Counsel and Secretary) of 60,000 and 50,000 shares, respectively, under PEDEVCO’s Amended and Restated 2012
Equity Incentive Plan during the year ended December 31, 2018. The restricted stock awards vest as follows: 100% on the six-month
anniversary of the grant date. These shares have a total fair value of $164,000 based on the market price on the issuance date.
Upon
Mr. Ingriselli’s resignation, noted above, the 60,000 shares of restricted stock fully vested on October 1, 2018 pursuant
to a separation agreement entered into with him.
Subsequent
restricted stock awards were granted to 12 employees and two directors totaling an aggregate of 714,000 shares (90,000 shares
on September 27, 2018 and 624,000 shares on December 12, 2018), under PEDEVCO’s Amended and Restated 2012 Equity Incentive
Plan. The grants for a total of 40,000 of the restricted stock awards vest as follows: 100% on the one-year anniversary of the
grant date. These shares have a total fair value of $88,000 based on the market price on the issuance date. The grant for 50,000
shares of restricted stock vest as follows: 50% on the one-year anniversary of the grant date and 50% on the second-year anniversary
of the grant date. These shares have a total fair value of $109,000 based on the market price on the issuance date. The grant
for 624,000 shares of restricted stock vest as follows: 33.3% on the one-year anniversary of the grant date, 33.3% on the two-year
anniversary of the grant date and 33.3% on the third-year anniversary of the grant date. These shares have a total fair value
of $830,000 based on the market price on the issuance date. In each case above the restricted shares are subject to the recipient
of the shares being an employee of or consultant to PEDEVCO on such vesting date, and subject to the terms and conditions of a
Restricted Shares Grant Agreement, as applicable, entered into by and between PEDEVCO and the recipient. In addition, 65,017 shares
were issued to an employee for the cashless exercise of options, and 192,208 shares were issued for the exercise of warrants at
an exercise price of $0.322 per share for an aggregate exercise price of $64,000.
In
April 2019, restricted stock awards were granted to three new employees and one consultant for an aggregate of 160,000 shares
of PEDEVCO Common Stock, under PEDEVCO’s Amended and Restated 2012 Equity Incentive Plan. The grant for a total of 50,000
of the restricted stock awards vests as follows: 100% on the one-year anniversary of the grant date, subject to the recipient’s
continued service with PEDEVCO. These shares have a total fair value of $135,000 based on the market price on the issuance date.
The grants for 110,000 shares of restricted stock vest as follows: 50% on the one-year anniversary of the grant date and 50% on
the second-year anniversary of the grant date, subject to the recipient’s continued service with PEDEVCO. These shares have
a total fair value of $253,000 based on the market price on the issuance date.
On
July 18, 2019, 50,000 shares of restricted stock were awarded to an advisor under PEDEVCO’s Amended and Restated 2012 Equity
Incentive Plan. The restricted stock vests as follows: 100% on the six-month anniversary of the grant date, subject to the recipient’s
continued service with PEDEVCO. These shares have a total fair value of $83,000, based on the market price on the issuance date.
On
August 28, 2019, restricted stock awards were granted to three directors for an aggregate of 170,000 shares of PEDEVCO Common
Stock, under PEDEVCO’s Amended and Restated 2012 Equity Incentive Plan (70,000 shares to Mr. John Scelfo and 50,000 shares
to Mr. H. Douglas Evans). The grant for a total of 120,000 of the restricted stock awards vests as follows: 100% on July 12, 2020,
subject to the recipient’s continued service with PEDEVCO. These shares have a total fair value of $187,000 based on the
market price on the issuance date. The grants for 50,000 shares of restricted stock vest as follows: 100% on September 27, 2020,
subject to the recipient’s continued service with PEDEVCO. These shares have a total fair value of $78,000 based on the
market price on the issuance date. Additionally, 50,000 shares of restricted stock were awarded to a director for advisory services
provided to the Company under PEDEVCO’s Amended and Restated 2012 Equity Incentive Plan. The restricted stock vests as follows:
100% on July 12, 2020, subject to the recipient’s continued service with PEDEVCO. These shares have a total fair value of
$78,000, based on the market price on the issuance date.
On
October 5, 2019, 250,000 shares of restricted stock were awarded to an advisor under PEDEVCO’s Amended and Restated 2012
Equity Incentive Plan. The restricted stock vests as follows: 100% on the six-month anniversary of the grant date, subject to
the recipient’s continued service with PEDEVCO. These shares have a total fair value of $350,000, based on the market price
on the issuance date.
On
November 8, 2019, PEDEVCO entered into an Advisory Agreement and Restricted Shares Grant Agreement with Viktor Tkachev, a greater
than 10% stockholder of PEDEVCO (who acquired $12 million of shares of PEDEVCO Common Stock on September 17, 2019), under
which Mr. Tkachev agreed to provide strategic planning and business development services, and pursuant to which 100,000 shares
of restricted PEDEVCO Common Stock were awarded to Mr. Tkachev under PEDEVCO’s Amended and Restated 2012 Equity Incentive
Plan, 100% of which vest on the six-month anniversary of the grant date, subject to the recipient’s continued service with
the Company and the terms and conditions of these agreements. These shares have a total fair value of $128,000 based on the market
price on the issuance date.
Also
on November 8, 2019, PEDEVCO entered into an Advisory Agreement with Ivar Siem, a member of the PEDEVCO Board, pursuant to which
the 50,000 restricted shares of PEDEVCO Common Stock previously awarded to Mr. Siem on August 28, 2019 under the Plan continue
to vest, with 100% vesting on July 12, 2020, subject to Mr. Siem continuing to provide advisory services to PEDEVCO on such vesting
date, and subject to the terms and conditions of a Restricted Shares Grant Agreement entered into by and between PEDEVCO and Mr.
Siem on August 28, 2019. The Advisory Agreement contains customary confidentiality, indemnification and no conflict language;
and may be terminated by PEDEVCO or the advisor with 15 days prior written notice for any reason.
On
January 13, 2020, restricted stock awards were granted to various employees and one consultant for an aggregate of 1,049,000 (including
924,000 restricted stock awards to officers of PEDEVCO) and 70,000 shares, respectively, of PEDEVCO Common Stock, under the Company’s
Amended and Restated 2012 Equity Incentive Plan. The grant of the 1,049,000 shares of restricted stock vest as follows: 33.3%
vest each subsequent year from the date of grant, contingent upon the recipient’s continued service with PEDEVCO. These
shares have a total fair value of $1,172,000, based on the market price on the issuance date. The grant of the 70,000 shares of
restricted stock vest as follows: 100% on the one-year anniversary of the grant date, subject to the recipient’s continued
service with PEDEVCO. These shares have a total fair value of $118,000, based on the market price on the issuance date.
In
February 2020, 55,000 shares of restricted common stock were forfeited to PEDEVCO and cancelled due to an employee termination.
As a result, these shares are once again eligible to be awarded under PEDEVCO’s Amended and Restated 2012 Equity Incentive
Plan.
On
August 27, 2020, PEDEVCO granted (i) 100,000 shares of restricted PEDEVCO Common Stock under PEDEVCO’s Amended and Restated
2012 Equity Incentive Plan (the “Plan”) to Mr. John Scelfo, which shares vest on July 12, 2021, (ii) 70,000 shares
of restricted PEDEVCO Common Stock under the Plan to Mr. H. Douglas Evans, which shares vest on September 27, 2021, and (iii)
70,000 shares of restricted PEDEVCO Common Stock under the Plan to Mr. Ivar Siem, which shares vest on July 12, 2021, in each
case subject to the recipient of the shares being a member of PEDEVCO’s Board of Directors on such vesting date, and subject
to the terms and conditions of a Restricted Shares Grant Agreement entered into by and between PEDEVCO and each recipient. These
restricted stock awards were issued and granted in consideration for Messrs. Scelfo, Evans and Siem serving as non-employee directors
of PEDEVCO.
The
awarded shares above are subject to trading restrictions, and forfeiture, subject to the vesting terms described above. When such
securities are vested in accordance with their terms, the trading restrictions are lifted.
Stock-based
compensation expense recorded related to restricted stock during the years ended December 31, 2019 and 2018 was $1,259,000 and
$659,000, respectively. The remaining amount of unamortized stock-based compensation expense related to restricted stock
at December 31, 2019 and 2018 was $999,000 and $967,000, respectively.
Options
On
August 14, 2019, PEDEVCO issued 9,782 total shares of PEDEVCO Common Stock upon the cashless exercise of stock options to purchase
an aggregate of 12,500 shares of PEDEVCO Common Stock with an exercise price of $0.31 per share, based on a then current market
value of $1.42 per share, under the terms of the options. The options had an intrinsic value of $14,000 on the exercise date.
On
September 27, 2018, PEDEVCO granted options to purchase an aggregate of 120,000 and 100,000 shares of PEDEVCO Common Stock an
exercise price of $2.19 per share to John J. Scelfo, its Chairman, and H. Douglas Evans, a Director, respectively, all pursuant
to PEDEVCO’s 2012 Amended and Restated Equity Incentive Plan and in consideration for their joining the PEDEVCO Board and
committees thereof. The options have a term of five years and fully vest on the one-year anniversary of the vesting commencement
date contingent upon the recipient’s continued service with PEDEVCO. The aggregate fair value of the options on the date
of grant, using the Black-Scholes model, was $417,000. Variables used in the Black-Scholes option-pricing model for the options
issued include: (1) a discount rate of 2.75%, (2) expected term of 3.0 years, (3) expected volatility of 171%,
and (4) zero expected dividends.
On
December 12, 2018, PEDEVCO granted options to purchase an aggregate of 50,000 shares of PEDEVCO Common Stock to an employee at
an exercise price of $1.33 per share. The options have a term of five years and fully vest in December 2021. 33.3% vest each subsequent
year from the date of grant contingent upon the recipient’s continued service with PEDEVCO. The aggregate fair value of
the options on the date of grant, using the Black-Scholes model, was $59,000. Variables used in the Black-Scholes option-pricing
model for the options issued include: (1) a discount rate of 2.75%, (2) expected term of 3.5 years, (3) expected
volatility of 164%, and (4) zero expected dividends.
On
January 13, 2020, PEDEVCO granted options to purchase an aggregate of 733,000 shares of PEDEVCO Common Stock to various PEDEVCO
employees at an exercise price of $1.68 per share. The options have a term of five years and fully vest in January 2023, with
33.3% of each grant vesting each subsequent year from the date of grant, contingent upon each recipient’s continued service
with PEDEVCO. The aggregate fair value of the options on the date of grant, using the Black-Scholes model, was $1,053,000. Variables
used in the Black-Scholes option-pricing model for the options issued include: (1) a discount rate of 1.63%, (2) expected term
of 3.5 years, (3) expected volatility of 155%, and (4) zero expected dividends.
Compensation
of Directors
The
following table sets forth compensation information with respect to PEDEVCO’s non-executive directors during its fiscal
year ended December 31, 2019.
Name
|
|
Fees Earned or
Paid in Cash
($)*
|
|
|
Stock
Awards
($)(1)(2)(3)
|
|
|
All Other
Compensation
($)
|
|
|
Total
($)
|
|
John J. Scelfo
|
|
$
|
—
|
|
|
$
|
109,200
|
|
|
$
|
—
|
|
|
$
|
109,200
|
|
Ivar Siem
|
|
$
|
—
|
|
|
$
|
156,000
|
|
|
$
|
—
|
|
|
$
|
156,000
|
|
H. Douglas Evans
|
|
$
|
—
|
|
|
$
|
78,000
|
|
|
$
|
—
|
|
|
$
|
78,000
|
|
*
|
The
table above does not include the amount of any expense reimbursements paid to the above directors. No directors received any Non-Equity
Incentive Plan Compensation or Nonqualified Deferred Compensation. Does not include perquisites and other personal benefits, or
property, unless the aggregate amount of such compensation is more than $10,000.
|
(1)
|
Amounts
in this column represent the aggregate grant date fair value of awards computed in accordance with Financial Accounting Standards
Board Accounting Standard Codification Topic 718. For additional information on the valuation assumptions with respect to the
restricted stock grants, refer to “Note 11 – Stockholders’ Equity – Common Stock” of PEDEVCO’s
audited consolidated financial statements included in this offer to exchange. These amounts do not correspond to the actual value
that will be recognized by the named individuals from these awards.
|
(2)
|
Mr.
Scelfo, Mr. Evans and Mr. Siem received grants of 70,000, 50,000 and 50,000 shares of restricted stock, respectively, on August
28, 2019, each with an aggregate grant date fair value of $109,200, $78,000 and $78,000, respectively, which will vest in full
on July 12, 2020, September 27, 2020 and July 12, 2020, respectively. For the year ended December 31, 2019, there was compensation
of $88,000, related to these grants.
|
(3)
|
Mr.
Siem also received an additional grant of 50,000 shares of restricted stock, on August 28, 2019, for advisory services provided
to PEDEVCO with an aggregate grant date fair value of $78,000, which will vest in full on July 12, 2019. For the year ended December
31, 2019, there was compensation of $26,000, related to these grants.
|
Effective
September 27, 2018, the PEDEVCO Board no longer has a formal compensation program; provided that the PEDEVCO Board and/or the
Compensation Committee may authorize compensation (including, but not limited to cash, options and restricted stock) to the
members of the PEDEVCO Board from time to time in their discretion.
Equity
Compensation Plan Information
2012
Equity Incentive Plan
General. On
June 26, 2012, the PEDEVCO Board adopted the Blast Energy Services, Inc. 2012 Equity Incentive Plan, which was approved by its
stockholders on July 30, 2012 and subsequently renamed to the PEDEVCO Corp. 2012 Equity Incentive Plan in connection with PEDEVCO’s
name change from Blast Energy Services, Inc. to PEDEVCO Corp. The 2012 Equity Incentive Plan provides for awards of incentive
stock options, non-statutory stock options, rights to acquire restricted stock, stock appreciation rights, or SARs, and performance
units and performance shares. Subject to the provisions of the 2012 Equity Incentive Plan relating to adjustments upon changes
in PEDEVCO Common Stock, an aggregate of 200,000 shares of PEDEVCO Common Stock were reserved for issuance under the
2012 Equity Incentive Plan. On April 23, 2014, the PEDEVCO Board adopted an amended and restated 2012 Equity Incentive Plan, to
increase by 500,000 shares, the number of awards available for issuance under the plan, which was approved by stockholders
on June 27, 2014. On July 27, 2015, the PEDEVCO Board adopted an amended and restated 2012 Equity Incentive Plan, to increase
by 300,000 shares, the number of awards available for issuance under the plan, which was approved by stockholders on
October 7, 2015. On October 21, 2016, the PEDEVCO Board adopted an amended and restated 2012 Equity Incentive Plan, to increase
by 500,000 shares, the number of awards available for issuance under the plan, which was approved by stockholders on
December 28, 2016. On November 6, 2017, the PEDEVCO Board adopted an amended and restated 2012 Equity Incentive Plan, to increase
by 1,500,000 shares, the number of awards available for issuance under the plan, which was approved by stockholders on December
28, 2017. On August 10, 2018, the PEDEVCO Board adopted an amended and restated 2012 Equity Incentive Plan, to increase by 3,000,000
shares, the number of awards available for issuance under the plan, which was approved by stockholders on September 27, 2018.
On July 1, 2019, the PEDEVCO Board adopted an amended and restated 2012 Equity Incentive Plan, to increase by 2,000,000 shares,
the number of awards available for issuance under the plan, which was approved by stockholders on August 28, 2019. PEDEVCO refers
to the 2012 Amended and Restated Incentive Plan as the 2012 Plan.
Purpose. The
PEDEVCO Board adopted the 2012 Plan to provide a means by which its employees, directors and consultants may be given an opportunity
to benefit from increases in the value of PEDEVCO Common Stock, to assist in attracting and retaining the services of such persons,
to bind the interests of eligible recipients more closely to PEDEVCO’s interests by offering them opportunities to acquire
shares of PEDEVCO Common Stock and to afford such persons stock-based compensation opportunities that are competitive with those
afforded by similar businesses.
Administration. Unless
it delegates administration to a committee, the PEDEVCO Board administers the 2012 Plan. Subject to the provisions of the 2012
Plan, the PEDEVCO Board has the power to construe and interpret the 2012 Plan, and to determine: (a) the fair value of PEDEVCO
Common Stock subject to awards issued under the 2012 Plan; (b) the persons to whom and the dates on which
awards will be
granted; (c) what types or combinations of types of awards will be granted; (d) the number of shares of PEDEVCO Common
Stock to be subject to each award; (e) the time or times during the term of each award within which all or a portion of such
award may be exercised; (f) the exercise price or purchase price of each award; and (g) the types of consideration permitted
to exercise or purchase each award and other terms of the awards.
Eligibility. Incentive
stock options may be granted under the 2012 Plan only to employees of PEDEVCO and its affiliates. Employees, directors and consultants
of PEDEVCO and its affiliates are eligible to receive all other types of awards under the 2012 Plan.
Terms
of Options and SARs. The exercise price of incentive stock options may not be less than the fair market value of PEDEVCO
Common Stock subject to the option on the date of the grant and, in some cases, may not be less than 110% of such fair market
value. The exercise price of nonstatutory options also may not be less than the fair market value of PEDEVCO Common Stock on the
date of grant.
Options
granted under the 2012 Plan may be exercisable in cumulative increments, or “vest,” as determined by the PEDEVCO Board.
The PEDEVCO Board has the power to accelerate the time as of which an option may vest or be exercised. The maximum term of options,
SARs and performance shares and units under the 2012 Plan is ten years, except that in certain cases, the maximum term is
five years. Options, SARs and performance shares and units awarded under the 2012 Plan generally will terminate three months after
termination of the participant’s service, subject to certain exceptions.
A
recipient may not transfer an incentive stock option otherwise than by will or by the laws of descent and distribution. During
the lifetime of the recipient, only the recipient may exercise an option, SAR or performance share or unit. The PEDEVCO Board
may grant nonstatutory stock options, SARs and performance shares and units that are transferable to the extent provided in the
applicable written agreement.
Terms
of Restricted Stock Awards. The PEDEVCO Board may issue shares of restricted stock under the 2012 Plan as a grant or
for such consideration, including services, and, subject to the Sarbanes-Oxley Act of 2002, promissory notes, as determined in
its sole discretion.
Shares
of restricted stock acquired under a restricted stock purchase or grant agreement may, but need not, be subject to forfeiture
to PEDEVCO or other restrictions that will lapse in accordance with a vesting schedule to be determined by the PEDEVCO Board.
In the event a recipient’s employment or service with PEDEVCO terminates, any or all of the shares of PEDEVCO Common Stock
held by such recipient that have not vested as of the date of termination under the terms of the restricted stock agreement may
be forfeited to PEDEVCO in accordance with such restricted stock agreement.
Rights
to acquire shares of PEDEVCO Common Stock under the restricted stock purchase or grant agreement shall be transferable by the
recipient only upon such terms and conditions as are set forth in the restricted stock agreement, as the PEDEVCO Board shall determine
in its discretion, so long as shares of PEDEVCO Common Stock awarded under the restricted stock agreement remain subject to the
terms of such agreement.
Adjustment
Provisions. If any change is made to the outstanding shares of PEDEVCO Common Stock without PEDEVCO’s receipt
of consideration (whether through reorganization, stock dividend or stock split, or other specified change in PEDEVCO’s
capital structure), appropriate adjustments may be made in the class and maximum number of shares of PEDEVCO Common Stock subject
to the 2012 Plan and outstanding awards. In that event, the 2012 Plan will be appropriately adjusted in the class and maximum
number of shares of PEDEVCO Common Stock subject to the 2012 Plan, and outstanding awards may be adjusted in the class, number
of shares and price per share of PEDEVCO Common Stock subject to such awards.
Effect
of Certain Corporate Events. In the event of (a) a liquidation or dissolution of PEDEVCO; (b) a merger
or consolidation of PEDEVCO with or into another corporation or entity (other than a merger with a wholly-owned subsidiary); (c) a
sale of all or substantially all of the assets of PEDEVCO; or (d) a purchase or other acquisition of more than 50% of the
outstanding stock of PEDEVCO by one person or by more than one person acting in concert, any surviving or acquiring corporation
may assume awards outstanding under the 2012 Plan or may substitute similar awards. Unless the stock award agreement otherwise
provides, in the event any surviving or acquiring corporation does not assume such awards or substitute similar awards, then the
awards will terminate if not exercised at or prior to such event.
Duration,
Amendment and Termination. The PEDEVCO Board may suspend or terminate the 2012 Plan without stockholder approval or ratification
at any time or from time to time. Unless sooner terminated, the 2012 Plan will terminate ten years from the date of its adoption
by the PEDEVCO Board, i.e., in June 2022.
The
PEDEVCO Board may also amend the 2012 Plan at any time, and from time to time. However, except as it relates to adjustments upon
changes in PEDEVCO Common Stock, no amendment will be effective unless approved by PEDEVCO’s stockholders to the extent
stockholder approval is necessary to preserve incentive stock option treatment for federal income tax purposes. The PEDEVCO Board
may submit any other amendment to the 2012 Plan for stockholder approval if it concludes that stockholder approval is otherwise
advisable.
As
of September 30, 2020, options to purchase 1,159,500 shares of PEDEVCO Common Stock and 5,390,130 shares of restricted stock have
been issued under the 2012 Plan, with 1,412,870 shares of PEDEVCO Common Stock remaining available for issuance under the 2012
Plan. The options have a weighted average exercise price of $2.26 per share and have expiration dates ranging from 2021 to 2025.
2012
Pacific Energy Development (Pre-Merger) Plan
On
February 9, 2012, prior to the Pacific Energy Development merger, Pacific Energy Development adopted the Pacific Energy Development
2012 Equity Incentive Plan (the “2012 Pre-Merger Plan”). PEDEVCO assumed the obligations of the 2012 Pre-Merger Plan
pursuant to the Pacific Energy Development merger, though the 2012 Pre-Merger Plan has been superseded by the 2012 Plan (described
above).
The
2012 Pre-Merger Plan provides for awards of incentive stock options, non-statutory stock options, rights to acquire restricted
stock, stock appreciation rights, or SARs, and performance units and performance shares. Subject to the provisions of the 2012
Pre-Merger Plan relating to adjustments upon changes in PEDEVCO Common Stock, an aggregate of 100,000 shares of PEDEVCO Common
Stock have been reserved for issuance under the 2012 Pre-Merger Plan.
The
board of directors of Pacific Energy Development adopted the 2012 Pre-Merger Plan to provide a means by which its employees, directors
and consultants may be given an opportunity to benefit from increases in the value of its PEDEVCO Common Stock, to assist in attracting
and retaining the services of such persons, to bind the interests of eligible recipients more closely to PEDEVCO’s interests
by offering them opportunities to acquire shares of PEDEVCO Common Stock and to afford such persons stock-based compensation opportunities
that are competitive with those afforded by similar businesses.
The
exercise price of incentive stock options may not be less than the fair market value of the PEDEVCO Common Stock subject to the
option on the date of the grant and, in some cases, may not be less than 110% of such fair market value. The exercise price of
nonstatutory options also may not be less than the fair market value of the PEDEVCO Common Stock on the date of grant. Options
granted under the 2012 Pre-Merger Plan may be exercisable in cumulative increments, or “vest,” as determined by the
board of directors of Pacific Energy Development at the time of grant.
Shares
of restricted stock could be issued under the 2012 Pre-Merger Plan as a grant or for such consideration, including services,
and, subject to the Sarbanes-Oxley Act of 2002, promissory notes, as determined in the sole discretion of the Pacific Energy Development
board of directors. Shares of restricted stock acquired under a restricted stock purchase or grant agreement could, but need not,
be subject to forfeiture or other restrictions that will lapse in accordance with a vesting schedule determined by the board of
directors of Pacific Energy Development at the time of grant. In the event a recipient’s employment or service with PEDEVCO
terminates, any or all of the shares of PEDEVCO Common Stock held by such recipient that have not vested as of the date of termination
under the terms of the restricted stock agreement may be forfeited to PEDEVCO in accordance with such restricted stock agreement.
Appropriate
adjustments may be made to outstanding awards in the event of changes in outstanding shares of PEDEVCO Common Stock, whether through
reorganization, stock dividend or stock split, or other specified change in capital structure of PEDEVCO. In the event of liquidation,
merger or consolidation, sale of all or substantially all of the assets of PEDEVCO, or other change in control, any surviving
or acquiring corporation may assume awards outstanding under the 2012 Pre-Merger Plan or may substitute similar awards. Unless
the stock award agreement otherwise provides, in the event any surviving or acquiring corporation does not assume such awards
or substitute similar awards, then the awards will terminate if not exercised at or prior to such event.
As
of the date of this Annual Report, 21,635 options remain outstanding under the 2012 Pre-Merger Plan. These options have
a weighted average exercise price of $4.98 per share and have expiration dates ranging from May 31, 2021 to June
18, 2022.
Agreements
with Current Named Executive Officers
Dr.
Simon Kukes
Dr.
Kukes has agreed to receive an annual salary of $1 as his compensation for serving as Chief Executive Officer of PEDEVCO and as
a member of the PEDEVCO Board and to not charge PEDEVCO for any personal business expenses he incurs in connection with such positions.
Notwithstanding the above, Dr. Kukes was not paid any salary for 2019 or 2018.
J.
Douglas Schick
On
August 1, 2018, in connection with his appointment as President of PEDEVCO, PEDEVCO entered into an offer letter with J. Douglas
Schick (the “Offer Letter”). Pursuant to the Offer Letter, Mr. Schick agreed to serve as President of PEDEVCO on an
at-will basis; PEDEVCO agreed to pay Mr. Schick $20,833 per month (as reduced by the Temporary Salary Reductions as discussed
below) and that Mr. Schick is eligible for an annual bonus in the discretion of PEDEVCO totaling up to 40% of his then current
salary and may also receive grants of restricted stock and options in the PEDEVCO Board’s sole discretion. Mr. Schick’s
employment may be terminated by him or PEDEVCO with 30 days prior written notice. In the event Mr. Schick’s employment
with PEDEVCO is terminated by PEDEVCO without “Cause,” PEDEVCO will (a) pay Mr. Schick an amount equal to twelve
(12) months of his then-
current annual base salary, and (b) immediately accelerate by twelve (12) months the vesting
of all outstanding PEDEVCO restricted stock and options exercisable for PEDEVCO capital stock held by Mr. Schick. For purposes
of the Offer Letter, “Cause” means Mr. Schick’s (1) conviction of, or plea of nolo contendere to, a felony
or any other crime involving moral turpitude; (2) fraud on or misappropriation of any funds or property of the Company or
any of its affiliates, customers or vendors; (3) act of material dishonesty, willful misconduct, willful violation of any
law, rule or regulation, or breach of fiduciary duty involving personal profit, in each case made in connection with his responsibilities
as an employee, officer or director of PEDEVCO and which has, or could reasonably be deemed to result in, a material adverse effect
upon PEDEVCO; (4) illegal use or distribution of drugs; (5) willful material violation of any policy or code of conduct
of PEDEVCO; or (6) material breach of any provision of the Offer Letter or any other employment, non-disclosure, non-competition,
non-solicitation or other similar agreement executed by him for the benefit of PEDEVCO or any of its affiliates, all as reasonably
determined in good faith by the PEDEVCO Board. However, an event that is or would constitute “Cause” shall cease to
be “Cause” if he reverses the action or cures the default that constitutes “Cause” within 10 days after
PEDEVCO notifies him in writing that Cause exists.
The
Offer Letter contains standard confidentiality provisions; a standard non-compete restriction prohibiting Mr. Schick from competing
against PEDEVCO during the term of his employment and for one year thereafter in connection with any directly competitive enterprise,
commercial venture, or project involving petroleum exploration, development, or production activities in the same geographic areas
as PEDEVCO’s activities or doing business with PEDEVCO during the six-month period before the termination of his employment,
with certain exceptions; and a non-solicitation provision prohibiting him from inducing or attempting to induce any employee of
PEDEVCO from leaving their employment with PEDEVCO and/or attempting to induce any consultant, service provider, customer or business
relation of PEDEVCO from terminating their relationship with PEDEVCO during the term of his employment and for one year thereafter.
On
March 31, 2020, Mr. Schick and the Company entered into an amendment to his Offer Letter discussed in greater detail below under
“Temporary Salary Reductions and Amendments to Employment Agreements”.
Clark
R. Moore
Pacific
Energy Development, PEDEVCO’s wholly-owned subsidiary, has entered into an employment agreement, dated June 10, 2011, as
amended January 11, 2013, with Clark Moore, its Executive Vice President, Secretary and General Counsel (the “Moore Employment
Agreement”), pursuant to which, effective June 1, 2011, Mr. Moore has been employed by Pacific Energy Development, with
a current annual base salary of $250,000 (which has been reduced by the Temporary Salary Reductions discussed below),
and a target annual cash bonus of between 20% and 40% of his base salary, awardable by the PEDEVCO Board in its discretion. In
addition, Mr. Moore’s employment agreement includes, among other things, severance payment provisions that would require
PEDEVCO to make lump sum payments equal to 18 months’ salary and target bonus to Mr. Moore in the event his employment is
terminated due to his death or disability, terminated without “Cause” or if he voluntarily resigns for “Good
Reason” (36 months in connection with a “Change of Control”), and continuation of benefits for up to 36 months
(48 months in connection with a “Change of Control”), as such terms are defined in the employment agreement. The employment
agreement also prohibits Mr. Moore from engaging in competitive activities during and following termination of his employment
that would result in disclosure of PEDEVCO’s confidential information, but does not contain a general restriction on engaging
in competitive activities.
For
purposes of the Moore Employment Agreement, the term “Cause” means his (1) conviction of, or plea of nolo contendere
to, a felony or any other crime involving moral turpitude; (2) fraud on or misappropriation of any funds or property of PEDEVCO
or any of its affiliates, customers or vendors; (3) act of material dishonesty, willful misconduct, willful violation of
any law, rule or regulation, or breach of fiduciary duty involving personal profit, in each case made in connection with his responsibilities
as an employee, officer or director of PEDEVCO and which has, or could reasonably be deemed to result in, a Material Adverse Effect
upon PEDEVCO; (4) illegal use or distribution of drugs; (5) material violation of any policy or code of conduct of PEDEVCO;
or (6) material breach of any provision of the employment agreement or any other employment, non-disclosure, non-competition,
non-solicitation or other similar agreement executed by him for the benefit of PEDEVCO or any of its affiliates, all as reasonably
determined in good faith by the PEDEVCO Board. However, an event that is or would constitute “Cause” shall cease to
be “Cause” if he reverses the action or cures the default that constitutes “Cause” within 10 days after
PEDEVCO notifies him in writing that Cause exists. No act or failure to act on Mr. Moore’s part will be considered “willful”
unless it is done, or omitted to be done, by him in bad faith or without reasonable belief that such action or omission was in
the best interests of PEDEVCO. Any act or failure to act that is based on authority given pursuant to a resolution duly passed
by the PEDEVCO Board, or the advice of counsel to PEDEVCO, shall be conclusively presumed to be done, or omitted to be done, in
good faith and in the best interests of PEDEVCO.
For
purposes of the Moore Employment Agreement, “Material Adverse Effect” means any event, change or effect that is materially
adverse to the condition (financial or otherwise), properties, assets, liabilities, business, operations or results of operations
of PEDEVCO or its subsidiaries, taken as a whole.
For
purposes of the Moore Employment Agreement, “Good Reason” means the occurrence of any of the following without his
written consent: (a) the assignment to him of duties substantially inconsistent with this employment agreement or a material
adverse change in his titles or authority; (b) any failure by PEDEVCO to comply with the compensation provisions of the agreement
in any material
way; (c) any material breach of the employment agreement by PEDEVCO; or (d) the relocation of him by
more than fifty (50) miles from the location of PEDEVCO’s office located in Danville, California. However, an event
that is or would constitute “Good Reason” shall cease to be “Good Reason” if: (i) he does not terminate
employment within 45 days after the event occurs; (ii) before he terminates employment, PEDEVCO reverses the action or cure
the default that constitutes “Good Reason” within 10 days after he notifies PEDEVCO in writing that Good Reason exists;
or (iii) he was a primary instigator of the “Good Reason” event and the circumstances make it inappropriate for
him to receive “Good Reason” termination benefits under the employment agreement (e.g., he agrees temporarily to relinquish
his position on the occurrence of a merger transaction he assists in negotiating).
For
purposes of the Moore Employment Agreement, “Change of Control” means: (i) a merger, consolidation or sale of
capital stock by existing holders of capital stock of PEDEVCO that results in more than 50% of the combined voting power of the
then outstanding capital stock of PEDEVCO or its successor changing ownership; (ii) the sale, or exclusive license, of all
or substantially all of PEDEVCO’s assets; or (iii) the individuals constituting the PEDEVCO Board as of the date of
the employment agreement (the “Incumbent Board of Directors”) cease for any reason to constitute at least 1/2
of the members of the PEDEVCO Board; provided, however, that if the election, or nomination for election by PEDEVCO’s stockholders,
of any new director was approved by a vote of the Incumbent Board of Directors, such new director shall be considered a member
of the Incumbent Board of Directors. Notwithstanding the foregoing and for purposes of clarity, a transaction shall not constitute
a Change in Control if: (w) its sole purpose is to change the state of PEDEVCO’s incorporation; (x) its sole purpose
is to create a holding company that will be owned in substantially the same proportions by the persons who held PEDEVCO’s
securities immediately before such transaction; or (y) it is a transaction effected primarily for the purpose of financing
PEDEVCO with cash (as determined by the PEDEVCO Board in its discretion and without regard to whether such transaction is effectuated
by a merger, equity financing or otherwise).
On
March 31, 2020, Mr. Moore and PEDEVCO entered into an amendment to his employment agreement discussed in greater detail below
under “Temporary Salary Reductions and Amendments to Employment Agreements”.
Paul
A. Pinkston
On
December 1, 2018, PEDEVCO appointed Mr. Pinkston as the Chief Accounting Officer of PEDEVCO and Mr. Pinkston commenced employment
with PEDEVCO pursuant to the terms of an Offer Letter, dated October 16, 2018, and effective December 1, 2018, entered into by
and between PEDEVCO and Mr. Pinkston (the “Pinkston Offer Letter”). Also effective on December 1, 2018, Mr. Pinkston
commenced serving as PEDEVCO’s Principal Financial and Accounting Officer of PEDEVCO.
Pursuant
to the Pinkston Offer Letter, Mr. Pinkston agreed to serve as Chief Accounting Officer of PEDEVCO on an at-will basis, PEDEVCO
agreed to pay Mr. Pinkston $11,666.67 per month (subject to the Temporary Salary Reductions discussed below), Mr. Pinkston is
eligible for an annual bonus in the discretion of the PEDEVCO Board totaling up to 30% of his then current salary, Mr. Pinkston
may also receive grants of restricted stock and options in the PEDEVCO Board’s sole discretion, and Mr. Pinkston’s
employment may be terminated by him or PEDEVCO with 30 days prior written notice. In addition, Mr. Pinkston was granted 30,000
shares of PEDEVCO’s Common Stock under PEDEVCO’s employee equity incentive plan, 50% of which shares vest on Mr. Pinkston’s
one (1) year anniversary of his employment commencement date, and 50% of which shares vest on Mr. Pinkston’s two (2) year
anniversary of his employment commencement date, subject to Mr. Pinkston’s continued service with PEDEVCO and the terms
of a Board-approved restricted stock purchase agreement entered into between Mr. Pinkston and PEDEVCO.
The
Pinkston Offer Letter contains standard confidentiality provisions and a standard a non-solicitation provision prohibiting him
from inducing or attempting to induce any employee of PEDEVCO from leaving their employment with PEDEVCO and/or attempting to
induce any consultant, service provider, customer or business relation of PEDEVCO from terminating their relationship with PEDEVCO
during the term of his employment and for one year thereafter.
Temporary
Salary Reductions and Amendments to Employment Agreements
On
March 31, 2020, as part of PEDEVCO s efforts to reduce operating and corporate costs, the independent Compensation Committee of
the PEDEVCO Board approved a 20% reduction in salary for all of PEDEVCO’s salaried employees, effective April 1, 2020 (the
“Temporary Salary Reductions”).
In
connection with the 20% salary reduction, on March 31, 2020, PEDEVCO and each of Mr. Douglas J. Schick, PEDEVCO’s President,
and Mr. Clark R. Moore, its Executive Vice President, General Counsel, and Secretary, entered into amendments to their respective
employment agreements (the “Amendments”) to effect the salary reductions on a temporary basis, until such time as
PEDEVCO determines, in its reasonable discretion, that oil markets have recovered to acceptable levels (the “Salary Reduction
Period”), which determination has not been made to date. The Amendments to Messrs. Schick’s and Moore’s employment
agreements do not, however, reduce the amount of severance compensation that such executive would receive under their respective
employment agreements in the event of an applicable termination of their respective employment, subject to the terms of such employment
agreements.
In
addition, the amendment entered into with Mr. Schick includes a provision whereby, in the event Mr. Schick’s employment
with PEDEVCO is voluntarily terminated by him due to PEDEVCO failing to pay his base salary (as currently reduced as disclosed
above) without his written consent, PEDEVCO will (a) continue to pay Mr. Schick an amount equal to his base salary as in effect
immediately before his termination of employment on the same bi-monthly schedule and amounts (less required withholdings) as he
received such salary payments prior to his date of termination (the “Cash Payments”), which Cash Payments shall be
reported by PEDEVCO on IRS Form 1099 as income to Mr. Schick and will continue until the earlier to occur of (x) the date that
is twelve (12) months after the termination of his employment or (y) the date that he commences employment with another employer
that pays him a base salary equal to, or greater than, his base salary as in effect immediately before his termination of employment,
provided that, if his new employer pays him less than his PEDEVCO base salary, he shall only be entitled to Cash Payment amounts
going forward through the remainder of the twelve (12) month term equal to (i) his Company base salary at the time of his termination
minus the salary he receives from his new employer; and (b) continue to vest his outstanding PEDEVCO restricted stock and options
exercisable for PEDEVCO capital stock issued to him by PEDEVCO which are then held by him on his date of termination on their
then-current vesting schedules during the period of up to twelve (12) months that he continues to receive the Cash Payments, in
exchange for a full and complete release of claims against PEDEVCO, its affiliates, officers and directors in a form reasonably
acceptable to PEDEVCO. Upon the date that his Cash Payments discontinue, he shall no longer continue to vest into any outstanding
PEDEVCO restricted stock or options. The Cash Payments payable to Mr. Schick and the other amounts, based on his salary, which
may be due to him upon termination of his offer letter upon certain events, and subject to the terms thereof, during the Salary
Reduction Period will continue to be based on Mr. Schick’s non-reduced salary.
As
discussed above, Dr. Simon Kukes, PEDEVCO’s Chief Executive Officer and director, has agreed to receive an annual salary
of $1 as his compensation for serving as Chief Executive Officer of PEDEVCO and as a member of the PEDEVCO Board and to not charge
PEDEVCO for any personal business expenses he incurs in connection with such positions. PEDEVCO does not currently have a formal
written agreement in place with Dr. Kukes. To date, Dr. Kukes has not accepted any salary from PEDEVCO (including his $1 annual
compensation).
Agreements
with Former Named Executive Officers
Frank
C. Ingriselli
Mr.
Frank C. Ingriselli entered into an Employment Agreement with Pacific Energy Development, PEDEVCO’s wholly-owned subsidiary
on May 10, 2018 (the “Ingriselli Employment Agreement”). Pursuant to the Ingriselli Employment Agreement, which had
an effective date of June 1, 2018, Mr. Ingriselli served as PEDEVCO’s President at an annual base salary of $250,000,
and a target annual cash bonus of between 20% and 40% of his base salary, awardable by the PEDEVCO Board in its discretion. PEDEVCO
also agreed to pay Mr. Ingriselli standard benefits as other executive officers of PEDEVCO. In addition, the Ingriselli Employment
Agreement included certain termination and severance provisions which provided for, among other things, severance payment provisions
that would require PEDEVCO to make lump sum payments equal to 18 months’ salary and target bonus (payable within thirty
days after termination) to Mr. Ingriselli in the event his employment was terminated due to his death or disability, terminated
without “Cause” or if he voluntarily resigned for “Good Reason” (36 months in connection with a “Change
of Control”), and continuation of benefits for up to 36 months (48 months in connection with a “Change of Control”),
as such terms are defined in the Ingriselli Employment Agreement.
The
definitions of “Cause” (including the applicable cure provisions associated therewith), “Material Adverse Effect”,
“Good Reason” and “Change of Control” in Mr. Ingriselli’s employment agreement were substantially
the same as in Mr. Moore’s employment agreement as discussed above.
In
addition, as additional consideration for Mr. Ingriselli rejoining PEDEVCO as its President (which position he held until August
2018) and Chief Executive Officer (which position he held until July 2018), on May 10, 2018, PEDEVCO granted Mr. Ingriselli
80,000 shares of restricted PEDEVCO Common Stock under PEDEVCO’s Amended and Restated 2012 Equity Incentive Plan, vesting
with respect to 60,000 shares on the six (6) month anniversary of June 1, 2018 and 20,000 of the shares on the nine (9) month
anniversary of June 1, 2018, subject to his continued service as an employee of or consultant to PEDEVCO on such vesting dates,
and subject to the terms and conditions of a Restricted Shares Grant Agreement entered into by and between PEDEVCO and Mr. Ingriselli.
In
an effort to reduce the general and administrative expenses of PEDEVCO, Mr. Ingriselli, PEDEVCO’s then-Chairman and
former President and Chief Executive Officer, agreed to retire from PEDEVCO as an employee, effective September 6, 2018. Mr.
Ingriselli continued as the Non-Executive Chairman of the PEDEVCO Board until his resignation from the PEDEVCO Board on September
27, 2018, and continued to work with PEDEVCO in a transitional consulting capacity until October 1, 2018 (the “Ingriselli
Transition Period”) through his wholly-owned consulting firm, Global Ventures Investments Inc. (“GVEST”),
pursuant to an Agreement dated September 6, 2018, entered into by and between PEDEVCO and GVEST (the “Consulting Agreement”). Pursuant
to the Consulting Agreement, through GVEST Mr. Ingriselli agreed to provide PEDEVCO with services in the areas of investor relations,
public relations, financing strategies, corporate strategies and development of business opportunities through the Ingriselli
Transition Period in exchange for the acceleration of vesting of an aggregate of 140,000 shares of restricted PEDEVCO Common Stock
previously issued to Mr. Ingriselli by PEDEVCO (the “Unvested Ingriselli Shares”), which would have otherwise vested
in full on March 1, 2019, subject to Mr. Ingriselli’s continued service to PEDEVCO, and would have otherwise been forfeited
by Mr. Ingriselli upon his resignation prior to such vesting date. In addition, the Company and Mr. Ingriselli entered
into an Employee Separation and Release dated September 6, 2018 (the “Ingriselli Separation Agreement”), pursuant
to which Mr. Ingriselli agreed to (i) waive all severance benefits to which he was entitled under his Executive Employment
Agreement dated May 10, 2018 (the “Ingriselli Employment Agreement”), including, but not limited to, waiver of any
payments by PEDEVCO to Mr. Ingriselli of a lump sum payment equal to
up to eighteen (18) months’ salary and 30% bonus,
and continued medical benefits for up to three (3) years, in the event of Mr. Ingriselli’s termination under certain
circumstances, pursuant to the terms of the Ingriselli Employment Agreement, and (ii) fully-release PEDEVCO from all claims,
in exchange for PEDEVCO agreeing to (x) allow Mr. Ingriselli to transfer the Unvested Ingriselli Shares to GVEST, and (y) pay
a lump sum cash payment of $350,000 to Mr. Ingriselli after seven (7) days following the effectiveness of the Separation
Agreement, which PEDEVCO paid in full.
Michael
L. Peterson
PEDEVCO
and Mr. Peterson (who previously served as PEDEVCO’s President and Chief Executive Officer) entered into a customary
Employee Separation and Release on May 10, 2018 (the “Separation Agreement”), pursuant to which Mr. Peterson agreed
to fully-release PEDEVCO from all claims, in exchange for PEDEVCO agreeing to make a lump sum payment of $20,000 upon effectiveness
of the Separation Agreement. In addition, in order to assist in the transition of his executive duties to Mr. Ingriselli, and
to continue to support PEDEVCO’s ongoing efforts to restructure its debt prior to its maturity in the second quarter of
2019, Mr. Peterson agreed to continue to work with PEDEVCO in a consulting capacity for a period of twelve (12) months commencing
June 1, 2018 (the “Consulting Term”, which was renewable thereafter for additional one month terms pursuant to the
terms of the agreement) pursuant to an Independent Contractor Agreement dated May 10, 2018 entered into by and between PEDEVCO
and Mr. Peterson (the “Peterson Consulting Agreement”). Pursuant to the Peterson Consulting Agreement,
Mr. Peterson provided PEDEVCO with executive transition, debt restructuring, strategic planning and capital markets support and
services through the Consulting Term in exchange for monthly fee of $5,000. The Peterson Consulting Agreement is terminable by
PEDEVCO at any time for “Cause”, as similarly defined under the Ingriselli Employment Agreement as described above.
PEDEVCO terminated the Peterson Consulting Agreement effective June 30, 2019.
On
September 1, 2011, Pacific Energy Development, PEDEVCO’s wholly-owned subsidiary, entered into a Consulting Agreement engaging
Michael L. Peterson to serve as Executive Vice President of Pacific Energy Development. This Consulting Agreement was superseded
by an employment offer letter dated February 1, 2012, which employment offer letter was later amended and restated in full on
June 16, 2012 and further amended on April 25, 2016 in connection with his promotion to the office of Chief Executive Officer
of PEDEVCO. Pursuant to Mr. Peterson’s employment offer letter, Mr. Peterson served the Chief Executive Officer and President
of PEDEVCO (positions he held until May 31, 2018) at an annual base salary of $300,000, and a target annual cash bonus
of between 20% and 40% of his base salary, awardable by the PEDEVCO Board in its discretion. Mr. Peterson’s employment offer
letter was terminated on May 31, 2018.
Gregory
Overholtzer
Mr.
Overholtzer served as the Chief Financial Officer of PEDEVCO from May 2016 to December 31, 2018, and formerly as PEDEVCO’s
Corporate Controller from January 2012 to May 2016, and as PEDEVCO’s Vice President, Finance and Corporate Controller from
June 2012 to May 2016. Effective May 1, 2016, in connection with Mr. Overholtzer’s appointment
as Chief Financial Officer of PEDEVCO, PEDEVCO entered into an Amendment No. 1 to Employment Agreement on April 25, 2016 with
Mr. Overholtzer (the “Amended Overholtzer Employment Agreement”), which amended that certain Employment Letter Agreement
dated June 16, 2012, entered into by and between PEDEVCO as successor-in-interest to Pacific Energy Development Corp. and Mr.
Overholtzer in connection with his original employment with PEDEVCO, and provided that PEDEVCO may terminate Mr. Overholtzer’
s employment for any reason with thirty (30) days prior written notice (the “Overholtzer Employment Agreement”).
Mr. Overholtzer had an annual base salary of $190,000, and was eligible for a discretionary cash performance bonus each year of
up to 30% of his then-current annual base salary.
In
connection with PEDEVCO’s consolidation of accounting operations to its new Houston, Texas headquarters, on December 31,
2018, the Company and Mr. Overholtzer entered into a Separation and General Release Agreement (the “Overholtzer Separation
Agreement”) pursuant to which, effective December 31, 2018 (the “Overholtzer Separation Date”), Mr. Overholtzer
and the Company mutually agreed to discontinue Mr. Overholtzer’s employment with PEDEVCO and Mr. Overholtzer resigned from
all positions held with PEDEVCO and its subsidiaries. Mr. Overholtzer continued to work with PEDEVCO in a transitional consulting
capacity until April 7, 2019 (the “Transition Period”) pursuant to a Consulting Agreement entered into by and
between PEDEVCO and Mr. Overholtzer on January 1, 2019 (the “Overholtzer Consulting Agreement”). Pursuant
to the Overholtzer Consulting Agreement, Mr. Overholtzer agreed to provide accounting and financial reporting services and support
to PEDEVCO for an average of up to six (6) hours per week during the Overholtzer Transition Period in exchange for cash compensation
of $15,000 per month and continued COBRA insurance coverage for Mr. Overholtzer and his dependents paid for by PEDEVCO during
the Overholtzer Transition Period. Upon the successful conclusion of the Overholtzer Transition Period, (i) the Company agreed
to accelerate the vesting of an aggregate of 20,000 shares of restricted PEDEVCO Common Stock previously issued to Mr. Overholtzer
by PEDEVCO (the “Unvested Overholtzer Shares”), which would have otherwise vested ratably over three years through
December 12, 2021, subject to Mr. Overholtzer’s continued service to PEDEVCO, and which would have otherwise been forfeited
by Mr. Overholtzer upon his separation from PEDEVCO prior to such vesting date, (ii) PEDEVCO agreed to accelerate the vesting
of options to purchase an aggregate of 30,000 shares of PEDEVCO Common Stock at an exercise price of $0.3088 per share previously
issued to Mr. Overholtzer by PEDEVCO (the “Unvested Overholtzer Options”), which would have otherwise vested in full
on June 28, 2019, subject to Mr. Overholtzer’s continued service to PEDEVCO, and which would have otherwise been forfeited
by Mr. Overholtzer
upon his separation from
PEDEVCO prior to such vesting date, and (iii) PEDEVCO agreed to extend the exercise period for all of Mr. Overholtzer’s
options for a period of three (3) years following the Overholtzer Separation Date (regardless of their original terms). In
addition, pursuant to the Overholtzer Separation Agreement, Mr. Overholtzer agreed to fully-release PEDEVCO from all claims in
exchange for PEDEVCO agreeing to pay a lump sum cash payment of $15,833.33 to Mr. Overholtzer following the effectiveness of the
Overholtzer Separation Agreement.
Certain
Relationships and Related Party Transactions
Except
as discussed below, referenced below, or otherwise disclosed above under “Executive Compensation”, “Agreements
with Current Named Executive Officers” and “Agreements with Former Named Executive Officers”, there have been
no transactions since January 1, 2018, and there is not currently any proposed transaction, in which PEDEVCO was or is to be a
participant, where the amount involved exceeds $120,000, and in which any officer, director, or any stockholder owning greater
than five percent (5%) of its outstanding voting shares, nor any member of the above referenced individual’s immediate family,
had or will have a direct or indirect material interest.
Certain
Agreements
On
September 20, 2018, SK Energy, a company wholly-owned by PEDEVCO’s Chief Executive Officer and director, Dr. Simon Kukes,
entered into an agreement with American Resources Inc. (“American”), whose principals are Ivar Siem, a member of the
PEDEVCO Board, and J. Douglas Schick, the President of PEDEVCO. Pursuant to the agreement, American agreed to assist Dr. Kukes
with his investments in PEDEVCO and SK Energy agreed to pay American 25% of the profit realized PEDEVCO by SK Energy, if any,
following the sale or disposal of the securities of PEDEVCO which SK Energy holds and may acquire in the future (prior to such
sale/disposition). The profit is to be calculated based on (x) the amount of consideration received by SK Energy in connection
with the sale of such securities, minus (y) the consideration paid by SK Energy for the securities, increased by 10% each
year that such securities are held. The agreement has a term of four years, but can be terminated at any time by SK Energy with
written notice to American.
Effective
November 8, 2019, PEDEVCO entered into an Advisory Agreement and Restricted Shares Grant Agreement with Viktor Tkachev, a greater
than 10% stockholder of PEDEVCO (who acquired $12 million of shares of common stock on September 17, 2019), under which
Mr. Tkachev agreed to provide strategic planning and business development services, and pursuant to which 100,000 shares
of restricted common stock were awarded to Mr. Tkachev under PEDEVCO’s Amended and Restated 2012 Equity Incentive Plan,
vesting in full on the six-month anniversary of the grant date, subject to his continued service with PEDEVCO, in consideration
for advisory services to be provided by Mr. Tkachev to PEDEVCO. The Advisory Agreement contains customary confidentiality, indemnification
and no conflict language, and may be terminated by PEDEVCO or the advisor with 15 days prior written notice for any reason.
Effective
November 8, 2019, PEDEVCO entered into an Advisory Agreement with Ivar Siem, a member of the PEDEVCO Board, pursuant to which
the 50,000 restricted shares of common stock previously awarded to Mr. Siem on August 28, 2019 under the Plan continue to vest,
with 100% vesting on July 12, 2020, subject to Mr. Siem continuing to provide advisory services to PEDEVCO on such vesting date,
and subject to the terms and conditions of a Restricted Shares Grant Agreement entered into by and between PEDEVCO and Mr. Siem
on August 28, 2019. The Advisory Agreement contains customary confidentiality, indemnification and no conflict language; and may
be terminated by PEDEVCO or the advisor with 15 days prior written notice for any reason.
Effective
August 27, 2020, PEDEVCO granted 70,000 shares of restricted PEDEVCO Common Stock under the Plan to Viktor Tkachev, a greater
than 10% shareholder of PEDEVCO (who acquired $12 million of shares of common stock on September 17, 2019), which shares
vest on February 27, 2021, subject to Mr. Tkachev’s continued service to PEDEVCO under that certain Advisory Agreement,
dated November 8, 2019, entered into by and between Mr. Tkachev and PEDEVCO (the “Advisory Agreement”) and a Restated
Shares Grant Agreement entered into by and between Mr. Tkachev and PEDEVCO. This restricted stock award was issued and granted
in consideration for Mr. Tkachev serving as an advisor to PEDEVCO.
SK
Energy Note and Related Transactions
On
June 26, 2018, PEDEVCO borrowed $7.7 million from SK Energy, which amount was evidenced by a Promissory Note dated June 25, 2018,
in the amount of $7.7 million (the “SK Energy Note”). SK Energy is 100% owned and controlled by Dr. Simon Kukes, PEDEVCO’s
Chief Executive Officer and director. The SK Energy Note accrues interest monthly at 8% per annum, payable quarterly (beginning
October 15, 2018), in either cash or shares of common stock (at the option of PEDEVCO), or with the consent of SK Energy, such
interest may be accrued and capitalized. If interest on the SK Energy Note is paid in common stock, SK Energy will be due that
number of shares of common stock as equals the amount due divided by the average of the closing sales prices of PEDEVCO Common
Stock for the ten trading days immediately preceding the last day of the calendar quarter prior to the applicable payment date,
rounded up to the nearest whole share of common stock (the “Interest Shares”). The SK Energy Note is due and payable
on June 25, 2021, but may be prepaid at any time, without penalty. Other than in connection with the Interest Shares. The SK Energy
Note contains standard and customary events of default and upon the occurrence of an event of default, the amount owed under the
SK Energy Note accrues interest at 10% per annum. As additional consideration for SK Energy agreeing to the terms of the SK Energy
Note, PEDEVCO issued SK Energy 600,000 shares of common stock (the “Loan Shares”).
As
part of the same transaction and as a required condition to closing the sale of the SK Energy Note, SK Energy entered into a Stock
Purchase Agreement with Golden Globe Energy (US), LLC (“GGE”), the then holder of outstanding 66,625 shares of Series
A Convertible Preferred Stock (convertible pursuant to their terms into 6,662,500 shares of PEDEVCO Common Stock – 47.6%
of PEDEVCO’s then outstanding shares post-conversion), pursuant to which on June 25, 2018, SK Energy purchased, for $100,000,
all of the Series A Convertible Preferred Stock).
Series
A Convertible Preferred Stock Amendment and Conversion
In
connection with the Stock Purchase Agreement, and immediately following the closing of the acquisition described in the Stock
Purchase Agreement (discussed above), PEDEVCO and SK Energy, as the then holder of all of the then outstanding shares of Series
A Convertible Preferred Stock, agreed to the filing of an Amendment to the Amended and Restated Certificate of Designations of
PEDEVCO Corp. Establishing the Designations, Preferences, Limitations and Relative Rights of Its Series A Convertible Preferred
Stock (the “Preferred Amendment”), which amended the designation of the Series A Convertible Preferred Stock (the
“Designation”) to remove the beneficial ownership restriction contained therein, which prevented any holder of Series
A Convertible Preferred Stock from converting such Series A Convertible Preferred Stock into shares of PEDEVCO Common Stock if
such conversion would result in the holder thereof holding more than 9.9% of then outstanding PEDEVCO Common Stock. PEDEVCO filed
the Preferred Amendment with the Secretary of State of Texas on June 26, 2018.
On
July 3, 2018, SK Energy converted all of the Series A Convertible Preferred Stock shares it acquired pursuant to the Stock Purchase
Agreement with GGE, pursuant to their terms, into 6,662,500 shares of PEDEVCO Common Stock, representing 45.3% of then outstanding
PEDEVCO Common Stock, and resulting in approximately 14,717,119 shares of PEDEVCO Common Stock being issued and outstanding. The
issuance was deemed a change of control under applicable NYSE American rules and regulations, provided that such issuance
was previously approved at the 2015 annual meeting of stockholders of PEDEVCO held on October 7, 2015. The conversion transaction
constituted a change in control of PEDEVCO under applicable NYSE American rules and regulations. The shares of common stock
issued upon conversion of the Series A Convertible Preferred Stock, together with the Loan Shares (issued to SK Energy on June
26, 2018) totaled 49.9% of the then outstanding shares of common stock, which shares are beneficially owned by SK Energy and Dr.
Kukes.
Convertible
Note Sales
On
August 1, 2018, PEDEVCO raised $23,600,000 through the sale of $23,600,000 in Convertible Promissory Notes (the “Convertible
Notes”). A total of $22,000,000 in Convertible Notes was purchased by SK Energy; $200,000 in Convertible Notes was purchased
by an executive officer of SK Energy; $500,000 in Convertible Notes was purchased by a trust affiliated with John J. Scelfo, a
director of PEDEVCO; $500,000 in Convertible Notes was purchased by an entity affiliated with Ivar Siem, PEDEVCO’s director,
and J. Douglas Schick, who was appointed as the President of PEDEVCO on August 1, 2018; $200,000 in Convertible Notes was purchased
by H. Douglas Evans, who was appointed as a member of the PEDEVCO Board on September 27, 2018; and $200,000 in Convertible Notes
were purchased by an unaffiliated party.
The
Convertible Notes accrue interest monthly at 8.5% per annum, which interest is payable on the maturity date unless otherwise converted
into PEDEVCO Common Stock as described below.
The
Convertible Notes and all accrued interest thereon are convertible into shares of PEDEVCO Common Stock, from time to time after
August 29, 2018, at the option of the holders thereof, at a conversion price equal to the greater of (x) $0.10 above the greater
of the book value of PEDEVCO Common Stock and the closing sales price of PEDEVCO Common Stock on the date the Convertible Notes
were entered into (the “Book/Market Price”) (which was $2.13 per share); (y) $1.63 per share; and (z) the
VWAP Price, defined as the volume weighted average price (calculated by aggregate trading value on each trading day) of PEDEVCO
Common Stock for the 20 trading days ending August 29, 2018, which price was $2.08 per share, and which conversion price is therefore
$2.13 per share.
The
conversion of the SK Energy Convertible Note is subject to a 49.9% conversion limitation (for so long as SK Energy or any of its
affiliates holds such note), which prevents the conversion of any portion thereof into common stock of PEDEVCO if such conversion
would result in SK Energy beneficially owning (as such term is defined in the Exchange Act) (“Beneficially Owning”)
more than 49.9% of the outstanding shares of PEDEVCO Common Stock.
The
conversion of the other Convertible Notes is subject to a 4.99% conversion limitation, at any time such note is Beneficially Owned
by any party other than (i) SK Energy or any of its affiliates (which is subject to the separate conversion limitation described
above); (ii) any officer of PEDEVCO; (iii) any director of PEDEVCO; or (iv) any person which at the time of first obtaining Beneficial
Ownership of the Convertible Note beneficially owns more than 9.99% of the outstanding PEDEVCO Common Stock or voting stock (collectively
(ii) through (iv), “Borrower Affiliates”). The Convertible Notes are not subject to a conversion limitation at any
time they are owned or held by Borrower Affiliates.
The
Convertible Notes are due and payable on August 1, 2021, but may be prepaid at any time, without penalty. The Convertible Notes
contain standard and customary events of default and upon the occurrence of an event of default, the amount owed under the Convertible
Notes accrues interest at 10% per annum.
The
terms of the Convertible Notes may be amended or waived and such amendment or waiver shall be applicable to all of the Convertible
Notes with the written consent of Convertible Note holders holding at least a majority in interest of the then aggregate dollar
value of Convertible Notes outstanding.
Additional
Convertible Note Sales
On
October 25, 2018, PEDEVCO borrowed an additional $7.0 million from SK Energy, through the issuance of a convertible promissory
note in the amount of $7.0 million (the “October 2018 Convertible Note”). The October 2018 Convertible Note accrues
interest monthly at 8.5% per annum, which is payable on the maturity date, unless otherwise converted into shares of PEDEVCO Common
Stock as described below. The October 2018 Convertible Note and all accrued interest thereon are convertible into shares of PEDEVCO
Common Stock, at the option of the holder thereof, at a conversion price equal to $1.79 per share. Further, the conversion of
the October 2018 Convertible Note is subject to a 49.9% conversion limitation which prevents the conversion of any portion thereof
into PEDEVCO Common Stock if such conversion would result in SK Energy or any of its affiliates beneficially owning more than
49.9% of the outstanding shares of PEDEVCO Common Stock. The October 2018 Convertible Note is due and payable on October 25, 2021
but may be prepaid at any time without penalty.
Also
on October 25, 2018, PEDEVCO and SK Energy agreed to convert an aggregate of $164,000 of interest accrued under the SK Energy
Note from its effective date through September 30, 2018 into 75,118 shares of PEDEVCO Common Stock, based on a conversion price
equal to $2.18 per share, pursuant to the conversion terms of the SK Energy Note.
January
2019 SK Energy Convertible Note
On
January 11, 2019, PEDEVCO borrowed an additional $15.0 million from SK Energy, through the issuance of a convertible promissory
note in the amount of $15.0 million (the “January 2019 Convertible Note”). The January 2019 Convertible Note
accrues interest monthly at 8.5% per annum, which is payable on the maturity date, unless otherwise converted into shares of PEDEVCO
Common Stock as described below. The January 2019 Convertible Note and all accrued interest thereon are convertible into shares
of PEDEVCO Common Stock, at the option of the holder thereof, at a conversion price equal to $1.50 per share. Further, the conversion
of the January 2019 Convertible Note is subject to a 49.9% conversion limitation which prevents the conversion of any portion
thereof into PEDEVCO Common Stock if such conversion would result in SK Energy or any of its affiliates beneficially owning more
than 49.9% of outstanding shares of PEDEVCO Common Stock. The January 2019, Convertible Note is due and payable on January 11,
2022 but may be prepaid at any time without penalty. In February 2019, the January 2019 Convertible Note was converted into PEDEVCO
Common Stock as discussed below.
Convertible
Notes Amendment and Conversion
On
February 15, 2019, PEDEVCO and SK Energy agreed to amend the terms of $23.6 million in Convertible Promissory Notes sold in August
2018 (including $22 million acquired by SK Energy) and a $7 million Convertible Note sold to SK Energy in October 2018, each
described in further detail above, as well as the January 2019 Convertible Note, whereby each of the notes were amended to remove
the conversion limitation that previously prevented SK Energy from converting any portion of the notes into common stock of PEDEVCO
if such conversion would have resulted in SK Energy beneficially owning more than 49.9% of the outstanding shares of PEDEVCO Common
Stock.
Immediately
following the entry into the Amendment, on February 15, 2019, SK Energy elected to convert (i) all $15,000,000 of the outstanding
principal and all $126,000 of accrued interest under the January 2019 Convertible Note into PEDEVCO Common Stock at a conversion
price of $1.50 per share as set forth in the January 2019 Convertible Note into 10,083,819 shares of restricted PEDEVCO Common
Stock, and (ii) all $7,000,000 of the outstanding principal and all $18,700 of accrued interest under the October 2018 note
into PEDEVCO Common Stock at a conversion price of $1.79 per share as set forth in the October 2018 note into 4,014,959 shares
of restricted PEDEVCO Common Stock, which shares in aggregate represented approximately 47.1% of the then 29,907,223 shares of
issued and outstanding PEDEVCO Common Stock after giving effect to the conversions.
SK
Energy Note Amendment; Note Purchases and Conversion
On
March 1, 2019, PEDEVCO and SK Energy entered into a First Amendment to Promissory Note (the “SK Energy Note Amendment”) which
amended the note dated June 25, 2018, evidencing $7.7 million of principal owed to SK Energy (the “SK Energy Note”),
to provide SK Energy the right, at any time, at its option, to convert the principal and interest owed under such SK Energy Note,
into shares of PEDEVCO Common Stock, at a conversion price of $2.13 per share. The SK Energy Note previously only included a conversion
feature whereby PEDEVCO had the option to pay quarterly interest payments on the SK Energy Note in shares of PEDEVCO Common Stock
instead of cash, at a conversion price per share calculated based on the average closing sales price of PEDEVCO Common Stock on
the NYSE American for the ten trading days immediately preceding the last day of the calendar quarter immediately prior to the
quarterly payment date.
In
addition, on March 1, 2019, the holders of $1,500,000 in aggregate principal amount of Convertible Notes issued by PEDEVCO on
August 1, 2018 (the “August 2018 Notes”) sold their August 2018 Notes at face value plus accrued and unpaid interest
through March 1, 2019 to SK Energy (the “August 2018 Note Sale”). Holders which sold their August 2018 Notes pursuant
to the August 2018 Note Sale to SK Energy include an executive officer of SK Energy ($200,000 in principal amount of August 2018
Notes); a trust affiliated
with John J. Scelfo, a director of PEDEVCO ($500,000 in principal amount of August 2018 Notes); an
entity affiliated with Ivar Siem, a director of PEDEVCO, and J. Douglas Schick the President of PEDEVCO ($500,000 in principal
amount of August 2018 Notes); and Harold Douglas Evans, a director of PEDEVCO ($200,000 in principal amount of August 2018 Notes).
Following
the August 2018 Note Sale, PEDEVCO’s sole issued and outstanding debt was the (i) $7,700,000 in principal, plus accrued
interest, under the SK Energy Note held by SK Energy, (ii) an aggregate of $23,500,000 in principal, plus accrued interest,
under the August 2018 Notes and SK Energy $22 million Convertible Note held by SK Energy, and (iii) $100,000 in principal,
plus accrued interest, under an August 2018 Note held by an unaffiliated holder (the “Unaffiliated Holder”).
Immediately
following the effectiveness of the SK Energy Note Amendment and August 2018 Note Sale, on March 1, 2019, SK Energy and the Unaffiliated
Holder elected to convert all $31,300,000 of outstanding principal and an aggregate of $1,462,818 of accrued interest under the
SK Energy Note, SK Energy $22 million Convertible Note and August 2018 Notes into PEDEVCO Common Stock at a conversion price of
$2.13 per share (the “Conversion Price” and the “Conversions”) as set forth in the SK Energy Note,
as amended, and the August 2018 Notes and SK Energy $22 million Convertible Note (collectively, the “Notes”), into
an aggregate of 15,381,605 shares of restricted PEDEVCO Common Stock (the “Conversion Shares”).
Common
Stock Issuance to SK Energy LLC
On
May 21, 2019, PEDEVCO raised $14,999,998.20 through the sale of 6,818,181 shares of restricted PEDEVCO Common Stock at a
price of $2.20 per share (the “Purchase Price”) to SK Energy, pursuant to a Common Stock Subscription Agreement, dated
May 21, 2019, entered into by and between PEDEVCO and SK Energy (the “Subscription Agreement”). The Purchase Price
represents a premium to the closing price of the PEDEVCO Common Stock on the NYSE American Exchange as of the closing date and
was above the greater of the book/market price of the PEDEVCO Common Stock for the purposes of the NYSE American Exchange.
Additional
Miscellaneous Related Party Transactions
On
June 25, 2018, pursuant to a Debt Repayment Agreement, PEDEVCO paid that certain Amended and Restated Secured Subordinated Promissory
Note, dated March 25, 2013, in the principal amount of $6,170,065, entered into by Pacific Energy Development Corp., its wholly-owned
subsidiary (“PEDCO”) and MIE Jurassic Energy Corporation (“MIEJ”), a subsidiary of MIE Holdings,
in consideration for $320,125 in cash.
On
August 1, 2018, Red Hawk Petroleum, LLC, PEDEVCO’s wholly-owned subsidiary (“Red Hawk”) entered into a Membership
Interest Purchase Agreement with MIEJ, pursuant to which PEDEVCO, through Red Hawk, acquired 100% of the outstanding membership
interests of Condor Energy Technology LLC (“Condor”) from MIEJ in consideration for $545,000.
On
June 25, 2018, PEDEVCO entered into Debt Repayment Agreements (the “Repayment Agreements”) with the holders of its
outstanding Tranche A Secured Promissory Notes (“Tranche A Notes”) and Tranche B Secured Promissory Notes (“Tranche
B Notes”), RJ Credit LLC, and MIEJ, pursuant to which, on June 26, 2018, PEDEVCO retired all of the then outstanding Tranche
A Notes, in the aggregate amount of approximately $5.7 million, for $3.8 million and all of the then outstanding Tranche B Notes
and notes held by RJ Credit LLC, in the aggregate amount of approximately $67.7 million, for an aggregate of $3,876,208.
Pursuant
to the terms of the Repayment Agreement relating to the Tranche B Notes, in addition to the cash consideration due to the Tranche
B Noteholders, as described above, PEDEVCO agreed to grant to certain of the noteholders their pro rata share of warrants to purchase
an aggregate of 1,448,472 shares of PEDEVCO Common Stock (the “Tranche B Warrants”). The Tranche B Warrants have a
term of three years and an exercise price equal to $0.322, one (1) cent above the closing price of PEDEVCO Common Stock on June 26,
2018 (“Repurchase Warrants”).
On
August 10, 2018 the PEDEVCO Board agreed to accelerate the vesting of 150,000 shares of restricted stock held by Mr. Adam McAfee,
a then current member of the PEDEVCO Board, effective as of the 2018 Annual Meeting, in consideration for Mr. McAfee’s service
on the PEDEVCO Board and its committees until the 2018 Annual Meeting, where he has not been nominated for reelection. These shares
would have otherwise vested December 28, 2018 had Mr. McAfee remained on the PEDEVCO Board on such date.
Mr.
David Steinberg (a former member of the PEDEVCO Board who resigned on July 11, 2018), entered into a Rescission Agreement (the
“Rescission Agreement”) pursuant to which PEDEVCO and Mr. Steinberg agreed to cancel and rescind an aggregate of 75,975
shares of restricted Company Common Stock originally granted to Mr. Steinberg pursuant to the Board Compensation Program in 2015
and 2016.
On
August 31, 2018, PEDEVCO entered into warrant repurchase agreements with certain of the holders of Repurchase Warrants, namely
Senior Health Insurance Company of Pennsylvania, Principal Growth Strategies, LLC, and RJ Credit LLC (collectively, the “Warrant
Holders”). Pursuant to the warrant repurchase agreements, PEDEVCO repurchased warrants to purchase an aggregate of 1,105,935
shares of PEDEVCO Common Stock (the shares of PEDEVCO Common Stock issuable upon exercise of which such Repurchase Warrants, the
“Warrant Shares”) held by the Warrant Holders, which warrants had a term of three years (through August 25, 2021)
and an exercise price equal to $0.322 per share. The Repurchase Warrants were repurchased for an aggregate of $1,095,000 or $0.99
per Warrant Share, which amount PEDEVCO paid to the Warrant Holders on September 17, 2018. Effective on the date of
payment of
the warrant purchase amounts, the Repurchase Warrants and the agreements evidencing such Repurchase Warrants were deemed to have
been repurchased by PEDEVCO and cancelled. The Warrant Repurchase Agreements also included a release by which the Warrant Holders
released PEDEVCO from any liability or claims associated with the Repurchase Warrants and certain of the Warrant Repurchase Agreements
included a release by which PEDEVCO released the applicable Warrant Holders party thereto. The terms of the Warrant Repurchase
Agreements were individually negotiated with each associated group of Warrant Holders.
On
November 1, 2019, PEDEVCO began subleasing approximately 300 square feet of office space at its current headquarters to SK Energy,
which is owned and controlled by Dr. Kukes, PEDEVCO’s Chief Executive Officer and a member of the PEDEVCO Board. The lease
renews on a monthly basis, may be terminated by either party at any time upon prior written notice delivered to the other party,
and has a monthly base rent of $1,200.
Review
and Approval of Related Party Transactions
PEDEVCO
has not adopted formal policies and procedures for the review, approval or ratification of transactions, such as those described
above, with its executive officer(s), director(s) and significant stockholders, provided that it is PEDEVCO’s policy that
any and all such transactions are presented and approved by the independent members of the PEDEVCO Board (typically through an
ad hoc committee formed solely for the purpose of approving each individual transaction), or the Audit Committee (which is tasked
with reviewing and approving proposed transactions between PEDEVCO and “related persons” as defined in Item 404 of
SEC Regulation S-K), or a majority of the PEDEVCO Board (with the interested parties abstaining) and future material transactions
between PEDEVCO and members of management or their affiliates shall be on terms no less favorable than those available from unaffiliated
third parties.
In
addition, PEDEVCO’s Code of Ethics, which is applicable to all of its employees, officers and directors, requires that
all employees, officers and directors avoid any conflict, or the appearance of a conflict, between an individual’s personal
interests and PEDEVCO’s interests.
INFORMATION
ABOUT THE PURCHASER
Purchaser
is a Texas limited liability company organized on October 2, 2020, with principal executive offices at 575 N. Dairy Ashford, Energy
Center II, Suite 210, Houston, Texas 77079. The telephone number of Purchaser’s principal executive offices is (713) 221-1768.
Purchaser is a wholly owned subsidiary of PEDEVCO that was formed to facilitate the transactions contemplated by this offer to
exchange. Purchaser has engaged in no activities to date and has no material assets or liabilities of any kind, in each case,
other than those incidental to its formation and its activities and obligations in connection with the offer.
PEDEVCO
is the sole member of the Purchaser. Simon G. Kukes, J. Douglas Schick, Paul A. Pinkston, and Clark R. Moore are the executive
officers of Purchaser. Information on these individuals is included in the section on directors and executive officers of PEDEVCO.
INFORMATION
ABOUT THE TRUST
All
information concerning the Trust, its businesses, operations, financial condition and management presented in this offer to exchange
is taken from publicly available information. Please see the section of this offer to exchange entitled “Note on Trust Information.”
Please also see “Risk Factors—Risk Factors Relating to PEDEVCO Following the Offer and the Second-Step Merger—PEDEVCO
has only conducted a review of the Trust’s publicly available information and has not had access to the Trust’s non-public
information.”
Description
of Business
General
SandRidge
Permian Trust is a statutory trust formed under the Delaware Statutory Trust Act pursuant to the Trust Agreement, as amended and
restated, by and among SandRidge, as Trustor, The Bank of New York Mellon Trust Company, N.A., as Trustee, and The Corporation
Trust Company, as Delaware Trustee in May 2011. The Trust’s affairs are administered by the Trustee, which maintains its
offices at 601 Travis Street, 16th Floor, Houston, Texas 77002. The Trust does not have any employees.
Copies
of reports filed by the Trust under the Exchange Act are available to holders of Trust Common Units and the public promptly after
such materials are filed with or furnished to the SEC by accessing the EDGAR system maintained by the SEC at www.sec.gov/edgar.
Certain information concerning the Trust and Trust Common Units as well as a link to the Trust’s filings with the SEC may
be obtained at the following website location: www.businesswire.com/cnn/per.htm. The Trust will also provide electronic or paper
copies of its filings free of charge upon request to the Trustee.
Formation
and Structure
The
Trust was formed to own Royalty Interests in the specified Underlying Properties located in Andrews County, Texas conveyed by
SandRidge to the Trust pursuant to the terms set forth in the Conveyances effective April 1, 2011 concurrent with the Offering
and sale of 34,500,000 of Trust Common Units in August 2011. As consideration for conveyance of the Royalty Interests, the Trust
remitted the net proceeds of the Offering, along with 4,875,000 Trust Common Units and 13,125,000 unregistered subordinated units
(the “Subordinated Units”), to certain wholly owned subsidiaries of SandRidge.
The
Royalty Interests entitle the Trust to receive (a) 80% of the proceeds (after deducting post-production costs and any applicable
taxes) from the sale of oil, natural gas and NGL production attributable to the net revenue interest of SandRidge in 517 oil and
natural gas wells drilled and completed as of April 1, 2011 on the Underlying Properties, including 21 wells awaiting Completion
at that time (the “Initial Wells”), and (b) 70% of the proceeds (after deducting post-production costs and any applicable
taxes) from the sale of oil, natural gas and NGL production attributable to the net revenue interest in 888 development wells
drilled and completed by an affiliate of SandRidge pursuant to the terms of a development agreement between the Trust and SandRidge
(the “Trust Development Wells”) within an area of mutual interest (“AMI”) designated in the development
agreement. The development agreement obligated SandRidge to drill and complete the Trust Development Wells by March 31, 2016.
SandRidge fulfilled this obligation in November 2014, and, as a result, the development agreement terminated and the Subordinated
Units issued to SandRidge were converted to Trust Common Units in January 2016 pursuant to the terms of the Trust Agreement.
On
November 1, 2018, SandRidge sold all of its interests in the Underlying Properties and all Trust Common Units which it owned to
Avalon Energy, LLC, a Texas limited liability company (“Avalon Energy”). In connection with this transaction (the
“Sale Transaction”), Avalon Exploration and Production LLC, an affiliate of Avalon Energy, LLC (“Avalon E&P”
and, together with Avalon Energy, “Avalon”), assumed all of SandRidge’s obligations under the Trust Agreement
and the administrative services agreement between SandRidge and the Trust (as further described below). As a part of the Sale
Transaction, SandRidge and Avalon entered into a transition services agreement whereby SandRidge provided certain transition services
to Avalon, including trust administration services, through April 30, 2019. The transition services agreement has expired. At
December 31, 2019, Avalon owned 13,125,000 Trust Common Units, or 25% of all issued and outstanding Trust units.
As
was the case with SandRidge prior to the Sale Transaction, pursuant to the terms of the Conveyances, Avalon is obligated to act
in good faith and as a reasonably prudent operator under the same or similar circumstances as it would if it were acting with
respect to its own properties, disregarding the existence of the Royalty Interests as burdens affecting such properties (the “Reasonably
Prudent Operator Standard”). The Conveyances generally permit Avalon to sell all or any part of its interest in the Underlying
Properties, if the Underlying Properties are sold subject to and burdened by the Royalty Interests.
The
Trust is passive in nature and neither the Trust nor the Trustee has any control over, or responsibility for, any operating or
capital costs related to the Underlying Properties. The business and affairs of the Trust are administered by the Trustee. However,
the Trustee has no authority over or responsibility for, and no involvement with, any aspect of the oil and natural gas operations
or other activities with respect to the Underlying Properties. The Trust Agreement generally limits the Trust’s business
activities to owning the Royalty Interests and certain activities reasonably related thereto, including activities required or
permitted by the terms of the Conveyances related to the Royalty Interests.
The
Trust will dissolve and begin to liquidate on March 31, 2031 (the “Termination Date”), unless sooner dissolved pursuant
to the terms of the Trust Agreement as described below and will soon thereafter wind up its affairs and terminate. At the Termination
Date, 50% of the Royalty Interests will revert automatically to Avalon. The remaining 50% of the Royalty Interests will be sold
at that time, and the net proceeds of the sale, as well as any remaining Trust cash reserves, will be distributed to the holders
of Trust Common Units on a pro rata basis, subject to Avalon’s right of first refusal to purchase the Royalty Interests
retained by the Trust at the Termination Date. The Trust may also dissolve should one of the following events occur prior to the
Termination Date: (a) the Trust sells all of the Royalty Interests; (b) cash available for distribution for any four consecutive
quarters, on a cumulative basis, is less than $5.0 million; (c) the holders of Trust Common Units approve an earlier dissolution
of the Trust; or (d) the Trust is judicially dissolved pursuant to the Delaware Trust Act. In the case of any of the foregoing,
the Trustee would then sell all of the Trust’s assets (subject to Avalon’s right of first refusal to purchase the
Royalty Interests retained by the Trust as of the date of such event), either by private sale or public auction, and distribute
the net proceeds of the sale to the holders of Trust Common Units after payment, or reasonable provision for payment, of all Trust
liabilities.
The
Trust is highly dependent on Avalon for multiple services, including: (a) the operation of the Underlying Properties and wells
located thereon; (b) the marketing and sale of hydrocarbon production from the wells; (c) the remittance of net proceeds from
the sale of production from wells burdened by the Royalty Interests to the Trust; (d) administrative services such as accounting,
tax preparation, bookkeeping and informational services performed on behalf of the Trust; and (e) the preparation and filing of
reports the Trust is or may be required to prepare and/or file in accordance with applicable tax and securities laws, exchange
listing rules and other requirements. The ability to operate the Underlying Properties depends on Avalon’s future financial
condition and economic performance, access to capital, and other factors, many of which are out of Avalon’s control. If
the reduced demand for crude oil in the global market resulting from the economic effects of the coronavirus pandemic and the
recent reduction in the benchmark price of crude oil persist for the near term or longer, such factors are likely to have a negative
impact on Avalon’s financial condition. This negative impact could affect Avalon’s ability to operate the wells and
provide services to the Trust.
Income
Tax Considerations
The
Trust is treated as a partnership for federal and applicable state income tax purposes, and holders of Trust Common Units are
treated as partners in that partnership for such purposes. For United States (“U.S.”) federal income tax purposes,
a partnership is not a taxable entity and incurs no U.S. federal income tax liability. With respect to state taxation, a partnership
typically is treated in the same manner as it is for U.S. federal income tax purposes. Each partner is required to take into account
his or her share of items of income, gain, loss, deduction and credit of the partnership in computing his or her federal income
tax liability, regardless of whether cash distributions are made to him or her by the partnership.
Distributions
by a partnership to a partner generally are not taxable to the partner (but instead reduce tax basis but not below zero) unless
the amount of cash distributed to such partner is in excess of the partner’s adjusted tax basis in his or her partnership
interest. To date, the Trust has distributed an amount of cash to holders of Trust Common Units in excess of their cash contributions
made at the time of the Offering of Trust Common Units.
The
Trust’s activities occur solely in Texas and, as a result, the Trust is deemed to have “nexus” under the Texas
franchise tax laws. Therefore, the Trust is required to pay Texas franchise tax each year at a maximum effective rate (subject
to changes in the statutory rate) of 0.1655% of all gross income.
Agreements
with Avalon
In
conjunction with the conveyance of the Royalty Interests to the Trust, the Trust entered into the following agreements with SandRidge
and/or one of its wholly-owned subsidiaries, which agreements were subsequently assigned to Avalon in connection with the Sale
Transaction:
Administrative
Services Agreement
The
Trust is a party to an administrative services agreement with Avalon, as assignee of SandRidge (the “Administrative Services
Agreement”), that obligates the Trust to pay Avalon an annual administrative services fee in the amount of $300,000, payable
quarterly, for accounting, tax preparation, bookkeeping and informational services to be performed by Avalon on behalf of the
Trust. Avalon is also entitled to receive reimbursement for its out-of-pocket fees, costs and expenses incurred in connection
with the provision of any of the services provided under this agreement. In connection with the Sale Transaction, Avalon assumed
the responsibility to provide such services to the Trust under the terms of the Administrative Services Agreement effective November
1, 2018.
The
Administrative Services Agreement will terminate on the earliest to occur of: (a) the date the Trust shall have dissolved and
commenced winding up in accordance with the Trust Agreement; (b) the date that all of the Royalty Interests have been terminated
or are no longer held by the Trust; (c) pertaining to administrative services being provided by Avalon, the date that either Avalon
or the Trustee may designate by delivering written notice no less than 90 days prior to such date, provided that Avalon cannot
terminate the agreement except in connection with the transfer of some or all of the Underlying Properties and the transferee
thereof assuming responsibility to perform the services in place of Avalon; and (d) a date mutually agreed by Avalon and the Trustee.
Registration
Rights Agreement
The
Trust entered into a registration rights agreement for the benefit of SandRidge and certain of its affiliates and transferees,
pursuant to which the Trust agreed to register the offering of unregistered Trust Common Units, now held by Avalon, upon request.
Upon the closing of the Sale Transaction, Avalon assumed the rights and obligations of SandRidge under the registration rights
agreement. Specifically, the Trust agreed:
|
●
|
to
use its reasonable best efforts to file a registration statement, including, if so requested, a shelf registration statement,
with the SEC within 45 days of receipt of a notice requesting the filing of a registration statement from Avalon;
|
|
●
|
to
use its reasonable best efforts to cause the registration statement or shelf registration statement to be declared effective under
the Securities Act as promptly as practicable after the filing thereof; and
|
|
●
|
to
continuously maintain the effectiveness of the registration statement under the Securities Act for 90 days (or continuously if
a shelf registration statement is requested) after the effectiveness thereof or until the Trust units covered by the registration
statement have been sold pursuant to such registration statement or until all registrable Trust units:
|
|
○
|
have
been sold pursuant to Rule 144 under the Securities Act if the transferee thereof does not receive “restricted securities”;
|
|
○
|
have
been sold in a private transaction in which the transferor’s rights under the registration rights agreement are not assigned
to the transferee of the Trust units; or
|
|
○
|
become
eligible for resale pursuant to Rule 144 (or any similar rule then in effect under the Securities Act).
|
The
holders will have the right to require the Trust to file no more than five registration statements in aggregate, one of which
has been filed to date on behalf of SandRidge. The Trust does not bear any expenses associated with such transactions.
Trust
Agreement
The
Trust Agreement provides that the Trust’s business activities are generally limited to owning the Royalty Interests and
administrative activities related thereto as set forth in the Trust Agreement, including activities required or permitted by the
terms of the Conveyances related to the Royalty Interests. The Trust is not permitted to acquire other oil and natural gas properties
or royalty interests and is not able to issue any additional Trust units.
The
beneficial interest in the Trust is divided into 52,500,000 Trust units, which now consist solely of Trust Common Units. Each
Trust unit (including Trust Common Units) represents an equal undivided beneficial interest in the property of the Trust.
Amendment
of the Trust Agreement generally requires the vote of holders of (i) a majority of the Trust Common Units (excluding Trust Common
Units owned by Avalon) and (ii) a majority of the Trust Common Units (including Trust Common Units owned by Avalon), in each case
voting in person or by proxy at a meeting of such holders of Trust Common Units at which a quorum is present. At any time that
Avalon owns less than 10% of the total Trust Common Units outstanding, however, the standard for approval will be the vote of
the holders of a majority of the Trust Common Units, including Trust Common Units owned by Avalon, voting in person or by proxy
at a meeting of the holders of Trust Common Units at which a quorum is present. Abstentions and broker non-votes will not be deemed
to be a vote cast. However, no amendment may:
|
●
|
increase
the power of the Trustee to engage in business or investment activities;
|
|
●
|
alter
the rights of the holders of Trust Common Units as among themselves; or
|
|
●
|
permit
the Trustee to distribute the Royalty Interests in kind.
|
Amendments
to the Trust Agreement’s provisions addressing the following matters may not be made without Avalon’s consent:
|
●
|
dispositions
of the Trust’s assets;
|
|
●
|
indemnification
of the Trustee;
|
|
●
|
reimbursement
of out-of-pocket expenses of Avalon when acting as the Trust’s agent;
|
|
●
|
termination
of the Trust; and
|
|
●
|
amendments
of the Trust Agreement.
|
Certain
amendments to the Trust Agreement do not require the vote of the holders of Trust Common Units. See “Permitted Amendments”
below.
The
business and affairs of the Trust are managed by the Trustee. The Trustee has no ability to manage or influence the operations
of the Underlying Properties. Avalon operates the Underlying Properties, but has no ability to manage or influence the management
of the Trust, except through its limited voting rights as a holder of Trust Common Units.
Duties
and Powers of the Trustee
The
duties and powers of the Trustee are specified in the Trust Agreement and by the laws of the State of Delaware, except as modified
by the Trust Agreement. The Trust Agreement provides that the Trustee does not have any duties or liabilities, including fiduciary
duties, except as expressly set forth in the Trust Agreement, and the duties and liabilities of the Trustee as set forth in the
Trust Agreement replace any other duties and liabilities, including fiduciary duties, to which the Trustee might otherwise be
subject.
The
Trustee’s principal duties consist of:
|
●
|
collecting
cash proceeds attributable to the Royalty Interests;
|
|
●
|
paying
expenses, charges and obligations of the Trust from the Trust’s assets;
|
|
●
|
making
cash distributions to the holders of Trust Common Units in accordance with the Trust Agreement;
|
|
●
|
causing
to be prepared and distributed a Schedule K-1 for each holder of Trust Common Units and preparing and filing tax returns on behalf
of the Trust; and
|
|
●
|
causing
to be prepared and filed reports required to be filed under the Exchange Act and under the rules of any securities exchange or
quotation system on which the Trust Common Units are listed or admitted to trading.
|
Avalon
provides, and SandRidge provided prior to the Sale Transaction, administrative and other services to the Trust in fulfillment
of certain of the foregoing duties, pursuant to the terms of the Administrative Services Agreement. SandRidge performed these
services on behalf of, and in conjunction with, Avalon pursuant to the terms of the transition services agreement, which terminated
on April 30, 2019.
Except
as set forth below, cash held by the Trustee as a reserve against future liabilities must be invested in:
|
●
|
interest-bearing
obligations of the United States government;
|
|
●
|
money
market funds that invest only in United States government securities;
|
|
●
|
repurchase
agreements secured by interest-bearing obligations of the United States government; or
|
|
●
|
bank
certificates of deposit.
|
Alternatively,
cash held for distribution at the next distribution date may be held in a non-interest-bearing account.
The
Trust may not acquire any asset except the Royalty Interests and cash and temporary cash investments, and it may not engage in
any investment activity except investing cash on hand.
The
Trust Agreement provides that the Trustee will not make business decisions affecting the assets of the Trust. However, the Trustee
may:
|
●
|
prosecute
or defend, and settle, claims of or against the Trust or its agents;
|
|
●
|
retain
professionals and other third parties to provide services to the Trust;
|
|
●
|
charge
for its services as Trustee;
|
|
●
|
retain
funds to pay for future expenses and deposit them with one or more banks or financial institutions (which may include the Trustee
to the extent permitted by law);
|
|
●
|
lend
funds at commercial rates to the Trust to pay the Trust’s expenses; and
|
|
●
|
seek
reimbursement from the Trust for its out-of-pocket expenses.
|
In
carrying out its powers and performing its duties to holders of Trust Common Units, the Trustee may act directly or in its discretion
(at the expense of the Trust) through agents pursuant to agreements entered into with any of them, and the Trustee will be liable
to the holders of Trust Common Units only for its own willful misconduct, acts or omissions made in bad faith, gross negligence,
or taxes, fees or other charges based on any fees, commissions or compensation received by it in connection with any of the transactions
contemplated by the Trust Agreement. The Trustee will not be liable for any act or omission of its agents unless the Trustee acted
with willful misconduct, bad faith or gross negligence in its selection and retention of such agents. The Trustee and its affiliates,
as well as each of its agents (including Avalon when acting in its capacity as an agent), will be indemnified and held harmless
by, and receive reimbursement from, the Trust against and from any liability or cost that it incurs individually in the administration
of the Trust, except in cases of willful misconduct, bad faith or gross negligence. The Trustee has a lien on the assets of the
Trust as security for
this indemnification and its compensation earned as Trustee. Holders of Trust Common Units will not be liable
to the Trustee for any indemnification. The Trustee ensures that all contractual liabilities of the Trust are limited to the assets
of the Trust. The Trustee has not loaned and does not intend to lend funds to the Trust.
Merger
or Consolidation of Trust
The
Trust may merge or consolidate with or into, or convert into, one or more limited partnerships, general partnerships, corporations,
business trusts, limited liability companies, or associations or unincorporated businesses if such transaction is agreed to by
the Trustee and approved by the vote of the holders of (i) a majority of the Trust Common Units (excluding Trust Common Units
owned by Avalon) and (ii) a majority of the Trust Common Units (including Trust Common Units owned by Avalon), in each case voting
in person or by proxy at a meeting of such holders at which a quorum is present and such transaction is permitted under the Delaware
Statutory Trust Act and any other applicable law. At any time that Avalon owns less than 10% of the total Trust Common Units outstanding,
however, the standard for approval will be the vote of the holders of a majority of the Trust Common Units, including Trust Common
Units owned by Avalon, voting in person or by proxy at a meeting of such holders at which a quorum is present.
Trustee’s
Power to Sell Royalty Interests
The
Trustee may sell the Royalty Interests under any of the following circumstances:
|
●
|
the
sale is requested by Avalon in accordance with the provisions of the Trust Agreement; or
|
|
●
|
the
sale is approved by the vote of the holders of (i) a majority of the Trust Common Units (excluding Trust Common Units owned by
Avalon) and (ii) a majority of the Trust Common Units (including Trust Common Units owned by Avalon), in each case voting in person
or by proxy at a meeting of such holders at which a quorum is present; except that at any time that Avalon owns less than 10%
of the total Trust Common Units outstanding, the standard for approval will be the vote of the holders of a majority of the Trust
Common Units, including Trust Common Units owned by Avalon, voting in person or by proxy at a meeting of such holders at which
a quorum is present.
|
Upon
dissolution of the Trust, the Trustee must sell those Royalty Interests that do not revert automatically to Avalon pursuant to
the terms of the Trust Agreement. No Trust unitholder approval is required in this event.
The
Trustee will distribute the net proceeds from any sale of the Royalty Interests and other assets to the holders of Trust Common
Units after payment or reasonable provision for payment of all liabilities of the Trust, including any amounts owed to its agents
(including Avalon acting in such capacity).
Permitted
Amendments
The
Trustee may amend or supplement the Trust Agreement, the conveyances, the Administrative Services Agreement, or the registration
rights agreement, without the approval of the holders of Trust Common Units, to cure ambiguities, to correct or supplement defective
or inconsistent provisions, to grant any benefit to all holders of Trust Common Units, to evidence or implement any changes required
by applicable law, or to change the name of the Trust; provided, however, that any such supplement or amendment does not adversely
affect the interests of the holders of Trust Common Units. Furthermore, the Trustee, acting alone, may amend the Administrative
Services Agreement without the approval of holders of Trust Common Units if such amendment would not increase the cost or expense
of the Trust or create an adverse economic impact on the holders of Trust Common Units.
All
other permitted amendments to the Trust Agreement and other agreements listed above may only be made by the vote of the holders
of (i) a majority of the Trust Common Units (excluding Trust Common Units owned by Avalon) and (ii) a majority of the Trust Common
Units (including Trust Common Units owned by Avalon), in each case voting in person or by proxy at a meeting of such holders at
which a quorum is present; except that at any time that Avalon owns less than 10% of the total Trust Common Units outstanding,
the standard for approval will be the vote of the holders of a majority of the Trust Common Units, including Trust Common Units
owned by Avalon, voting in person or by proxy at a meeting of such holders at which a quorum is present. Abstentions and broker
non-votes will not be deemed to be a vote cast.
Miscellaneous
The
Trustee may consult with legal counsel (which may include legal counsel to Avalon), accountants, tax advisors, geologists and
engineers and other parties the Trustee believes to be qualified as experts on the matters for which advice is sought. The Trustee
will be protected for any action it takes in good faith reliance upon the opinion of an expert.
The
Delaware Trustee and the Trustee may resign at any time or be removed with or without cause at any time by the vote of the holders
of a majority of the Trust Common Units (excluding Trust Common Units owned by Avalon), voting in person or by proxy at a meeting
of such holders at which a quorum is present; except that at any time that Avalon owns less than 10% of the outstanding Trust
Common Units, the standard for approval will be the vote of the holders of a majority of the Trust Common Units, including Trust
Common Units owned by Avalon, voting in person or by proxy at a meeting of such holders at which a quorum is present. Abstentions
and broker non-votes will not be deemed to be a vote cast. Any successor must be a bank or trust company meeting certain requirements
including having combined capital, surplus and undivided profits of at least $20 million, in the case of the Delaware Trustee,
and $100 million, in the case of the Trustee.
Distributions
The
Trustee makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s
administrative expenses, property taxes and Texas franchise taxes, and cash reserves withheld by the Trustee, on or about the
60th day following the completion of each quarter. Each distribution covers production for a three-month period. The amount of
Trust revenues and cash distributions to holders of Common Units depends on:
|
●
|
oil,
natural gas and NGL prices received;
|
|
●
|
volume
of oil, natural gas and NGL produced and sold;
|
|
●
|
post-production
costs (which includes internal costs and third person costs incurred by Avalon) and any applicable taxes; and
|
|
●
|
the
Trust’s general and administrative expenses.
|
The
amount of the quarterly distributions will fluctuate from quarter to quarter, depending on the factors discussed above. There
is no minimum required distribution. See Note 4 to the Trust’s audited statements included in this offer to exchange for
further discussion of Trust distributions.
If
at any time the Trust’s cash on hand (including available cash reserves) is not sufficient to pay the Trust’s ordinary
course administrative expenses as they become due, the Trust may borrow funds from the Trustee or other lenders, including Avalon,
to pay such expenses. The Trustee has not loaned and does not intend to lend funds to the Trust. If such funds are borrowed, no
further distributions will be made to holders of Trust Common Units (except in respect of any previously determined quarterly
distribution amount) until the borrowed funds have been repaid.
The
Trust Agreement provides that, if at any time the Trust’s cash on hand (including available cash reserves) is not sufficient
to pay the Trust’s ordinary course administrative expenses as they become due, Avalon (as assignee of SandRidge) will, at
the Trustee’s request, loan funds to the Trust necessary to pay such expenses. Any such loan will be on an unsecured basis,
and the terms of such loan will be substantially the same as those which would be obtained in an arms’ length transaction
between Avalon and an unaffiliated third party. If Avalon provides such funds to the Trust, Avalon may permit the Trust to make
distributions prior to Avalon being repaid for such loan. In addition, Avalon would become a creditor of the Trust and its interest
as a creditor could conflict with the interests of other holders of Trust Common Units. The Trust did not borrow funds from SandRidge,
and to date, the Trust has not borrowed funds from Avalon.
Properties
As
of December 31, 2019, 2018 and 2017, the Trust’s properties consisted of Royalty Interests in (a) the Initial Wells and
(b) 856 additional wells (equivalent to 888 Trust Development Wells under the development agreement) that were drilled and perforated
for Completion between April 1, 2011 and December 31, 2014. SandRidge was credited for having drilled one full Trust Development
Well if a well was drilled and perforated for Completion to the Grayburg/San Andres formation and SandRidge’s net revenue
interest in the well was equal to 69.3%. For wells in which SandRidge had a net revenue interest equal to or greater than 69.3%,
SandRidge received proportionate credit for such well. The wells are located on properties situated in the greater Fuhrman-Mascho
field, a field in Andrews County, Texas, that produces primarily oil from the Grayburg/San Andres formation in the Permian Basin.
Proved
Reserves
The
following estimates of net proved oil, natural gas and NGL reserves are based on reserve reports prepared by Netherland, Sewell
& Associates, Inc. (“Netherland Sewell”), independent petroleum engineers. The PV-10 and Standardized Measure
shown in the table below are not intended to represent the current value of estimated oil, natural gas and NGL reserves attributable
to the Royalty Interests as of the dates shown. The reserve reports as of December 31, 2019, 2018 and 2017 were based on the average
price during the 12-month periods ended December 31, 2019, 2018 and 2017, using first-day-of-the-month prices for each month.
Refer to “Risk Factors—Risks Relating to the Trust” and “Information about the Trust--Trustee’s
Discussion and Analysis of Financial Condition and Results of Operations” in in evaluating the reserve information presented
below.
Avalon
provides, and SandRidge provided prior to the Sale Transaction, certain services respecting the estimation of net proved oil,
natural gas and NGL reserves to the Trust pursuant to the terms of the Administrative Services Agreement. SandRidge performed
these services on behalf of, and in conjunction with, Avalon pursuant to the terms of the transition services agreement, until
April 30, 2019 (the date on which such agreement terminated). Consistent with past practice, the process begins with an Avalon
staff reservoir engineer collecting and verifying all pertinent data, including but not limited to well test data, production
data, historical pricing, cost information, property ownership interests, reservoir data, and geosciences data. This data was
reviewed by various levels of Avalon management for accuracy, before consultation with the independent petroleum engineers. Members
of Avalon management, including its staff reservoir engineer, regularly consulted with the independent petroleum engineers during
the reserve estimation process to review properties, assumptions, and any new data available. The internal reserve estimates completed
and methodologies used by Avalon were compared to the independent petroleum engineers’ estimates and conclusions before
the reserve estimates were included in the independent petroleum engineers’ reports. Additionally, members of Avalon’s
senior management reviewed and approved the reserve reports contained herein.
Internal
Controls
Avalon’s
Vice President - Petroleum Engineering is the technical person primarily responsible for overseeing the preparation of the Trust’s
reserve estimates on behalf of the Trustee. He has a Bachelor of Science degree in Civil Engineering with over 40 years of practical
industry experience, including estimating and evaluating reserve information. In addition, he has been a certified professional
engineer in the State of Texas since July 1983 and a member of the Society of Petroleum Engineers since 1975.
In
order to ensure the reliability of reserves estimates, Avalon’s internal controls observed within the reserve estimation
process included:
|
●
|
No
employee’s compensation is tied to the amount of reserves booked.
|
|
●
|
Reserves
estimates are prepared by experienced reservoir engineers or under their direct supervision.
|
|
●
|
The
Vice President - Petroleum Engineering reports directly to Avalon’s President.
|
|
●
|
Avalon
management follows comprehensive SEC-compliant internal policies to determine and report proved reserves including:
|
|
●
|
confirming
that reserve estimates include all applicable properties and are based upon proper working and net revenue interests;
|
|
●
|
reviewing
and using in the estimation process data provided by other departments within Avalon, such as Accounting; and
|
|
●
|
comparing
and reconciling internally generated reserve estimates to those prepared by third parties.
|
The
independent petroleum engineers estimated all of the proved reserve information in these reserve reports in accordance with the
definitions and guidelines of the SEC and in conformity with the Accounting Standards Codification Topic 932, Extractive Activities-Oil
and Gas. Neither Netherland Sewell nor any officer or employee of Avalon owns an interest in any of the Underlying Properties,
nor are they employed on a contingent basis. The qualifications of Netherland Sewell’s technical personnel primarily responsible
for overseeing the preparation of the Trust’s reserves estimates included in this report include the following:
|
●
|
practicing
consulting petroleum engineering since 2013 and over 14 years of prior industry experience;
|
|
●
|
licensed
professional engineers in the State of Texas; and
|
|
●
|
a
Bachelor of Science Degree in Chemical Engineering.
|
These
qualifications meet or exceed the Society of Petroleum Engineers’ standard requirements to be a professionally qualified
Reserve Estimator and Auditor.
Reporting
of Natural Gas Liquids
Natural
gas liquids, or NGL, are produced as a result of the processing of a portion of the Trust’s natural gas production stream.
At December 31, 2019, NGL constituted approximately 9% of the Trust’s total proved reserves on a barrel equivalent basis
and represented volumes to be produced from properties where contracts are in place for the extraction and separate sale of NGL.
NGL are products sold by the gallon. In reporting proved reserves and production of NGL, production and reserves have been included
in barrels. The extraction of NGL in the processing of natural gas reduces the volume of natural gas available for sale. All production
information related to natural gas is reported net of the effect of any reduction in natural gas volumes resulting from the processing
and extraction of NGL.
A
summary of the Trust’s proved oil, natural gas and NGL reserves, all of which are located in the State of Texas, is presented
below:
|
|
December 31,
|
|
Estimated Proved Reserves(1)
|
|
2019
|
|
|
2018
|
|
|
2017
|
|
Developed
|
|
|
|
|
|
|
|
|
|
Oil (MBbls)
|
|
|
3,918.7
|
|
|
|
4,567.5
|
|
|
|
4,999.9
|
|
NGL (MBbls)
|
|
|
411.5
|
|
|
|
691.8
|
|
|
|
758.9
|
|
Natural gas (MMcf)
|
|
|
1,359.1
|
|
|
|
2,163.8
|
|
|
|
2,544.4
|
|
Total proved developed (MBoe)(2)
|
|
|
4,556.8
|
|
|
|
5,619.9
|
|
|
|
6,182.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Undeveloped(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil (MBbls)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
NGL (MBbls)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Natural gas (MMcf)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Total proved undeveloped (MBoe)(2)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Proved
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil (MBbls)
|
|
|
3,918.7
|
|
|
|
4,567.5
|
|
|
|
4,999.9
|
|
NGL (MBbls)
|
|
|
411.5
|
|
|
|
691.8
|
|
|
|
758.9
|
|
Natural gas (MMcf)
|
|
|
1,359.1
|
|
|
|
2,163.8
|
|
|
|
2,544.4
|
|
Total proved (MBoe)(2)
|
|
|
4,556.8
|
|
|
|
5,619.9
|
|
|
|
6,182.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PV-10 (in millions)(4)
|
|
$
|
104.0
|
|
|
$
|
135.7
|
|
|
$
|
123.2
|
|
Standardized Measure of Discounted Net Cash Flows (in millions)(5)
|
|
$
|
103.8
|
|
|
$
|
135.5
|
|
|
$
|
123.0
|
|
(1)
|
Determined
using a 12-month average of the first-day-of-the-month index price without giving effect to derivative transactions. The prices
used in the reserve report yield weighted average wellhead prices, which are based on first-day-of-the-month index prices and
adjusted for transportation and regional price differentials. The index prices and the equivalent weighted average wellhead prices
are shown in the table below.
|
|
|
|
Weighted average wellhead prices
|
|
|
Index prices
|
|
|
|
|
Oil
(per Bbl)
|
|
|
NGL
(per Bbl)
|
|
|
Natural gas
(per Mcf)
|
|
|
Oil
(per Bbl)
|
|
|
Natural gas
(per Mcf)
|
|
December 31, 2019
|
|
|
$
|
51.58
|
|
|
$
|
19.55
|
|
|
$
|
0.88
|
|
|
$
|
55.85
|
|
|
$
|
2.58
|
|
December 31, 2018
|
|
|
$
|
59.12
|
|
|
$
|
24.91
|
|
|
$
|
1.89
|
|
|
$
|
65.56
|
|
|
$
|
3.10
|
|
December 31, 2017
|
|
|
$
|
47.70
|
|
|
$
|
20.07
|
|
|
$
|
2.13
|
|
|
$
|
51.34
|
|
|
$
|
2.98
|
|
(2)
|
Barrel
of oil equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of oil, which approximates the relative energy
content of oil as compared to natural gas.
|
(3)
|
Royalty
Interests conveyed to the Trust by Avalon were in proved properties only.
|
(4)
|
PV-10
is the present value of estimated future net revenue to be generated from the production of proved reserves, discounted at 10%
per annum to reflect timing of future cash flows and calculated without deducting future income taxes. PV-10 is a non-GAAP financial
measure and generally differs from standardized measure of discounted net cash flows, or Standardized Measure, the most directly
comparable GAAP financial measure, because it does not include the effects of income taxes on future net revenues. Neither PV-10
nor Standardized Measure are intended to represent an estimate of fair market value of the Royalty Interests. PV-10 is used by
the industry as an arbitrary reserve asset value measure to compare the relative size and value of the proved reserves held by
companies without regard to the specific tax characteristics of such entities. The following table provides a reconciliation of
Standardized Measure to PV-10:
|
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
|
2017
|
|
|
|
(in millions)
|
|
Standardized Measure of Discounted Net Cash Flows(4)
|
|
$
|
103.8
|
|
|
$
|
135.5
|
|
|
$
|
123.0
|
|
Present value of future income tax discounted at 10%
|
|
|
0.2
|
|
|
|
0.2
|
|
|
|
0.2
|
|
PV-10
|
|
$
|
104.0
|
|
|
$
|
135.7
|
|
|
$
|
123.2
|
|
(5)
|
Standardized
Measure represents the present value of estimated future cash inflows from proved oil, natural gas and NGL reserves, less future
development and production costs, and income tax expenses, discounted at 10% per annum to reflect timing of future cash flows
and using the same pricing assumptions as are used to calculate PV-10. Standardized Measure differs from PV-10 as Standardized
Measure includes the effect of future income taxes.
|
Proved
reserves are those quantities of oil, natural gas and NGL that, by analysis of geoscience and engineering data, can be estimated
with reasonable certainty to be economically producible from a given date forward, from known reservoirs, and under existing economic
conditions, operating methods and government regulations, prior to the time at which contracts providing the right to operate
expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods
are used for estimation. To be classified as proved reserves, the project to extract the oil or natural gas must have commenced
or the operator must be reasonably certain that it will commence the project within a reasonable period of time.
The
area of a reservoir considered proved includes (i) the area identified by drilling and limited by fluid contacts, if any, and
(ii) adjacent undrilled portions of the reservoir that can, with reasonable certainty, be judged to be continuous with the identified
area and
to contain economically producible oil or natural gas on the basis of available geoscience and engineering data. In the
absence of data on fluid contacts, proved quantities in a reservoir are limited by the lowest known hydrocarbons as seen in a
well penetration unless geoscience, engineering or performance data and reliable technology establish a lower contact with reasonable
certainty.
Where
direct observation from well penetrations has defined a highest known oil elevation and the potential exists for an associated
gas cap, proved oil reserves may be assigned in the structurally higher portions of the reservoir only if geoscience, engineering
or performance data and reliable technology establish the higher contact with reasonable certainty.
Reserves
that can be produced economically through application of improved recovery techniques (such as fluid injection) are included in
the proved classification when (i) successful testing by a pilot project in an area of the reservoir with properties no more favorable
than in the reservoir as a whole, the operation of an installed program in the reservoir, or an analogous reservoir, or other
evidence using reliable technology establishes the reasonable certainty of the engineering analysis on which the project or program
was based and (ii) the project has been approved for development by all necessary parties and entities, including governmental
entities.
Existing
economic conditions include prices and costs at which hydrocarbons can be economically produced from a known reservoir. In determining
the amount of proved reserves, the price used must be the average price during the 12-month period prior to the ending date of
the period covered by the reserve report, determined as an unweighted arithmetic average of the first-day-of-the-month price for
each month within such period, unless prices are defined by contractual arrangements, excluding escalations based upon future
conditions.
Proved
Undeveloped Reserves
SandRidge
was obligated to drill, or cause to be drilled, the Trust Development Wells by March 31, 2016. SandRidge fulfilled its drilling
obligation to the Trust in November 2014, and neither SandRidge nor Avalon has any future drilling obligations to the Trust. Accordingly,
the Trust has not had any proved undeveloped reserves since December 31, 2014 and will not have any proved undeveloped reserves
in the future.
Production
and Price History
The
following tables set forth information regarding the net oil, natural gas and NGL production attributable to the Royalty Interests
and certain price and cost information for each of the periods indicated.
|
|
Year
Ended December 31,
|
|
|
|
2019(1)
|
|
|
2018(2)
|
|
|
2017(3)
|
|
Production Data
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil (MBbls)
|
|
|
414
|
|
|
|
485
|
|
|
|
584
|
|
NGL (MBbls)
|
|
|
57
|
|
|
|
72
|
|
|
|
83
|
|
Natural gas (MMcf)
|
|
|
181
|
|
|
|
227
|
|
|
|
281
|
|
Combined equivalent
volumes (MBoe)(4)
|
|
|
501
|
|
|
|
595
|
|
|
|
714
|
|
Average daily combined
equivalent volumes (MBoe/d)
|
|
|
1.4
|
|
|
|
1.6
|
|
|
|
2.0
|
|
Average Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil (per Bbl)
|
|
$
|
50.77
|
|
|
$
|
56.96
|
|
|
$
|
45.44
|
|
NGL (per Bbl)
|
|
$
|
20.00
|
|
|
$
|
24.16
|
|
|
$
|
19.27
|
|
Combined oil and NGL
(per Bbl)
|
|
$
|
47.06
|
|
|
$
|
52.70
|
|
|
$
|
42.18
|
|
Natural gas (per Mcf)
|
|
$
|
1.22
|
|
|
$
|
1.91
|
|
|
$
|
2.30
|
|
Combined equivalent
(per Boe)
|
|
$
|
44.66
|
|
|
$
|
50.08
|
|
|
$
|
40.33
|
|
Average Prices - including
impact of post-production expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural gas (per Mcf)
|
|
$
|
0.95
|
|
|
$
|
1.71
|
|
|
$
|
2.10
|
|
Combined equivalent
(per Boe)
|
|
$
|
44.56
|
|
|
$
|
50.00
|
|
|
$
|
40.24
|
|
Expenses (per Boe)
|
|
|
|
|
|
|
|
|
|
|
|
|
Post-production
|
|
$
|
0.10
|
|
|
$
|
0.08
|
|
|
$
|
0.08
|
|
Production taxes
|
|
$
|
2.12
|
|
|
$
|
2.39
|
|
|
$
|
1.93
|
|
Total expenses
|
|
$
|
2.22
|
|
|
$
|
2.47
|
|
|
$
|
2.01
|
|
(1)
|
Production
volumes and related revenues and expenses for the year ended December 31, 2019 (included in 2019 net revenue distributions to
the Trust) represent production from September 1, 2018 to August 31, 2019.
|
(2)
|
Production
volumes and related revenues and expenses for the year ended December 31, 2018 (included in 2018 net revenue distributions to
the Trust) represent production from September 1, 2017 to August 31, 2018.
|
(3)
|
Production
volumes and related revenues and expenses for the year ended December 31, 2017 (included in 2017 net revenue distributions to
the Trust) represent production from September 1, 2016 to August 31, 2017.
|
(4)
|
Barrel
of oil equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of oil, which approximates the relative energy
content of oil as compared to natural gas.
|
Productive
Wells
The
following table sets forth as of December 31, 2019 the number of productive wells burdened by the Royalty Interests. Productive
wells consist of producing wells and wells capable of producing. Gross wells are the total number of producing wells burdened
by the Royalty Interests and net wells are the sum of the Trust’s fractional Royalty Interests owned in gross wells.
|
|
Oil
|
|
|
Natural Gas
|
|
|
Total
|
|
|
|
Gross
|
|
|
Net
|
|
|
Gross
|
|
|
Net
|
|
|
Gross
|
|
|
Net
|
|
Productive Wells
|
|
|
1,035
|
|
|
|
565
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,035
|
|
|
|
565
|
|
Developed
and Undeveloped Acreage
As
of December 2014, SandRidge had drilled and perforated for completion 888 equivalent Trust Development Wells, thus fulfilling
its drilling obligation. Accordingly, the AMI terminated effective December 2014, and no undeveloped acreage constituting a part
of the Underlying Properties exists.
Drilling
Activity
There
were no wells drilled or completed during 2019 or 2018, and there were no wells to be drilled or awaiting completion at December
31, 2019 or 2018.
Marketing
and Customers
Avalon
has the responsibility to market, or cause to be marketed, the oil, natural gas and NGL production attributable to the Underlying
Properties and is not permitted to charge any marketing fees when determining the net proceeds upon which the royalty payments
are calculated, except for marketing fees and costs of non-affiliates. SandRidge performed these services on behalf of, and in
conjunction with, Avalon during the first four months of 2019 pursuant to the terms of the transition services agreement, which
terminated on April 30, 2019. As a result, the net proceeds to the Trust from the sales of oil, natural gas and NGL production
from the Underlying Properties for the years ended December 31, 2019 and 2018 are determined based on the same price (net of post-production
costs) that Avalon received for oil, natural gas and NGL production attributable to its interest in the Underlying Properties.
During
each of 2019 and 2018, two customers individually accounted for more than 10% of total revenue attributable to the Royalty Interests.
The number of readily available purchasers for the production from the Underlying Properties reduces the risk that the loss of
a single customer in the area in which Avalon sells oil, natural gas and NGL production from the Underlying Properties would materially
affect the Trust’s revenue. See the table below for additional information on Avalon’s major customers for production
from the Underlying Properties from January 1, 2018 to October 31, 2019.
|
|
Sales
|
|
|
% of Revenue
|
|
|
|
(in thousands)
|
|
|
|
|
|
2019
|
|
|
|
|
|
|
|
|
Enterprise Crude Oil LLC
|
|
$
|
17,063
|
|
|
|
81.2
|
%
|
ConocoPhillips Company
|
|
$
|
3,951
|
|
|
|
18.8
|
%
|
2018
|
|
|
|
|
|
|
|
|
Enterprise Crude Oil LLC
|
|
$
|
22,685
|
|
|
|
76.0
|
%
|
ConocoPhillips Company
|
|
$
|
4,917
|
|
|
|
16.5
|
%
|
In
October 2019, Avalon entered into a crude oil purchasing agreement with Ace Gathering Inc., a Texas corporation doing business
as Ace Energy Solutions (“ACE”). Pursuant to the terms of the contract, Avalon is required to deliver all crude oil
produced from wells it operates, including the Underlying Properties, beginning November 1, 2019. As a result, all production
from the Underlying Properties is committed to ACE under the contract through December 31, 2021. The price for each barrel of
crude oil delivered under the contract is NYMEX West Texas Intermediate averaged over the month of delivery, subject to certain
adjustments as set forth in the contract. Avalon entered into this contract, together with an agreement whereby Avalon can purchase
condensate from ACE to use in its well workover program, in order to maximize the price of production, as well as the transparency
of pricing, from the Underlying Properties and other properties operated by Avalon. Transportation of crude oil sold by Avalon
will continue to utilize existing pipeline systems and suppliers, including Enterprise Crude Oil LLC and ConocoPhillips Company.
Title
to Properties
The
Underlying Properties are subject to certain burdens that are described in more detail below. To the extent that these burdens
and obligations affect the rights of Avalon in production and the value of production from the Underlying Properties, they have
been taken into account in calculating the Trust’s interest and in estimating the size and value of the reserves attributable
to the Royalty Interests. The Underlying Properties are typically subject, in one degree or another, to one or more of the following:
|
●
|
royalties
and other burdens, express and implied, under oil and natural gas leases;
|
|
●
|
production
payments and similar interests and other burdens created by Avalon’s predecessors in title;
|
|
●
|
a
variety of contractual obligations arising under operating agreements, farm-out agreements, production sales contracts and other
agreements that may affect the Underlying Properties or their titles;
|
|
●
|
liens
that arise in the normal course of operations, such as those for unpaid taxes, statutory liens securing unpaid suppliers and contractors
and contractual liens under operating agreements that are not yet delinquent or, if delinquent, are being contested in good faith;
|
|
●
|
pooling,
unitization and communitization agreements, declarations and orders;
|
|
●
|
easements,
restrictions, rights-of-way and other matters that commonly affect real property;
|
|
●
|
conventional
rights of reassignment that obligate Avalon to reassign all or part of a property to a third party if Avalon intends to release
or abandon such property; and
|
|
●
|
rights
reserved to or vested in the appropriate governmental agency or authority to control or regulate the Underlying Properties.
|
Avalon
believes that its title to the Underlying Properties and the Trust’s title to the Royalty Interests are good and defensible
in accordance with standards generally accepted in the oil and natural gas industry, subject to such exceptions as are not so
material as to detract substantially from the use or value of such properties or Royalty Interests.
Competition
and Markets
The
production and sale of oil, natural gas and NGL is highly competitive. Competitors in the Permian Basin include major oil and
gas companies, independent oil and gas companies, and individual producers and operators. There are numerous producers in the
Permian Basin, and competitive position in this area is affected by price, contract terms and quality of service.
Oil,
natural gas and NGL compete with other forms of energy available to customers, primarily based on price. These alternate forms
of energy include electricity, coal and fuel oils. Changes in the availability or price of oil, natural gas or other forms of
energy, as well as business conditions, conservation, legislation, regulations and the ability to convert to alternate fuels and
other forms of energy may affect the demand for oil, natural gas and NGL.
Future
price fluctuations for oil, natural gas and NGL will directly impact Trust distributions, estimates of reserves attributable to
the Royalty Interests and estimated and actual future net revenues to the Trust. Due to the many uncertainties that affect the
supply and demand for oil, natural gas and NGL, reliable predictions of future oil, natural gas and NGL supply and demand, future
product prices or the effect of future product prices on Trust distributions cannot be made. However, lower production volumes
and product prices will adversely affect Trust distributions.
Seasonal
Nature of Business
Generally,
demand for oil, natural gas and NGL decreases during the summer months and increases during the winter months. Certain natural
gas users utilize natural gas storage facilities and purchase some of their anticipated winter requirements during the summer,
which can lessen seasonal demand fluctuations. Seasonal weather conditions and lease stipulations can limit producing activities
and other oil and natural gas operations. These seasonal anomalies can increase competition for equipment, supplies and personnel
during the spring and summer months, which could lead to shortages and increased costs or delay operations.
Insurance
Avalon
operates all of the wells burdened by the Royalty Interests. Avalon maintains insurance, in accordance with industry practice,
against some, but not all, of the operating risks to which its operating affiliate is exposed. Generally, insurance policies include
coverage for general liability (including sudden and accidental pollution), physical damage to certain oil and natural gas properties,
auto liability, worker’s compensation and employer’s liability, among other things.
Avalon
maintains general liability insurance coverage up to $1 million per occurrence and $2 million aggregate policy limit, which includes
(i) completed operations coverage and (ii) sudden and accidental environmental liability coverage for the effects of pollution
on third parties, arising from operations. The general liability insurance policy contains limits subject to certain customary
exclusions and limitations, as well as deductibles that must be met prior to recovery. In addition, Avalon maintains $25 million
in excess liability coverage, which is in addition to and triggered if the general liability per occurrence limit is reached,
and may be subject to a deductible that must be met prior to recovery. Avalon also maintains worker’s compensation coverage
in accordance with Texas statutory requirements and employee liability coverage of $1 million by accident or by disease.
All
of Avalon’s third-party contractors are required to sign master services agreements in which they agree (a) to indemnify
Avalon for injuries and deaths of the service provider’s employees as well as contractors and subcontractors hired by the
service provider and (b) name Avalon as an additional insured on their insurance policies. Similarly, Avalon generally agrees
to indemnify each third-party contractor against claims made by employees of Avalon and Avalon’s other contractors. Additionally,
each party generally is responsible for damage to its own property.
The
third-party contractors that perform hydraulic fracturing operations sign the master services agreements containing the indemnification
provisions noted above. Currently there are no insurance policies in effect intended to provide coverage for losses solely related
to hydraulic fracturing operations as none have been performed by Avalon on the Underlying Properties or other properties owned
by Avalon.
Avalon
annually re-evaluates the purchase of insurance, coverage limits and deductibles. Future insurance coverage for the oil and natural
gas industry could increase in cost and may include higher deductibles or retentions. In addition, some forms of insurance may
become unavailable in the future or unavailable on terms that are economically acceptable. No assurance can be given that insurance
may be maintained in the future at rates considered reasonable. Self-insurance or only catastrophic coverage may be elected for
certain risks in the future.
The
Trust does not maintain any insurance policies or coverage against any of the risks of conducting oil and gas exploration and
production or related activities.
Regulation
Oil
and Natural Gas Regulations
The
oil and natural gas industry is extensively regulated by numerous federal, state, local and regional authorities, as well as Native
American tribes. Legislation affecting the oil and natural gas industry is under constant review for amendment or expansion, frequently
increasing the regulatory burden. Also, numerous departments and agencies, both federal and state, and Native American tribes
are authorized by statute to issue rules and regulations affecting the oil and natural gas industry and its individual members,
some of which carry substantial penalties for noncompliance. Although the regulatory burden on the oil and natural gas industry
increases the cost of doing business and, consequently, affects its profitability, these burdens generally do not affect SandRidge
or Avalon any differently or to any greater or lesser extent than they affect other companies in the industry with similar types,
quantities and locations of production.
The
availability, terms and cost of transportation significantly affect sales of oil, natural gas and NGL. The interstate transportation
and sale for resale of oil, natural gas and NGL is subject to federal regulation, including regulation of the terms, conditions
and rates for interstate transportation, storage and various other matters, primarily by the Federal Energy Regulatory Commission
(“FERC”). Federal and state regulations govern the price and terms for access to oil and natural gas pipeline transportation.
FERC’s regulations for interstate oil and natural gas transmission in some circumstances may also affect the intrastate
transportation of oil and natural gas.
However,
sales of oil, natural gas and NGL produced from the Underlying Properties are not currently regulated and are transacted at market
prices. Although oil, natural gas and NGL prices are currently unregulated, Congress historically has been active in the area
of oil and natural gas regulation. Whether new legislation to regulate oil, natural gas and NGL prices might be proposed, what
proposals, if any, might actually be enacted by Congress or the various state legislatures, and what effect, if any, the proposals
might have on the operations of the Underlying Properties cannot be predicted.
Production
Operations
are subject to various types of regulation at federal, state and local levels. These types of regulation include reports concerning
operations. Most states, and some counties, municipalities and Native American tribal areas also regulate one or more of the following
activities: the rates of production, or “allowables”, the use of surface or subsurface waters, the surface use and
restoration of properties upon which wells are drilled, the plugging and abandoning of wells, and the notice to surface owners
and other third parties.
State
laws regulate the size and shape of drilling and spacing units or proration units governing the pooling of oil and natural gas
properties. Some states allow forced pooling or integration of tracts to facilitate exploration while other states rely on voluntary
pooling of lands and leases. In some instances, forced pooling or unitization may be implemented by third parties and may reduce
Avalon’s interest in the unitized properties. In addition, state conservation laws establish maximum rates of production
from oil and natural gas wells, generally prohibit the venting or flaring of natural gas and impose requirements regarding the
ratability of production. These laws and regulations may limit the amount of oil, natural gas and NGL production from its wells
or limit the number of wells or the locations which can be drilled. Moreover, each state generally imposes a production or severance
tax with respect to the production and sale of oil, natural gas and NGL within its jurisdiction.
Federal,
state and local regulations provide detailed requirements for the abandonment of wells, closure or decommissioning of production
facilities and pipelines, and for site restorations, in areas where the Underlying Properties are located. For example, the Railroad
Commission of Texas imposes financial assurance requirements on operators, and the United States Army Corps of Engineers (“ACE”)
and many other state and local authorities also have regulations for plugging and abandonment, decommissioning and site restoration.
Natural
Gas Sales and Transportation
Historically,
federal legislation and regulatory controls have affected the price of the natural gas Avalon produces and the manner in which
Avalon markets its production. FERC has jurisdiction over the transportation and sale for resale of natural gas in interstate
commerce by natural gas companies under the Natural Gas Act of 1938 and the Natural Gas Policy Act of 1978. Various federal laws
enacted since 1978 have resulted in the removal of all price and non-price controls for sale of domestic natural gas sold in first
sales, which include all of Avalon’s sales of from the Underlying Properties. Under the Energy Policy Act of 2005, FERC
has substantial enforcement authority to prohibit the manipulation of natural gas markets and enforce its rules and orders, including
the ability to assess substantial civil penalties.
FERC
also regulates interstate natural gas transportation rates and service conditions and establishes the terms under which Avalon
may use interstate natural gas pipeline capacity, which affects the marketing of natural gas produced from the Underlying Properties,
as well as the revenues it receives for sales of its natural gas and release of its natural gas pipeline capacity. Commencing
in 1985, FERC promulgated a series of orders, regulations and rule makings that significantly fostered competition in the business
of transporting and marketing gas. Currently, interstate pipeline companies are required to provide nondiscriminatory transportation
services to producers, marketers and other shippers, regardless of whether such shippers are affiliated with an interstate pipeline
company. FERC’s initiatives have led to the development of a competitive, open access market for natural gas purchases and
sales that permits all purchasers of natural gas to buy gas directly from third-party sellers other than pipelines. However, the
natural gas industry historically has been very heavily regulated; therefore, the less stringent regulatory approach currently
pursued by FERC and Congress might not continue indefinitely into the future. Avalon is not able to determine what effect, if
any, future regulatory changes might have on future natural gas related activities with respect to the Underlying Properties.
Under
FERC’s current regulatory regime, transmission services must be provided on an open-access, nondiscriminatory basis at cost-based
rates or at market-based rates if the transportation market at issue is sufficiently competitive. Gathering service, which occurs
upstream of jurisdictional transmission services, is regulated by the states – in the case of Texas by the Railroad Commission
of Texas. Although its policy is still in flux, in the past FERC has reclassified certain jurisdictional transmission facilities
as non-jurisdictional gathering facilities, which has the tendency to increase the cost of transporting gas to point-of-sale locations.
Oil
Price Controls and Transportation Rates
Sales
prices of oil and NGL produced from the Underlying Properties are not currently regulated and are made at market prices. Sales
of these commodities are, however, subject to laws and to regulations issued by the Federal Trade Commission (the “FTC”)
prohibiting manipulative or fraudulent conduct in the wholesale petroleum market. The FTC holds substantial enforcement authority
under these regulations, including the ability to assess substantial civil penalties.
The
price received from the sale of these products may be affected by the cost of transporting the products to market. Some transportation
of oil, natural gas and NGL is through interstate common carrier pipelines. Effective as of January 1, 1995, FERC implemented
regulations generally grandfathering all previously approved interstate transportation rates and establishing an indexing system
for those rates by which adjustments are made annually based on the rate of inflation, subject to certain conditions and limitations.
FERC’s regulation of crude oil and natural gas liquids transportation rates may tend to increase the cost of transporting
crude oil and natural gas liquids by interstate pipelines, although the annual adjustments may result in decreased rates in a
given year. Every five years, FERC must examine the relationship between the annual change in the applicable index and the actual
cost changes experienced in the oil pipeline industry. Avalon is not able at this time to predict the effects of these regulations
or FERC proceedings, if any, on the transportation costs associated with crude oil producing operations.
Environmental
and Occupational Safety and Health Regulation
Oil,
natural gas and NGL exploration, development and production operations are subject to stringent and complex federal, state, tribal,
regional and local laws and regulations governing worker safety and health, the discharge and disposal of substances into the
environment, and the protection of the environment and natural resources. Numerous governmental entities, including the U.S. Environmental
Protection Agency (“EPA”), the Occupational Safety and Health Administration (“OSHA”), ACE, and analogous
state and local agencies (and, under certain laws, private individuals), have the power to enforce compliance with these laws
and regulations and any permits issued under them. These laws and regulations may, among other things: (i) require permits to
conduct exploration, drilling, water withdrawal, wastewater disposal and other production related activities; (ii) govern the
types, quantities and concentrations of substances that may be disposed or released into the environment or injected into formations
in connection with drilling or production activities, and the manner of any such disposal, release or injection; (iii) limit or
prohibit construction or require formal mitigation measures in sensitive areas such as wetlands, wilderness areas or areas inhabited
by endangered or threatened species; (iv) require investigatory and remedial actions to mitigate pollution conditions arising
from or attributable to former operations of the Underlying Properties; (v) impose safety and health restrictions designed to
protect employees from exposure to hazardous or dangerous substances; and (vi) impose obligations to reclaim and abandon well
sites and pits. Failure to comply with these laws and regulations may result in the assessment of sanctions, including administrative,
civil and criminal penalties, the imposition of investigatory, remedial or corrective action obligations, the occurrence of delays
or restrictions in permitting or performance of projects and the issuance of orders enjoining operations in affected areas.
Since
taking office, the Trump Administration has taken steps aimed at reducing federal regulatory burdens and costs for the oil and
gas industry. Nevertheless, changes in environmental regulation may place more restrictions and limitations on activities that
may affect the environment. Any changes in or more stringent enforcement of these laws and regulations that result in delays or
restrictions in permitting or development of projects, or more stringent or costly construction, drilling, water management or
completion activities or waste handling, storage, transport, remediation, or disposal, emission or discharge requirements could
have a material adverse effect on the Trust’s revenues. Moreover, accidental releases, including spills, may occur in the
course of operations on the Underlying Properties, and significant costs could be incurred as a result of such releases or spills,
including third-party claims for damage to property and natural resources or personal injury. While Avalon believes that compliance
with existing environmental laws and regulations and that continued compliance with existing requirements will not materially
affect operation of the Underlying Properties, it is possible that Avalon may incur substantial costs in the future related to
revised or additional environmental regulations that could have a material adverse effect on its business, financial condition,
and results of operations.
The
following is a summary of the more significant existing and proposed environmental and occupational safety and health laws and
regulations, as amended from time to time, to which the Underlying Properties and Avalon's business operations are subject and
for which compliance may have a material adverse impact on the Trust or operation of the Underlying Properties.
Hazardous
Substances and Wastes
The
federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) and comparable state laws
may impose strict, joint and several liability, without regard to fault or legality of conduct on certain persons who are responsible
for the release of a “hazardous substance” into the environment. These persons include current and prior owners or
operators of the site where the release of a hazardous substance occurred as well as entities that disposed or arranged for the
disposal of the hazardous substance released at the site. Under CERCLA, these “responsible parties” may be liable
for the costs of cleaning up sites where hazardous substances have been released into the environment, for damages to natural
resources resulting from the release and for the costs of certain environmental and health studies. Additionally, landowners and
other third parties may file claims for personal injury and natural resource and property damage allegedly caused by the release
of hazardous substances into the environment. CERCLA also authorizes the EPA and, in some instances, third parties to act in response
to threats to the public health or the environment from a hazardous substance release and to pursue steps to recover costs incurred
for those actions from responsible parties. Despite the so-called “petroleum exclusion,” certain products used by
Avalon and used previously by SandRidge in the course of operations at the Underlying Properties may be regulated as CERCLA hazardous
substances. To date, none of the Underlying Properties have been subject to CERCLA response actions.
The
federal Resource Conservation and Recovery Act (“RCRA”) and comparable state statutes and implementing regulations
impose strict “cradle-to-grave” requirements on the generation, transportation, treatment, storage and disposal and
cleanup of hazardous and non-hazardous wastes. SandRidge, Avalon and any other operators of the Underlying Properties have and
will generate wastes that are subject to the requirements of RCRA and comparable state statutes. Drilling fluids, produced waters
and other wastes associated with the exploration, production and/or development of oil and natural gas, including naturally-occurring
radioactive material, if properly handled, are currently excluded from regulation as hazardous wastes under RCRA and, instead,
are regulated under RCRA’s less stringent non-hazardous waste requirements. However, it is possible that these wastes could
be classified as hazardous wastes in the future. For example, in December 2016, the EPA and environmental groups entered into
a consent decree to address the EPA’s alleged failure to timely assess its RCRA Subtitle D criteria regulations exempting
certain exploration and production related oil and natural gas wastes from regulation as hazardous wastes under RCRA. The consent
decree requires the EPA to propose a rulemaking no later than March 15, 2019 for revision of certain Subtitle D criteria regulations
pertaining to oil and natural gas wastes or to sign a determination that revision of the regulations is not necessary. The EPA
fulfilled its obligation under the consent decree by issuing a determination on April 23, 2019 that revisions to existing RCRA
Subtitle D regulations governing oil and natural gas wastes are not necessary, along with a report supporting that determination.
Any future change in the exclusion for such wastes could potentially result in an increase in the cost of managing and disposing
of those wastes.
Air
Emissions and Climate Change.
The
federal Clean Air Act, as amended (“CAA”), and comparable state laws and regulations restrict the emission of air
pollutants through emissions standards, construction and operating permitting programs, and the imposition of other compliance
requirements. These laws and regulations may require pre-approval for the construction or modification of certain projects or
facilities expected to produce or significantly increase air emissions, strict compliance with air permit requirements or the
utilization of specific equipment or technologies to control emissions. The need to acquire such permits has the potential to
delay or limit the development of oil and natural gas projects or require Avalon to incur certain capital expenditures for air
pollution control equipment or other air emissions-related issues.
Furthermore,
in 2009, the EPA published its findings that emissions of carbon dioxide, methane and certain other “greenhouse gases”
(collectively, “GHGs”) present an endangerment to public health and the environment because emissions of such gases
are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. The EPA has taken
a number of steps aimed at gathering information about, and reducing the emissions of, GHGs from industrial sources, including
oil and natural gas
sources. The EPA has adopted rules requiring the reporting of GHG emissions from oil, natural gas and NGL
production and processing facilities on an annual basis, as well as reporting GHG emissions from gathering and boosting systems,
oil well completions and workovers using hydraulic fracturing. The EPA also has adopted and implemented regulations under existing
provisions of the CAA that, among other things, establish Prevention of Significant Deterioration (“PSD”) construction
and Title V operating permit reviews for GHG emissions from certain large stationary sources that already are potential major
sources of certain principal, or criteria, pollutant emissions. Facilities required to obtain PSD permits for their GHG emissions
also will be required to meet “best available control technology” standards that typically are established by the
states. This rule could adversely affect Avalon’s operations upon the Underlying Properties and restrict or delay its ability
to obtain air permits for new or modified facilities that exceed GHG emission thresholds.
In
2012, the EPA published a final rule adopting federal New Source Performance Standards (“NSPS”) that require the reduction
of volatile organic compound emissions from certain fractured and refractured natural gas wells for which well completion is conducted
and further require that most wells use reduced emission completions, also known as “green completions.” These regulations
also establish specific new requirements regarding emissions from production-related wet seal and reciprocating compressors, and
from pneumatic controllers and storage vessels. In June 2016, the EPA published a final rule adopting additional NSPS requirements
for new, modified, or reconstructed oil and gas facilities that require control of the greenhouse gas methane from affected facilities,
including requirements to find and repair fugitive leaks of methane emissions at well sites (“Methane Rule”). In addition,
in November 2016, the U.S. Department of the Interior Bureau of Land Management (“BLM”) issued final rules to reduce
methane emissions from venting, flaring, and leaks during oil and gas operations on federal and tribal lands (the “BLM Methane
and Waste Prevention Rule”) that are substantially similar to the EPA’s Methane Rule.
The
EPA also is charged with establishing ambient air quality standards, the implementation of which can indirectly impact Avalon’s
operations. For example, in October 2015, the EPA lowered the National Ambient Air Quality Standard (“NAAQS”), for
ozone from 75 to 70 parts per billion. Although the EPA has designated all counties in which the Underlying Properties are located
as attainment areas for the 2015 ozone standard, these determinations may be revised in the future. State implementation of the
revised NAAQS could result in stricter permitting requirements, delay or prohibit Avalon’s ability to obtain such permits,
and result in increased expenditures for pollution control equipment, the costs of which could be significant.
Following
the 2016 presidential election and change in administrations, President Trump signed Executive Order 13783 directing federal agencies
to review and, if appropriate, revise all existing regulations “that potentially burden the development or use of domestic
energy resources, with particular attention to oil and gas.” Pursuant to the Executive Order, the BLM and EPA commenced
reviews of the BLM Methane and Waste Prevention Rule and the oil and gas NSPS, respectively. In December 2017, the BLM published
a final rule to temporarily suspend or delay certain requirements contained in the November 2016 final rule until January 17,
2019, including those requirements relating to venting, flaring and leakage from oil and gas production activities. Further, in
September 2018, the BLM published a final rule revising or rescinding certain provisions of the BLM Methane and Waste Prevention
Rule. This action has been challenged by the states of California and New Mexico, as well as environmental groups, in the Northern
District of California. Such litigation is still pending. Separately, the EPA’s review of its regulations resulted in (a)
then EPA Administrator Scott Pruitt withdrawing the request for information needed to develop emissions guidelines for existing
facilities in March, 2017, (b) a proposal to delay implementation of the Methane Rule, and (c) the convening of a reconsideration
proceeding that resulted in two 2018 rulemaking projects aimed at rolling back certain Methane Rule requirements. In August 2019,
the EPA proposed amendments to the Methane Rule aimed at eliminating federal requirements that oil and gas companies install technology
to detect and fix methane leaks from wells, pipelines and storage facilities, while maintaining the rule’s substantive emissions
control requirements because they serve to control emissions of other, non-methane pollutants. The ultimate fate of the Methane
Rule requirements is unclear. Nevertheless, regulations promulgated under the CAA may require Avalon to incur expenses to install
and utilize specific equipment, technologies, or work practices to control emissions from its operations.
The
Congressional reaction to the BLM and EPA action has been mixed, but there seems to be growing support, at least in the House
of Representatives, in support for maintaining and potentially strengthening methane regulation. During the current Congressional
session, five bills have been introduced which, if enacted, would codify existing methane regulations and/or force additional
regulatory action. Examples include the Super Pollutants Act (H.R. 4143), which would codify the oil and gas NSPS and require
the EPA to develop emissions guidelines for existing oil and gas facilities within two years, and the CLEAN Future Act which aims
to achieve a 100% clean economy by not later than 2050 including a plan to achieve “net zero” GHGs.
Although
future federal GHG regulations for the oil and gas industry remain a possibility given the long-term trend towards increasing
regulation, the form of these regulations remains uncertain as the Trump administration has made it clear they will oppose any
such regulation. Moreover, several states have already adopted rules requiring operators of both new and existing oil and gas
facilities to develop and implement leak detection and repair (“LDAR”) program and to install devices on certain equipment
to capture 95% of methane emissions. Compliance with these rules could require Avalon to purchase pollution control equipment
and optical gas imaging equipment for LDAR inspections, and to hire additional personnel to assist with inspection and reporting
requirements.
Compliance
with these and other air pollution control and permitting requirements has the potential to increase Avalon’s production
costs, which costs could be significant. Additionally, violations of lease conditions or regulations related to air emissions
can result in civil and criminal penalties, as well as potential court injunctions curtailing operations and canceling leases.
Such enforcement liabilities can result from either governmental or citizen enforcement.
Water
Discharges
The
federal Clean Water Act (“CWA”) and analogous state laws and implementing regulations impose restrictions and strict
controls regarding the discharge of pollutants into waters of the United States and waters of the states, respectively. Pursuant
to these laws and regulations, the discharge of pollutants to regulated waters is prohibited unless it is permitted by the EPA,
ACE or an analogous state agency. The discharge of wastewater from most onshore oil and gas exploration and production activities
is currently prohibited east of the 98th meridian. Additionally, in June 2016, the EPA issued a final rule implementing wastewater
pre-treatment standards that prohibit onshore unconventional oil and natural gas extraction facilities from sending wastewater
directly to publicly owned treatment works (“POTW”).
Unconventional
extraction facilities are in certain circumstances allowed by federal regulations to send wastewater to an off-site private centralized
wastewater treatment facility that can either discharge treated water or send it to a POTW. The EPA is conducting a study of the
treatment and discharge of oil and gas wastewater. Any restriction of disposal options for hydraulic fracturing waste and other
changes to CWA discharge requirements may result in increased costs. Avalon does not presently discharge pollutants associated
with the exploration, development and production of oil, natural gas and NGL on the Underlying Properties into federal or state
waters. Rather, it disposes of such fluids by regulated injection into salt water disposal wells located on the Underlying Properties
in compliance with the Underground Injection Control program described below.
How
the EPA and the ACE define “waters of the United States” (“WOTUS”) can impact Avalon’s regulatory
and permitting obligations under the CWA. The EPA and the ACE promulgated rules defining the scope of WOTUS that became effective
in September 2015. On October 22, 2019, the EPA and the ACE published a final rule that repealed the 2015 definition of WOTUS
and recodified longstanding regulatory definitions of WOTUS that existed prior to the 2015 rule to promote regulatory consistency
across the United States. On February 14, 2019, EPA and the ACE had published a proposed revised definition of WOTUS intended
to clarify and narrow the definition from that in the 2015 rule. The comment period on the proposed changes to the definition
of WOTUS closed on April 15, 2019, and a final rule is expected to be published in early 2020. It is anticipated that petitions
for review of any 2020 WOTUS rule will be filed and that litigation over the definition of WOTUS will continue. To the extent
that Avalon must obtain permits for the discharge of pollutants or for dredge and fill activities in wetland areas or other waters
of the United States, Avalon could face increased costs and delays associated with obtaining such permits under any broader definition
of WOTUS that expands the scope of CWA jurisdiction.
Finally,
the Oil Pollution Act of 1990 (“OPA”), which amends the CWA, establishes standards for prevention, containment and
cleanup of oil spills into waters of the United States. The OPA requires measures to be taken to prevent the accidental discharge
of oil into waters of the United States from onshore production facilities. Measures under the OPA and/or the CWA include: inspection
and maintenance programs to minimize spills from oil storage and conveyance systems; the use of secondary containment systems
to prevent spills from reaching nearby waterbodies; proof of financial responsibility to cover environmental cleanup and restoration
costs that could be incurred in connection with an oil spill; and the development and implementation of spill prevention, control
and countermeasure (“SPCC”) plans to prevent and respond to oil spills. The OPA also subjects owners and operators
of facilities to strict, joint and several liability for all containment and cleanup costs and certain other damages arising from
a spill. SandRidge has developed and implemented SPCC plans for the Underlying Properties as required under the CWA, and Avalon
is continuing to administer these SPCC plans.
Subsurface
Injections
Any
underground injection operations that may be performed by Avalon in the future are subject to the Safe Drinking Water Act (“SDWA”),
as well as analogous state laws and regulations. Under the SDWA, the EPA established the Underground Injection Control (“UIC”)
program, which established the minimum program requirements for state and local programs regulating underground injection activities.
The UIC program includes requirements for permitting, testing, monitoring, record keeping and reporting of injection well activities,
as well as a prohibition against the migration of fluid containing any contaminant into underground sources of drinking water.
Texas state regulations require a permit from the Railroad Commission of Texas to operate underground injection wells. Avalon
has obtained such UIC permits. Although Avalon monitors the injection process of its injection wells, any leakage from the subsurface
portions of such wells could cause degradation of fresh groundwater resources, potentially resulting in suspension of Avalon’s
UIC permit, issuance of fines and penalties from governmental agencies, incurrence of expenditures for remediation of the affected
resource and imposition of liability by third-parties claiming damages for alternative water supplies, property damages and personal
injuries. Some states have considered laws mandating flowback and produced water recycling. Other states, including Texas, have
undertaken studies to assess the feasibility of recycling produced water on a large scale. For example, in July 2018, the EPA
partnered with New Mexico to evaluate alternatives to injection of wastewater from exploration and production activities by reusing
it or treating it for reintroduction into the hydrologic cycle or both, and to propose potential regulations related thereto.
If laws mandating reuse and/or treatment in lieu of injection are adopted for the counties in which the Underlying Properties
are located, Avalon’s operating costs may increase significantly.
Endangered
Species. The federal Endangered Species Act (“ESA”) restricts activities that may affect endangered or threatened
species or their habitats without first obtaining an incidental take permit and implementing mitigation measures. Similar protections
are offered to migratory birds under the federal Migratory Bird Treaty Act. If endangered species are located in areas of the
Underlying Properties where seismic surveys, development activities or abandonment operations may be conducted, the work could
be prohibited or delayed or expensive mitigation may be required. In February 2016, the U.S. Fish and Wildlife Service (“USFWS”)
published a final policy which alters how it identifies critical habitat for endangered and threatened species. On August 27,
2019, the USFWS published a final rule adopting several changes to ESA regulations, including changes to the procedures and criteria
for listing or removing species from the Lists of Endangered and Threatened Wildlife and Plants and for designating critical habitat.
A critical habitat designation could result in further material restrictions to federal and private land use and could delay or
prohibit land access or development. The designation of previously unprotected species as threatened or endangered in areas where
operations on the Underlying Properties are located could cause Avalon to incur increased costs arising from species protection
measures or could result in limitations on exploration and production activities that could have an adverse impact on the ability
to develop and produce reserves from the Underlying Properties.
Employee
Health and Safety
The
operations of Avalon are subject to a number of federal and state laws and regulations, including the federal Occupational Safety
and Health Act and comparable state statutes, whose purpose is to protect the health and safety of workers. In addition, the Hazard
Communication Standard implemented by OSHA requires Avalon to maintain information concerning hazardous materials used or produced
in its operations and to provide this information to employees. Pursuant to the Federal Emergency Planning and Community Right-to-Know
Act, facilities that store hazardous chemicals that are subject to OSHA’s Hazard Communication Standard above certain threshold
quantities must submit information regarding those chemicals by March 1 of each year to state and local authorities in order to
facilitate emergency planning and response. That information is generally available to employees, state and local governmental
authorities, and the public. Avalon has been and is submitting this information to these authorities for the Underlying Properties.
Description
of Property
Information
regarding the Trust’s properties is included above under “Information about the Trust—Description of Business.”
Also, refer to Note 9 to the Trust’s audited financial statements included in this offer to exchange.
Legal
Proceedings
None.
Trustee’s
Discussion and Analysis of Financial Information and Results of Operations
Introduction
The
following discussion and analysis are intended to help the reader understand the financial condition, results of operations, liquidity
and capital resources of the Trust. This discussion and analysis should be read in conjunction with the Trust’s unaudited
interim financial statements and the accompanying notes included in this offer to exchange and the Trust’s audited financial
statements and the accompanying notes included this offer to exchange. All information regarding operations is provided to the
Trustee by Avalon.
Overview
The
Trust is a statutory trust formed under the Delaware Statutory Trust Act pursuant the Trust Agreement by and among SandRidge,
as Trustor, The Bank of New York Mellon Trust Company, N.A., as Trustee, and The Corporation Trust Company, as Delaware Trustee.
The
Trust holds Royalty Interests in specified oil and natural gas properties located in Underlying Properties in Andrews County,
Texas. These Royalty Interests were conveyed by SandRidge to the Trust concurrent with the initial public offering of the Trust’s
Common Units in August 2011 pursuant to the terms set forth in Conveyances effective April 1, 2011. As consideration for conveyance
of the Royalty Interests, the Trust remitted the proceeds of the offering, along with 4,875,000 Trust Common Units and 13,125,000
Subordinated Units to certain wholly-owned subsidiaries of SandRidge.
Pursuant
to a development agreement between the Trust and SandRidge, SandRidge was obligated to drill, or cause to be drilled, 888 Trust
Development Wells within the AMI by March 31, 2016. SandRidge fulfilled this obligation in November 2014. As no additional development
wells will be drilled, the Trust’s production is expected to decline each quarter during the remainder of its life. As a
result of SandRidge fulfilling its drilling obligation, the subordinated units converted to Common Units in January 2016. At October
31, 2018, SandRidge owned 13,125,000 Common Units, or 25% of all Common Units.
On
November 1, 2018, SandRidge sold all of its interests in the Underlying Properties and all of its Common Units in the Sale Transaction
to Avalon. The Conveyances permitted SandRidge to sell all or any part of its interest in the Underlying Properties, where the
Underlying Properties were sold subject to and burdened by the Royalty Interests. In connection with the Sale Transaction, Avalon
and its affiliates assumed all of SandRidge’s obligations under the Conveyances and the Trust Agreement and the Administrative
Services Agreement between SandRidge and the Trust pursuant to which SandRidge and Avalon have provided accounting, tax preparation,
bookkeeping and informational services to the Trust. In addition, SandRidge assigned its rights to Avalon under the registration
rights agreement between SandRidge and the Trust. As of June 30, 2020, Avalon holds 13,125,000 Common Units, or 25% of all Trust
units.
In
connection with the Sales Transaction, Avalon obtained the WaFed Loan from WaFed pursuant to the terms of a Loan Agreement and
related security documents. Avalon used the proceeds of the WaFed Loan to fund a portion of the purchase price for the interests
in the Underlying Properties and Trust Common Units acquired in the Sale Transaction. The WaFed Loan is secured by the WaFed Collateral.
The Royalty Interests are not part of the WaFed Collateral.
The
Trust is passive in nature and neither the Trust nor the Trustee has any control over, or responsibility for, any operating or
capital costs related to the Underlying Properties. The business and affairs of the Trust are administered by the Trustee. The
Trust Agreement generally limits the Trust’s business activities to owning the Royalty Interests and activities reasonably
related thereto, including activities required or permitted by the terms of the Conveyances.
The
Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s
administrative expenses, property tax and Texas franchise tax and cash reserves withheld by the Trustee, on or about the 60th
day following the completion of each quarter. Due to the timing of the payment of production proceeds to the Trust, each distribution
covers production from a three-month period consisting of the first two months of the most recently ended quarter and the final
month of the quarter preceding it.
The
Trust will dissolve and begin to liquidate on the Termination Date of March 31, 2031, unless sooner dissolved in accordance with
the terms of the Trust Agreement as described below and will soon thereafter wind up its affairs and terminate. At the Termination
Date, 50% of the Royalty Interests will revert automatically to Avalon. The remaining 50% of the Royalty Interests will be sold
at that time, with the net proceeds of the sale, as well as any remaining Trust cash reserves, distributed to the holders of Trust
Common Units on a pro rata basis, subject to Avalon’s right of first refusal to purchase the Royalty Interests retained
by the Trust at the Termination Date. In addition, the Trust will dissolve if one of the following events occurs prior to the
Termination Date: (a) the Trust sells all of the Royalty Interests; (b) cash available for distribution for any four consecutive
quarters, on a cumulative basis, is less than $5.0 million; (c) the holders of Trust Common Units approve an earlier dissolution
of the Trust; or (d) the Trust is judicially dissolved pursuant to the provisions of the Delaware Statutory Trust Act. In the
case of any of the foregoing, the Trustee would then sell all of the Trust’s assets (subject to Avalon’s right of
first refusal to purchase the Royalty Interests retained by the Trust as of the date of such event), either by private sale or
public auction, and distribute the net proceeds of the sale to the holders of Trust Common Units after payment, or reasonable
provision for payment, of all Trust liabilities.
Commodity
Price Volatility
The
Trust’s quarterly cash distributions are highly dependent upon the prices realized from the sale of oil, natural gas and
NGL. The markets for these commodities are volatile and experienced significant fluctuations during 2019 and have declined sharply
in 2020 in response to the economic effects of the dispute over production levels between Russia and the members of the Organization
of Petroleum Exporting Countries and the global outbreak of the novel form of coronavirus known as COVID-19. These actions led
to an immediate and steep decrease in oil prices, which reached a closing NYMEX price low of negative $37.63 per barrel of crude
oil in April 2020. The spot price for WTI crude oil has decreased from $61.17 per barrel on January 2, 2020 to $40.77 per barrel
on August 3, 2020. A buildup in inventories, lower global demand, political unrest, or other factors, such as the economic effects
of the COVID-19 pandemic, could cause prices for U.S. oil, natural gas and NGL to fluctuate significantly in the future. As a
result, there can be no assurance that prices for oil, natural gas and NGL will be maintained at a constant level for any significant
period of time.
COVID-19
The
COVID-19 pandemic has resulted in widespread and localized health crises that adversely affect general commercial activity, the
economies and financial markets of many countries and localities, as well as global demand for oil, natural gas and NGL. COVID-19
and the federal, state and local governmental responses to the pandemic also have resulted in significant business and operational
disruptions, including business closures, disruptions to supply chains, travel restrictions and limitations on the availability
of workforces. The full impact of COVID-19 is unknown and is rapidly evolving, and it is not possible to reliably estimate the
impact that these developments will have on future periods. A prolonged period of low crude oil and natural gas prices will adversely
affect Avalon as the operator of the Underlying Properties. If commodity prices for crude oil, natural gas and NGL remain at reduced
levels, distributions to holders of Common Units will be substantially lower than historical distributions, and in certain periods
there may be no distribution to holders of Common Units.
Potential
Early Termination of the Trust
The
Trust Agreement provides that the Trust will terminate if cash available for distribution for any four consecutive quarters, on
a cumulative basis, is less than $5.0 million. If this early termination event occurs, the Trust Agreement will require the Trustee
to sell the Royalty Interests, either by private sale or public auction, subject to Avalon's right of first refusal to purchase
the Royalty Interests. After the sale of all of the Royalty Interests, payment of all Trust liabilities and establishment of reasonable
provisions for the payment of additional anticipated or contingent Trust expenses or liabilities, the Trustee will distribute
the net proceeds of the sale to the holders of Trust Common Units.
Based
on Avalon’s estimates for the next twelve months regarding projected production from the Underlying Properties and estimated
pricing for WTI crude oil based on futures prices as of August 1, 2020 readily available in the public market, adjusted for differentials,
and assuming that Avalon is unable to make the quarterly payment to the Trust for the three-month period ended March 31, 2020
as discussed below under “Liquidity and Capital Resources-Future Trust Distributions to Unitholders”, cash available
for distribution for the four consecutive quarters ending December 31, 2020, on a cumulative basis, may fall below $5.0 million,
which would require the Trust to commence termination shortly after the required quarterly cash distribution is to be made in
February 2021. If that occurs, the Trustee would be required to sell all of the Trust’s remaining assets and liquidate the
Trust. Due to this uncertainty, there is substantial doubt regarding the Trust’s ability to continue as a going concern
within one year after the date that the financial statements are issued. The Trust’s financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
Status
of NYSE Delisting
As
previously disclosed, on December 27, 2019, the Trust received written notification from The New York Stock Exchange (“NYSE”)
that the Trust no longer satisfied the continued listing compliance standards set forth under Rule 802.01C of the NYSE Listed
Company Manual because the average closing price of the Trust units fell below $1.00 over a 30 consecutive trading-day period.
If the Trust were unable to regain compliance with the applicable standards within a six-month cure period, the NYSE would commence
suspension and delisting procedures. Although the Trust units continue to be traded on the NYSE, the Trust might be unable to
maintain compliance with the NYSE’s listing standards and could again become subject to the NYSE delisting procedures. On
April 23, 2020, the NYSE notified the Trustee that pursuant to temporary NYSE rule changes adopted in response to the dramatic
fluctuations in the capital markets resulting from the COVID-19 pandemic, the cure period in which the Trust may regain compliance
with the applicable listing standards has been extended to September 5, 2020.
The
NYSE announced the suspension of trading of the Trust units due to non-compliance with Rule 802.01C of the NYSE Listed Company
Manual, effective as of the close of trading on September 8, 2020, and announced that it was initiating proceedings to delist
the Trust units.
Properties
As
of June 30, 2020, the Trust’s assets consisted of Royalty Interests that burden the Trust Wells, all of which are located
in Andrews County, Texas.
Distributions
The
Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s
administrative expenses, property tax and Texas franchise tax and cash reserves withheld by the Trustee, on or about the 60th
day following the completion of each quarter. Holders of Trust Common Units are responsible for all federal and state tax liabilities
associated with distributions they receive from the Trust.
Pursuant
to Internal Revenue Code (“IRC”) Section 1446, withholding tax on income effectively connected to a United States
trade or business allocated to non-U.S. persons (“ECI”) should be made at the highest marginal rate. Under IRC Section
1441, withholding tax on fixed, determinable, annual, periodic income from United States sources allocated to non-U.S. persons
should be made at 30% of gross income unless the rate is reduced by treaty. This is intended to be a qualified notice to nominees
and brokers as provided for under Treasury Regulation Section 1.1446-4(b) by the Trust, and while specific relief is not specified
for IRC Section 1441 income, this disclosure is intended to suffice. Nominees and brokers should withhold at the highest marginal
rate on the distribution made to non-U.S. persons. The Tax Cuts and Jobs Act (the “TCJA”) enacted in December 2017
treats a non-U.S. holder’s gain on the sale of Trust units as ECI to the extent such holder would have had ECI if the Trust
had sold all of its assets at fair market value on the date of the exchange. The TCJA also requires the transferee of units to
withhold 10% of the amount realized on the sale of exchange of units (generally, the purchase price) unless the transferor certifies
that it is not a nonresident alien individual or foreign corporation. Pending the finalization of proposed regulations under IRC
Section 1446, the IRS has suspended this new withholding obligation with respect to publicly traded partnerships such as the Trust,
which is classified as a partnership for federal and state income tax purposes.
Results
of Trust Operations
Results
of the Trust for the Years Ended December 31, 2019 and 2018
The
primary factors affecting the Trust’s revenues and costs are the quantity of oil, natural gas and NGL production attributable
to the Royalty Interests and the prices received for such production. Royalty income, post-production expenses and certain taxes
are recorded on a cash basis when the Trust receives net revenue distributions from Avalon. Information regarding the Trust’s
revenues, expenses, production and pricing for the years ended December 31, 2019 and 2018 is presented below.
|
|
Year Ended December 31,
|
|
|
|
2019(1)
|
|
|
2018(2)
|
|
Production data
|
|
|
|
|
|
|
|
|
Oil (MBbls)
|
|
|
414
|
|
|
|
485
|
|
NGL (MBbls)
|
|
|
57
|
|
|
|
72
|
|
Natural gas (MMcf)
|
|
|
181
|
|
|
|
227
|
|
Combined equivalent volumes (MBoe)(3)
|
|
|
501
|
|
|
|
595
|
|
Average daily combined equivalent volumes (MBoe/d)
|
|
|
1.4
|
|
|
|
1.6
|
|
Well data
|
|
|
|
|
|
|
|
|
Initial and Trust Development Wells producing - average
|
|
|
1,035
|
|
|
|
1,064
|
|
Revenues (in thousands)
|
|
|
|
|
|
|
|
|
Royalty income
|
|
$
|
22,442
|
|
|
$
|
29,857
|
|
Total revenue
|
|
$
|
22,442
|
|
|
$
|
29,857
|
|
Expenses (in thousands)
|
|
|
|
|
|
|
|
|
Post-production expenses
|
|
$
|
50
|
|
|
$
|
46
|
|
Property taxes
|
|
|
—
|
|
|
|
1,559
|
|
Production taxes
|
|
|
1,061
|
|
|
|
1,423
|
|
Franchise taxes
|
|
|
47
|
|
|
|
47
|
|
Trust administrative expenses
|
|
|
1,734
|
|
|
|
1,402
|
|
Cash reserves withheld (used), net of amounts (used) withheld for current Trust expenses
|
|
|
2,261
|
|
|
|
54
|
|
Total expenses
|
|
$
|
5,153
|
|
|
$
|
4,531
|
|
Distributable income available to unitholders
|
|
$
|
17,289
|
|
|
$
|
25,326
|
|
|
|
|
|
|
|
|
|
|
Average prices
|
|
|
|
|
|
|
|
|
Oil (per Bbl)
|
|
$
|
50.77
|
|
|
$
|
56.96
|
|
NGL (per Bbl)
|
|
$
|
20.00
|
|
|
$
|
24.16
|
|
Combined oil and NGL (per Bbl)
|
|
$
|
47.06
|
|
|
$
|
52.70
|
|
Natural gas (per Mcf)
|
|
$
|
1.22
|
|
|
$
|
1.91
|
|
Combined equivalent (per Boe)
|
|
$
|
44.66
|
|
|
$
|
50.08
|
|
Average prices - including impact of post-production expenses
|
|
|
|
|
|
|
|
|
Natural gas (per Mcf)
|
|
$
|
0.95
|
|
|
$
|
1.71
|
|
Combined equivalent (per Boe)
|
|
$
|
44.56
|
|
|
$
|
50.00
|
|
Expenses (per Boe)
|
|
|
|
|
|
|
|
|
Post-production
|
|
$
|
0.10
|
|
|
$
|
0.08
|
|
Production taxes
|
|
$
|
2.12
|
|
|
$
|
2.39
|
|
(1)
|
Production
volumes and related revenues and expenses for the year ended December 31, 2019 included in 2019 net revenue distributions to the
Trust represent oil, natural gas and NGL production from September 1, 2018 to August 31, 2019.
|
(2)
|
Production
volumes and related revenues and expenses for the year ended December 31, 2018 (included in 2018 net revenue distributions to
the Trust) represent oil, natural gas and NGL production from September 1, 2017 to August 31, 2018.
|
(3)
|
Barrel
of oil equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of oil, which approximates the relative energy
content of oil as compared to natural gas.
|
Comparison
of Results of the Trust for the Years Ended December 31, 2019 and 2018
Revenues
Royalty
Income. Royalty income is a function of production volumes attributable to the Royalty Interests sold and associated prices received
by Avalon. Royalty income received during the year ended December 31, 2019 totaled $22.4 million compared to $29.9 million received
during the year ended December 31, 2018. The approximately $7.5 million decrease in royalty income consisted of approximately
$3.0 million attributable to a decrease in prices received from the sale of oil, gas and NGL attributable to the Royalty Interests
and approximately $4.5 million attributable to a decrease in total volumes produced from wells burdened by the Royalty Interests.
The average number of producing wells burdened by the Royalty Interests decreased by 29 during the year ended December 31, 2019
as compared to the year ended December 31, 2018.
Expenses
Post-Production
Expenses. The Trust bears post-production expenses related to production attributable to the Royalty Interests. Post-production
expenses generally consist of costs incurred to gather, store, compress, transport, process, treat, dehydrate and market, as applicable,
the oil, natural gas and NGL produced from wells burdened by and attributable to the Royalty Interests. Post-production expenses
for the year ended December 31, 2019 increased to approximately $50,000 from approximately $46,000 for the year ended December
31, 2018 primarily as a result of an increase in gas transfer fees.
Property
Taxes. Property taxes paid during the year ended December 31, 2018 were approximately $1.6 million, which related to 2018 property
taxes. No property tax payments were made during 2019, as approximately $1.7 million in 2019 property taxes were paid in January
2020.
Production
Taxes. Production taxes are calculated as a percentage of oil, natural gas and NGL revenues, excluding the net amount of any applicable
tax credits. Production taxes for the year ended December 31, 2019 totaled $1.1 million, or $2.12 per Boe, and were approximately
4.7% of royalty income. Production taxes for the year ended December 31, 2018 totaled $1.4 million, or $2.39 per Boe, and were
approximately 4.8% of royalty income.
Texas
Franchise Tax. The Trust paid its Texas franchise tax for the year ended December 31, 2018 of approximately $0.1 million, or approximately
0.2% of 2018 royalty income, during the year ended December 31, 2019. The Trust’s estimated Texas franchise tax for the
year ended December 31, 2019 of approximately $0.1 million, or approximately 0.2% of 2019 royalty income, is expected to be paid
during the year ending December 31, 2020.
Distributable
Income
Distributable
income for the year ended December 31, 2019 was $17.3 million, which included a net addition of approximately $2.3 million to
the cash reserve for the payment of future Trust expenses reflecting approximately $4.0 million withheld in aggregate from 2019
cash distributions to holders of Trust Common Units partially offset by approximately $1.7 million used to pay Trust expenses
during the period.
Distributable
income for the year ended December 31, 2018 was $25.3 million, which included a net addition of approximately $0.1 million to
the cash reserve for the payment of future Trust expenses reflecting approximately $3.1 million withheld in aggregate from 2018
cash distributions to holders of Trust Common Units partially offset by approximately $3.0 million used to pay Trust expenses
during the period.
Results
of the Trust for the Three and Six Months ended June 30, 2020 and 2019
The
primary factors affecting the Trust’s revenues and costs are the quantity of oil, natural gas and NGL production from the
Trust Wells, the prices received for such production and post-production costs (primarily transportation). Royalty income, post-production
expenses and certain taxes are recorded on a cash basis when net revenue distributions are received by the Trust from Avalon.
Information regarding the Trust’s production, pricing and costs for the three- and six-month periods ended June 30, 2020
and 2019 is presented below.
|
|
Three
Months Ended
June 30,
|
|
|
Six
Months Ended
June 30,
|
|
|
|
2020(1)
|
|
|
2019(2)
|
|
|
2020(3)
|
|
|
2019(4)
|
|
Production
Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
(MBbls)
|
|
|
—
|
|
|
|
104
|
|
|
|
93
|
|
|
|
213
|
|
NGL
(MBbls)
|
|
|
—
|
|
|
|
15
|
|
|
|
10
|
|
|
|
31
|
|
Natural
gas (MMcf)
|
|
|
—
|
|
|
|
46
|
|
|
|
39
|
|
|
|
97
|
|
Combined
equivalent volumes (MBoe)
|
|
|
—
|
|
|
|
126
|
|
|
|
110
|
|
|
|
260
|
|
Average
daily combined equivalent volumes (MBoe/d)
|
|
|
—
|
|
|
|
1.4
|
|
|
|
1.2
|
|
|
|
1.4
|
|
Well
Data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Initial
and Trust Development Wells producing - average
|
|
|
990
|
|
|
|
1,024
|
|
|
|
1,020
|
|
|
|
1,042
|
|
Revenues
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalty
income
|
|
$
|
3
|
|
|
$
|
4,901
|
|
|
$
|
5,292
|
|
|
$
|
11,158
|
|
Total
revenue
|
|
|
3
|
|
|
|
4,901
|
|
|
|
5,292
|
|
|
|
11,158
|
|
Expenses
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Post-production
expenses
|
|
|
—
|
|
|
|
8
|
|
|
|
15
|
|
|
|
20
|
|
Production
taxes
|
|
|
—
|
|
|
|
233
|
|
|
|
254
|
|
|
|
533
|
|
Property
taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
1,676
|
|
|
|
—
|
|
Franchise
taxes
|
|
|
36
|
|
|
|
47
|
|
|
|
36
|
|
|
|
47
|
|
Trust
administrative expenses
|
|
|
338
|
|
|
|
609
|
|
|
|
1,046
|
|
|
|
1,042
|
|
Cash
reserves withheld for current Trust expenses, net of amounts (used) withheld
|
|
|
(371
|
)
|
|
|
224
|
|
|
|
(1,945
|
)
|
|
|
755
|
|
Total
expenses
|
|
|
3
|
|
|
|
1,121
|
|
|
|
1,082
|
|
|
|
2,397
|
|
Distributable
income available to unitholders
|
|
$
|
—
|
|
|
$
|
3,780
|
|
|
$
|
4,210
|
|
|
$
|
8,761
|
|
Average
Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
(per Bbl)
|
|
|
—
|
|
|
$
|
43.59
|
|
|
$
|
53.93
|
|
|
$
|
48.12
|
|
NGL
(per Bbl)
|
|
|
—
|
|
|
$
|
18.54
|
|
|
$
|
19.48
|
|
|
$
|
22.51
|
|
Combined
oil and NGL (per Bbl)
|
|
|
—
|
|
|
$
|
40.45
|
|
|
$
|
50.51
|
|
|
$
|
44.89
|
|
Natural
gas (per Mcf)
|
|
|
—
|
|
|
$
|
2.08
|
|
|
$
|
0.92
|
|
|
$
|
1.91
|
|
Combined
equivalent (per Boe)
|
|
|
—
|
|
|
$
|
38.75
|
|
|
$
|
47.89
|
|
|
$
|
42.81
|
|
Average
Prices — including impact of post-production expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Natural
gas (per Mcf)
|
|
|
—
|
|
|
$
|
1.91
|
|
|
$
|
0.53
|
|
|
$
|
1.70
|
|
Combined
equivalent (per Boe)
|
|
|
—
|
|
|
$
|
38.69
|
|
|
$
|
47.76
|
|
|
$
|
42,74
|
|
Expenses
(per Boe)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Post-production
production
|
|
|
—
|
|
|
$
|
0.06
|
|
|
$
|
0.14
|
|
|
$
|
0.08
|
|
Production
taxes
|
|
|
—
|
|
|
$
|
1.85
|
|
|
$
|
2.31
|
|
|
$
|
2.05
|
|
|
(1)
|
Related
revenues and expenses for the three-month period ended June 30, 2020.
|
|
(2)
|
Production
volumes and related revenues and expenses for the three-month period ended June 30, 2019
(included in SandRidge’s May 2019 net revenue distributions to the Trust) represent
production from December 1, 2018 to February 28, 2019.
|
|
(3)
|
Production
volumes and related revenues and expenses for the six-month period ended June 30, 2020
(included in Avalon’s February 2020 net revenue distribution to the Trust) represent
production from September 1, 2019 to February 29, 2020.
|
|
(4)
|
Production
volumes and related revenues and expenses for the six-month period ended June 30, 2019
(included in SandRidge’s February 2019 and May 2019 net revenue distributions to
the Trust) represent production from September 1, 2018 to February 28, 2019.
|
Three
Months Ended June 30, 2020 Compared to the Three Months Ended June 30, 2019
Revenues
Royalty
Income. Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received.
There was no royalty income during the three-month period ended June 30, 2020 as a result of Avalon’s failure to pay proceeds
owed to the Trust for the period from December 1, 2019 to February 29, 2020 in the amount of approximately $4.7 million. Royalty
income received during the three-month period ended June 30, 2019 totaled approximately $4.9 million.
Expenses
Production
Taxes. Production taxes are calculated as a percentage of oil and natural gas revenues, net of any applicable tax credits. No
production taxes were paid by the Trust for the three-month period ended June 30, 2020. Production taxes for the three-month period
ended June 30, 2019 totaled approximately $0.2 million, or $1.85 per Boe, and were approximately 4.8% of royalty income.
Trust
Administrative Expenses. Trust administrative expenses generally consist of fees paid to the Trustee and the Delaware Trustee,
administrative services fees paid to Avalon, tax return and related form preparation fees, legal and accounting fees, and other
expenses incurred as a result of being a publicly traded entity. Trust administrative expenses for the three-month period ended
June 30, 2020 totaled approximately $0.3 million compared to approximately $0.6 million for the three-month period ended June
30, 2019. The decrease during the 2020 period primarily relates to the timing of administrative expense payments.
Distributable
Income
There
was no distributable income for the three-month period ended June 30, 2020 as Avalon was unable to pay the approximately $4.7
million it owes the Trust, which reflects production from December 1, 2019 to February 29, 2020. Distributable income for the
three-month period ended June 30, 2019 was $3.8 million, which included a net addition of approximately $0.2 million to the cash
reserve for the payment of future Trust expenses, reflecting approximately $0.8 million withheld from the May 2019 cash distribution
to holders of Trust Common Units partially offset by approximately $0.6 million used to pay Trust expenses during the period.
Six
Months Ended June 30, 2020 Compared to the Six Months Ended June 30, 2019
Revenues
Royalty
Income. Royalty income received during the six-month period ended June 30, 2020 totaled $5.3 million compared to $11.2 million
received during the six-month period ended June 30, 2019. The decrease is the result of Avalon’s failure to pay proceeds
owed to the Trust for the period from December 1, 2019 to February 29, 2020 in the amount of approximately $4.7 million. The average
number of producing Trust Wells in the six-month period ended June 30, 2020 decreased by 22 from 1,042 Trust Wells in the six-month
period ended June 30, 2019, because certain Trust Wells that could not produce minerals in commercial quantities due to a continuing
decline in production were shut in.
Expenses
Property
Taxes. Property taxes paid during the six months ended June 30, 2020 were approximately $1.7 million, which related to 2019 property
taxes. There were no property taxes paid during the six months ended June 30, 2019 as the applicable taxes were paid during a
prior period.
Production
Taxes. Production taxes paid for the six-month period ended June 30, 2020 totaled approximately $0.3 million, or $2.31 per Boe,
and were approximately 4.8% of royalty income.
Production
taxes for the six-month period ended June 30, 2019 totaled approximately $0.5 million, or $2.05 per Boe, and were approximately
4.8% of royalty income.
Distributable
Income
Distributable
income for the six-month period ended June 30, 2020 was $4.2 million, which included a net reduction of approximately $1.6 million
to the cash reserve for the payment of future Trust expenses, reflecting approximately $2.4 million used to pay Trust expenses
during the period partially offset by approximately $0.8 million withheld from the February 2020 cash distribution to holders
of Trust Common Units.
Distributable
income for the six-month period ended June 30, 2019 was $8.8 million, which included a net addition of approximately $0.8 million
to the cash reserve for the payment of future Trust expenses, reflecting approximately $1.8 million withheld in aggregate from
the February 2019 and May 2019 cash distributions to holders of Trust Common Units partially offset by approximately $1.0 million
used to pay Trust expenses during the period.
Liquidity
and Capital Resources
The
Trust has no source of liquidity or capital resources other than cash flow generated from the Royalty Interests and borrowings
to fund administrative expenses, including any amounts borrowed under Avalon’s loan commitment. The Trust’s primary
uses of cash are distributions to holders of Trust Common Units, the payment of Trust administrative expenses, establishing reserves
(as determined by the Trustee) for future liabilities, the payment of applicable taxes and the payment of expense reimbursements
to Avalon for out-of-pocket expenses incurred on behalf of the Trust. The Trust does not have any obligation to pay any costs
associated with the operation of the Trust Wells.
Administrative
expenses include payments to the Trustee and the Delaware Trustee as well as a quarterly fee of $75,000 paid to Avalon pursuant
to the Administrative Services Agreement. Each quarter, the Trustee determines the amount of funds available for distribution.
Available funds are the excess cash, if any, received by the Trust from the sale of production attributable to the Royalty Interests
during that quarter over the Trust’s expenses for the quarter. If at any time the Trust’s cash on hand (including
available cash reserves) is not sufficient to pay the Trust’s ordinary course administrative expenses as they become due,
the Trust may borrow funds from the Trustee or other lenders, including Avalon, to pay such expenses. The Trustee does not intend
to lend funds to the Trust. Pursuant to the Trust Agreement, if at any time the Trust’s cash on hand (including available
cash reserves) is not sufficient to pay the Trust’s ordinary course administrative expenses as they become due, Avalon (as
the assignee of SandRidge) will, at the Trustee’s request, loan funds to the Trust necessary to pay such expenses. Any funds
loaned by Avalon pursuant to this commitment will be limited to the payment of current accounts payable or other obligations to
trade creditors in connection with obtaining goods or services or the payment of other current liabilities arising in the ordinary
course of the Trust’s business, and may not be used to satisfy Trust indebtedness, or to make distributions. If Avalon loans
funds pursuant to this commitment, no further distributions will be made to holders of Trust Common Units (except in respect of
any previously determined quarterly cash distribution amount) until such loan is repaid in full, with interest, unless Avalon
consents to any further distributions. Any such loan will be on an unsecured basis, and the terms of such loan will be substantially
the same as that which would be obtained in an arm’s length transaction between Avalon and an unaffiliated third party.
No such loan was outstanding at June 30, 2020 or December 31, 2019, and given Avalon’s current financial condition, as further
discussed under “-Avalon’s Financial Condition” below, it is unlikely such loan could be made.
Commencing
with the distribution to holders of Trust Common Units paid in the first quarter of 2019, the Trustee has withheld, and in the
future intends to withhold, the greater of $190,000 or 3.5% of the funds otherwise available for distribution to holders of Trust
Common Units each quarter to gradually increase cash reserves for the payment of future known, anticipated or contingent expenses
or liabilities by a total of approximately $2,275,000. In 2019, the Trustee withheld an aggregate of $760,000 from the funds otherwise
available for distribution to holders of Trust Common Units. In February 2020, the Trustee withheld approximately $190,000 from
the funds otherwise available for distribution. In July 2020, the Trustee withheld approximately $190,000 from funds otherwise
available for distribution.
The
Trust is highly dependent on Avalon for multiple services, including the operation of the Trust Wells, remittance of net proceeds
from the sale of associated production to the Trust, administrative services such as accounting, tax preparation, bookkeeping,
regulatory filings and information services performed on behalf of the Trust, and potentially for loans to pay Trust administrative
expenses. Avalon is a relatively new oil and gas company formed in August 2018 with no prior operating history. Avalon’s
ability to continue operating the Underlying Properties depends on its future financial condition and economic performance, access
to capital, and other factors, many of which are out of Avalon’s control. If the reduced demand for crude oil in the global
market resulting from the economic effects of the COVID-19 pandemic and the recent reduction in the benchmark price of crude oil
persist for the near term or longer, such factors are likely to have a negative impact on Avalon’s financial condition.
This negative impact could affect Avalon’s ability to operate the Trust Wells and provide services to the Trust. Avalon
has informed the Trustee that during 2019, Avalon repaired 29 producing Trust Wells to increase production. Avalon has reported
that this effort, combined with higher-than-expected lease operating expenses (“LOE”) and declining oil prices, contributed
to an operating loss for Avalon in 2019, despite Avalon’s efforts to reduce LOE (including shutting in some non-economic
Trust Wells, alternating production to reduce electrical and other field operating costs, and staff lay-offs). Avalon has informed
the Trustee that Avalon is likely to shut in additional Trust Wells that are not capable of producing oil and natural gas in paying
quantities, as permitted under the Conveyances. Avalon shut in 23 Trust Wells and 79 Trust Wells during the first and second quarters
of 2020, respectively. Avalon did not repair any producing Trust Wells to increase production during the first half of 2020. As
a result of the operating loss for Avalon in 2019, Avalon has informed the Trustee that Avalon’s independent public accounting
firm included an emphasis of matter paragraph in its audit report on Avalon’s financial statements for the fiscal year ended
December 31, 2019.
Trust
Distributions to Holders of Trust Common Units
During
the years ended December 31, 2019 and 2018, the Trust’s distributions to its holders of Trust Common Units were as follows:
|
|
Covered
Production Period
|
|
Date
Declared
|
|
Date
Paid
|
|
Total
Distribution Paid
|
|
|
|
|
|
|
|
|
|
|
(in
millions)
|
|
Calendar
Quarter 2019
|
|
|
|
|
|
|
|
|
|
|
First
Quarter
|
|
September
1, 2018 - November 30, 2018
|
|
January
24, 2019
|
|
February
22, 2019
|
|
$
|
5.0
|
|
Second
Quarter
|
|
December
1, 2018 - February 28, 2019
|
|
April
25, 2019
|
|
May
24, 2019
|
|
$
|
3.7
|
|
Third
Quarter
|
|
March
1, 2019 - May 31, 2019
|
|
July
24, 2019
|
|
August
23, 2019
|
|
$
|
4.7
|
|
Fourth
Quarter
|
|
June
1, 2019 - August 31, 2019
|
|
October
24, 2019
|
|
November
24, 2019
|
|
$
|
3.8
|
|
Calendar
Quarter 2018
|
|
|
|
|
|
|
|
|
|
|
First
Quarter
|
|
September
1, 2017 - November 30, 2017
|
|
January
25, 2018
|
|
February
23, 2018
|
|
$
|
5.9
|
|
Second
Quarter
|
|
December
1, 2017 - February 28, 2018
|
|
April
26, 2018
|
|
May
25, 2018
|
|
$
|
6.6
|
|
Third
Quarter
|
|
March
1, 2018 - May 31, 2018
|
|
July
26, 2018
|
|
August
24, 2018
|
|
$
|
6.8
|
|
Fourth
Quarter
|
|
June
1, 2018 - August 31, 2018
|
|
October
25, 2018
|
|
November
23, 2018
|
|
$
|
6.0
|
|
On
February 28, 2020, the Trust paid a cash distribution of $0.080 per Trust unit covering production for the three-month period
from September 1, 2019 to November 30, 2019. The distribution totaled $4.19 million and was made to holders of Trust Common Units
of record as of February 14, 2020.
During
the six-month period ended June 30, 2020, the Trust’s distributions to holders of Trust Common Units were as follows:
|
|
|
|
|
|
|
|
Total
|
|
|
Distribution
|
|
|
|
Covered
|
|
|
|
|
|
Distribution
|
|
|
Per
Common
|
|
|
|
Production
Period
|
|
Date
Declared
|
|
Date
Paid
|
|
Paid
|
|
|
Unit
|
|
|
|
|
|
|
|
|
|
|
(in
millions)
|
|
|
|
|
|
Calendar
Quarter 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
Quarter
|
|
September
1, 2019 —
November 30, 2019
|
|
January
23, 2020
|
|
February
28, 2020
|
|
$
|
4.2
|
|
|
$
|
0.080
|
|
Second
Quarter
|
|
December
1, 2019 —
February 29, 2020
|
|
April
23, 2020
|
|
—
|
|
|
—
|
|
|
|
—
|
|
As
previously reported in the Trust’s Form 8-K filed on April 23, 2020, Avalon has informed the Trustee that Avalon was unable
to pay on a timely basis the approximately $4.65 million it owes the Trust, which reflects the quarterly distribution amount for
the three-month period ended March 31, 2020 (which primarily relates to production attributable to the Trust’s interests
from December 1, 2019 to February 29, 2020) of approximately $3.73 million, or $0.071 per unit, together with approximately $0.73
million of Trust expenses and $0.19 million to be withheld by the Trustee for the Trust’s previously disclosed cash reserve
for future known, anticipated or contingent expenses or liabilities of the Trust. Consequently, the Trustee was unable to make
the quarterly distribution to holders of Trust Common Units for the three-month period ended March 31, 2020. In accordance with
the terms of the Conveyances, the unpaid amount owed the Trust will accrue interest at the rate of interest per annum publicly
announced from time to time by The Bank of New York Mellon Trust Company, N.A. at its “prime rate” in effect at its
principal office in New York City until paid to the Trust. The accrued interest from May 15, 2020 to June 30, 2020 was approximately
$19,000. Avalon has informed the Trustee that Avalon intends to make the payment of the distribution to the Trust, with interest
in accordance with the Conveyances, when funds are available to do so; however, as discussed below, Avalon believes it will be
unable to generate sufficient cash for quarterly payments to the Trust for the foreseeable future.
Avalon
has informed the Trustee that Avalon is using its commercially reasonable efforts to preserve the oil and gas leases burdened
by the Royalty Interests so that in the future, assuming that oil prices return to a profitable level, the Trust will still hold
its Royalty Interests, and holders of Trust Common Units may have the opportunity to receive future quarterly distributions. Avalon
also has informed the Trustee that it believes that continuing production from those Trust Wells required to preserve such leases
is preferable to stopping production, as the failure to continue production would result in a termination of Avalon’s working
interest in such Trust Wells and, therefore, the Royalty Interests, which would have a material adverse effect on the Trust’s
financial condition. Avalon has reported to the Trustee that Avalon therefore used revenues it received during the production
period from December 1, 2019 to February 29, 2020 to pay the operating expenses necessary to maintain production from the Trust
Wells and to pay oil and gas lessor royalties, as the proceeds attributable to Avalon’s net revenue interest in the Underlying
Properties was insufficient to cover all such costs. Avalon had anticipated that revenues from current period production would
be sufficient to fund the quarterly payment to the Trust; however, revenues from current period production have been insufficient
to generate the cash needed to make the quarterly payment to the Trust for the quarter ended March 31, 2020 due to the sharp drop
in crude oil prices during the first quarter of 2020. In April 2020, Avalon informed the Trustee that due to Avalon’s decision
to prioritize the preservation of oil and gas leases burdened by the Royalty Interests, coupled with the sharp decline in oil
and gas prices since the beginning of 2020, as discussed elsewhere, at that time Avalon did not believe it would be able to generate
sufficient cash for quarterly payments to the Trust for the foreseeable future. However, with the recovery of crude oil prices
since the end of April 2020 and with increased cost-cutting efforts, Avalon has informed the Trust that it will make a payment
of approximately $1.7 million to the Trust for the three-month period ended June 30, 2020 (which primarily relates to production
attributable to the Trust’s Royalty Interests from March 1, 2020 to May 31, 2020), and the Trust has announced a quarterly
distribution to holders of Trust Common Units of $652,000 for that period. As the COVID pandemic continues to show no signs of
abating and has recently resurged in the United States, Avalon has informed the Trust that it believes crude oil prices will continue
to fluctuate dramatically and cannot assure the Trust of its ability to generate sufficient cash to make all future quarterly
payments to the Trust on a timely basis.
The
Trustee intends to continue to monitor this situation closely and, if appropriate, may take legal action against Avalon to enforce
the Trust’s rights under the Conveyances.
Future
Trust Distributions to Holders of Trust Common Units
During
the three-month production period from March 31, 2020 to May 31, 2020, combined sales volumes were lower than the previous period.
On July 23, 2020, the Trust declared a cash distribution of $0.012 per unit covering production for the period. The distribution
will be paid on or about August 31, 2020 to record holders of Trust Common Units as of August 17, 2020 and was calculated as follows
(in thousands, except for unit and per unit amounts):
Revenues
|
|
|
|
Royalty
income
|
|
$
|
1,663
|
|
Total
revenues
|
|
|
1,663
|
|
Expenses
|
|
|
|
|
Post-production
expenses
|
|
|
11
|
|
Production
taxes
|
|
|
80
|
|
Cash
reserves withheld by Trustee(1)
|
|
|
730
|
|
Total
expenses
|
|
|
821
|
|
Distributable
income to unitholders
|
|
$
|
842
|
|
Additional
cash reserve(2)
|
|
|
190
|
|
Distributable
income available to unitholders
|
|
$
|
652
|
|
Distributable
income per unit (52,500,000 units issued and outstanding)
|
|
$
|
0.012
|
|
|
(1)
|
Includes
amounts withheld for payment of future Trust administrative expenses.
|
|
(2)
|
Cash
reserve increase for the payment of future known, anticipated or contingent expenses
or liabilities.
|
Avalon’s
Financial Condition
The
reduced demand for crude oil in the global market resulting from the economic effects of the COVID-19 pandemic and the ongoing
fluctuations and the recent dramatic reduction in the benchmark price of crude oil from mid-February to late April 2020 have had
a negative impact on Avalon’s financial condition. Avalon has informed the Trustee that it has shut in additional Trust
Wells that are not capable of producing oil and natural gas in paying quantities, as permitted under the Conveyances, in an effort
to further reduce LOE. These Trust Wells were not necessary to hold the leasehold interests burdened by the Trust’s Royalty
Interests. Avalon shut in 23 Trust Wells and 79 Trust Wells during the first and second quarters of 2020, respectively.
Due
to the reduction in the number of producing wells (including Trust Wells and other wells owned by Avalon) and the resulting expected
reduction in the proved reserves attributable to Avalon’s net revenue interest in the Underlying Properties and other oil
and gas assets, Avalon notified the Trust in April 2020 that it expected WaFed to notify Avalon (concurrent with WaFed’s
redetermination of the borrowing base under the terms of the WaFed Loan) that the borrowing base would be reduced to less than
the outstanding principal amount of the WaFed Loan. As Avalon has indicated to the Trust that Avalon does not presently have sufficient
cash available to pay down the principal amount of the WaFed Loan to come into compliance with any adjustment to the borrowing
base, it is possible that WaFed could foreclose on the collateral securing the WaFed Loan or take other steps to protect its interest
in such collateral. Since April 2020, Avalon has been in discussions with WaFed regarding forbearance of certain breached financial
covenants and an extension of the WaFed Loan. On July 30, 2020, Avalon and WaFed entered into an amendment to the WaFed Loan that,
among other things (i) extends the date on which Avalon is obligated to provide a reserve report to WaFed (regarding the redetermination
of the borrowing base) to September 15, 2020, (ii) provides for additional collateral for the WaFed Loan, (iii) requires increased
financial and operations reporting, and (iv) requires Avalon to pay off the WaFed Loan by October 15, 2020. In addition, WaFed
and a third party entered into a Participation Agreement with respect to the WaFed Loan where such third party has the right to
purchase the WaFed Loan in the event Avalon does not meet the conditions of the amended WaFed Loan. Avalon has informed the Trust
that if it is unsuccessful in its efforts to recapitalize and pay off the WaFed Loan, it anticipates that WaFed will call the
WaFed Loan and foreclose on its collateral, which could occur as early as late October 2020. If such foreclosure were to occur,
Avalon would lose its working interest in the Underlying Properties and could be replaced as operator of the Underlying Properties.
See “Risk Factors - The value of the Royalty Interests is highly dependent on the performance and financial condition of
Avalon” in for a discussion of additional risks relating to the WaFed Loan and Avalon’s financial condition. The Trustee
intends to continue to monitor this situation closely and will take any appropriate action to protect its Royalty Interests, including
legal action to enforce its rights under the Conveyance.
Contractual
Obligations
Pursuant
to the terms of the Administrative Services Agreement, the Trust is obligated to pay Avalon an annual administrative services
fee of $300,000 ($75,000 payable quarterly in arrears) for accounting, tax preparation, bookkeeping, and informational services
to be performed on behalf of the Trust for the remaining life of the Trust. Pursuant to the Trust Agreement, the Trust pays the
Trustee an annual administrative fee, which until April 1, 2017 was $150,000. The annual fee can be adjusted for inflation by
no more than 3% in any year through 2030. The annual administrative fee, which was adjusted for inflation in July 2019, currently
is approximately $158,000. In addition, under the Trust Agreement the Trust is obligated to pay the Delaware Trustee an annual
fee of $2,400 throughout the life of the Trust.
Critical
Accounting Policies and Estimates
The
financial statements of the Trust are significantly affected by its basis of accounting and estimates related to the Royalty Interests
and proved reserves, as summarized below.
Basis
of Accounting
The
financial statements of the Trust differ from financial statements prepared in accordance with accounting principles generally
accepted in the United States of America (“GAAP”) as the Trust records revenues when cash is received (rather than
when earned) and expenses when paid (rather than when incurred) and may also establish cash reserves for contingencies, which
would not be accrued in financial statements prepared in accordance with GAAP. This comprehensive basis of accounting other than
GAAP corresponds to the accounting permitted for royalty trusts by the SEC as specified by Staff Accounting Bulletin Topic 12:E,
Financial Statements of Royalty Trusts. Amortization of investment in the Royalty Interests, calculated on a unit-of-production
basis, and any impairment thereto is charged directly to trust corpus. Distributions to holders of Trust Common Units are recorded
when declared. Because the Trust’s financial statements are prepared on a modified cash basis, most accounting pronouncements
are not applicable to the Trust’s financial statements.
Proved
Reserves
The
proved oil, natural gas and NGL reserves attributable to the Royalty Interests are estimated by independent petroleum engineers.
Estimates of proved reserves are based on the quantities of oil, natural gas and NGL that geological and engineering data demonstrate,
with reasonable certainty, to be recoverable in future years from known reservoirs under existing economic and operating conditions.
However, there are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future revenues,
rates of production and timing of development expenditures, including many factors beyond the Trust’s control. Estimating
reserves is very complex and relies on assumptions and subjective interpretations of available geologic, geophysical, engineering
and production data, and the accuracy of reserve estimates is a function of the quality and quantity of available data, engineering
and geological interpretation and judgment. In addition, as a result of volatility of changing market conditions, commodity prices
will vary from period to period, causing estimates of proved reserves to vary, as well as causing estimates of future net revenues
to vary. Estimates of proved reserves are key components of the Trust’s most significant financial estimates as discussed
further below.
Amortization
of Investment in Royalty Interests
Amortization
of investment in the Royalty Interests is calculated on a calendar-based units-of-production basis, whereby the Trust’s
cost basis is divided by the proved reserves attributable to the Royalty Interests to derive an amortization rate per reserve
unit. The rate used to record amortization is dependent upon the estimate of total proved reserves attributable to the Royalty
Interests, which incorporates various assumptions and future projections. If the estimates of total proved reserves decline significantly,
the rate at which the Trust records amortization would increase, reducing trust corpus. Such a decline in reserves may result
from lower commodity prices, which may make it uneconomic for Avalon to produce from the Underlying Properties, or from other
factors, including changes to estimates for other reasons. Changes in reserve quantity estimates are dependent on future economic
and operational conditions and cannot be predicted.
Impairment
of Investment in Royalty Interests
The
investment in the Royalty Interests is assessed to determine whether net capitalized cost is impaired whenever events or changes
in circumstances indicate that the carrying amount may not be recoverable. Potential impairments of the investment in the Royalty
Interests are determined by comparing the net capitalized costs of investment in the Royalty Interests to undiscounted future
net revenues attributable to the Trust’s interest in the proved oil, natural gas and NGL reserves attributable to the Royalty
Interests. The Trust provides a write-down to the extent that the net capitalized costs exceed the fair value of the Royalty Interests,
which is determined using future cash flows of the oil, natural gas and NGL reserves attributable to the Royalty Interests, discounted
at a rate based upon the weighted average cost of capital of publicly traded royalty trusts. Different pricing assumptions or
discount rates could result in a different calculated impairment. No impairments were recorded in 2019 or 2018. Material write-downs
in subsequent periods may occur if commodity prices decline significantly on a sustained basis.
Refer
to Note 2 to the financial statements included in Item 8 of this report for the Trust’s significant accounting policies.
Off-balance
sheet arrangements
As
of December 31, 2019, the Trust had no off-balance sheet arrangements.
Changes
in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Security
Ownership of Management and Certain Beneficial Owners
The
following table sets forth certain information regarding the beneficial ownership of the Trust units as of March 10, 2020 by each
person who, to the Trustee’s knowledge, beneficially owns more than 5% of the outstanding Trust units.
Name
and Address of Beneficial Owner
|
|
Title
of Class
|
|
Amount
and Nature of
Beneficial Ownership
|
|
|
Percent
of
Class
|
|
Avalon
Energy, LLC
5000 Quorum Drive, Suite 205
Dallas, Texas 75254
|
|
Common
units
|
|
|
13,125,000
|
|
|
|
25%
|
|
According
to Amendment No. 5 to the Schedule 13D filed by Montare Resources I, LLC on October 2, 2020, Montare Resources I, LLC has sole
voting power and sole dispositive power over 2,695,363 Trust Common Units, representing 5.1% of the outstanding Trust Common Units.
The address of Montare Resources I, LLC is 400 East Las Colinas Blvd., Suite 680, Irving Texas 75039.
Directors
and Executive Officers
The
Trust has no directors or executive officers. The Trustee is a corporate trustee that may be removed by the affirmative vote of
the holders of not less than a majority of the outstanding Trust units, excluding Trust units held by Avalon, at a special meeting
of the holders of Trust Common Units at which a quorum is present.
The
Trust does not have a board of directors. Further, the Trust relies on an exemption from the director independence requirements
of the New York Stock Exchange set forth in Rule 10A-3(c)(7) under the Exchange Act, applicable to listed issuers organized as
trusts that do not have a board of directors.
Executive
Compensation
During
the years ended December 31, 2019 and 2018, the Trustee and the Delaware Trustee received administrative fees from the Trust pursuant
to the terms of the Trust Agreement. See the disclosures in the section entitled “Information about the Trust—Trustee’s
Discussion and Analysis of Financial Information and Results of Operations—Liquidity and Capital Resources – Contractual
Obligations” for the amounts of such compensation. The Trust does not have any executive officers, directors or employees.
Because the Trust does not have a board of directors, it does not have a compensation committee.
Certain
Relationships and Related Party Transactions
Avalon
(as the assignee of SandRidge) and the Trust are parties to the Administrative Services Agreement and the registration rights
agreement. The Trust makes certain payments to Avalon, the Trustee and the Delaware Trustee, and previously made certain payments
to SandRidge, pursuant to the Trust Agreement and the Administrative Services Agreement. Descriptions of these agreements are
included in “Information about the Trust—Description of Business” and “Information about the Trust--Trustee’s
Discussion and Analysis of Financial Condition and Results of Operations”; and in Note 6 to the Trust’s audited financial
statements included in this offer to exchange. In addition, the description of the Offering included in “Information about
the Trust—Description of Business” of this offer to exchange is hereby incorporated by reference.
BACKGROUND
OF THE OFFER
PEDEVCO’s
management regularly reviews transaction alternatives across the oil and gas industry.
During
May 2017, J. Douglas Schick, current President of PEDEVCO, while he was the Chief Financial Officer and VP of Business Development
for American Resources, Inc., was approached by the principals of Avalon Energy to partner with them in a transaction where Avalon
was to buy the Underlying Properties from SandRidge. Mr. Schick declined to partner with or join Avalon at that time. Mr. Schick
continued to analyze the Trust as a potential acquisition target, and monitored the Trust periodically through March 2019, including
being approached by several brokers on behalf of Avalon throughout that period.
On
March 3, 2020, Mr. Schick was contacted by Frank Saldana of Petro-Val A&D Advisors asking whether PEDEVCO would have an interest
in either acquiring Avalon or providing financing for Avalon. Initially Mr. Schick indicated PEDEVCO would have an interest taking
over operations on the Underlying Properties for Washington Federal, National Association (“WaFed”) in the event Avalon
were to default on its loan from WaFed (the “WaFed Loan”).
On
March 27, 2020, Mr. Schick discussed Avalon at PEDEVCO’s weekly executive committee meeting, and noted PEDEVCO’s desire
to take a closer look at the Underlying Properties. PEDEVCO’s executive committee consists of members of PEDEVCO senior
management. At this time, PEDEVCO was only initially interested in becoming the contract operator of the Underlying Properties
on behalf of WaFed in the event of a foreclosure on Avalon, and not acquiring Trust Common Units. Updates regarding Avalon were
provided at nearly every weekly executive committee meeting thereafter.
On
April 8, 2020, Mr. Schick had a telephone conference call with a member of PEDEVCO’s outside oil and gas consultant, representatives
of Petro-Val Advisors, and William S. Montgomery Jr. and Danny Jester of Avalon’s Board of Managers to discuss a potential
acquisition of Avalon by PEDEVCO, or alternatively, for PEDEVCO to become the contract operator of the Underlying Properties.
On
April 22, 2020, Mr. Schick notified the PEDEVCO Board of management’s interest in potentially working with WaFed to take
over operations of the Underlying Properties. No definitive plans were determined at this time.
On
April 23, 2020, the Trust issued a press release announcing that the quarterly distribution for the three-month period ended March
31, 2020 of approximately $3.73 million, or $0.071 per unit, would not be paid in May 2020 because Avalon was unable to pay on
a timely basis the approximately $4.65 million it owed the Trust.
On
May 1, 2020, Mr. Schick had a phone conversation with Rusty Stehr, Senior Vice President at WaFed, and expressed interest by PEDEVCO
to take over operations and invest capital to increase production on the Underlying Properties on behalf of WaFed. Mr. Schick
had been previously notified by Petro-Val Advisors and the two Avalon Board members that Avalon was heavily distressed and WaFed
may be interested in a solution. Mr. Stehr notified Mr. Schick that WaFed was not looking to foreclose on the WaFed Loan at that
time.
On
May 1, 2020, after further analyzing the Trust, the Underlying Properties and Conveyances, as well as the Trust’s filings
with the SEC, Mr. Schick discovered that the Trust Agreement allowed for mergers or consolidations of the Trust with other entities.
At this point, Mr. Schick decided the best course of action for PEDEVCO and the holders of Trust Common Units would be to approach
the Trustee about discussing a potential acquisition of the Trust by PEDEVCO.
On
May 4, 2020, Mr. Schick initiated efforts to contact the Trustee, Ms. Sarah Newell, through email and telephone. Mr. Schick was
unable to make contact with Ms. Newell until July 15, 2020, as discussed below.
On
May 7, 2020, Mr. Schick provided another update to the PEDEVCO Board regarding management’s interests in potentially pursuing
a transaction to acquire the Underlying Properties through the issuance of PEDEVCO Common Stock, among other potential transactions
and business combinations. Mr. Schick also informed the PEDEVCO Board of his efforts to contact Ms. Newell.
On
May 12, 2020, Mr. Schick spoke with William S. Montgomery Jr. of Avalon. Prior to the conversation, PEDEVCO and Mr. Montgomery
executed a one-way non-disclosure agreement, which protected information that PEDEVCO may disclose to Avalon. During this call,
Mr. Schick and Mr. Montgomery discussed a potential business combination with Avalon.
On
May 15, 2020, Mr. Schick delivered a proposal to Avalon regarding an acquisition of Avalon by PEDEVCO, and PEDEVCO’s interest
in pursuing an acquisition of the Trust Common Units. The proposal contemplated that Avalon sell all of its interests and assets
(including Trust Common Units) to PEDEVCO in exchange for PEDEVCO assuming Avalon’s liabilities and PEDEVCO’s issuance
of approximately $6.25 million of PEDEVCO Common Stock, after which PEDEVCO would acquire the remaining Trust Common Units in
a transaction with the Trust. On or about May 19, 2020, Carter Montgomery of Avalon notified Mr. Schick that Avalon had decided
to go in a different direction.
On
May 18, 2020, Messrs. Schick, Clark Moore, the Executive Vice President and General Counsel of PEDEVCO, and Jody Crook, of PEDEVCO,
and Messrs. Carter Montgomery, Steven Pugh, Danny Jester, William S. Montgomery, Jr., and Ms. Bonnie Seggelink from Avalon had
a teleconference regarding potential business combination transactions involving Avalon, including, but not limited to, PEDEVCO
acquiring Avalon or PEDEVCO acquiring certain assets from Avalon which underlie the Trust’s assets.
On
May 19, 2020, PEDEVCO requested that PEDEVCO and Avalon enter into a non-disclosure agreement. The parties never entered into
a non-disclosure agreement.
On
June 23, 2020, Mr. Schick had a conference call with members of the Avalon board to discuss details of a potential offer for Avalon
and sale of a portion of the Underlying Trust assets.
On
June 25, 2020, PEDEVCO sent a non-binding indication of interest to Avalon expressing an interest in acquiring approximately $5.0
million of the Underlying Properties. PEDEVCO believes this communication was not received by Avalon until July 3, 2020. PEDEVCO
was notified by Steven Pugh, Chief Executive Officer of Avalon, after several days that Avalon was not interested in pursuing
the transaction.
On
July 15, 2020, Ms. Newell responded to Mr. Schick’s prior attempts to connect and notified Mr. Schick that if PEDEVCO was
interested in acquiring Trust Common Units, that PEDEVCO should speak to Avalon.
On
August 13, 2020, Mr. Schick notified the PEDEVCO executive committee and the PEDEVCO Board of an interest in issuing an open letter
to the Trust, Avalon and holders of Trust Common Units expressing PEDEVCO’s interest in engaging in discussions regarding
a potential business combination involving PEDEVCO, the Trust and Avalon. Without taking formal action, the PEDEVCO Board unanimously
expressed support and approval to move forward with the open letter.
On
August 25, 2020, PEDEVCO sent a letter to Avalon regarding an indication of interest to purchase Trust Common Units held by Avalon,
as well as any and all working interests, overriding royalty interests, wellbore and leasehold interests held and operated by
Avalon in the Underlying Properties. The letter expressed an intent contingent upon the negotiation, execution and delivery of
a definitive agreement. The letter contemplated a transaction in which PEDEVCO would acquire the Trust Common Units held by Avalon
at a price of $0.38 per Trust Common Unit (15% premium to the then price of $0.33 per Trust Common Unit), payable in PEDEVCO Common
Stock, and $2,000,000 in cash and assumption of the WaFed Loan for the other assets. The letter requested access to Avalon and
the Trust’s books and records for the purposes of diligence.
On
August 25, 2020, PEDEVCO also sent a letter to the Trustee, expressing an interest in pursuing discussions regarding the acquisition
of all of the publicly held Trust Common Units. The letter expressed an intent contingent upon the negotiation, execution and
delivery of a definitive agreement. The letter contemplated a transaction in which PEDEVCO would acquire the publicly held Trust
Common Units at a price of $0.38 per Common Unit (15% premium to the current price of $0.33 per Trust Common Unit), payable in
PEDEVCO Common Stock, through an exchange offer. The letter noted that the transaction would be subject to the successful tender
of all the Trust Common Units held by the public, or such less number as determined by PEDEVCO in its sole discretion. The letter
requested access to the list of holders of Trust Common Units for purposes of the offer, as well as to the Trust’s books
and records for diligence.
On
August 26, 2020, at approximately 12:35, P.M., Eastern Time, the Trust responded to PEDEVCO, and indicated that the Trust Agreement
does not authorize the Trustee to enter into an arrangement with an offeror or with respect to a negotiated exchange offer or
tender offer for the outstanding Trust Common Units, and accordingly, the Trustee declined to enter into discussions with PEDEVCO
regarding the transactions contemplated by PEDEVCO’s indication of interest dated August 25, 2020.
On
August 26, 2020, at approximately 1:20 P.M., Eastern Time, Mr. Schick responded to the Trust, expressing a continued desire to
engage with the Trust and the Trustee.
On
August 26, 2020, at approximately 4:05 P.M., Eastern Time, PEDEVCO issued a public open letter (the “Open Letter”)
to the Trustee, holders of Trust Common Units, and Avalon regarding PEDEVCO’s previously delivered letters on August 25,
2020. The Open Letter indicated PEDEVCO’s interest in, and requested meaningful negotiations with respect to, a potential
acquisition of all the Trust Common Units of the Trust, its underlying assets, and operatorship thereof. The Open Letter described
PEDEVCO’s beliefs that the Trust is likely to be delisted from the NYSE and be dissolved with its assets liquidated in less
than a year, and that the best way for holders of Trust Common Units to have a chance of salvaging, retaining and growing their
investment is through the Trustee and Avalon engaging in meaningful discussions with PEDEVCO in contemplation of the potential
acquisition of the Trust, its underlying assets, and their operatorship through the issuance of PEDEVCO Common Stock for Trust
Common Units.
On
August 27, 2020, at approximately 9:00 A.M. Eastern Time, Avalon and Montare jointly filed Amendment No. 1 to Schedule 13D (the
“First Amendment”), disclosing that on August 26, 2020, Montare, Avalon and certain of their respective affiliates
(including Avalon Energy Exploration and Production (“Avalon E&P”)) had entered into a Contribution and Support
Agreement (the “Contribution and Support Agreement”), pursuant to which Avalon, among other things, (i) agreed to,
subject to certain conditions, contribute all of the Trust Common Units beneficially owned by Avalon and all other assets, owned
by Avalon (including the working interests underlying the overriding royalty interests held by the Trust) to Montare in exchange
for interests in Montare or an affiliate thereof (the “Contribution Transaction”), (ii) granted exclusivity and an
irrevocable proxy to Montare to vote all Trust Common Units beneficially owned by Avalon, (iii) agreed to support Montare’s
acquisition of all of the issued and outstanding Trust Common Units not owned by Avalon pursuant to a merger of Montare (or a
newly organized subsidiary of Montare) with and into the Trust, with Montare (or its subsidiary, as applicable) surviving the
merger (or another alternative transaction with respect to the Trust acceptable to Montare) (the “Montare Transaction”),
and any related actions taken by Montare with respect to the Montare Transaction, including by exercising any of Avalon’s
rights under the Trust agreement, and (iv) to not take any action that, directly or indirectly, is detrimental to or hinders Montare’s
ability to consummate the Montare Transaction. The consummation of the Contribution Transaction was noted to be subject to certain
conditions, including Montare’s determination in its sole and absolute discretion that all conditions necessary for the
consummation of the Montare Transaction have been satisfied or waived.
The
First Amendment also noted Montare had entered into a Participation Agreement with WaFed, with respect to the WaFed Loan, whereby
Montare purchased an undivided participation interest in the WaFed Loan (the “Participation Agreement”). Pursuant
to the Participation Agreement, Montare stated it has the right to purchase the WaFed Loan in the event Avalon does not meet the
conditions of the WaFed Loan.
On
August 27, 2020 at approximately 9:30 A.M., Eastern Time, Montare issued a press release describing the Contribution and Support
Agreement and related transactions described in its First Amendment. The press release is filed as Exhibit 99.2 to the First Amendment.
On
August 27, 2020, beginning at approximately 11:00 A.M., Eastern Time, PEDEVCO held its annual shareholders meeting.
On
August 27, 2020, at approximately 3:20 P.M., Eastern Time, PEDEVCO issued a press release providing its first status update regarding
the Open Letter. In the press release, PEDEVCO noted that the Trustee notified PEDEVCO that its authority as Trustee is limited
to taking actions in furtherance of achieving the purposes of the Trust as set forth in the Trust Agreement, and, as a result,
the Trustee is not authorized to enter into an arrangement with an offeror with respect to a negotiated exchange offer or tender
offer for the outstanding Trust Common Units, or to express support for any such offer, and, accordingly again declined to enter
into discussions with PEDEVCO regarding the proposed transactions contemplated by PEDEVCO’s indication of interest, but
that PEDEVCO continued to request the Trustee engage in discussions. The press release further noted that PEDEVCO had subsequently
become aware of the Montare Transaction, including Avalon’s support of Montare’s acquisition of the Trust (either
by merger, acquisition of assets, acquisition of the remaining Trust Common Units not owned by Avalon or otherwise).
On
August 27, 2020, at approximately 4:00 P.M., Eastern Time, the Trust issued a press release confirming its receipt of the Open
Letter from PEDEVCO. In the press release, the Trust indicated again that the Trust Agreement does not authorize the Trustee to
enter into an arrangement with an offeror or with respect to a negotiated exchange offer or tender offer for the outstanding Trust
Common Units, and accordingly, the Trustee declined to enter into discussions with PEDEVCO regarding the transactions contemplated
by PEDEVCO’s indication of interest dated August 25, 2020. The Trustee recommended that holders of Trust Common Units defer
making any investment decision with respect to their Trust Common Units until such time as a tender offer or exchange offer is
filed with the SEC. The Trustee also recommended that holders of Trust Common Units, before making any investment decision with
respect to their Trust Common Units, consider the First Amendment that Avalon and Montare jointly filed with the SEC on August
27, 2020.
On
August 27, 2020, at approximately 7:00 P.M., Eastern Time, Mr. Pugh of Avalon delivered a letter to PEDEVCO on behalf of Avalon
and Avalon E&P. Copied on the correspondence was Montare. The letter noted that at jointly called meetings of the Board of
Managers of Avalon and Avalon E&P held on May 18, 2020, July 9, 2020 and July 20, 2020, that the prior indications of interests
previously sent by PEDEVCO were rejected. The letter also indicated that on August 26, 2020, the Board of Managers of Avalon E&P
met to discuss PEDEVCO’s August 25, 2020 letter, and that they determined to reject it because it is less favorable to the
members of Avalon than other proposals received by Avalon E&P and Avalon. The letter noted the Montare Transaction, and that
it would expect that PEDEVCO will not have any further communication with any member of Avalon E&P or Avalon or any prior
or current managers of those entities, and that it would be deemed interference with the ongoing business of Avalon. Finally,
the letter claimed that the parties had shared material, non-public information in prior discussions and requested return of that
information or a certificate of destruction, and that it could not be used for any purpose other than an evaluation of a possible
purchase of Avalon assets. The letter was filed as an exhibit 99.3 to Amendment No. 2 to Schedule 13D filed jointly by Montare
and Avalon with the SEC on August 28, 2020.
On
August 28, 2020, at approximately 6:00 P.M., Eastern Time, PEDEVCO issued a press release providing a second status update regarding
its Open Letter. The press release noted that on the evening of August 27, 2020, Avalon had notified PEDEVCO that each of the
Board of Managers of Avalon and Avalon E&P had evaluated PEDEVCO’s proposal and had rejected it. The press release further
noted that Avalon had indicated it will not entertain further communications from PEDEVCO. PEDEVCO noted that it
continues
to evaluate options for a potential acquisition of all of the Trust Common Units, the working interests underlying the Royalty
Interests and operatorship thereof.
On
August 31, 2020, Mr. Schick, on behalf of PEDEVCO replied to the letter delivered by Avalon and Avalon E&P, noting that, as
requested in the letter, it would communicate with Montare and its officers and principals going forward. PEDEVCO further noted
that it had not entered into a confidentiality agreement with Avalon, Avalon E&P or any of its affiliates, and if Avalon believed
that such an agreement existed, to produce a copy.
On
September 4, 2020, Haynes and Boone, LLP, counsel for Montare, sent a letter to PEDEVCO. The letter demanded that PEDEVCO cease
and desist communications with Montare, Avalon and WaFed. The letter referenced the Contribution Agreement and other contemplated
transactions between Montare and Avalon, and outlined various of the communications described above.
On
September 2, 2020, Montare and Avalon sent a letter to the Trust updating the Trustee with respect to its current view of future
quarterly distributions. As further outlined in the letter, Avalon advised the Trust that it did not believe that the termination
of the Trust and the related sales process set forth in the Trust Agreement would occur anytime soon given its current estimates
of future distributions. Avalon instead urged the Trustee to discuss a possible transaction with Montare believing that Montare
is best positioned to deliver a transaction that provides the highest value to holders of Trust Common Units. The letter noted
Montare and Avalon’s desire to negotiate a transaction with the Trust that they believed would be in the best interest of
all holders of Trust Common Units, that Montare had the necessary capital to effect a cash transaction for holders of Trust Common
Units that is substantially greater than the total amount of distributions that holders of Trust Common Units can be expected
to receive prior to the time the Trust would dissolve, and that Montare would be willing to offer a premium over the average market
value of the Trust Common Units. The letter is filed as exhibit 99.4 to Amendment No. 3 to the Schedule 13D filed jointly by Avalon
and Montare with the SEC on September 8, 2020.
On
September 4, 2020, the Trustee responded to the letter sent by Montare and Avalon on September 2, 2020. The Trustee noted that
its belief of a liquidation of the Trust in approximately February 2021 was due to statements provided by Avalon to the Trust
for inclusion in the Trust’s quarterly report on Form 10-Q for the quarter ended June 30, 2020, and noted its surprise for
projections showing cumulative distributions exceeding $5.0 million during each four-quarter period until March 2024. The letter
responded to various other points in Avalon and Montare’s September 2, 2020 letter, and noted that the Trustee is willing
to listen to a proposal by Avalon and Montare. The Trustee’s letter is furnished as exhibit 99.1 to the Trust’s current
report on Form 8-K filed on September 8, 2020.
On
September 5, 2020 and September 8, 2020, representatives of PEDEVCO attempted to contact counsel for WaFed to determine if WaFed
believed it was restricted from communicating with PEDEVCO with no response.
In
light of the Trustee’s indicated inability to negotiate with PEDEVCO, and because PEDEVCO believes that holders of Trust
Common Units should be entitled to make their own decision with respect to an exchange offer and whether a transaction with PEDEVCO
is more favorable to remaining a holder of Trust Common Units, PEDEVCO is making the offer directly to holders of Trust Common
Units upon the terms and subject to the conditions set forth in this offer to exchange as an alternative to a negotiated transaction
with the Trust.
REASONS
FOR THE OFFER
PEDEVCO
believes that the combination of PEDEVCO and the Trust represents a financially and strategically compelling, value-creating opportunity
for both PEDEVCO stockholders and holders of Trust Common Units. PEDEVCO believes that the value that could be created by combining
PEDEVCO and the Trust significantly outweighs—and is incremental to—anything holders of Trust Common Units may realize
by remaining a holder of Trust Common Units. PEDEVCO believes the offer is the best available option for holders of Trust Common
Units to maximize the value of their investment while retaining potential upside.
PEDEVCO
believes the offer is compelling for the following reasons:
|
●
|
Attractive
Exchange Ratio: Based on the closing price of PEDEVCO Common Stock on the NYSE
American on October 12, 2020 ($1.34),
the equivalent market value of the fractional share of PEDEVCO Common Stock to be issued
in the exchange offer would be $0.536.
The closing price of a Trust Common Unit on the OTC Pink Sheets on October 12, 2020 was $0.44.
|
|
●
|
Continuation
of Investment: PEDEVCO believes the continued viability of the Trust as an investment
vehicle appears to be in question given the structural disincentives to further development
of the Underlying Properties, and because the Trust has a finite life that may be coming
to an end. PEDEVCO believes that by joining with PEDEVCO, holders of Trust Common Units
have the opportunity to continue their existing investment, as well as obtain an interest
in PEDEVCO’s current assets, with a stable business partner who will endeavor to
monitor and enhance the value of the Royalty Interests rather than be a passive investment
vehicle like the Trust.
|
|
●
|
Publicly
Traded Stock of a Reporting Company Listed on NYSE American: Upon completion
of the offer and the second-step merger, holders of Trust Common Units will receive free
trading shares of PEDEVCO Common Stock. PEDEVCO Common Stock is listed on the NYSE American,
and may provide a more liquid and developed trading market than the Trust’s Common
Units, which are currently traded on the OTC Pink Market.
|
|
●
|
Geographic
Focus and Familiarity of Underlying Properties: PEDEVCO’s Permian assets
are geologically analogous to the Underlying Properties for which the Trust’s Royalty
Interests are dependent, as they are both assets producing from the San Andres formation.
PEDEVCO’s operations team has significant experience managing San Andres assets
throughout the Permian Basin and managed the offsetting Furman-Mascho field assets that
underlie the Underlying Properties, and it believes it could work with the operator of
the Underlying Properties using its existing knowledge to enhance production.
|
|
●
|
Financially
Supportive Sponsor: As of October 13, 2020, SK Energy, which is 100% owned and controlled
by Dr. Simon Kukes, PEDEVCO’s Chief Executive Officer and a director, has loaned
PEDEVCO an aggregate of $51.7 million since June 2018 to support PEDEVCO’s operations
and for acquisitions, all of which loans were evidenced by promissory notes on substantially
more favorable terms to PEDEVCO than could be obtained with third parties, and all of
which loans have been converted into PEDEVCO Common Stock on substantially more favorable
terms than could be obtained by third parties. Additionally, pursuant to subscription
agreements, SK Energy purchased an additional aggregate of 15.0 million shares of common
stock from PEDEVCO in private transactions for $28.0 million, also on substantially more
favorable terms to PEDEVCO than could be obtained with third parties. SK Energy has verbally
advised PEDEVCO that it intends to provide PEDEVCO additional funding as needed, although
it is under no obligation to do so. PEDEVCO believes that holders of PEDEVCO Common Stock
benefit by having a sponsor who has an active role in promoting PEDEVCO and supporting
its operations.
|
|
●
|
No
Significant Hurdles: Assuming satisfaction of the Minimum Tender Condition and
the Trustee Consent Condition, PEDEVCO does not believe there is a substantial risk to
completion of the second-step merger and that it can be completed promptly following
the exchange offer.
|
PEDEVCO
realizes there can be no assurance about future results, including results expected as described in the reasons listed above,
such as assumptions regarding potential synergies or other benefits to be realized following the offer. PEDEVCO’s reasons
for the offer and all other information in this section are forward-looking in nature and, therefore, should be read in light
of the factors discussed in the sections of this offer to exchange titled “Risk Factors” and “Forward-Looking
Statements.”
THE
OFFER
Overview
PEDEVCO
is offering to exchange each issued and outstanding Trust Common Unit for the Consideration set forth on the cover page of this
offer to exchange subject to the procedures described in this offer to exchange and in the related letter of transmittal. PEDEVCO
will not allot or issue fractional PEDEVCO Common Stock to holders of Trust Common Units who accept the offer. To the extent that
you would be entitled to a fractional share of PEDEVCO Common Stock, those fractional entitlements will be aggregated and, if
a fractional share results from such aggregation, you will be entitled to receive, in lieu of such fractional share, an amount
in cash determined by multiplying the fractional share by a price equal to the average of the closing prices of PEDEVCO Common
Stock on the NYSE American on each of the five NYSE American trading days ending on the 10th business day prior to the date of
expiration of the offer.
The
offer will expire at 5:00 p.m., New York City time, on November 30, 2020, unless PEDEVCO extends the period of time for which
the offer is open, in which case the expiration time will be the latest time and date on which the offer, as so extended, expires.
The
offer is subject to a number of conditions, which are described in the section of this offer to exchange titled “The Offer—Conditions
to the Offer.” PEDEVCO expressly reserves the right, subject to the applicable rules and regulations of the SEC, to waive
any condition of the offer described herein in its discretion, except for the Registration Statement Condition, PEDEVCO Shareholder
Approval Condition, Government Approval Condition and Stock Exchange Listing Condition, each of which cannot be waived. PEDEVCO
expressly reserves the right to make any changes to the terms and conditions of the offer (subject to any obligation to extend
the offer pursuant to the applicable rules and regulations of the SEC).
The
purpose of the offer is for PEDEVCO to acquire all of the outstanding Trust Common Units in order to combine the businesses of
PEDEVCO and the Trust. PEDEVCO intends, promptly after consummation of the offer and satisfaction of the conditions in the Trust
Agreement, including the Trustee’s consent, which is a condition to this offer, to cause the Trust to merge with Purchaser,
after which the Trust would be a direct or indirect, wholly owned subsidiary of PEDEVCO.
The
Trustee has indicated that it is unable to negotiate with PEDEVCO. In light of the Trustee’s indicated inability to negotiate
with PEDEVCO, and because PEDEVCO believes that holders of Trust Common Units should be entitled to make their own decision with
respect to an exchange offer and whether a transaction with PEDEVCO is more favorable to remaining a holder of Trust Common Units,
PEDEVCO is making the offer directly to holders of Trust Common Units upon the terms and subject to the conditions set forth in
this offer to exchange as an alternative to a negotiated transaction with the Trust.
In
the event PEDEVCO accepts Trust Common Units for exchange in the offer, PEDEVCO intends to acquire the Trust pursuant to the second-step
merger. The consideration payable to holders of Trust Common Units in the second-step merger is described in more detail in this
offer to exchange. After the second-step merger, former remaining holders of Trust Common Units will no longer have any ownership
interest in the Trust and will be shareholders of PEDEVCO.
Subject
to applicable law, PEDEVCO reserves the right to amend the offer in any respect or terminate it, including in connection with
entering into a merger agreement with the Trust. Holders of Trust Common Units should be aware that no merger agreement has been
entered into between PEDEVCO and the Trust.
PEDEVCO
estimates that, upon consummation of the offer and the second-step merger, former holders of Trust Common Units will own, in the
aggregate, approximately 22.5% of the issued and outstanding PEDEVCO Common Stock (approximately 22.1% on a fully diluted basis)
as a result of having been holders of Trust Common Units. For a more detailed discussion of the assumptions on which this estimate
is based, see the section of this offer titled “The Offer—Ownership of PEDEVCO After the Offer.”
Consideration
Payable in the Second-Step Merger
In
the second-step merger, each remaining Trust Common Unit (other than Trust Common Units held by PEDEVCO and its subsidiaries)
will be cancelled and converted into the right to receive the Consideration. See the section of this offer to exchange titled
“The Offer—Purpose of the Offer; Second-Step Merger.”
Expiration
of the Offer
The
offer is scheduled to expire at 5:00 p.m., New York City time, on November 30, 2020, unless extended by PEDEVCO. For more information,
you should read the discussion under the section of this offer to exchange titled “The Offer—Extension, Termination
and Amendment.”
Extension,
Termination and Amendment
Subject
to the applicable rules and regulations of the SEC and the terms and conditions of the offer, PEDEVCO expressly reserves the right
(but will not be obligated): (1) to extend, for any reason, the period of time during which the offer is open; (2) to delay acceptance
for exchange of, or the exchange of, Trust Common Units in order to comply in whole or in part with applicable law (any such delay
shall be effected in compliance with Rule 14e-1(c) under the Exchange Act, which requires PEDEVCO to pay the consideration offered
or to return Trust Common Units deposited by or on behalf of holders of Trust Common Units promptly after the termination or withdrawal
of the offer); (3) to amend or terminate the offer for any reason without accepting for exchange or exchanging any Trust Common
Units, including under circumstances where any of the conditions referred to in the section of this offer to exchange titled “The
Offer—Conditions to the Offer” have not been satisfied or if PEDEVCO or any of its subsidiaries enters into a definitive
agreement or announces an agreement in principle with the Trust providing for a merger or other business combination or transaction
with or involving the Trust, or the purchase or exchange of securities or assets of the Trust, or PEDEVCO and the Trust reach
any other agreement or understanding, in either case, pursuant to which it is agreed or provided that the offer will be terminated;
and (4) to amend the offer or to waive any conditions to the offer at any time, except for the Registration Statement Condition,
PEDEVCO Shareholder Approval Condition, Government Approval Condition and Stock Exchange Listing Condition, in each case by giving
oral or written notice of such delay, termination, waiver or amendment to the exchange agent and by making public announcement
thereof.
Any
such extension, delay, termination, waiver or amendment will be followed as promptly as practicable by a public announcement thereof.
In the case of an extension, the related announcement will be issued no later than 9:00 a.m. New York City time, on the next business
day after the previously scheduled expiration time. Subject to applicable law (including Rules 14d-4(d)(i), 14d-6(c) and 14e-1
under the Exchange Act, which require that any material change in the information published, sent or given holders of Trust Common
Units in connection with the offer be promptly disseminated to stockholders in a manner reasonably designed to inform stockholders
of such changes) and without limiting the manner in which PEDEVCO may choose to make any public announcement, PEDEVCO will have
no obligation to publish, advertise or otherwise communicate any information of this type, other than by issuing a press release
or other announcement.
Rule
14e-1(c) under the Exchange Act requires PEDEVCO to pay the consideration offered or return the Trust Common Units tendered promptly
after the termination or withdrawal of the offer.
If
PEDEVCO increases or decreases the percentage of Trust Common Units being sought or the consideration offered in the offer and
the offer is scheduled to expire at any time before the expiration of ten business days from, and including, the date that notice
of such increase or decrease is first published, sent or given in the manner specified above, the offer will be extended until
the expiration of ten business days from, and including, the date of such notice. If PEDEVCO makes a material change in the terms
of the offer (other than a change in the percentage of securities sought or the consideration offered in the offer) or in the
information concerning the offer, or waives a material condition of the offer, PEDEVCO will extend the offer, if required by applicable
law, for a period sufficient to allow holders of Trust Common Units to consider the amended terms of the offer. PEDEVCO will comply
with Rule 14d-4(d)(2) under the Exchange Act in connection with material changes to the terms of the offer.
This
offer to exchange, the letter of transmittal and all other relevant materials are being mailed to record holders of Trust Common
Units and furnished to brokers, dealers, banks, trust companies and similar persons whose names, or the names of whose nominees,
appear on the Trust’s list of holders of Trust Common Units, or, if applicable, who are listed as participants in a clearing
agency’s security position listing for subsequent transmittal to beneficial owners of Trust Common Units by PEDEVCO.
As
used in this offer to exchange, when we refer to a business day, we mean any day other than a Saturday, Sunday or federal holiday,
and consisting of the time period from 12:01 a.m. through 12:00 midnight, New York City time. If, prior to the expiration time,
PEDEVCO increases the consideration being exchanged for Trust Common Units pursuant to the offer, such increased consideration
will be received by all holders of Trust Common Units whose Trust Common Units are exchanged pursuant to the offer, whether or
not such Trust Common Units were tendered prior to the announcement of the increase of such consideration.
No
subsequent offering period will be available after the offer.
Exchange
of Trust Common Units; Delivery of PEDEVCO Common Stock
Upon
the terms and subject to the conditions of the offer (including, if the offer is extended or amended, the terms and conditions
of any extension or amendment), PEDEVCO will accept for exchange promptly after the expiration time all Trust Common Units validly
tendered and not properly withdrawn (in accordance with the procedure set out in the section of this offer to exchange titled
“The Offer—Withdrawal Rights”) prior to the expiration time. PEDEVCO will exchange all Trust Common Units validly
tendered and not withdrawn promptly following the acceptance of Trust Common Units for exchange pursuant to the offer. PEDEVCO
expressly reserves the right, in its discretion, but subject to the applicable rules and regulations of the SEC, to delay acceptance
for and thereby delay exchange of Trust Common Units in order to comply in whole or in part with applicable laws or if any of
the conditions referred to in the section of this offer to exchange titled “The Offer—Conditions to the Offer”
have not been satisfied or if any event specified in that section has occurred.
In
all cases, PEDEVCO will exchange all Trust Common Units tendered and accepted for exchange pursuant to the offer only after timely
receipt by the exchange agent of: (1) the certificates representing such Trust Common Units (or a timely confirmation of a book-entry
transfer of such Trust Common Units into the exchange agent’s account at DTC, pursuant to the procedures set forth in the
section of this offer to exchange titled “The Offer—Procedure for Tendering,” which we refer to as a book-entry
confirmation), (2) the letter of transmittal (or a manually signed facsimile thereof), properly completed and duly executed, with
any required signature guarantees or, in the case of a book-entry transfer, an Agent’s Message, and (3) any other documents
required under the letter of transmittal. When we refer to an Agent’s Message, we mean a message transmitted by DTC to,
and received by, the exchange agent and forming a part of the book-entry confirmation which states that DTC has received an express
acknowledgment from the participant in DTC tendering the Trust Common Units that are the subject of such book-entry confirmation,
that such participant has received and agrees to be bound by the letter of transmittal and that PEDEVCO may enforce such agreement
against such participant.
For
purposes of the offer, PEDEVCO will be deemed to have accepted for exchange, and thereby exchanged, Trust Common Units validly
tendered and not properly withdrawn, if and when PEDEVCO gives oral or written notice to the exchange agent of PEDEVCO’s
acceptance for exchange of such Trust Common Units pursuant to the offer. Upon the terms and subject to the conditions of the
offer, exchange of Trust Common Units accepted for exchange pursuant to the offer will be made by deposit of the offer consideration
being exchanged therefor with the exchange agent, which will act as agent for tendering holders of Trust Common Units for the
purpose of receiving the offer consideration from PEDEVCO and transmitting such offer consideration to tendering holders of Trust
Common Units whose Trust Common Units have been accepted for exchange. Under no circumstances will PEDEVCO pay interest on
the offer consideration for Trust Common Units, regardless of any extension of the offer or other delay in making such exchange.
If
any tendered Trust Common Units are not accepted for exchange for any reason, or if certificates representing such Trust Common
Units are submitted evidencing more Trust Common Units than are tendered, certificates evidencing unexchanged or untendered Trust
Common Units will be returned, without expense, to the tendering holder of Trust Common Units (or, in the case of Trust Common
Units tendered by book-entry transfer into the exchange agent’s account at DTC pursuant to the procedures set forth below
under the section in this offer to exchange titled “The Offer—Procedure for Tendering,” such Trust Common Units
will be credited to an account maintained at DTC), as promptly as practicable following expiration or termination of the offer.
PEDEVCO
reserves the right to transfer or assign, in whole or in part from time to time to one or more of its affiliates, the right to
exchange all or any portion of the Trust Common Units tendered pursuant to the offer, but any such transfer or assignment will
not relieve PEDEVCO of its obligations under the offer or prejudice the rights of the tendering holders of Trust Common Units
to exchange Trust Common Units validly tendered and accepted for exchange pursuant to the offer.
Cash
in Lieu of Fractional PEDEVCO Common Stock
PEDEVCO
will not allot or issue fractional PEDEVCO Common Stock to holders of Trust Common Units who accept the offer. To the extent that
you would be entitled to fractional shares, those fractional entitlements will be aggregated and, if a fractional share of PEDEVCO
Common Stock results from such aggregation, you will be entitled to receive, in lieu of such fractional share, an amount in cash
determined by multiplying the fractional share by a price equal to the average of the closing prices of PEDEVCO Common Stock on
the NYSE on each of the five NYSE American trading days ending on the 10th business day prior to the date of expiration of the
offer.
Procedure
for Tendering
In
order for holders of Trust Common Units to validly tender Trust Common Units pursuant to the offer, the exchange agent must receive
prior to the expiration time the letter of transmittal (or a manually signed facsimile thereof), properly completed and duly executed,
together with any required signature guarantees or, in the case of a book-entry transfer, an Agent’s Message, and any other
documents required by the letter of transmittal, at one of its addresses set forth on the back cover of this offer to exchange
and either (1) the certificates representing tendered Trust Common Units must be received by the exchange agent at such address
or such Trust Common Units must be tendered pursuant to the procedure for book-entry transfer described below and a book-entry
confirmation must be received by the exchange agent (including an Agent’s Message), in each case prior to the expiration
time, or (2) the tendering holder of Trust Common Units must comply with the guaranteed delivery procedures described below.
The
method of delivery of certificates and all other required documents, including delivery through DTC, is at the option and risk
of the tendering holder of Trust Common Units, and the delivery will be deemed made only when actually received by the exchange
agent. If delivery is by mail, registered mail with return receipt requested, properly insured, is recommended. In all cases,
sufficient time should be allowed to ensure timely delivery.
Book-Entry
Transfer. The exchange agent will establish accounts with respect to the Trust Common Units at DTC for purposes of the
offer. Any financial institution that is a participant in the system of DTC may make a book-entry delivery of Trust Common Units
by causing DTC to transfer such Trust Common Units into the exchange agent’s account at DTC in accordance with DTC’s
procedures for such transfer. However, although delivery of Trust Common Units may be effected through book-entry transfer at
DTC, an Agent’s Message and any other required documents must, in any case, be received by the exchange agent at one of
its addresses set forth on the back cover of this offer to exchange prior to the expiration time. Delivery of documents to
DTC does not constitute delivery to the exchange agent.
Signature
Guarantees. No signature guarantee is required on a letter of transmittal if: (1) the letter of transmittal is signed
by a registered holder of Trust Common Units who has not completed either the box titled “Special Issuance or Payment Instructions”
or the box titled “Special Delivery Instructions” on the letter of transmittal or (2) Trust Common Units are tendered
for the account of a financial institution that is a member of the Security Transfer Agent Medallion Signature Program, or by
any other “Eligible Guarantor Institution,” as such term is defined in Rule 17Ad-15 under the Exchange Act (each of
which we refer to as an Eligible Institution). In all other cases, all signatures on letters of transmittal must be guaranteed
by an Eligible Institution. If a certificate representing Trust Common Units is registered in the name of a person other than
the signer of the letter of transmittal, then such certificate must be endorsed or accompanied by appropriate stock powers, in
either case signed exactly as the name(s) of the registered holder(s) appears on the certificate, with the signature(s) on such
certificate or stock powers guaranteed by an Eligible Institution. Please refer to the instructions in the letter of transmittal.
Guaranteed
Delivery. If a holder of Trust Common Units desires to tender Trust Common Units pursuant to the offer and such holder’s
certificates representing such Trust Common Units are not immediately available, such holder cannot deliver such certificates
and all other required documents to the exchange agent prior to the expiration time, or such holder cannot complete the procedure
for delivery by book-entry transfer on a timely basis, such Trust Common Units may nevertheless be tendered, provided that all
the following conditions are satisfied:
|
1.
|
the
tender is made by or through an Eligible Institution;
|
|
2.
|
a
properly completed and duly executed notice of guaranteed delivery, substantially in
the form made available by PEDEVCO, is received by the exchange agent prior to the expiration
time as provided below; and
|
|
3.
|
the
Trust Common Unit certificates (or book-entry confirmation) representing all tendered
Trust Common Units, in proper form for transfer, in each case together with the letter
of transmittal (or a manually signed facsimile thereof), properly completed and duly
executed, with any required signature guarantees (or, in the case of a book-entry transfer,
an Agent’s Message in lieu of the letter of transmittal), and any other documents
required by the letter of transmittal, are received by the exchange agent within three
NYSE trading days after the date of execution of such notice of guaranteed delivery.
|
The
notice of guaranteed delivery may be delivered by hand or mail or by facsimile transmission to the exchange agent and must include
a guarantee by an Eligible Institution in the form set forth in such notice of guaranteed delivery.
In
all cases, exchange of Trust Common Units tendered and accepted for exchange pursuant to the offer will be made only after timely
receipt by the exchange agent of the certificates representing such Trust Common Units, or a book-entry confirmation of the delivery
of such Trust Common Units, and the letter of transmittal (or a manually signed facsimile thereof), properly completed and duly
executed, with any required signature guarantees or, in the case of a book-entry transfer, an Agent’s Message, and any other
documents required by the letter of transmittal.
Determination
of Validity. PEDEVCO’s interpretation of the terms and conditions of the offer (including the letter of transmittal
and the instructions thereto) will be final and binding to the fullest extent permitted by law. All questions as to the form of
documents and the validity, form, eligibility (including time of receipt) and acceptance for exchange of any Trust Common Units
will be determined by PEDEVCO in its discretion, which determination shall be final and binding to the fullest extent permitted
by law. PEDEVCO reserves the absolute right to reject any and all tenders determined by it not to be in proper form or the
acceptance of or exchange for which may, in the opinion of its counsel, be unlawful. PEDEVCO also reserves the absolute right
to waive any condition of the offer to the extent permitted by applicable law except for the Registration Statement Condition,
PEDEVCO Shareholder Approval Condition, Government Approval Condition and Stock Exchange Listing Condition or any defect or irregularity
in the tender of any Trust Common Units of any particular holder, whether or not similar defects or irregularities are waived
in the case of other holders. No tender of Trust Common Units will be deemed to have been validly made until all defects and irregularities
relating thereto have been cured or waived. None of PEDEVCO or any of its respective affiliates or assigns, the exchange agent,
the information agents or any other person will be under any duty to give notification of any defects or irregularities in tenders
or incur any liability for failure to give any such notification.
A
tender of Trust Common Units pursuant to any of the procedures described above will constitute the tendering holder’s acceptance
of the terms and conditions of the offer, as well as the tendering holder’s representation and warranty to PEDEVCO that
(1) such holder owns the tendered Trust Common Units, (2) the tender complies with Rule 14e-4 under the Exchange Act, (3) such
holder has the full power and authority to tender, sell, assign and transfer the tendered Trust Common Units and (4) when the
same are accepted for exchange by PEDEVCO, PEDEVCO will acquire good and unencumbered title thereto, free and clear of all liens,
restrictions, charges and encumbrances and not subject to any adverse claims.
The
acceptance for exchange by PEDEVCO of Trust Common Units pursuant to any of the procedures described above will constitute a binding
agreement between the tendering holder of Trust Common Units and PEDEVCO upon the terms and subject to the conditions of the offer.
Appointment.
By executing a letter of transmittal, or through delivery of an Agent’s Message, as set forth above, a tendering holder
of Trust Common Units irrevocably appoints designees of PEDEVCO as such holder’s agents, attorneys-in-fact and proxies,
each with full power of substitution, in the manner set forth in the letter of transmittal, to the full extent of such holder’s
rights with respect to Trust Common Units tendered by such holder and accepted for exchange by PEDEVCO. All such powers of attorney
and proxies will be considered irrevocable and coupled with an interest in the tendered Trust Common Units. Such appointment will
be effective when, and only to the extent that, PEDEVCO accepts such Trust Common Units for exchange. Upon appointment, all prior
powers of attorney and proxies given by such holder with respect to the Trust Common Units will be revoked, without further action,
and no subsequent powers of attorney or proxies may be given nor any subsequent written consent executed by such holder (and,
if given or executed, will not be deemed to be effective) with respect thereto. The designees of PEDEVCO will, with respect to
the Trust Common Units for which the appointment is effective, be empowered to exercise all voting, consent and other rights of
such holder as they in their discretion may deem proper at any meeting of holders of Trust Common Units or any adjournment or
postponement thereof, by written consent in lieu of any such meeting or otherwise. PEDEVCO reserves the right to require that,
in order for Trust Common Units to be deemed validly tendered, immediately upon PEDEVCO’s acceptance of Trust Common Units
for exchange, PEDEVCO must be able to exercise full voting, consent and other rights with respect to such Trust Common Units.
The
foregoing proxies are effective only upon acceptance for exchange of Trust Common Units tendered pursuant to the offer. The offer
does not constitute a solicitation of proxies (absent an exchange of Trust Common Units) for any meeting holders of Trust Common
Units, which will be made only pursuant to separate proxy materials complying with the requirements of the rules and regulations
of the SEC.
Withdrawal
Rights
Tenders
of Trust Common Units made pursuant to the offer are irrevocable except that such Trust Common Units may be withdrawn at any time
prior to the expiration time and, if PEDEVCO has not accepted the Trust Common Units for exchange, at any time following 60 days
from commencement of the offer. If PEDEVCO elects to extend the offer, is delayed in its acceptance for exchange of Trust Common
Units or is unable to accept Trust Common Units for exchange pursuant to the offer for any reason, then, without prejudice to
PEDEVCO’s rights under the offer, the exchange agent may, on behalf of PEDEVCO, retain tendered Trust Common Units, and
such Trust Common Units may not be withdrawn except to the extent that tendering holders of Trust Common Units are entitled to
withdrawal rights as described in this section. Any such delay will be by extension of the offer to the extent required by law.
See the section of this offer to exchange titled “The Offer—Extension, Termination and Amendment.”
For
a withdrawal to be effective, a written or facsimile transmission notice of withdrawal must be timely received by the exchange
agent at its address set forth on the back cover page of this offer to exchange. Any such notice of withdrawal must specify the
name of the person who tendered the Trust Common Units to be withdrawn, the number of Trust Common Units to be withdrawn and the
name of the registered holder of such Trust Common Units, if different from that of the person who tendered such Trust Common
Units. If certificates representing Trust Common Units to be withdrawn have been delivered or otherwise identified to the exchange
agent, then, prior to the physical release of such certificates, the serial numbers shown on such certificates must be submitted
to the exchange agent and, unless such Trust Common Units have been tendered by or for the account of an Eligible Institution,
the signature(s) on the notice of withdrawal must be guaranteed by an Eligible Institution. If Trust Common Units have been tendered
pursuant to the procedure for book-entry transfer as set forth in the section of this offer to exchange titled “The Offer—Procedure
for Tendering,” any notice of withdrawal must specify the name and number of the account at DTC to be credited with the
withdrawn Trust Common Units.
Withdrawals
of tendered Trust Common Units may not be rescinded. Any tendered Trust Common Units properly withdrawn will thereafter be deemed
not to have been validly tendered for purposes of the offer. However, withdrawn Trust Common Units may be re-tendered at any time
prior to the expiration time by following one of the procedures described in the section of this offer to exchange titled “The
Offer—Procedure for Tendering.”
All
questions as to the form and validity (including time of receipt) of any notice of withdrawal will be determined by PEDEVCO in
its discretion, which determination will be final and binding to the fullest extent permitted by law. None of PEDEVCO or any of
its respective affiliates or assigns, the exchange agent, the information agents or any other person will be under any duty to
give any notification of any defects or irregularities in any notice of withdrawal or incur any liability for failure to give
any such notification.
Announcement
of Results of the Offer
PEDEVCO
will announce the final results of the offer, including whether all of the conditions to the offer have been satisfied or waived
and whether PEDEVCO will accept the tendered Trust Common Units for exchange after the expiration time. The announcement will
be made by a press release.
Material
U.S. Federal Income Tax Consequences
The
following is a general discussion of the material U.S. federal income tax consequences to U.S. holders (as referred to below)
of Trust Common Units whose Trust Common Units are exchanged pursuant to the offer or the second-step merger. The following discussion
is based on the Internal Revenue Code, which we refer to as the Code, the U.S. Treasury regulations promulgated thereunder and
judicial and administrative authorities, rulings and decisions, all as in effect as of the date of this offer to exchange. These
authorities may change, possibly with retroactive effect, and any such change could affect the accuracy of the statements and
conclusions set forth in this discussion. This discussion does not address any state, local or foreign tax consequences, nor does
it address any U.S. federal tax considerations other than those pertaining to the U.S. federal income tax.
The
following discussion applies only to U.S. holders of Trust Common Units who hold such Trust Common Units as a capital asset within
the meaning of Section 1221 of the Code (generally, property held for investment). Further, this discussion does not purport to
consider all aspects of U.S. federal income taxation that might be relevant to U.S. holders in light of their particular circumstances
and does not apply to holders subject to special treatment under the U.S. federal income tax laws (such as, for example, dealers
or brokers in securities, commodities or foreign currencies, traders in securities that elect to apply a mark-to-market method
of accounting, banks and certain other financial institutions, insurance companies, mutual funds, tax-exempt organizations, holders
liable for the alternative minimum tax, partnerships or other pass-through entities or investors in partnerships or such other
pass-through entities, regulated investment companies, real estate investment trusts, controlled foreign corporations, passive
foreign investment companies, former citizens or residents of the United States, U.S. expatriates, holders whose functional currency
is not the U.S. dollar, holders who hold Trust Common Units as part of a hedge, straddle, constructive sale or conversion transaction
or other integrated investment, or holders who acquired Trust Common Units through a tax qualified retirement plan or otherwise
as compensation). This discussion does not address tax consequences that may be relevant to particular holders in light of their
individual circumstances, including the impact of the Medicare contribution tax on net investment income, nor does it address
any tax consequences arising under the laws of any state, local or non-U.S. jurisdiction, or under any U.S. federal laws other
than those pertaining to income taxes.
If
an entity or arrangement treated as a partnership for U.S. federal income tax purposes holds Trust Common Units, the tax treatment
of a partner in such partnership generally will depend on the status of the partner and the activities of the partnership. If
you are a partner of a partnership holding Trust Common Units, you should consult your tax advisor regarding the tax consequences
of the partnership exchanging the Trust Common Units pursuant to the offer or the second-step merger.
For
purposes of this discussion, the term “U.S. holder” means a beneficial owner of Trust Common Units that is: (1) a
citizen or resident of the United States; (2) a corporation (or any other entity or arrangement treated as a corporation for U.S.
federal income tax purposes) created or organized under the laws of the United States, any state thereof, or the District of Columbia;
(3) a trust if (x) a court within the United States is able to exercise primary supervision over the trust’s administration
and one or more U.S. persons are authorized to control all substantial decisions of the trust or (y) it has a valid election in
effect under applicable U.S. Treasury regulations to be treated as a U.S. person; or (4) an estate the income of which is subject
to U.S. federal income tax regardless of its source.
THIS
DISCUSSION IS PROVIDED FOR GENERAL INFORMATION ONLY AND IS NOT A COMPLETE ANALYSIS OR DESCRIPTION OF ALL POTENTIAL U.S. FEDERAL
INCOME TAX CONSEQUENCES OF THE OFFER, SECOND-STEP MERGER OR THE RECEIPT, OWNERSHIP AND DISPOSITION OF SHARES OF PEDEVCO COMMON
STOCK RECEIVED IN THE OFFER OR SECOND-STEP MERGER. EACH HOLDER OF TRUST COMMON UNITS IS STRONGLY URGED TO CONSULT WITH AND RELY
UPON ITS OWN TAX ADVISOR AS TO THE SPECIFIC FEDERAL, STATE, LOCAL AND NON-U.S. TAX CONSEQUENCES TO SUCH HOLDER OF THE OFFER, SECOND-STEP
MERGER AND THE RECEIPT, OWNERSHIP AND DISPOSITION OF SHARES OF PEDEVCO COMMON STOCK RECEIVED IN THE OFFER OR SECOND-STEP MERGER,
TAKING INTO ACCOUNT ITS OWN PARTICULAR CIRCUMSTANCES.
Tax
Consequences of the Offer or the Second-Step Merger Generally
The
receipt of PEDEVCO Common Stock and cash by a U.S. holder pursuant to the offer or the second-step merger will be a taxable transaction
for U.S. federal income tax purposes.
A
U.S. holder of Trust Common Units generally will recognize gain or loss equal to the difference, if any, between (1) the sum of
the fair market value of PEDEVCO Common Stock received by such U.S. holder in the offer or the second-step merger and cash received
in lieu of a fractional share and (2) such U.S. holder’s adjusted tax basis in the Trust Common Units surrendered in exchange
therefor. For this purpose, U.S. holders of Trust Common Units must calculate gain or loss separately for each identified block
of Trust Common Units exchanged (that is, Trust Common Units acquired at the same cost in a single transaction).
Any
gain or loss recognized in the offer and the second-step merger generally will be treated as capital gain or loss. However, a
portion of this gain or loss, which could be substantial, will be separately computed and taxed as ordinary income or loss under
Section 751 of the Code to the extent attributable to “unrealized receivables,” including depreciation recapture,
or to “inventory items” owned by the Trust. Ordinary income attributable to unrealized receivables and inventory items
may exceed net taxable gain realized upon the exchange of Trust Common Units pursuant to the offer and second-step merger and
may be recognized even if there is a net
taxable loss realized on the exchange of such U.S. holder’s Trust Common Units
pursuant to the offer and second-step merger. Consequently, a U.S. holder may recognize both ordinary income and capital loss
upon the exchange of Trust Common Units in the offer and second-step merger.
Any
capital gain or loss recognized by a U.S. holder generally will be long-term capital gain or loss if the U.S. holder has held
the Trust Common Units for more than one year as of the date of exchange of Trust Common Units pursuant to the offer or the second-step
merger (as the case may be). Long-term capital gains recognized by U.S. holders that are not corporations generally will be eligible
for preferential rates of U.S. federal income taxation. The deductibility of capital losses recognized by U.S. holders generally
is subject to limitations under the Code.
A
U.S. Holder of Trust Common Units will be allocated its share of the Trust’s items of income, gain, loss and deduction for
the taxable period of the Trust that includes the date of the offer or second-step merger (as applicable) in accordance with the
terms of the Trust Agreement. The U.S. holder will be subject to U.S. federal income taxes on any such allocated income and gain
even if such U.S. holder does not receive a cash distribution from the Trust. Any such income and gain allocated to the U.S. holder
will increase the U.S. holder’s tax basis in the Trust Common Units held and, therefore, will reduce the gain, or increase
the loss, recognized by such U.S. holder resulting from the offer and second-step merger. Any losses or deductions allocated to
a U.S. holder will decrease the U.S. holder’s tax basis in the Trust Common Units held and, therefore, will increase the
gain, or reduce the loss, recognized by such U.S. holder resulting from the offer and second-step merger.
For
U.S. federal income tax purposes, a U.S. holder’s aggregate tax basis in the PEDEVCO Common Stock received pursuant to the
offer or the second-step merger will be equal to the fair market value of PEDEVCO Common Stock received by such U.S. holder pursuant
to the offer or the second-step merger (as the case may be), and a U.S. holder’s holding period with respect to such PEDEVCO
Common Stock will begin on the day following the date its Trust Common Units are exchanged pursuant to the offer or the second-step
merger (as the case may be).
Because
the ultimate U.S. federal income tax consequences would depend upon each holder’s particular circumstances, holders of Trust
Common Units (including non-U.S. holders) should consult their tax advisors regarding the application of the foregoing rules to
their particular circumstances and any actions that may be taken to mitigate the potential application of such rules, including
the advisability of selling their Trust Common Units or PEDEVCO Common Stock (and considerations relating to the timing of any
such sales).
Information
Reporting and Backup Withholding
Payments
made to U.S. holders in exchange for Trust Common Units pursuant to the offer or the second-step merger will be subject to information
reporting and may be subject to backup withholding. To avoid backup withholding, U.S. holders that do not otherwise establish
an exemption should complete and return IRS Form W-9, certifying that such U.S. holder is a U.S. person, the taxpayer identification
number provided is correct and such U.S. holder is not subject to backup withholding. Certain holders (including, with respect
to certain types of payments, corporations) generally are not subject to backup withholding. Backup withholding is not an additional
tax. U.S. holders may use amounts withheld and paid over the IRS as a credit against their U.S. federal income tax liability or
may claim a refund of any excess amounts withheld by timely filing a claim for refund with the IRS.
Owning
and Disposing of PEDEVCO Common Stock
Taxation
of Distributions
The
gross amount of a distribution made by PEDEVCO with respect to PEDEVCO Common Stock will be a dividend for U.S. federal income
tax purposes to the extent paid out of PEDEVCO’s current or accumulated earnings and profits as determined for U.S. federal
income tax purposes. If a distribution exceeds the portion of PEDEVCO’s current and accumulated earnings and profits as
determined for U.S. federal income tax purposes attributable to such distribution, the excess generally will be treated as a nontaxable
return of capital to the extent of a U.S. holder’s tax basis in such share and thereafter as a capital gain.
Dividends
received by a corporate U.S. holder may be eligible for the dividends received deduction allowed only to corporations, subject
to applicable limitations. Corporate U.S. holders should consult with their tax advisors with respect to the potential application
of the dividends received deduction. Dividends received by an individual U.S. holder may be taxed at the lower applicable long-term
capital gains rate if such dividends are treated as “qualified dividend income” for U.S. federal income tax purposes.
Sale
or Other Disposition of PEDEVCO Common Stock
A
U.S. holder will recognize gain or loss for U.S. federal income tax purposes upon a sale or other disposition of PEDEVCO Common
Stock in an amount equal to the difference, if any, between the amount realized from such sale or disposition and the U.S. holder’s
adjusted tax basis in such PEDEVCO Common Stock (as determined on a share by share basis) on the date of disposition. Such gain
or loss will be capital gain or loss and will be long-term capital gain or loss if the PEDEVCO Common Stock has been held for
more than one year as of the date of disposition. Long-term capital gains recognized by an individual and any other non-corporate
U.S. holder generally will be eligible for reduced rates of taxation. Capital losses recognized by a U.S. holder may offset capital
gains and, in the case of individuals, no more than $3,000 of ordinary income. Capital losses recognized by U.S. holders that
are corporations may only be used to offset capital gains.
Information
Reporting and Backup Withholding
Dividend
payments with respect to PEDEVCO Common Stock and proceeds from the sale or other disposition of PEDEVCO Common Stock, may be
subject to information reporting to the IRS and possible United States backup withholding. To avoid backup withholding, U.S. holders
that do not otherwise establish an exemption should complete and return IRS Form W-9, certifying that such U.S. holder is a U.S.
person, the taxpayer identification number provided is correct and such U.S. holder is not subject to backup withholding. Certain
holders (including, with respect to certain types of payments, corporations) generally are not subject to backup withholding.
Backup
withholding is not an additional tax. Amounts withheld as backup withholding may be credited against a U.S. holder’s U.S.
federal income tax liability, and a U.S. holder generally may obtain a refund of any excess amounts withheld under the backup
withholding rules by timely filing the appropriate claim for refund with the IRS and furnishing any required information.
Ownership
of PEDEVCO After the Offer
PEDEVCO
estimates that, upon consummation of the offer and the second-step merger, former holders of Trust Common Units will own, in the
aggregate, approximately 22.5% of the issued and outstanding PEDEVCO Common Stock (approximately 22.1% on a fully diluted basis)
as a result of having been holders of Trust Common Units. This estimate assumes that:
|
●
|
the
number of outstanding Trust Common Units immediately prior to the consummation of the
offer is 52,500,000, the total number of outstanding Trust Common Units reported in the
Trust 10-Q as of July 30, 2020; and
|
|
●
|
pursuant
to the offer, Purchaser acquires all of the outstanding Trust Common Units for the Consideration.
|
Purpose
of the Offer; Second-Step Merger
The
purpose of the offer is for PEDEVCO to acquire all of the outstanding Trust Common Units in order to combine the businesses of
PEDEVCO and the Trust. PEDEVCO intends, promptly after consummation of the offer and satisfaction of the conditions in the Trust
Agreement, including the Trustee’s consent, which is a condition to the offer, to cause the Trust to merge with Purchaser,
after which the Trust would be a direct or indirect, wholly owned subsidiary of PEDEVCO. The purpose of the second-step merger
is for PEDEVCO to acquire all issued and outstanding Trust Common Units that are not acquired in the offer.
In
the second-step merger, each remaining Trust Common Units (other than those held by PEDEVCO and its subsidiaries), which we refer
to as a remaining Trust Common Unit, will be cancelled and converted into the right to receive the Consideration.
After
the second-step merger, PEDEVCO will own all of the issued and outstanding Trust Common Units. See the sections of this offer
to exchange titled “The Offer—Statutory Requirements; Approval of the Second-Step Merger”; and “The Offer—Plans
for the Trust.”
Statutory
Requirements; Approval of the Second-Step Merger
Under
Section 3815(a) of the Delaware Trust Act, a statutory trust may merge or consolidate with or into another business entity formed
or organized or existing under the laws of the State of Delaware or any other state or jurisdiction, with either the trust or
other business entity surviving. Section 3815(a) of the Delaware Trust Act further provides that unless otherwise provided in
the governing instrument of a statutory trust that is not a registered investment company, an agreement of merger or consolidation
shall be approved by each such statutory trust which is to merge or consolidate by all of the beneficial owners and all of the
trustees. Section 3806(f)(1) of the Delaware Trust Act provides that unless otherwise provided in the governing instrument of
a statutory trust, on any matter that is to be voted on by the beneficial owners, the beneficial owners may take such action without
a meeting, without a prior notice and without a vote if consented to, in writing, or by electronic transmission by beneficial
owners having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting
at which all interests in the statutory trust entitled to vote thereon were present and voted.
Pursuant
to Section 9.04 of the Trust Agreement, the Trust may merge or consolidate with or into, or convert into, one or more other corporations,
partnerships, limited liability companies, trusts, estates or other entity, organization or association in accordance with Section
3815 of the Trust Act if such transaction: (1) is agreed to by the Trustee; (2) approved by the vote of a Unit Majority at a meeting
duly called and held in accordance with Article VIII; and (3) is permitted under the Trust Act and any other applicable law. A
“Unit Majority” is defined in the Trust Agreement as (i) a majority of the Trust Common Units (excluding Trust Common
Units owned by SandRidge and its Affiliates ) and (ii) a majority of the Trust Common Units, in each case present in person or
by proxy at a meeting at which a quorum is present; provided, that, at any time when SandRidge and its Affiliates collectively
own less than 10% of the outstanding Trust Common Units, “Unit Majority” means a majority of the Trust Common Units
present in person or by proxy at a meeting at which a quorum is present. In connection with the Sale Transaction in November 1,
2018, Avalon and its affiliates assumed all of SandRidge’s obligations under the Trust Agreement.
Upon
completion of the offer to exchange, assuming the satisfaction of the Minimum Tender Condition, PEDEVCO will have a majority of
the outstanding Trust Common Units. Furthermore, assuming satisfaction of the Trustee Consent Condition, PEDEVCO will have the
approval for the Trustee for the second-step merger. PEDEVCO believes it will be able to, and intends to, approve the
second-step
merger acting by written consent under Section 3806(f)(1) of the Delaware Trust Act as a holder of a Unit Majority of the Trust
Common Units because the Trust Agreement does not presently prohibit action by written consent. PEDEVCO intends to file a preliminary
information statement with respect to the written consent in lieu of a special meeting to approve the second-step merger prior
to, or promptly after, the completion of the offer to exchange.
While
the Trust Agreement does not expressly prohibit action by written consent of a holder of Trust Common Units, parties may challenge
the ability of PEDEVCO to act by written consent, including the Trustee, Avalon or Montare, which may delay or prevent the second-step
merger.
Please
see “Risk Factors—Risk Factors Relating to the Offer and Second-Step Merger—If PEDEVCO completes the exchange
offer in accordance with the Minimum Tender Condition and Trustee Consent Condition, it believes it will be able to approve the
second-step merger without a vote of holders of Trust Common Units who did not accept the exchange offer.”
No
Appraisal/Dissenters’ Rights
Holders
of Trust Common Units do not have dissenters’ or appraisal rights in connection with the offer.
Additionally,
Section 3815(h) of the Delaware Trust Act provides that unless otherwise provided in a governing instrument or an agreement of
merger or consolidation or a plan of division, no appraisal rights are available with respect to a beneficial interest or another
interest in a statutory trust, including in connection with any amendment of a governing instrument, any merger or consolidation
in which the statutory trust is a constituent party to the merger or consolidation, any division of the statutory trust or the
sale of all or substantially all of the statutory trust’s assets. The Trust Agreement does not provide for appraisal rights.
Accordingly, holders of Trust Common Units will not have appraisal rights in the second-step merger.
Please
see “Risk Factors—Risk Factors Relating to the Offer and Second-Step Merger— There will not be appraisal or
dissenters rights with respect to the exchange offer or second-step merger.”
Plans
for the Trust
The
offer is the first step in PEDEVCO’s plan to acquire all of the issued and outstanding Trust Common Units and effect a combination
of PEDEVCO and the Trust. PEDEVCO intends, promptly following acceptance for exchange and exchange of Trust Common Units in the
offer and satisfaction of the conditions in the Trust Agreement, including the Trustee’s consent which is a condition to
this offer, to cause the Trust to complete the second-step merger pursuant to which PEDEVCO will acquire all remaining Trust Common
Units. See the sections of this offer to exchange titled “The Offer—Purpose of the Offer; Second-Step Merger”
and “The Offer—Statutory Requirements; Approval of the Second-Step Merger.”
If,
and to the extent that, PEDEVCO acquires control of the Trust or otherwise obtains access to the books and records of the Trust,
PEDEVCO intends to conduct a detailed review of the Trust’s assets, particularly its Royalty Interest and its relationship
with Avalon as the operator and working interest owner of the Underlying Properties, and consider and determine what, if any,
changes would be desirable in light of the circumstances which then exist. Such strategies could include, among other things:
|
●
|
more
engagement and oversight of Avalon and other operator of the Underlying Properties than
the Trust is currently permitted to do under its Trust Agreement;
|
|
●
|
strategic
relationships, joint ventures, financial support any other arrangements and business
relationships or business combinations with Avalon and any other operator of the Underlying
Properties; or
|
|
●
|
pursuit
and enforcement of legal rights that may existing between the Trust and Avalon and any
other operator under the Royalty Interests.
|
While
PEDEVCO does not have present plans to remove the Trustee, PEDEVCO may in the future consider removing the Trustee, subject to
the provisions of the Trust Agreement in effect at that time.
Additionally,
while PEDEVCO does not have any present plans to amend the Trust Agreement (except in connection with the second-step merger),
PEDEVCO may in the future amend provisions of the Trust Agreement.
Except
as indicated in this offer to exchange, neither PEDEVCO nor any of PEDEVCO’s subsidiaries has any current plans or proposals
that relate to or would result in (1) any extraordinary transaction, such as a merger, reorganization or liquidation of the Trust,
(2) any purchase, sale or transfer of a material amount of assets of the Trust, (3) any material change in the present dividend
rate or policy, or indebtedness or capitalization of the Trust, (4) any replacement or removal of the Trustee, (5) any other material
change in the Trust’s structure or business, or (6) any class of equity securities of the Trust becoming eligible for termination
of registration under Section 12(g)(4) of the Exchange Act.
Effect
of the Offer on the Market for Trust Common Units; Registration under the Exchange Act; Margin Regulations
Effect
of the Offer on the Market for the Trust Common Units
The
exchange of Trust Common Units by PEDEVCO pursuant to the offer will reduce the number of Trust Common Units that might otherwise
trade publicly and will reduce the number of holders of Trust Common Units, which could adversely affect the liquidity and market
value of the remaining Trust Common Units held by the public. The extent of the public market for Trust Common Units and the availability
of quotations reported in the over-the-counter market depends upon the number of holders of Trust Common Units, the aggregate
market value of the Trust Common Units remaining at such time, and the interest of maintaining a market in the Trust Common Units
on the part of any securities firms and other factors. According to the Trust’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2020, as of July 30, 2020, there were 52,500,000 Trust Common Units outstanding, and according to the Trust’s
Annual Report on 10-K for the year ended December 31, 2019, there were ten holders of record of Trust Common Units as of March
10, 2020 (the actual number of holders of Trust Common Units is likely significantly higher than the number of holders of record).
PEDEVCO intends, promptly after consummation of the offer and satisfaction of the conditions in the Trust Agreement, including
the Trustee’s consent which is a condition to this offer, to cause the Trust to merge with Purchaser.
Registration
Under the Exchange Act
The
Trust Common Units are currently registered under the Exchange Act. This registration may be terminated upon application by the
Trust to the SEC if the Trust Common Units are not listed on a “national securities exchange” and there are fewer
than 300 record holders. Termination of registration would substantially reduce the information required to be furnished by the
Trust to holders of Trust Common Units and to the SEC and would make certain provisions of the Exchange Act, such as the short-swing
profit recovery provisions of Section 16(b), the requirement of furnishing a proxy statement in connection with stockholders’
meetings and the requirements of Exchange Act Rule 13e-3 with respect to “going private” transactions, no longer applicable
to Trust Common Units. In addition, “affiliates” of the Trust and persons holding “restricted securities”
of the Trust may be deprived of the ability to dispose of these securities pursuant to Rule 144 under the Securities Act. If registration
of Trust Common Units is not terminated prior to the second-step merger, then the registration of Trust Common Units under the
Exchange Act will be terminated upon consummation of the second-step merger. PEDEVCO intends, promptly after consummation of the
offer and satisfaction of the conditions in the Trust Agreement, including the Trustee’s consent which is a condition to
this offer, to cause the Trust to merge with Purchaser.
Margin
Regulations
If
securities are “margin securities,” as such term is defined under the rules of the Board of Governors of the Federal
Reserve System, which we refer to as the Federal Reserve Board, it has the effect, among other things, of allowing brokers to
extend credit on the collateral of such securities. Depending upon factors similar to those described above regarding listing
and market quotations, following the offer, it is possible that the Trust Common Units might no longer constitute “margin
securities” for purposes of the margin regulations of the Federal Reserve Board, in which event such Trust Common Units
could no longer be used as collateral for loans made by brokers. In addition, if registration of the Trust Common Units under
the Exchange Act were terminated, the Trust Common Units would no longer constitute “margin securities.” PEDEVCO intends,
promptly after consummation of the offer and satisfaction of the conditions in the Trust Agreement, including the Trustee’s
consent which is a condition to this offer, to cause the Trust to merge with Purchaser, which will cause the Trust Common Units
to no longer constitute “margin securities.”
Conditions
to the Offer
Notwithstanding
any other provision of the offer and in addition to (and not in limitation of) PEDEVCO’s right to extend and amend the offer
at any time, in its discretion, PEDEVCO shall not be required to accept for exchange any Trust Common Units tendered pursuant
to the offer, shall not (subject to any applicable rules and regulations of the SEC, including Rule 14e-1(c) under the Exchange
Act) be required to make any exchange for Trust Common Units accepted for exchange and may extend, terminate or amend the offer,
if immediately prior to the expiration of the offer, in the reasonable judgment of PEDEVCO, any one or more of the following conditions
shall not have been satisfied:
Minimum
Tender Condition
There
shall have been validly tendered and not properly withdrawn prior to the expiration of the offer, a number of Trust Common Units
which, together with any other Trust Common Units that Purchaser then owns or has a right to acquire, is a majority of the total
number of outstanding Trust Common Units as of the date that PEDEVCO accepts Trust Common Units for exchange pursuant to the offer.
Trustee
Consent Condition
The
Trustee shall have consented, pursuant to the Trust Agreement, to the second-step merger as the second-step merger on the terms
and conditions described in this offer to exchange, and has not required or implemented any conditions to the second-step merger
that, in the reasonable judgment of PEDEVCO, could hinder or delay the second-step merger.
PEDEVCO
Shareholder Approval Condition
PEDEVCO
has received the approval by a sufficient number of its shareholders of the issuance of PEDEVCO Common Stock contemplated in connection
with the offer and the second-step merger, in accordance with the rules of the NYSE American, on which the PEDEVCO Common Stock
is listed. PEDEVCO expects to file a preliminary information statement with respect to the shareholder written consent in lieu
of a special meeting to make the approval effective promptly after the date of this offer to exchange.
As
of October 13, 2020, directors, executive officers and their affiliates held approximately 63,759,778 issued and outstanding shares
of PEDEVCO Common Stock, representing 88% of the voting power of the issued and outstanding PEDEVCO Common Stock.
Governmental
Approval Condition
Any
waiting (or extension thereof) period applicable to the offer and the second-step merger under any applicable antitrust law shall
have expired or been terminated, and any approvals or clearances determined by PEDEVCO to be required or advisable thereunder
shall have been obtained on terms satisfactory to PEDEVCO, and any other any other approval, permit, authorization, extension,
action or non-action, waiver or consent of any governmental authority as determined by PEDEVCO to be required or advisable shall
have been obtained on terms satisfactory to PEDEVCO.
Stock
Exchange Listing Condition
The
PEDEVCO Common Stock issuable to holders of Trust Common Units in connection with the offer and the second-step merger shall have
been approved for listing on the NYSE American, subject to official notice of issuance.
Registration
Statement Condition
The
registration statement of which this offer to exchange is a part shall have become effective under the Securities Act. No stop
order suspending the effectiveness of the registration statement shall have been issued, and no proceedings for that purpose shall
have been initiated or be threatened, by the SEC.
No
Injunction Condition
No
court or other governmental entity of competent jurisdiction shall have enacted, issued, promulgated, enforced or entered any
law, statute or ordinance, common law, rule, regulation, standard, judgment, order, writ, injunction, decree, arbitration award
or agency requirement (whether temporary, preliminary or permanent) that is in effect and restrains, enjoins or otherwise prohibits
consummation of the offer and the second-step merger.
No
Trust Material Adverse Effect Condition
There
shall not have occurred any change, event, circumstance or development, which PEDEVCO refers to as a Circumstance, that has had,
or would reasonably be likely to have, Trust Material Adverse Effect.
When
we refer to a Trust Material Adverse Effect, we mean, any Circumstance that, individually or in the aggregate:
|
(i)
|
has
had, or would reasonably be expected to have, a materially adverse effect on the financial
condition, business, operations, assets, liabilities or results of operations of the
Trust; or
|
|
(ii)
|
would,
or would reasonably be expected to, materially impair the ability of the Trust to consummate
the offer or the second-step merger;
|
provided,
however, that solely for purposes of the foregoing clause (i) only, to the extent any Circumstance results from the following
items, then it will be excluded in determining whether there has been an Trust Material Adverse Effect:
|
(A)
|
changes
after the date hereof in GAAP or the official interpretation or enforcement thereof or
any other accounting requirements generally applicable to the industry in which the Trust
operates;
|
|
(B)
|
changes
after the date hereof generally affecting the financial, securities, debt or financing
markets or general economic or political conditions;
|
|
(C)
|
changes
after the date hereof in law of general applicability to companies in the industry in
the Trust operates;
|
|
(D)
|
acts
or declarations of war or other armed hostilities, sabotage or terrorism; and
|
|
(E)
|
any
failure by the Trust to meet any internal or published estimates, budgets, projections,
forecasts or predictions of financial performance for any period (it being agreed that
the underlying cause of any such failure described in this clause (E) may be considered
in determining whether or not a Trust Material Adverse Effect has occurred);
|
provided
further that, in the case of clauses (A), (B), (C) and (D), any such Circumstances may be taken into account in determining whether
or not there has been a Trust Material Adverse Effect to the extent any such Circumstance has been, or is reasonably likely to
be, disproportionately adverse to the Trust, taken as a whole, as compared to other participants in the industry in which the
Trust operates.
Other
Conditions to the Offer
None
of the following events shall have occurred and be continuing and be of a nature that could reasonably be expected to make it
inadvisable for us to complete the offer or second-step merger:
|
1.
|
there
shall be threatened, instituted or pending any action, proceeding or application before
any court, government or governmental authority or other regulatory or administrative
agency or commission, domestic or foreign:
|
|
(A)
|
which
challenges the acquisition by PEDEVCO of the Trust or Trust Common Units, seeks to restrain,
delay or prohibit the consummation of the offer or the second-step merger or seeks to
obtain any material damages or otherwise directly or indirectly relates to the offer
or the second-step merger;
|
|
(B)
|
which
seeks to prohibit or impose material limitations on PEDEVCO’s acquisition, ownership
or operation of all or any portion of PEDEVCO’s or the Trust’s businesses
or assets (including the businesses or assets of PEDEVCO’s affiliates and subsidiaries)
or of Trust Common Units (including, without limitation, the ability of PEDEVCO to act
by written consent as a holder of Trust Common Units, or to vote with respect to the
Trust Common Units purchased by PEDEVCO or an affiliate thereof on an equal basis with
all other holders of Trust Common Units on all matters presented to the holders of Trust
Common Units), or seeking to impose appraisal rights, or seeks to compel PEDEVCO to dispose
of or hold separate all or any portion of its own or the Trust’s businesses or
assets (including the businesses or assets of their respective affiliates and subsidiaries)
as a result of the transactions contemplated by the offer or the second-step merger;
|
|
(C)
|
which
might adversely affect PEDEVCO, the Trust, or any of their respective affiliates or subsidiaries,
which PEDEVCO refers to as an Adverse Effect, or result in a diminution in the value
of Trust Common Units or the benefits expected to be derived by PEDEVCO as a result of
the transactions contemplated by the offer and the second-step merger, which we refer
to as a Diminution in Value;
|
|
(D)
|
which
seeks to impose any condition to the offer or the second-step merger unacceptable to
PEDEVCO (including the Trustee seeking to impose a condition on its consent that PEDEVCO
not act by written consent to approve the second-step merger or seeking to condition
its consent on appraisal rights), except that this condition will not fail to be satisfied
as a result of a governmental entity requiring that PEDEVCO (i) divest, license, or hold
separate (including by trust or otherwise) any businesses or assets of PEDEVCO, the Trust
or their respective affiliates, or (ii) agree to or effect any action that limits any
freedom of action with respect to PEDEVCO’s, the Trust’s or their respective
affiliates’ ability to retain, operate, manage, govern or influence any of their
respective businesses or assets, which requirements in clauses (i) and (ii) we collectively
refer to as a Regulatory Action, as long as such Regulatory Action would not have a material
adverse effect on the financial condition, business, operations, assets, liabilities
or results of operations of PEDEVCO, the Trust and their respective subsidiaries, taken
as a whole; or
|
|
(E)
|
adversely
affecting the issuance of PEDEVCO Common Stock in the offer or second-step merger;
|
|
2.
|
other
than applicable antitrust laws and regulations, any statute, rule, regulation or order
or injunction shall be sought, proposed, enacted, promulgated, entered, enforced or deemed
or become applicable to the offer, the second-step merger or the transactions contemplated
by the offer or second-step merger that might, directly or indirectly, result in any
of the consequences referred to in clauses (A) through (E) of paragraph (1) above, except
that this condition will not fail to be satisfied as a result of a governmental entity
requiring that PEDEVCO agree to or effect any Regulatory Action as long as such Regulatory
Action would not have a material adverse effect on the financial condition, business,
operations, assets, liabilities or results of operations of PEDEVCO or the Trust, taken
as a whole;
|
|
3.
|
there
shall have occurred:
|
|
(A)
|
any
general suspension of, or limitation on times or prices for, trading in securities on
any national securities exchange or in the over-the-counter market;
|
|
(B)
|
any
decline in either the Dow Jones Industrial Average, the Standard and Poor’s Index
of 500 Industrial Companies or the Nasdaq 100 Index by any amount in excess of 15% measured
from the close of business on October 12, 2020;
|
|
(C)
|
a
declaration of a banking moratorium or any suspension of payments in respect of banks
in the United States;
|
|
(D)
|
the
outbreak or escalation of a war, armed hostilities or other international or national
calamity directly or indirectly involving the United States;
|
|
(E)
|
any
limitation (whether or not mandatory) by any governmental authority or other regulatory
agency on, or any other event which might affect the extension of credit by, banks or
other lending institutions or the availability of the financing generally;
|
|
(F)
|
a
suspension of or limitation (whether or not mandatory) on the currency exchange markets
or the imposition of, or material changes in, any currency or exchange control laws in
the United States; or
|
|
(G)
|
in
the case of any of the foregoing existing at the time of the commencement of the offer,
a material acceleration or worsening thereof;
|
|
(A)
|
issued,
distributed, pledged or sold, or authorized, or proposed the issuance, distribution,
pledge or sale of:
|
|
i.
|
any
beneficial interests (including Trust Common Units) or securities convertible into or
exchangeable for any beneficial interests, or any rights, warrants or options to acquire
any such beneficial interests or convertible securities or any other securities of the
Trust;
|
|
ii.
|
any
other securities in respect of, in lieu of or in substitution for Trust Common Units;
or
|
|
iii.
|
any
debt securities or any securities convertible into or exchangeable for debt securities
or any rights, warrants or options entitling the holder thereof to purchase or otherwise
acquire any debt securities;
|
|
(B)
|
purchased
or otherwise acquired, or proposed or offered to purchase or otherwise acquire, any outstanding
Trust Common Units or other securities;
|
|
(C)
|
proposed,
recommended, authorized, declared, issued or paid any dividend or distribution on any
Trust Common Units or any other security, whether payable in cash, securities or other
property, other than the Trust’s regularly quarterly distributions;
|
|
(D)
|
altered
or proposed to alter any material term of any outstanding security, including Trust Common
Units;
|
|
(E)
|
incurred,
agreed to incur or announced its intention to incur any debt other than in the ordinary
course of business and consistent with past practice;
|
|
(F)
|
authorized,
recommended, proposed or publicly announced its intent to enter into any merger, consolidation,
liquidation, dissolution, business combination, acquisition or disposition of assets
or securities other than in the ordinary course of business, any material change in its
capitalization, any release or relinquishment of any material contractual (including
any Royalty Interests) or other rights or any comparable event, or taken any action to
implement any such transaction previously authorized, recommended, proposed or publicly
announced; or
|
|
(G)
|
entered
into any other agreement or otherwise effected any other arrangement with any other party
or, which in any of the cases described in (A) through (F) above might, individually
or in the aggregate, have an Adverse Effect or result in a Diminution in Value;
|
|
5.
|
The
Trust shall have amended or proposed or authorized any amendment to the Trust Agreement,
Certificate of Trust or similar organizational documents, or PEDEVCO shall have learned
that the Trust or any other party shall have proposed, adopted or recommended any such
amendment, which has not previously been publicly disclosed by the Trust and also set
forth in filings with the SEC prior to commencement of the offer, in a manner that, in
the reasonable judgment of PEDEVCO, might, directly or indirectly
|
|
(A)
|
delay
or otherwise restrain, impede or prohibit the offer or the second-step merger; or
|
|
(B)
|
prohibit
or limit the full rights of ownership of Trust Common Units by PEDEVCO or any of its affiliates, including, without limitation,
the ability to act by written consent, or to vote with respect to the Trust
|
|
|
Common
Units purchased by PEDEVCO or an affiliate thereof on an equal basis with all other holders
of Trust Common Units on all matters presented to the holders of Trust Common Units;
|
|
6.
|
The
Trust shall have transferred into trust, escrow or similar arrangement any amounts required
to fund any existing benefit, employment or severance agreements with any of Trustee
or any of its employees or shall have entered into or otherwise effected with its officers
or any other employees any additional benefit, employment, severance or similar agreements,
arrangements or plans other than in the ordinary course of business or entered into or
amended any agreements, arrangements or plans so as to provide for increased benefits
to such employee or employees as a result of or in connection with the transactions contemplated
by the offer or the second-step merger;
|
|
(A)
|
a
tender or exchange offer for some or all of the Trust Common Units has been publicly
proposed to be made or has been made by another person (including the Trust, Avalon or
Montare but excluding PEDEVCO or any of its affiliates), or has been publicly disclosed,
or PEDEVCO otherwise learns that any person or “group” (as defined in Section
13(d)(3) of the Exchange Act) has acquired or proposes to acquire beneficial ownership
of more than 5% of beneficial interests of the Trust (including the Trust Common Units),
through the acquisition of Trust Common Units, the formation of a group or otherwise,
or is granted any option, right or warrant, conditional or otherwise, to acquire beneficial
ownership of more than 5% of any beneficial interest of the Trust (including the Trust
Common Units) other than acquisitions for bona fide arbitrage purposes only and other
than as disclosed in a Schedule 13D or 13G on file with the SEC on the date of this offer
to exchange;
|
|
(B)
|
any
such person or group which, prior to the date of this offer to exchange, had filed such
a Schedule 13D or 13G with the SEC has acquired or proposes to acquire beneficial ownership
of additional beneficial interests in the Trust (including Trust Common Units), through
the acquisition of Common Units, the formation of a group or otherwise, constituting
1% or more of the Common Units, or is granted any option, right or warrant, conditional
or otherwise, to acquire beneficial ownership of additional Trust Common Units constituting
1% or more of the Trust Common Units;
|
|
(C)
|
after
the date of this offer to exchange, any person or group has entered into a definitive
agreement or an agreement in principle or made a proposal with respect to a tender or
exchange offer or a merger, consolidation or other business combination with or involving
the Trust; or
|
|
(D)
|
after
the date of this offer to exchange, any person has filed a Notification and Report Form
under the Hart-Scott-Rodino Act or made a public announcement reflecting an intent to
acquire the Trust or any assets or securities of the Trust;
|
|
8.
|
PEDEVCO
becomes aware:
|
|
(A)
|
that
any material contractual right of the Trust (including the Royalty Interests) has been
or will be impaired or otherwise adversely affected or that any material amount of indebtedness
of the Trust has been accelerated or has otherwise become due or become subject to acceleration
prior to its stated due date, in each case with or without notice or the lapse of time
or both, as a result of or in connection with the offer or the completion by PEDEVCO
or any of its affiliates of the second-step merger or any other business combination
involving the Trust; or
|
|
(B)
|
of
any covenant, term or condition in any instrument or agreement of the Trust that, in
PEDEVCO’s reasonable judgment, has or may have material adverse significance with
respect to either the value of the Trust or the value of the Trust Common Units to PEDEVCO
or any of its affiliates (including, without limitation, any event of default that may
ensue as a result of or in connection with the offer, the acceptance for payment of or
payment for some or all of the Trust Common Units by PEDEVCO or its completion of the
second-step merger or any other similar business combination involving the Trust; or
|
|
(A)
|
granted
to any person proposing a merger or other business combination with or involving the
Trust or the purchase or exchange of securities or assets of the Trust or any of its
subsidiaries any type of option, warrant or right which, in PEDEVCO’s reasonable
judgment, constitutes a “lock-up” device (including, without limitation,
a right to acquire or receive any Trust Common Units or other securities, assets or business
of the Trust; or
|
|
(B)
|
paid
or agreed to pay any cash or other consideration to any party in connection with or in
any way related to any such business combination, purchase or exchange.
|
Each
of the conditions under this section of this offer to exchange titled “The Offer—Conditions to the Offer” is
for the sole benefit of PEDEVCO and may be asserted by PEDEVCO regardless of the circumstances (including any action or inaction
by PEDEVCO) giving rise to any such conditions or, except as otherwise expressly set forth herein to the contrary, may be waived
by PEDEVCO in whole or in part at any time and from time to time in PEDEVCO’s sole discretion. The determination as to whether
any condition has occurred shall be in PEDEVCO’s reasonable judgment and that judgment shall be final and binding on all
parties. The failure by PEDEVCO at any time to exercise any of the foregoing rights shall not be deemed a waiver of any such right
and each such right shall be deemed an ongoing right which may be asserted at any time and from time to time. Notwithstanding
the fact that PEDEVCO reserves the right to assert the occurrence of a condition following acceptance for exchange but prior to
exchange in order to delay issuance of PEDEVCO Common Stock or cancel PEDEVCO’s obligation to pay the consideration payable
for properly tendered Trust Common Units, PEDEVCO will either promptly pay that consideration for properly tendered Trust Common
Units or promptly return such Trust Common Units. A public announcement shall be made of a material change in, or waiver of, such
conditions, and the offer may, in certain circumstances, be extended in connection with any such change or waiver.
Consummation
of the offer is not subject to any financing conditions.
Dividends
and Distributions
If,
on or after the date hereof, the Trust should (1) split, combine or otherwise change the Trust Common Units or its capitalization,
(2) acquire currently outstanding Trust Common Units or otherwise cause a reduction in the number of Trust Common Units or (3)
issue or sell additional Trust Common Units, shares of any other class of beneficial interests or capital stock, other voting
securities or any securities convertible into, or rights, warrants or options to acquire, any of the foregoing, then, subject
to the conditions of the offer above, PEDEVCO, in its sole discretion, may make such adjustments as it deems appropriate in the
offer price and other terms of the offer, including, without limitation, the number or type of securities offered to be purchased.
If,
on or after the date of this offer to exchange, the Trust should declare or pay any cash dividend on the Trust Common Units or
other distribution on Trust Common Units, other than the Trust’s regular quarterly distribution, or issue with respect to
the Trust Common Units any additional Trust Common Units, shares of any other class of beneficial interests or capital stock,
other voting securities or any securities convertible into, or rights, warrants or options, conditional or otherwise, to acquire,
any of the foregoing, payable or distributable to holders of record on a date prior to the transfer of the Trust Common Units
purchased pursuant to the offer to PEDEVCO or its nominee or transferee on the Trust’s Common Unit transfer records, then,
subject to the conditions of the offer above, (1) the offer price and other terms of the offer may, in PEDEVCO’s sole discretion,
be adjusted to reflect the amount of any such cash dividend or cash distribution and (2) the whole of any such non-cash dividend,
distribution or issuance to be received by the tendering holders will (i) be received and held by the tendering holders for PEDEVCO’s
account and will be required to be promptly remitted and transferred by each tendering holder to the exchange agent for PEDEVCO’s
account, accompanied by appropriate documentation of transfer, or (ii) at PEDEVCO’s direction, be exercised for PEDEVCO’s
benefit, in which case the proceeds of such exercise will promptly be remitted to PEDEVCO. Pending such remittance and subject
to applicable law, PEDEVCO will be entitled to all rights and privileges as owner of any such non-cash dividend, distribution,
issuance or proceeds and may withhold the entire offer price or deduct from the offer price the amount or value thereof, as determined
by PEDEVCO in its sole discretion.
Certain
Legal Matters
General.
Except as otherwise disclosed herein, based upon an examination of publicly available filings with respect to the Trust, PEDEVCO
is not aware of any licenses or other regulatory permits which appear to be material to the business of the Trust and which might
be adversely affected by the acquisition of Trust Common Units by PEDEVCO pursuant to the offer or the second-step merger or,
except as otherwise described in this offer to exchange, or of any approval or other action by any governmental, administrative
or regulatory agency or authority which would be required for the acquisition or ownership of Trust Common Units by PEDEVCO pursuant
to the offer or the second-step merger. Should any such approval or other action be required, it is currently contemplated that
such approval or action would be sought or taken. There can be no assurance that any such approval or action, if needed, would
be obtained or, if obtained, that it will be obtained without substantial conditions or that adverse consequences might not result
to the Trust’s or PEDEVCO’s business or that certain parts of the Trust’s or PEDEVCO’s business might
not have to be disposed of in the event that such approvals were not obtained or such other actions were not taken, any of which
could cause PEDEVCO to elect to terminate the offer for any reason without the acceptance for exchange of Trust Common Units thereunder.
PEDEVCO’s obligation under the offer to accept for exchange and issue PEDEVCO Common Stock is subject to certain conditions
specified above.
No
Antitrust Clearance. Due to the size of the transaction, PEDEVCO does not believe the offer to exchange and second-step
merger is subject to review by the Federal Trade Commission (the “FTC”), and the Department of Justice (the “DOJ”
and, together with the FTC, the “antitrust agencies”). If the HSR Act were to apply to the offer or second-step merger,
the offer or second-step merger could not be completed until certain information has been provided to the antitrust agencies and
the applicable HSR Act waiting period has expired or been terminated. If subject to the HSR Act, the antitrust agencies frequently
scrutinize the legality under the antitrust laws of transactions such as PEDEVCO’s acquisition of Trust Common Units pursuant
to the offer and have broad flexibility to take such action as the antitrust agencies deem necessary or desirable in the public
interest, including seeking to enjoin the a transaction.
States
and private parties may also bring legal actions under the antitrust laws. There can be no assurance that a challenge to the offer
and/or the second-step merger on antitrust grounds will not be made, or if such a challenge is made, what the result will be.
See the section of this offer to exchange titled “The Offer—Conditions to the Offer” for certain conditions
to the offer, including conditions with respect to litigation and certain governmental actions.
The
offer and/or the second-step merger may be subject to review by antitrust authorities in jurisdictions outside the United States.
Under some of these jurisdictions, the offer and/or the second-step merger may not be consummated before a notification has been
submitted to the relevant antitrust authority and/or certain consents, approvals, permits or authorizations have been obtained
and/or the applicable waiting period has expired or has been terminated; in addition, there may be jurisdictions where the submission
of a notification is only voluntary but advisable. PEDEVCO intends to make all necessary and advisable (at the sole discretion
of PEDEVCO) notifications in these jurisdictions as soon as practicable. The consummation of the offer and/or of the second-step
merger is subject to the condition that the waiting period (or extension thereof) applicable to the offer and the second-step
merger under any applicable antitrust laws and regulations shall have expired or been earlier terminated, and any approvals or
clearances determined by PEDEVCO to be required or advisable thereunder shall have been obtained.
State
Takeover Laws. A number of states have adopted laws and regulations applicable to offers to acquire securities of corporations
or other entities which are incorporated in such states and/or which have substantial assets, stockholders, principal executive
offices or principal places of business therein. PEDEVCO does not believe that any state takeover laws purport to apply to the
offer or the second-step merger. PEDEVCO has not currently complied with any state takeover statute or regulation. PEDEVCO reserves
the right to challenge the applicability or validity of any state law purportedly applicable to the offer or the second-step merger
and nothing in this offer to exchange or any action taken in connection with the offer or the second-step merger is intended as
a waiver of such right. If it is asserted that any state takeover statute is applicable to the offer or the second-step merger
and if an appropriate court does not determine that it is inapplicable or invalid as applied to the offer or the second-step merger,
PEDEVCO might be required to file certain information with, or to receive approvals from, the relevant state authorities, we might
be unable to accept for payment or pay for Trust Common Units tendered pursuant to the offer, or be delayed in consummating the
offer or the second-step merger. In such case, PEDEVCO may not be obliged to accept for payment or pay for any Trust Common Units
tendered pursuant to the offer.
Regulatory
Approvals
As
described in the Governmental Approvals Condition, the offer and the second-step merger may also be subject to review by government
authorities and other regulatory agencies, including in jurisdictions outside the U.S. PEDEVCO intends to file promptly all notifications
that it determines are necessary or advisable under the applicable laws, rules and regulations of the respective identified authorities,
agencies and jurisdictions for the consummation of the offer and/or the second-step merger and to file all post-completion notifications
that it determines are necessary or advisable as soon as possible after completion has taken place.
Issuance
of PEDEVCO Common Stock in the Offer
PEDEVCO’s
Certificate of Formation authorizes 200,000,000 shares of PEDEVCO Common Stock. As of October 13, 2020, there were 72,463,340
shares of Common Stock issued and outstanding. At the proposed exchange ratio of 4/10ths of one share of PEDEVCO Common Stock
for each Trust Common Unit, PEDEVCO would issue 21,000,000 shares of PEDEVCO Common Stock.
Certain
Relationships with the Trust and Interest of PEDEVCO and PEDEVCO’s Executive Officers and Directors in the Offer
Except
as set forth in this offer to exchange, neither PEDEVCO nor, to the best of PEDEVCO’s knowledge, any of its directors,
executive officers or other affiliates, or any of their associates, has any contract, arrangement, understanding or
relationship with any other person with respect to any securities of the Trust, including, but not limited to, any contract,
arrangement, understanding or relationship concerning the transfer or the voting of any securities, joint ventures, loan or
option arrangements, puts or calls, guaranties of loans, guaranties against loss or the giving or withholding of proxies.
Except as otherwise described in this offer to exchange, there have been no contacts, negotiations or transactions during the
past two years, between PEDEVCO or, to the best of PEDEVCO’s knowledge, any of its directors, executive officers or
other affiliates, or any of their associates, on the one hand, and the Trust or its affiliates, on the other hand, concerning
a merger, consolidation or acquisition, an exchange offer or other acquisition of securities, an election of directors, or a
sale or other transfer of a material amount of assets.
The
name, citizenship, business address, business telephone number, principal occupation or employment, and five-year employment history
for each of the directors and executive officers of PEDEVCO and certain other information are set forth in “Information
about PEDEVCO—Directors and Executive Officers.” Except as described in this offer to exchange none of PEDEVCO or,
after due inquiry and to the best knowledge and belief of PEDEVCO, any of PEDEVCO’s directors, executive officer or affiliates,
or any of their associates, has during the last five years (1) been convicted in a criminal proceeding (excluding traffic violations
or similar misdemeanors) or (2) been a party to any judicial or administrative proceeding (except for matters that were dismissed
without sanction or settlement) that resulted in a judgment, decree or final order enjoining the person from future violations
of, or prohibiting activities subject to, federal or state securities laws or finding any violation of such laws. Except as set
forth in this offer to exchange, to PEDEVCO’s knowledge, after reasonable inquiry, none of none of PEDEVCO’s directors,
executive officers or affiliates, nor any of their respective associates or majority-owned subsidiaries, beneficially owns or
has the right to acquire any securities of the Trust or has effected any transaction in securities of the Trust during the past
60 days.
PEDEVCO
does not believe that the offer and the second-step merger will result in a change in control under any of PEDEVCO’s equity
plans or any agreement between PEDEVCO and any of its directors or executive officers. As a result, no stock options or other
outstanding equity awards held by such persons will vest as a result of the offer and the second-step merger, nor will any director
or executive officer have any rights to enhanced severance payments or benefits upon certain types of terminations following the
offer and the second-step merger.
Fees
and Expenses
Information
Agent
PEDEVCO
has retained InvestorCom as the information agent in connection with the offer. The information agent may contact holders of Trust
Common Units by mail, telephone, facsimile, the Internet, e-mail, newspapers and other publications of general distribution and
in person and may request brokers, dealers, commercial banks, trust companies and other nominees to forward materials relating
to the offer to beneficial owners of Trust Common Units. InvestorCom will also provide certain advisory services in connection
with the offer to exchange. PEDEVCO will pay the information agent a customary fee for these services, in addition to reimbursing
the information agent for its reasonable out-of-pocket expenses. PEDEVCO has agreed to indemnify the information agent against
certain liabilities and expenses in connection with the offer.
Exchange
Agent
In
addition, PEDEVCO has retained American Stock Transfer & Trust Company, LLC as the exchange agent in connection with the offer.
PEDEVCO will pay the exchange agent reasonable and customary compensation for its services in connection with the offer, will
reimburse the exchange agent for its reasonable out-of-pocket expenses and will indemnify the exchange agent against certain liabilities
and expenses.
Accounting
Treatment
The
proposed acquisition of the Trust would be accounted for under the acquisition method of accounting under U.S. generally accepted
accounting principles, with PEDEVCO recognizing the allocation of the purchase price to the net identifiable assets acquired from
the date of completion of offer and second-step merger with the Trust’s net identifiable asset being recorded at their fair
values at the same date.
PEDEVCO
applied Accounting Standards Update (ASU) No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business
when determining the accounting treatment of the proposed transaction. ASU 2017-01 created a new framework for entities to use
in evaluating whether an integrated set of assets and activities (collectively a “set”) should be accounted for as
an acquisition of a business or a group of assets. It added an initial screen to determine if substantially all of the fair value
of the gross assets acquired is concentrated in a single asset or group of similar assets under the business combination guidance
(ASC 805). If that screen is met, the set is not a business.
The
Trust is a passive investment for which there are no buying or selling of assets or royalty interests by the Trust. PEDEVCO is
to acquire all royalty interest only in the Trust’s producing properties in a single geographic area and no employees or
other assets or liabilities are to be acquired, aside from cash and cash equivalents. Cash and cash equivalents are excluded from
gross assets for the screen test. The Trust does not contain any working interest or operatorship in any of the producing properties
for which it is paid royalties. The Trust pays administration expenses to a Trustee for normal expenses of being a publicly traded
entity and to the operator of the properties when the operator is acting in its capacity as agent of the Trust.
When
considering the screen test in paragraphs 805-10-55-5A through 55C, PEDEVCO concluded that its investment in royalty interests
are a single asset in accordance with paragraph 805-10-55-5B. As a result, the set would meet the screen test and would not be
a business combination. Therefore, PEDEVCO applied the acquisition method of accounting.
Per
SEC reporting guidance for an asset acquisition, PEDEVCO is to allocate the fair value of the shares of PEDEVCO Common Stock to
be exchanged for outstanding Trust Common Units. The fair value of this consideration (purchase price) provided will then be allocated
to the net identifiable assets acquired from the Trust.
UNAUDITED
PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The
unaudited pro forma condensed combined financial statements are based on the historical consolidated financial statements of PEDEVCO
and the Trust as adjusted to give effect to the offer and second-step merger. The unaudited pro forma condensed
combined balance sheet as of June 30, 2020 assumes that the offer and second-step merger were completed
on June 30, 2020. The unaudited pro forma condensed combined statements of operations for the six months ended June 30, 2020 and
the year ended December 31, 2019 give pro forma effect to the offer and second-step merger as if they had occurred on January
1, 2019.
It
should be noted that PEDEVCO is not affiliated with the Trust and has not had the cooperation of the Trust or due diligence access
to the Trust in the preparation of these unaudited pro forma condensed combined financial statements. PEDEVCO has not received,
in connection with the proposed offer and second-step merger, information from the Trust for any purpose, including preparing
these unaudited pro forma condensed combined financial statements. Accordingly, these unaudited pro forma condensed combined financial
statements have been prepared by PEDEVCO based solely on publicly available information, including the Trust’s financial
statements filed with the SEC. Supplemental information and procedures may provide PEDEVCO with additional information that could
materially affect the purchase price allocation as well as the accompanying assumptions and pro forma adjustments. Disclosures
are included in the accompanying notes to the unaudited pro forma condensed combined financial information to the extent certain
limitations are identified, which may have a significant impact on the pro forma adjustments.
The
assumptions and estimates underlying the unaudited adjustments to the unaudited pro forma condensed combined financial statements
are described in the accompanying notes, which should be read in conjunction with, the following included elsewhere in this prospectus:
|
●
|
PEDEVCO’s
unaudited condensed financial statements and related notes as of and for the three and
six months ended June 30, 2020.
|
|
●
|
The
Trust’s unaudited condensed consolidated financial statements and related notes
as of and for the three and six months ended June 30, 2020.
|
|
●
|
PEDEVCO’s
audited financial statements and related notes for the year ended December 31, 2019.
|
|
●
|
The
Trust’s audited consolidated financial statements and related notes for the year
ended December 31, 2019.
|
|
●
|
PEDEVCO’s
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
|
|
●
|
The
Trust’s Management’s Discussion and Analysis of Financial Condition and Results
of Operations.
|
PEDEVCO
applied ASC 805 Business Combinations (“ASC 805”) to determine if the proposed transaction represents a business combination
or an asset acquisition, per SEC rules and US GAAP. ASC 805 states that if an entity concludes that substantially all of the
fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable
assets, then the acquisition is accounted for as an asset acquisition. Also, under ASC 805 guidance, three elements to an
integrated set of activities are required for an entity to be classified as a business: inputs, processes, and
outputs.
Per
ASC 805 guidance, PEDEVCO concluded that substantially all of the fair value of the gross assets acquired is concentrated in a
single identifiable asset (royalty interest) and, therefore, the set is not considered a business, and no further analysis is
required (see “The Offer—Accounting Treatment” for additional discussion of the account treatment of the proposed
transaction).
The
table below summarizes the allocation of the purchase price to the net identifiable assets acquired. This allocation is based
on the price of PEDEVCO common stock at closing on October 9, 2020 of $1.45 per share (in thousands except for share or unit and
per share or unit data):
Consideration paid:
|
|
|
|
Common stock (21,000,000 shares at $1.45 per share as of October 9, 2020) (1)
|
|
$
|
30,450,000
|
|
Estimated transaction fees (2)
|
|
|
566,000
|
|
Total consideration paid
|
|
$
|
31,016,000
|
|
|
|
|
|
|
Net assets acquired:
|
|
|
|
|
Cash
|
|
$
|
2,763,000
|
|
Investment in royalty interests
|
|
|
28,253,000
|
|
Total net assets acquired
|
|
$
|
31,016,000
|
|
(1)
|
Based
on the closing share price on October 9, 2020 of PEDEVCO ($1.45) and the Trust ($0.4214),
PEDEVCO is offering 4/10ths of one share of PEDEVCO Common Stock for each outstanding
Trust Common Unit, which would represent the issuance of 21,000,000 shares of PEDEVCO
Common Stock in exchange for the 52,500,000 outstanding Trust Common Units. PEDEVCO currently
has 72,463,340 shares of issued and outstanding common stock and with the addition of
the 21,000,000 shares, noted above, that would bring the total number of PEDEVCO shares
issued and outstanding to 93,463,340.
|
(2)
|
Represents
estimated transaction fees associated with the acquisition, which include $300,000 (legal
fees), $137,600 (information agent fees), $52,000 (solicitation), $34,000 (printing fees),
$30,000 (exchange agent fees), $9,000 (accounting fees), $3,300 (SEC filing fees) and
$500 (reserve engineer fees). For asset acquisitions, transaction costs are capitalized
as a component of the purchase price.
|
The
unaudited pro forma condensed combined financial statements do not give effect to any anticipated synergies, operating
efficiencies or cost savings that may be associated with the offer and second-step merger.
The
unaudited condensed combined pro forma adjustments reflecting the consummation of the offer and second-step merger are based on
certain estimates and assumptions. These estimates and assumptions are based on information available as of the dates of these
unaudited pro forma condensed combined financial statements and may be revised as additional information becomes available. Therefore,
it is likely that the actual adjustments will differ from the pro forma adjustments and it is possible the difference may be material.
The unaudited pro forma condensed combined financial statements also do not give effect to any anticipated synergies, operating
efficiencies or cost savings that may be associated with the offer and second-step merger.
Upon
consummation of the offer and second-step merger, PEDEVCO anticipates reviewing the allocation above for impairment triggering
events such as, but not limited to, significant downturns in
economic conditions related to the oil and gas industry, increased competition, and regulatory action. Currently, PEDEVCO
expects commodity prices to remain volatile for the remainder of the year. Commodity prices are affected by many factors outside
of PEDEVCO’s control, including changes in market supply and demand, which are impacted
by, among other factors, weather conditions, inventory storage levels, basis differentials and other factors. As a result, PEDEVCO
cannot accurately predict future commodity prices and, therefore, PEDEVCO cannot determine with any degree of certainty what effect
increases or decreases in these prices will have on production volumes or revenues. Therefore, material write-downs and impairment
of the net assets acquired in subsequent periods may occur if commodity prices decline significantly.
The
purpose of the offer is for PEDEVCO to acquire all of the outstanding Trust Common Units in order to combine the businesses of
PEDEVCO and the Trust. In the offer and second-step merger, each Trust Common Unit will be exchanged
for 4/10ths of one share of PEDEVCO’s common stock.
PEDEVCO
CORP.
UNAUDITED
PROFORMA COMBINED BALANCE SHEET
as
of June 30, 2020
|
|
PEDEVCO Corp
|
|
|
The Trust
|
|
|
Pro-Forma
Adjustments
|
|
Pro-Forma
Combined
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
10,209
|
|
|
$
|
2,763
|
|
|
$
|
(566
|
)(a)
|
$
|
12,406
|
|
Accounts receivable – oil and gas
|
|
|
646
|
|
|
|
—
|
|
|
|
—
|
|
|
646
|
|
Prepaid expenses and other current assets
|
|
|
33
|
|
|
|
—
|
|
|
|
—
|
|
|
33
|
|
Total current assets
|
|
|
10,888
|
|
|
|
2,763
|
|
|
|
(566
|
)
|
|
13,085
|
|
Oil and gas properties:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil and gas properties, subject to amortization, net
|
|
|
83,744
|
|
|
|
—
|
|
|
|
—
|
|
|
83,744
|
|
Oil and gas properties, not subject to amortization, net
|
|
|
8,090
|
|
|
|
—
|
|
|
|
—
|
|
|
8,090
|
|
Total oil and gas properties, net
|
|
|
91,834
|
|
|
|
—
|
|
|
|
—
|
|
|
91,834
|
|
Investment in royalty interests
|
|
|
—
|
|
|
|
549,831
|
|
|
|
5,715
|
(b)
|
|
555,546
|
|
Less: accumulated amortization and impairment
|
|
|
—
|
|
|
|
(527,293
|
)
|
|
|
—
|
|
|
(527,293
|
)
|
Net investment in royalty interests
|
|
|
—
|
|
|
|
22,538
|
|
|
|
5,715
|
|
|
28,253
|
|
Operating lease – right-of-use asset
|
|
|
316
|
|
|
|
—
|
|
|
|
—
|
|
|
316
|
|
Other assets
|
|
|
3,557
|
|
|
|
—
|
|
|
|
—
|
|
|
3,557
|
|
Total assets
|
|
$
|
106,595
|
|
|
$
|
25,301
|
|
|
$
|
5,149
|
|
$
|
137,045
|
|
Liabilities and Shareholders’ Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
2,729
|
|
|
$
|
—
|
|
|
$
|
—
|
|
$
|
2,729
|
|
Accrued expenses
|
|
|
299
|
|
|
|
—
|
|
|
|
—
|
|
|
299
|
|
Revenue payable
|
|
|
799
|
|
|
|
—
|
|
|
|
—
|
|
|
799
|
|
PPP loan - current
|
|
|
93
|
|
|
|
—
|
|
|
|
—
|
|
|
93
|
|
Operating lease liabilities – current
|
|
|
101
|
|
|
|
—
|
|
|
|
—
|
|
|
101
|
|
Total current liabilities
|
|
|
4,021
|
|
|
|
—
|
|
|
|
—
|
|
|
4,021
|
|
Long-term liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PPP loan
|
|
|
277
|
|
|
|
—
|
|
|
|
—
|
|
|
277
|
|
Operating lease liabilities
|
|
|
248
|
|
|
|
—
|
|
|
|
—
|
|
|
248
|
|
Asset retirement obligations
|
|
|
1,973
|
|
|
|
—
|
|
|
|
—
|
|
|
1,973
|
|
Total liabilities
|
|
|
6,519
|
|
|
|
—
|
|
|
|
—
|
|
|
6,519
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock, $0.001 par value, 200,000,000 shares authorized; 93,125,328 shares issued and outstanding
|
|
|
72
|
|
|
|
—
|
|
|
|
21
|
(c)
|
|
93
|
|
TRUST CORPUS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trust corpus, 52,500,000 units issued and outstanding at June 30, 2020
|
|
|
—
|
|
|
|
25,301
|
|
|
|
(25,301
|
)(d)
|
|
—
|
|
Additional paid-in capital
|
|
|
202,598
|
|
|
|
—
|
|
|
|
30,429
|
(c)
|
|
233,027
|
|
Accumulated deficit
|
|
|
(102,594
|
)
|
|
|
—
|
|
|
|
—
|
|
|
(102,594
|
)
|
Total shareholders’ equity
|
|
|
100,076
|
|
|
|
25,301
|
|
|
|
5,149
|
|
|
130,526
|
|
Total liabilities and shareholders’ equity
|
|
$
|
106,595
|
|
|
$
|
25,301
|
|
|
$
|
5,149
|
|
$
|
137,045
|
|
(a)
Reflects estimated transaction fees associated with the acquisition (see purchase price allocation table above).
(b)
Reflects the amount of consideration (purchase price) of the net identifiable assets acquired (see purchase price allocation table
above).
(c)
Reflects the issuance of 4/10ths of one share of PEDEVCO Common Stock for each Trust Common Unit.
(d)
Reflects the elimination of the equity of the Trust as part of the transaction.
PEDEVCO
CORP.
UNAUDITED
PROFORMA COMBINED STATEMENT OF OPERATIONS
For
the six months ended June 30, 2020
(amounts
in thousands, except share and per share data)
|
|
PEDEVCO
Corp
|
|
|
The
Trust
|
|
|
Pro-Forma
Adjustments
|
|
|
Pro-Forma
Combined
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil and
gas sales
|
|
$
|
3,488
|
|
$
|
—
|
|
$
|
—
|
|
$
|
3,488
|
|
Royalty income
|
|
|
—
|
|
|
5,292
|
|
|
—
|
|
|
5,292
|
|
Total Revenues
|
|
|
3,488
|
|
|
5,292
|
|
|
—
|
|
|
8,780
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease operating costs
|
|
|
2,272
|
|
|
1,981
|
*
|
|
—
|
|
|
4,253
|
|
Exploration expense
|
|
|
30
|
|
|
—
|
|
|
—
|
|
|
30
|
|
Selling, general and
administrative expense
|
|
|
3,545
|
|
|
1,046
|
|
|
—
|
|
|
4,591
|
|
Depreciation, depletion,
amortization and accretion
|
|
|
5,349
|
|
|
—
|
|
|
—
|
|
|
5,349
|
|
Total operating expenses
|
|
|
11,196
|
|
|
3,027
|
|
|
—
|
|
|
14,223
|
|
Operating income (loss)
|
|
|
(7,708
|
)
|
|
2,265
|
|
|
—
|
|
|
(5,443
|
)
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
32
|
|
|
—
|
|
|
—
|
|
|
32
|
|
Other income (expense)
|
|
|
678
|
|
|
—
|
|
|
—
|
|
|
678
|
|
Cash reserves used for
current Trust expenses, net of amounts used
|
|
|
—
|
|
|
1,945
|
|
|
—
|
|
|
1,945
|
|
Total other income (expense)
|
|
|
710
|
|
|
1,945
|
|
|
—
|
|
|
2,655
|
|
Net loss
|
|
$
|
(6,998
|
)
|
|
—
|
|
$
|
4,210
|
(a)
|
$
|
(2,788
|
)
|
Distributable income
available to unitholders
|
|
|
|
|
$
|
4,210
|
|
$
|
(4,210
|
)(a)
|
|
|
|
Loss per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.10
|
)
|
|
|
|
|
|
|
$
|
(0.03)
|
|
Diluted
|
|
$
|
(0.10
|
)
|
|
|
|
|
|
|
$
|
(0.03)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributable income
per unit (52,500,000 units issued and outstanding)
|
|
|
|
|
$
|
0.080
|
|
|
|
|
|
|
|
Weighted average number
of common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
72,060,812
|
|
|
|
|
|
21,000,000
|
(b)
|
|
93,060,812
|
|
Diluted
|
|
|
72,060,812
|
|
|
|
|
|
21,000,000
|
(b)
|
|
93,060,812
|
|
*
Includes post-production expenses, production taxes, property taxes and franchise taxes.
(a)
Reflects the combining of net income (loss) associated with the acquisition.
(b)
Reflects the issuance of 4/10ths of one share of PEDEVCO Common Stock for each Trust Common Unit (see purchase price allocation
table above).
PEDEVCO
CORP.
UNAUDITED
PROFORMA COMBINED STATEMENT OF OPERATIONS
For
the year ended December 31, 2019
(amounts
in thousands, except share and per share data)
|
|
PEDEVCO
Corp
|
|
|
The
Trust
|
|
|
Pro-Forma
Adjustments
|
|
Pro-Forma
Combined
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
Oil and gas sales
|
|
$
|
12,972
|
|
|
$
|
—
|
|
|
$
|
—
|
|
$
|
12,972
|
|
Royalty income
|
|
|
—
|
|
|
|
22,442
|
|
|
|
—
|
|
|
22,442
|
|
Total Revenues
|
|
|
12,972
|
|
|
|
22,442
|
|
|
|
—
|
|
|
35,414
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease operating costs
|
|
|
6,817
|
|
|
|
1,158
|
*
|
|
|
—
|
|
|
7,975
|
|
Exploration expense
|
|
|
110
|
|
|
|
—
|
|
|
|
—
|
|
|
110
|
|
Selling, general and administrative expense
|
|
|
5,785
|
|
|
|
1,734
|
|
|
|
—
|
|
|
7,519
|
|
Depreciation, depletion, amortization and accretion
|
|
|
11,031
|
|
|
|
—
|
|
|
|
—
|
|
|
11,031
|
|
Loss on settlement of ARO
|
|
|
496
|
|
|
|
—
|
|
|
|
—
|
|
|
496
|
|
Total operating expenses
|
|
|
24,239
|
|
|
|
2,892
|
|
|
|
—
|
|
|
27,131
|
|
Gain on sale of oil and gas properties
|
|
|
1,040
|
|
|
|
—
|
|
|
|
—
|
|
|
1,040
|
|
Operating income (loss)
|
|
|
(10,227
|
)
|
|
|
19,550
|
|
|
|
—
|
|
|
9,323
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(824
|
)
|
|
|
—
|
|
|
|
—
|
|
|
(824
|
)
|
Interest income
|
|
|
55
|
|
|
|
—
|
|
|
|
—
|
|
|
55
|
|
Other expense
|
|
|
(106
|
)
|
|
|
—
|
|
|
|
—
|
|
|
(106
|
)
|
Cash reserves withheld, net of amounts used for current Trust expenses
|
|
|
—
|
|
|
|
2,261
|
|
|
|
—
|
|
|
2,261
|
|
Total other income (expense)
|
|
|
(875
|
)
|
|
|
2,261
|
|
|
|
—
|
|
|
1,386
|
|
Net income (loss)
|
|
$
|
(11,102
|
)
|
|
|
—
|
|
|
$
|
17,289
|
(a)
|
$
|
6,187
|
|
Distributable income available to unitholders
|
|
|
|
|
|
$
|
17,289
|
|
|
$
|
(17,289
|
)(a)
|
|
|
|
Earnings (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.22
|
)
|
|
|
|
|
|
|
|
|
$
|
0.09
|
|
Diluted
|
|
$
|
(0.22
|
)
|
|
|
|
|
|
|
|
|
$
|
0.09
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributable income per unit (52,500,000 units issued and outstanding)
|
|
|
|
|
|
$
|
0.329
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
51,214,986
|
|
|
|
|
|
|
|
21,000,000
|
(b)
|
|
72,214,986
|
|
Diluted
|
|
|
51,214,986
|
|
|
|
|
|
|
|
21,000,000
|
(b)
|
|
72,456,849
|
|
*
Includes post-production expenses, production taxes, property taxes and franchise taxes.
(a)
Reflects the combining of net income (loss) associated with the acquisition.
(b)
Reflects the issuance of 4/10ths of one share of PEDEVCO Common Stock for each Trust Common Unit (see purchase price allocation
table above).
Note
1. Basis of Pro Forma Presentation
The
historical consolidated financial statements have been adjusted in the unaudited pro forma condensed combined financial information
to give effect to pro forma events that are (1) directly attributable to the offer and second-step merger, (2) factually supportable,
and (3) with respect to the statement of operations, expected to have a continuing impact on the results of the combined company.
The
unaudited pro forma condensed combined financial statements have been prepared for illustrative purposes only and are not necessarily
indicative of what the actual results of operations and financial position would have been had the offer and second-step merger
taken place on the dates indicated, nor do they purport to project the future consolidated results of operations or financial
position of PEDEVCO. They should be read in conjunction with the historical consolidated financial statements and notes thereto
of PEDEVCO and the Trust.
There
were no significant intercompany balances or transactions between PEDEVCO and the Trust as of the date and for the period of these
unaudited pro forma combined financial statements.
The
pro forma basic and diluted earnings per share amounts presented in the unaudited pro forma condensed combined statements of operations
are based upon the number of PEDEVCO’s shares outstanding, assuming the Asset Acquisition and related transactions occurred
on January 1, 2019.
Note
2. Earnings (Loss) Per Share
Pro
Forma Weighted Average Shares (Basic and Diluted)
The
pro forma weighted average shares calculations have been performed for the six months ended June 30, 2020 and the year ended December
31, 2019. The unaudited condensed combined pro forma income loss per share (“EPS”), basic and diluted, are computed
by dividing income or loss by the weighted- average number of shares of common stock outstanding during the period and taking
into consideration the potentially dilutive effect of options and warrants.
Prior
to the proposed offer and second-step merger, PEDEVCO had 72,125,328 shares of common stock issued and outstanding as of June
30, 2020. In connection with the closing of the proposed offer and second step merger, 21,000,000 shares of PEDEVCO Common Stock
will be issued to the holders of Trust Common, resulting in a total of 93,125,328 shares of PEDEVCO common stock issued and outstanding
(see the Unaudited Proforma Combined Statements of Operations above for the combined income (loss) and weighted average share
amounts presented below).
|
|
For the Six Months Ended
June 30, 2020
Proforma Combined
|
|
|
For the Year Ended
December 31, 2019
Proforma Combined
|
|
Numerator:
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(2,788
|
)
|
|
$
|
6,187
|
|
Effect of common stock equivalents
|
|
|
—
|
|
|
|
—
|
|
Net income (loss) adjusted for common stock equivalents
|
|
$
|
(2,788
|
)
|
|
$
|
6,187
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average common shares – basic
|
|
|
93,060,812
|
|
|
|
72,214,986
|
|
Dilutive effect of common stock equivalents:
|
|
|
|
|
|
|
|
|
PEDEVCO Options and Warrants
|
|
|
—
|
|
|
|
241,863
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average common shares – diluted
|
|
|
93,060,812
|
|
|
|
72,456,849
|
|
Earnings (loss) per common share – basic
|
|
$
|
(0.03
|
)
|
|
$
|
0.09
|
|
Earnings (loss) per common share – diluted
|
|
$
|
(0.03
|
)
|
|
$
|
0.09
|
|
DESCRIPTION
OF PEDEVCO CAPITAL STOCK
The
following summary of the terms of the capital stock of PEDEVCO is not meant to be complete and is qualified by reference to the
relevant provisions of Texas law and the PEDEVCO Certificate of Formation and the PEDEVCO Bylaws. Copies of the PEDEVCO Certificate
of Formation and PEDEVCO Bylaws are included as exhibits to the Registration Statement for which this offer to exchange forms
a part and will be sent to holders of shares of PEDEVCO Common Stock and holders of Trust Common Units upon request. See “Where
You Can Find More Information” below.
Authorized
Capitalization
The
total number of authorized shares of PEDEVCO Common Stock is 200,000,000 shares, $0.001 par value per share.
The
total number of “blank check” authorized shares of PEDEVCO preferred stock is 100,000,000 shares, $0.001 par value
per share. The total number of designated shares of PEDEVCO Series A Convertible Preferred Stock is 66,625. No shares of any class
of preferred stock are outstanding
PEDEVCO
Common Stock
Voting
Rights. Each share of PEDEVCO Common Stock is entitled to one vote on all stockholder matters. Shares of PEDEVCO Common Stock
do not possess any cumulative voting rights.
Except
for the election of directors, if a quorum is present, an action on a matter is approved if it receives the affirmative vote of
the holders of a majority of the voting power of the shares of capital stock present in person or represented by proxy at the
meeting and entitled to vote on the matter, unless otherwise required by applicable law, Texas law, the PEDEVCO Certificate of
Formation or the PEDEVCO Bylaws. The election of directors will be determined by a plurality of the votes cast in respect of the
shares present in person or represented by proxy at the meeting and entitled to vote, meaning that the nominees with the greatest
number of votes cast, even if less than a majority, will be elected. The rights, preferences and privileges of holders of PEDEVCO
Common Stock are subject to, and may be impacted by, the rights of the holders of shares of any series of preferred stock that
PEDEVCO has designated, or may designate and issue in the future.
Dividend
Rights. Each share of PEDEVCO Common Stock is entitled to equal dividends and distributions per share with respect to the
PEDEVCO Common Stock when, as and if declared by The PEDEVCO Board, subject to any preferential or other rights of any outstanding
preferred stock.
Liquidation
and Dissolution Rights. Upon liquidation, dissolution or winding up, PEDEVCO Common Stock will be entitled to receive pro
rata on a share-for-share basis, the assets available for distribution to the stockholders after payment of liabilities and payment
of preferential and other amounts, if any, payable on any outstanding preferred stock.
Other
Matters. No holder of any shares of PEDEVCO Common Stock has a preemptive right to subscribe for any of PEDEVCO’s securities,
nor are any shares of PEDEVCO Common Stock subject to redemption or convertible into other securities.
Limitation
of Liability and Indemnification of Officers and Directors
Section
7.001 of the TBOC permits a Texas corporation to limit the personal liability of directors to it or its shareholders for monetary
damages for any act or omission in a director’s capacity as director. Under the provisions of Chapter 8 of the TBOC, PEDEVCO
may indemnify its directors, officers, employees and agents and purchase and maintain liability insurance for those persons. Chapter
8 of the TBOC provides that any director or officer of a Texas corporation may be indemnified against judgments, penalties, fines,
settlements and reasonable expenses actually incurred by him or her in connection with or in defending any action, suit or proceeding
in which he or she is a party by reason of his or her position. With respect to any proceeding arising from actions taken in his
or her official capacity as a director or officer, he or she may be indemnified so long as it shall be determined that he or she
conducted himself in good faith and that he or she reasonably believed that such conduct was in the corporation’s best interests.
In cases not concerning conduct in his or her official capacity as a director or officer, a director may be indemnified as long
as he or she reasonably believed that his or her conduct was not opposed to the corporation’s best interests. In the case
of any criminal proceeding, a director or officer may be indemnified if he or she had no reasonable cause to believe his or her
conduct was unlawful. If a director or officer is wholly successful, on the merits or otherwise, in connection with such a proceeding,
such indemnification is mandatory.
The
PEDEVCO Certificate of Formation provides that its directors are not personally liable to PEDEVCO or its shareholders for monetary
damages for an act or omission in their capacity as a director. A director may, however, be found liable for, and PEDEVCO may
be prohibited from indemnifying them against:
|
●
|
any
breach of the director’s duty of loyalty to PEDEVCO or its shareholders;
|
|
●
|
acts
or omissions not in good faith that constitute a breach of the director’s duty
to PEDEVCO;
|
|
●
|
acts
or omissions that involve intentional misconduct or a knowing violation of law;
|
|
●
|
any
transaction from which the director receives an improper benefit; or
|
|
●
|
acts
or omissions for which the liability is expressly provided by an applicable statute.
|
PEDEVCO’s
Certificate of Formation also provides that it will indemnify its directors, and may indemnify its agents, to the fullest extent
permitted by applicable Texas law from any expenses, liabilities or other matters. Insofar as indemnification for liabilities
arising under the Securities Act may be permitted for directors, officers and controlling persons of PEDEVCO under the PEDEVCO
Certificate of Formation, it is the position of the SEC that such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable.
Indemnification
Agreements
PEDEVCO
has entered into indemnification agreements with each of its officers and directors pursuant to which PEDEVCO has agreed, to the
maximum extent permitted by applicable law and subject to the specified terms and conditions set forth in each agreement, to indemnify
a director or officer who acts on PEDEVCO’s behalf and is made or threatened to be made a party to any action or proceeding
against expenses, judgments, fines and amounts paid in settlement that are incurred by such officer or director in connection
with the action or proceeding. The indemnification provisions apply whether the action was instituted by a third party or by PEDEVCO.
PEDEVCO also maintains insurance on behalf of its officers and directors that provides coverage for expenses and liabilities incurred
by them in their capacities as officers and directors.
Business
Combinations under Texas Law
A
number of provisions of Texas law, the PEDEVCO Certificate of Formation and PEDEVCO Bylaws could make it more difficult for the
acquisition of PEDEVCO by means of a tender offer, a proxy contest or otherwise and the removal of incumbent officers and directors.
These provisions are intended to discourage coercive takeover practices and inadequate takeover bids and to encourage persons
seeking to acquire control of PEDEVCO to negotiate first with the PEDEVCO Board.
PEDEVCO
is subject to the provisions of Title 2, Chapter 21, Subchapter M of the Texas Business Organizations Code (the “Texas Business
Combination Law”). That law provides that a Texas corporation may not engage in specified types of business combinations,
including mergers, consolidations and asset sales, with a person, or an affiliate or associate of that person, who is an “affiliated
shareholder”, for a period of three years from the date that person became an affiliated shareholder, subject to certain
exceptions (described below). An “affiliated shareholder” is generally defined as the holder of 20% or more of the
corporation’s voting shares. The law’s prohibitions do not apply if the business combination or the acquisition of
shares by the affiliated shareholder was approved by the board of directors of the corporation before the affiliated shareholder
became an affiliated shareholder; or the business combination was approved by the affirmative vote of the holders of at least
two-thirds of the outstanding voting shares of the corporation not beneficially owned by the affiliated shareholder, at a meeting
of shareholders called for that purpose, not less than six months after the affiliated shareholder became an affiliated shareholder.
Because
PEDEVCO has more than 100 of record shareholders, PEDEVCO is considered an “issuing public corporation” for purposes
of this law. The Texas Business Combination Law does not apply to the following:
|
●
|
the
business combination of an issuing public corporation: where the corporation’s
original charter or bylaws contain a provision expressly electing not to be governed
by the Texas Business Combination Law; or that adopts an amendment to its charter or
bylaws, by the affirmative vote of the holders, other than affiliated shareholders, of
at least two-thirds of the outstanding voting shares of the corporation, expressly electing
not to be governed by the Texas Business Combination Law and so long as the amendment
does not take effect for 18 months following the date of the vote and does not apply
to a business combination with an affiliated shareholder who became affiliated on or
before the effective date of the amendment;
|
|
●
|
a
business combination of an issuing public corporation with an affiliated shareholder
that became an affiliated shareholder inadvertently, if the affiliated shareholder divests
itself, as soon as possible, of enough shares to no longer be an affiliated shareholder
and would not at any time within the three-year period preceding the announcement of
the business combination have been an affiliated shareholder but for the inadvertent
acquisition;
|
|
●
|
a
business combination with an affiliated shareholder who became an affiliated shareholder
through a transfer of shares by will or intestacy and continuously was an affiliated
shareholder until the announcement date of the business combination; or
|
|
●
|
a
business combination of a corporation with its wholly owned Texas subsidiary if the subsidiary
is not an affiliate or associate of the affiliated shareholder other than by reason of
the affiliated shareholder’s beneficial ownership of voting shares of the corporation.
|
Neither
the PEDEVCO Certificate of Formation nor the PEDEVCO Bylaws contain any provision expressly providing that PEDEVCO will not be
subject to the Texas Business Combination Law. The Texas Business Combination Law may have the effect of
inhibiting a non-negotiated
merger or other business combination involving PEDEVCO, even if that event would be beneficial to PEDEVCO’s shareholders.
Anti-Takeover
Provisions of PEDEVCO Charter Documents
The
PEDEVCO Certificate of Formation and PEDEVCO Bylaws contain various provisions intended to promote the stability of PEDEVCO’s
stockholder base and render more difficult certain unsolicited or hostile attempts to take PEDEVCO over, that could disrupt PEDEVCO,
divert the attention of PEDEVCO’s directors, officers and employees and adversely affect the independence and integrity
of PEDEVCO’s business. These provisions include:
|
●
|
Special
Meetings of Stockholders — The PEDEVCO Bylaws provide that special meetings
of the stockholders may only be called by the PEDEVCO Chairman, President, a committee
of the PEDEVCO Board duly designated and whose powers and authority include the power
to call meetings, or upon written notice to the PEDEVCO Board by PEDEVCO stockholders
holding not less than 30% of PEDEVCO’s outstanding voting capital stock.
|
|
●
|
Amendment
of Bylaws — The PEDEVCO Bylaws may be amended by the PEDEVCO Board alone.
|
|
●
|
Advance
Notice Procedures — The PEDEVCO Bylaws establish an advance notice procedure
for stockholder proposals to be brought before an annual meeting of PEDEVCO stockholders.
At an annual meeting, PEDEVCO stockholders elect a Board of Directors and transact such
other business as may properly be brought before the meeting. By contrast, at a special
meeting, PEDEVCO stockholders may transact only the business for the purposes specified
in the notice of the meeting.
|
|
●
|
No
cumulative voting — The PEDEVCO Certificate of Formation and Bylaws do not
include a provision for cumulative voting in the election of directors.
|
|
●
|
Vacancies
— The PEDEVCO Bylaws provide that vacancies on the PEDEVCO may be filled by
a majority of directors in office, although less than a quorum, and not by the stockholders.
|
|
●
|
Preferred
Stock — The PEDEVCO Certificate of Formation allows PEDEVCO to issue up to
100,000,000 shares of preferred stock, of which 66,625 shares have been designated as
Series A Convertible Preferred Stock. The undesignated preferred stock may have rights
senior to those of the PEDEVCO Common Stock and that otherwise could adversely affect
the rights and powers, including voting rights, of the holders of PEDEVCO Common Stock.
In some circumstances, this issuance could have the effect of decreasing the market price
of the PEDEVCO Common Stock as well as having an anti-takeover effect.
|
|
●
|
Authorized
but Unissued Shares — The PEDEVCO Board may cause PEDEVCO to issue authorized
but unissued shares of PEDEVCO Common Stock in the future without stockholders’
approval. These additional shares may be utilized for a variety of corporate purposes,
including future public offerings to raise additional capital, corporate acquisitions
and employee benefit plans. The existence of authorized but unissued shares of PEDEVCO
Common Stock could render more difficult or discourage an attempt to obtain control of
a majority of PEDEVCO Common Stock by means of a proxy contest, tender offer, merger
or otherwise.
|
COMPARISON
OF THE RIGHTS OF HOLDERS
Holders
of Trust Common Units who validly tender their Trust Common Units in the offer and do not properly withdraw such Trust Common
Units will receive PEDEVCO Common Stock following consummation of the offer.
PEDEVCO
is a Texas corporation and the rights of holders of PEDEVCO Common Stock are governed by the TBOC, the PEDEVCO Certificate of
Formation and the PEDEVCO Bylaws. The Trust is a Delaware Statutory Trust and the rights of holders of Trust Common Units are
governed by the Trust Agreement and the Delaware Trust Act.
The
following is a summary comparison of:
|
●
|
the
current rights of holders of Trust Common Units; and
|
|
●
|
the
rights holders of Trust Common Units will have as holders of PEDEVCO Common Stock under
the TBOC, PEDEVCO Certificate of Formation and PEDEVCO Bylaws upon the consummation of
the offer and the second-step merger.
|
The
following summary is not a complete statement of the rights of holders PEDEVCO Common Stock or Trust Common Units or a complete
description of the specific provisions referred to below. The statements in this section are qualified in their entirety by reference
to, and are subject to, the detailed provisions of the TBOC, the Delaware Trust Act, the Trust Agreement, the PEDEVCO Certificate
of Formation and the PEDEVCO Bylaws. Copies of the PEDEVCO Certificate of Formation and PEDEVCO Bylaws included as exhibits to
the Registration Statement this offer to exchange forms a part and will be sent to holders of Trust Common Units, upon request.
See the section of this offer to exchange titled “Where You Can Find More Information.”
|
|
PEDEVCO
|
|
Trust
|
Authorized
Capital
|
|
|
|
|
|
|
The
total number of authorized shares of PEDEVCO Common Stock is 200,000,000 shares, $0.001
par value per share.
The
total number of “blank check” authorized shares of PEDEVCO preferred stock is 100,000,000 shares, $0.001 par
value per share. The total number of designated shares of PEDEVCO Series A Convertible Preferred Stock is 66,625.
|
|
The
beneficial interest in the Trust is divided into 52,500,000 Trust units, which now consist
solely of Trust Common Units. Each Trust unit represents an equal undivided beneficial
interest in the property of the Trust.
Neither
the Trustee nor the Delaware Trustee shall cause or permit the Trust to issue Trust Common Units or other securities after
the closing date of the initial public offering.
|
Voting
Rights
|
|
Each
share of PEDEVCO Common Stock is entitled to one vote on all stockholder matters. Shares
of PEDEVCO Common Stock do not possess any cumulative voting rights.
Except
as otherwise required by law, the holders of 33 1/3% of all of the shares of the PEDEVCO Common Stock entitled to vote
at the meeting, present in person or by proxy, shall constitute a quorum for all purposes at any meeting of stockholders.
In the absence of a quorum at any meeting or any adjournment thereof, the holders of a majority of the shares of stock
entitled to vote who are present, in person or by proxy, or, in the absence therefrom of all the stockholders, any officer
entitled to preside at, or to act as secretary of, such meeting may adjourn such meeting to another place, date or time.
Except
for the election of directors, if a quorum is present, an action on a matter is approved if it receives the affirmative
vote of the holders of a majority of the voting power of the shares of capital stock present in person
|
|
Holders
of Trust Common Units only have voting rights on matters specified in the Trust Agreement.
Matters
voted on by holders of Trust Common Units are subject to either a Unit Majority or a Special Unit Majority.
A
“Special Unit Majority” means (i) a majority of the Trust Common Units (excluding Trust Common Units owned
by Avalon and its Affiliates) present in person or by proxy at a meeting at which a quorum is present; provided, that,
at any time when Avalon and its Affiliates collectively own less than 10% of the outstanding Trust Common Units, “Special
Unit Majority” means a majority of the Trust Common Units present in person or by proxy at a meeting at which a
quorum is present. For the purposes of calculating a Special Unit Majority, abstentions and broker non-votes shall not
be deemed to be a vote cast.
A
“Unit Majority” means (i) a majority of the Trust Common Units (excluding Trust
|
|
|
or represented
by proxy at the meeting and entitled to vote on the matter, unless otherwise required by applicable law, Texas law, the
PEDEVCO Certificate of Formation, as amended or the PEDEVCO Bylaws, as amended.
The
election of directors will be determined by a plurality of the votes cast in respect of the shares present in person or
represented by proxy at the meeting and entitled to vote, meaning that the nominees with the greatest number of votes
cast, even if less than a majority, will be elected.
The
rights, preferences and privileges of holders of PEDEVCO Common Stock are subject to, and may be impacted by, the rights
of the holders of shares of any series of preferred stock that PEDEVCO has designated, or may designate and issue in the
future.
|
|
Common Units owned by Avalon
and its Affiliates) and (ii) a majority of the Trust Common Units, in each case present in person or by proxy at a meeting
at which a quorum is present; provided, that, at any time when Avalon and its Affiliates collectively own less than 10%
of the outstanding Trust Common Units, “Unit Majority” means a majority of the Trust Units present in person
or by proxy at a meeting at which a quorum is present. For the purposes of calculating a Unit Majority, abstentions and
broker non-votes shall not be deemed to be a vote cast.
|
Number
and Election of Directors; Matters Related to the Trustee
|
|
PEDEVCO’s
Bylaws provide that the number of directors who shall constitute the PEDEVCO Board shall
equal not less than 1 nor more than 10, as the PEDEVCO Board or majority stockholders
may determine by resolution from time to time.
PEDEVCO’s
Bylaws provide that stockholders of PEDEVCO shall elect the directors at the annual or adjourned annual meeting (except
as otherwise provided herein for the filling of vacancies). Each director shall hold office until his death, resignation,
retirement, removal, or disqualification, or until his successor shall have been elected and qualified.
|
|
The
Trust does not have directors. The Trust Agreement provides voting rights to holders
of Trust Common Units to remove and replace (but not elect) the Trustee. See “Vacancies
on the Board of Directors and Removal of Directors; Vacancy and Removal of Trustee”
below.
|
Vacancies
on the Board of Directors and Removal of Directors; Vacancy and Removal of Trustee
|
|
The
PEDEVCO Bylaws provide that any vacancy on the PEDEVCO Board, whether because of death,
resignation, disqualification, an increase in the number of directors, or any other cause
may be filled by a majority of the remaining directors, a sole remaining director, or
the majority stockholders. Any director elected to fill a vacancy shall hold office until
his death, resignation, retirement, removal, or disqualification, or until his successor
shall have been elected and qualified.
PEDEVCO’s
Bylaws provide that stockholders holding a majority of the outstanding shares entitled to vote at an election of directors
may remove any director or the entire Board of Directors at any time, with or without cause.
|
|
The
Delaware Trustee or the Trustee may be removed as trustee, with or without cause, by
the vote of a Special Unit Majority at a meeting duly called and held in accordance with
the Trust Agreement; provided, however, that any removal of the Delaware Trustee shall
be effective only at such time as a successor Delaware Trustee, fulfilling the requirements
of Section 3807(a) of the Delaware Trust Act, has been appointed and has accepted such
appointment; and provided, further, that any removal of the Trustee shall be effective
only at such time as a successor Trustee has been appointed and has accepted such appointment
in accordance with the Trust Agreement.
Avalon
will not be entitled to vote on the removal of the Trustee or appointment of a successor trustee. However, at any time
Avalon and its affiliates own less than 10% of the total
|
|
|
|
|
Trust Common Units outstanding, matters voted on by holders of
Trust Common Units will be subject to approval by a majority of the Trust Common Units, including Trust Common Units owned
by Avalon, voting in person or by proxy at a meeting of such holders at which a quorum is present.
|
Amendments
to Certificate of Formation and Certificate of Trust
|
|
PEDEVCO’s
Certificate of Formation provides that in addition to any vote of the holders of any
class or series of the stock of PEDEVCO required by law or by the PEDEVCO Certificate
of Formation, the affirmative vote of the holders of a majority of the voting power of
all of the then outstanding shares of capital stock of PEDEVCO entitled to vote generally
in the election of directors, voting together as a single class, shall be required to
amend or repeal provisions of PEDEVCO Certificate of Formation, except to the extent
a greater vote is required by the PEDEVCO Certificate of Formation or any provision of
law.
Notwithstanding
any other provisions of the PEDEVCO Certificate of Formation or any provision of law that might otherwise permit a lesser
or no vote, but in addition to any affirmative vote of the holders of any particular class or series of the capital stock
of PEDEVCO required by law or by the PEDEVCO Certificate of Formation, the affirmative vote of the holders of not less
than a majority of the outstanding shares of capital stock of PEDEVCO then entitled to vote upon the election of directors,
voting together as a single class, shall be required to amend, repeal or adopt any provision inconsistent with, Article
V, Article IX, Article X, or Article XI of the PEDEVCO Certificate of Formation.
|
|
Section
3810(b)(1) of the Delaware Trust Act provides that a certificate of trust may be amended
by filing a certificate of amendment thereto in the office of the Secretary of State
of the State of Delaware. Section 3810(b)(2) provides that except to the extent otherwise
provided in the certificate of trust or in the governing instrument of a statutory trust,
a certificate of trust may be amended at any time for any purpose as the trustees may
determine. A trustee who becomes aware that any statement in a certificate of trust was
false when made or that any matter described has changed making the certificate false
in any material respect shall promptly file a certificate of amendment.
The
Trust Agreement provides that in the event that a responsible officer of either the Delaware Trustee or the Trustee becomes
aware that any statement contained or matter described in the Trust’s Certificate of Trust has changed, making it
false in any material respect, it will notify the other trustee and the Delaware Trustee shall promptly file or cause
to be filed in the office of the Secretary of State of Delaware an amendment of same at the written direction of the Trustee,
duly executed in accordance with Section 3811 of the Trust Act, in order to effect such change thereto.
The
Trust Agreement further provides that upon the written request by Avalon submitted to the Trustee and the Delaware Trustee,
the Trustee shall, without the vote or consent of any holders of Trust Common Units, take all action necessary to change
the name of the Trust to a name mutually agreeable to the Trustee and Avalon and, upon effecting such name change, the
Delaware Trustee, acting pursuant to the written instructions of the Trustee, shall amend the Certificate of Trust on
file in the office of the Secretary of State of the state of Delaware to reflect such name change.
|
Amendments
to Bylaws and Trust Agreement
|
|
Subject
to the provision of PEDEVCO’s Certificate of Formation, the PEDEVCO Bylaws may be amended by the PEDEVCO Board or by
the holders of PEDEVCO Common Stock.
|
|
Amendment
of the Trust Agreement generally requires the vote of holders of (i) a majority of the
Trust Common Units (excluding Trust Common Units owned by Avalon and its affiliates)
and (ii) a majority of the Trust Common Units (including Trust Common Units owned by
Avalon and its affiliates), in each case voting in person or by proxy at a meeting of
such holders of Trust Common Units at which a quorum is present. At any time that Avalon
and its affiliates own less than 10% of the total Trust Common Units outstanding, however,
the standard for approval will be the vote of the holders of a majority of the Trust
Common Units, including Trust Common Units owned by Avalon, voting in person or by proxy
at a meeting of the holders of Trust Common Units at which a quorum is present. Abstentions
and broker non-votes will not be deemed to be a vote cast. However, no amendment may:
●
increase the power of the Trustee to engage in business or investment activities;
●
alter the rights of the holders of Trust Common Units as among themselves; or
●
permit the Trustee to distribute the Royalty Interests in kind.
Amendments
to the Trust Agreement’s provisions addressing the following matters may not be made without Avalon’s consent:
●
dispositions of the Trust’s assets;
●
indemnification of the Trustee;
●
reimbursement of out-of-pocket expenses of Avalon when acting as the Trust’s agent;
●
termination of the Trust; and
●
amendments of the Trust Agreement.
Certain
amendments to the Trust Agreement do not require the vote of the holders of Trust Common Units. The Trustee may amend
or supplement the Trust Agreement, the conveyances, the Administrative Services Agreement, or the registration rights
agreement, without the approval of the holders of Trust Common Units, to cure ambiguities, to correct or supplement defective
or inconsistent provisions, to grant any benefit to all holders of Trust Common Units, to evidence or implement any changes
required by applicable law, or to change the name of the Trust; provided, however, that any such supplement or amendment
does not adversely affect the interests of the holders of Trust Common Units.
|
|
|
|
|
Furthermore, the Trustee, acting alone,
may amend the Administrative Services Agreement without the approval of holders of Trust Common Units if such amendment
would not increase the cost or expense of the Trust or create an adverse economic impact on the holders of Trust Common
Units.
All
other permitted amendments to the Trust Agreement and other agreements listed above may only be made by the vote of the
holders of (i) a majority of the Trust Common Units (excluding Trust Common Units owned by Avalon) and (ii) a majority
of the Trust Common Units (including Trust Common Units owned by Avalon), in each case voting in person or by proxy at
a meeting of such holders at which a quorum is present; except that at any time that Avalon owns less than 10% of the
total Trust Common Units outstanding, the standard for approval will be the vote of the holders of a majority of the Trust
Common Units, including Trust Common Units owned by Avalon, voting in person or by proxy at a meeting of such holders
at which a quorum is present. Abstentions and broker non-votes will not be deemed to be a vote cast.
|
Ability
to Call Special Meeting of Stockholders and holders of Trust Common Units
|
|
The
PEDEVCO Bylaws provide that special meetings of the stockholders may only be called by
the PEDEVCO Chairman, President, a committee of the PEDEVCO Board duly designated and
whose powers and authority include the power to call meetings, or upon written notice
to the PEDEVCO Board by PEDEVCO stockholders holding not less than 30% of PEDEVCO’s
outstanding voting capital stock.
|
|
Any
special meeting of the holders of Trust Common Units may be called by the (i) Trustee
or (ii) by holders of Trust Common Units owning of record not less than 10% in number
of the then outstanding Trust Common Units. The Trustee may, but shall not be obligated
to, call meetings of holders of Trust Common Units to consider amendments, waivers, consents
and other changes relating to the transaction documents to which the Trust is a party.
In addition, at the written request of the Delaware Trustee, unless the Trustee appoints
a successor Delaware Trustee in accordance with Section 6.05 of the Trust Agreement,
the Trustee shall call such a meeting but only for the purpose of appointing a successor
to the Delaware Trustee upon its resignation.
|
Ability
of Stockholders or Unitholders to Act by Written Consent
|
|
PEDEVCO’s
Bylaws provide that any action required to be taken at any annual or special meeting
of stockholders of PEDEVCO or any action which may be taken at any annual or special
meeting of such stockholders, may be taken without a meeting, without prior notice and
without a vote, if a consent or consents in writing setting forth the action so taken,
shall have been signed by the holder or holders of shares representing at least the minimum
number of votes that would be necessary to take the action that is the subject of the
consent at a meeting in which each stockholder entitled to vote on the action is present
and votes.
|
|
Section
3806(f)(1) of the Delaware Trust Act provides that unless otherwise provided in the governing
instrument of a statutory trust, on any matter that is to be voted on by the beneficial
owners, the beneficial owners may take such action without a meeting, without a prior
notice and without a vote if consented to, in writing, or by electronic transmission
by beneficial owners having not less than the minimum number of votes that would be necessary
to authorize or take such action at a meeting at which all interests in the statutory
trust entitled to vote thereon were present and voted.
The
Trust Agreement does not expressly prohibit action by written consent.
|
Limitations
of Personal Liability and Indemnification of Directors and Officers, Trustee and other persons
|
|
Section
7.001 of the TBOC permits a Texas corporation to limit the personal liability of directors
to it or its shareholders for monetary damages for any act or omission in a director’s
capacity as director. Under the provisions of Chapter 8 of the TBOC, PEDEVCO may indemnify
its directors, officers, employees and agents and purchase and maintain liability insurance
for those persons. Chapter 8 of the TBOC provides that any director or officer of a Texas
corporation may be indemnified against judgments, penalties, fines, settlements and reasonable
expenses actually incurred by him or her in connection with or in defending any action,
suit or proceeding in which he or she is a party by reason of his or her position. With
respect to any proceeding arising from actions taken in his or her official capacity
as a director or officer, he or she may be indemnified so long as it shall be determined
that he or she conducted himself in good faith and that he or she reasonably believed
that such conduct was in the corporation’s best interests. In cases not concerning
conduct in his or her official capacity as a director or officer, a director may be indemnified
as long as he or she reasonably believed that his or her conduct was not opposed to the
corporation’s best interests. In the case of any criminal proceeding, a director
or officer may be indemnified if he or she had no reasonable cause to believe his or
her conduct was unlawful. If a director or officer is wholly successful, on the merits
or otherwise, in connection with such a proceeding, such indemnification is mandatory.
The
PEDEVCO Certificate of Formation provides that its directors are not personally liable to PEDEVCO or its shareholders
for
|
|
Except
as expressly set forth in the Trust Agreement, none of the Trustee or the Delaware Trustee
shall have any duties or liabilities, including fiduciary duties, to the Trust or any
holder of Trust Common Units. To the extent that, at law or in equity, the Trustee and
the Delaware Trustee have duties, including fiduciary duties, and liabilities relating
thereto to the Trust or any holder of Trust Common Units, the Trustee and the Delaware
Trustee shall not be liable to the Trust or to any holder of Trust Common Units for its
good faith reliance on the provisions of the Trust Agreement. For the avoidance of doubt,
to the fullest extent permitted by law, no person other than the Trustee and the Delaware
Trustee shall have any duties (including fiduciary duties) or liabilities at law or in
equity to the Trust, any holder of Trust Common Units or any other person. The provisions
of the Trust Agreement, to the extent that they restrict or eliminate the duties (including
fiduciary duties) and liabilities of the Trustee or the Delaware Trustee or any other
person otherwise existing at law or in equity are agreed by the parties thereto and the
Trust to replace such other duties and liabilities of the Trustee, the Delaware Trustee
and such other Persons.
Notwithstanding
any other provision of this the Trust Agreement, each of the Delaware Trustee and the Trustee, in carrying out its powers
and performing its duties, may act directly or in its discretion (at the expense of the Trust) through Agents pursuant
to agreements entered into with any of them, and each of the Delaware Trustee and the Trustee shall be liable only for
(i) its own willful misconduct, (ii) acts or omissions in bad faith or that constitute gross negligence, and (iii) taxes,
fees or other charges based on any fees, commissions or
|
|
|
monetary damages for an act or omission in their capacity as a director. A director may, however, be found liable
for, and PEDEVCO may be prohibited from indemnifying them against:
●
any breach of the director’s duty of loyalty to PEDEVCO or its shareholders;
●
acts or omissions not in good faith that constitute a breach of the director’s duty to PEDEVCO;
●
acts or omissions that involve intentional misconduct or a knowing violation of law;
●
any transaction from which the director receives an improper benefit; or
●
acts or omissions for which the liability is expressly provided by an applicable statute.
PEDEVCO’s
Certificate of Formation also provides that it will indemnify its directors, and may indemnify its agents, to the fullest
extent permitted by applicable Texas law from any expenses, liabilities or other matters. Insofar as indemnification for
liabilities arising under the Securities Act may be permitted for directors, officers and controlling persons of PEDEVCO
under the PEDEVCO Certificate of Formation, it is the position of the SEC that such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable.
PEDEVCO
has entered into indemnification agreements with each of its officers and directors pursuant to which PEDEVCO has agreed,
to the maximum extent permitted by applicable law and subject to the specified terms and conditions set forth in each
agreement, to indemnify a director or officer who acts on PEDEVCO’s behalf and is made or threatened to be made
a party to any action or proceeding against expenses, judgments, fines and amounts paid in settlement that are incurred
by such officer or director in connection with the action or proceeding. The indemnification provisions apply whether
the action was instituted by a third party or by PEDEVCO. PEDEVCO also maintains insurance on behalf of its officers and
directors that provides coverage for expenses and liabilities incurred by them in their capacities as officers and directors.
|
|
compensation received by it in connection with any of the transactions
contemplated by this Agreement, and shall not otherwise be liable under any circumstances whatsoever, including but not
limited to any act or omission of any Agent unless such Entity has acted with willful misconduct, in bad faith or with
gross negligence in the selection, retention or supervision of such Agent. Notwithstanding any other provision of this
Agreement, each Agent of the Delaware Trustee and the Trustee (including Avalon and any of its Affiliates when acting
as such), in carrying out its powers and performing its duties, may act directly or in its discretion (at the expense
of the Trust) through its own agents and shall not otherwise be liable for any act or omission unless such Agent has acted
with willful misconduct, in bad faith or with gross negligence. Neither the Trustee nor the Delaware Trustee shall have
any liability to any persons other than the holders of Trust Common Units in accordance with Section 3803 of the Delaware
Trust Act and, for the avoidance of any doubt, neither shall have any liability hereunder to the holders of Trust Common
Units absent (i) its own willful misconduct or (ii) acts or omissions in bad faith or which constitute gross negligence.
No Trustee or Delaware Trustee shall be individually liable by reason of any act or omission of any other Trustee or Delaware
Trustee. In the event of a claim brought against the Delaware Trustee or the Trustee for willful misconduct, acts or omissions
in bad faith or gross negligence, their “management liability” insurance coverages (that is, directors &
officers liability and crime insurance coverages) shall be primary to, and non-contributing with, any other insurance
maintained by the holders of Trust Common Units.
Each
of the Delaware Trustee and the Trustee, and each Agent of the Delaware Trustee or the Trustee (including Avalon and any
of its Affiliates when acting as such), shall be protected in relying or reasonably acting upon any notice, certificate,
opinion or advice of counsel or tax advisor; report of independent registered public accounting firm, petroleum engineer,
geologist, auditor or other expert. In addition, each of the Delaware Trustee and the Trustee, and each Agent of the Delaware
Trustee or the Trustee (including Avalon and any of its Affiliates when acting as such) shall be protected in relying
or reasonably acting upon any other document or instrument reasonably believed by such entity or person to be true and
accurate. Each of the Delaware Trustee and the Trustee,
|
|
|
|
|
and each Agent of the Delaware Trustee or the Trustee (including
Avalon and any of its Affiliates when acting as such), is specifically authorized to rely upon the application of Article
8 of the Uniform Commercial Code, the application of the Uniform Act for Simplification of Fiduciary Security Transfers
and the application of other statutes and rules with respect to the transfer of securities, each as adopted and then in
force in the State of Delaware, as to all matters affecting title, ownership, warranty or transfer of the Trust Common
Units, without any personal liability for such reliance, and the indemnity granted under Section 6.02 of the Trust Agreement
shall specifically extend to any matters arising as a result thereof. Further, and without limiting the foregoing, each
of the Delaware Trustee and the Trustee is specifically authorized and directed to rely upon the validity of each of the
Conveyances and the title held by the Trust in the Royalty Interests pursuant thereto and the validity of the Derivatives
Agreement and Direct Hedge Contracts, and is further specifically authorized and directed to rely upon opinions of counsel
in the State of Texas where the Underlying Properties are located, and on any notice, certificate or other statement of
Avalon or information furnished by Avalon without any liability in any capacity for such reliance.
The
Trustee and the Delaware Trustee, as well as each of their respective Agents (including Avalon and any of its Affiliates
when acting as such) and Affiliates, shall be indemnified and held harmless by, and receive reimbursement from, the Trust
against and from any and all liabilities, obligations, actions, suits, costs, expenses, claims, damages, losses, penalties,
taxes, fees and other charges (collectively, “Expenses,” excluding, however, any taxes and fees payable by
the Trustee and the Delaware Trustee based on any fees, commissions or compensation received by the Trustee and the Delaware
Trustee for their services hereunder) incurred by it individually in the administration of the Trust, or as a result of
any act done or performed or omission occurring on account of its being Trustee or Delaware Trustee (or such Agent or
Affiliate), as applicable, except such Expenses as to which it is liable under Section 6.01 of the Trust Agreement. Each
of the Trustee and the Delaware Trustee shall have a lien upon the Trust Estate for payment of such indemnification and
reimbursement (including, without limitation, repayment of any funds borrowed from any Entity serving as a fiduciary hereunder),
as well as for compensation to be paid to such Entity, in each case entitling such
|
|
|
|
|
Entity to priority as to payment thereof
over payment to any other Person under this Agreement. Neither the Trustee, the Delaware Trustee, nor any of their respective
Agents shall be entitled to any reimbursement or indemnification from any holder of Trust Common Units for any Expense
incurred by the Delaware Trustee, or the Trustee or any of their respective Agents, their right of reimbursement and indemnification,
if any, except as provided in Section 6.02(b) of the Trust Agreement, being limited solely to the Trust Estate, whether
or not the Trust Estate is exhausted without full reimbursement or indemnification of the Trustee, the Delaware Trustee
or any of their respective Agents. All legal or other expenses reasonably incurred by the Trustee or the Delaware Trustee
in connection with the investigation or defense of any Expenses as to which such Entity is entitled to indemnity under
Section 6.02(a) of the Trust Agreement shall be paid out of the Trust Estate.
Avalon
shall indemnify and hold harmless each of the Delaware Trustee and the Trustee (but not the Trust or holder of Trust Common
Units), and any Agents and Affiliates thereof, individually and as trustee, against any Expenses to which such Entity
or Agent thereof may become subject solely as a result of its position and service as trustee of the Trust under or with
respect to any Environmental Law, insofar as such Expenses arise out of, are based upon or connected with the Underlying
Properties, except for Expenses arising from any acts of such Entity or Agent not expressly contemplated hereunder. Avalon
shall also indemnify and hold harmless each of the Delaware Trustee and the Trustee (but not the Trust or holders of Common
Units), and any Agents and Affiliates thereof, individually and as trustee, against any Expenses to which such Entity
or Agent thereof may become subject solely as a result of its position and service as trustee of the Trust arising out
of, based upon or connected with (i) any reset, termination and replacement, or other modification of any hedge contracts,
(ii) the assignment, novation or other transfer of any hedge contracts, or (iii) the entry by the Trust into new hedge
contracts, in each case pursuant to Section 2.02 of the Administrative Services Agreement or Article III of the Derivatives
Agreement. The obligations of Avalon hereunder may be assigned or transferred to any Entity acquiring the Underlying Property
to which each Expense relates; provided, however, such Entity unconditionally agrees in writing, reasonably satisfactory
to the Trustee and the Delaware
|
|
|
|
|
Trustee, to assume SandRidge’s obligations under Section 6.02(b).
If
any action or proceeding shall be brought or asserted against the Trustee or the Delaware Trustee or any Agent or Affiliate
thereof (each referred to as an “Indemnified Party” and, collectively, the “Indemnified Parties”)
in respect of which indemnity may be sought from Avalon (the “Indemnifying Party”) pursuant to Section 6.02(b),
of which the Indemnified Party shall have received notice, the Indemnified Party shall promptly notify the Indemnifying
Party in writing, and the Indemnifying Party shall assume the defense thereof, including the employment of counsel reasonably
satisfactory to the Indemnified Party and the payment of all expenses. The Indemnified Party shall have the right to employ
separate counsel in any such action and to participate in the defense thereof, but the fees and expenses of such counsel
shall be at the expense of the Indemnified Party unless (i) the Indemnifying Party has agreed to pay such fees and expenses,
(ii) the Indemnifying Party shall have failed to assume the defense of such action or proceeding and employ counsel reasonably
satisfactory (including the qualifications of such counsel) to the Indemnified Party in respect of any such action or
proceeding or (iii) the named parties to any such action or proceeding include both the Indemnified Party and the Indemnifying
Party, and the Indemnified Party shall have been advised by counsel that there may be one or more legal defenses available
to such Indemnified Party that are different from or additional to those available to the Indemnifying Party (in which
case, if the Indemnified Party notifies the Indemnifying Party in writing that it elects to employ separate counsel at
the expense of the Indemnifying Party, the Indemnifying Party shall not have the right to assume the defense of such action
or proceeding on behalf of the Indemnified Party and the Indemnified Party may employ such counsel for the defense of
such action or proceeding as is reasonably satisfactory to the Indemnifying Party; it being understood, however, that
the Indemnifying Party shall not, in connection with any one such action or proceeding or separate but substantially similar
or related actions or proceedings in the same jurisdiction arising out of the same general allegations or circumstances,
be liable for the fees and expenses of more than one separate firm of attorneys for the Indemnified Parties at any time).
The Indemnifying Party shall not be liable for any settlement of any such action or proceeding effected without the written
consent
|
|
|
|
|
of the Indemnifying Party (which consent shall not be unreasonably withheld, conditional or delayed), but, if
settled with such written consent, or if there be a final judgment for the plaintiff in any such action or proceeding,
the Indemnifying Party agrees (to the extent stated above) to indemnify and hold harmless the Indemnified Party from and
against any loss or liability by reason of such settlement or judgment to the extent provided for in Section 6.02(b).
Avalon
and its Affiliates have entered into the Transaction Documents to which they are a party and may exercise their rights
and discharge their obligations fully, without hindrance or regard to conflict of interest principles, duty of loyalty
principles or other breach of fiduciary duties, all of which defenses, claims or assertions are hereby expressly waived
by the other parties to the Trust Agreement and holders of Trust Common Units. Neither SandRidge nor any of its Affiliates
shall be a fiduciary with respect to the Trust or the holders of Trust Common Units. To the extent that, at law or in
equity, SandRidge or its Affiliates have duties (including fiduciary duties) and liabilities relating thereto to the Trust
or to the holders of Trust Common Units, such duties and liabilities are hereby eliminated to the fullest extent permitted
by law.
|
Preemptive
Rights, Redemption and Conversion
|
|
No
holder of any shares of PEDEVCO Common Stock has a preemptive right to subscribe for
any of PEDEVCO’s securities, nor are any shares of PEDEVCO Common Stock subject
to redemption or convertible into other securities.
|
|
Holders
of Trust Common Units do not have preemptive rights.
|
Dividends
and Distributions
|
|
Each
share of PEDEVCO Common Stock is entitled to equal dividends and distributions per share
with respect to the PEDEVCO Common Stock when, as and if declared by the PEDEVCO Board,
subject to any preferential or other rights of any outstanding preferred stock.
|
|
The
Trustee makes quarterly cash distributions of substantially all of its cash receipts,
after deducting amounts for the Trust’s administrative expenses, property taxes
and Texas franchise taxes, and cash reserves withheld by the Trustee, on or about the
60th day following the completion of each quarter. Each distribution covers production
for a three-month period. The amount of Trust revenues and cash distributions to holders
of Trust Common Units depends on:
●
oil, natural gas and NGL prices received;
●
volume of oil, natural gas and NGL produced and sold;
●
post-production costs (which includes internal costs and third person costs incurred
|
|
|
|
|
by Avalon) and any applicable taxes;
and
●
the Trust’s general and administrative expenses.
The
amount of the quarterly distributions will fluctuate from quarter to quarter, depending on the factors discussed above.
There is no minimum required distribution.
|
Liquidation
and Dissolution Rights
|
|
Pursuant
to the TBOC, the winding up of a domestic corporation is required on:
●
the expiration of any period of duration specified in the domestic entity's governing documents;
●
a voluntary decision to wind up the domestic entity;
●
an event specified in the governing documents of the domestic entity requiring the winding up, dissolution, or termination
of the domestic entity, other than an event specified in another subdivision of this section;
●
an event specified in other sections of this code requiring the winding up or termination of the domestic entity, other
than an event specified in another subdivision of this section; or
●
a decree by a court requiring the winding up, dissolution, or termination of the domestic entity, rendered under this
code or other law.
Upon
liquidation, dissolution or winding up, PEDEVCO Common Stock will be entitled to receive pro rata on a share-for-share
basis, the assets available for distribution to the stockholders after payment of liabilities and payment of preferential
and other amounts, if any, payable on any outstanding preferred stock.
|
|
The
Trust shall dissolve and commence winding-up its business and affairs upon the first
to occur of the following events or times:
●
the disposition of all of the Royalty Interests and other assets (other than cash), tangible or intangible, including
accounts receivable and claims or rights to payment, constituting the Trust estate;
●
an election by the Trustee to dissolve the Trust that is approved by the holders of a Unit Majority at a meeting duly
called and held in accordance with Article VIII of the Trust Agreement;
●
the aggregate Quarterly Cash Distribution Amounts for any four consecutive quarters, on a cumulative basis, is less than
$5.0 million;
●
the entry of a decree of judicial dissolution of the Trust pursuant to the provisions of the Trust Act; and
●
the Liquidation Date.
Upon
the sale of all or a portion of the Trust Estate pursuant to Section 3.02 of the Trust Agreement or the dissolution of
the Trust pursuant to the provisions above, the Trustee shall sell for cash in one or more sales all of the properties
other than cash then constituting the Trust Estate after any reconveyance of assets to Avalon pursuant to the Conveyances;
provided, however, Avalon shall have a right of first refusal to acquire the subject properties being offered in each
sale pursuant to the procedures in the Trust Agreement.
|
Anti-Takeover
Statutes
|
|
PEDEVCO
is subject to the provisions of Title 2, Chapter 21, Subchapter M of the Texas Business
Organizations Code (the “Texas Business Combination Law”). That law provides
that a Texas corporation may not engage in specified types of business combinations,
including mergers, consolidations and asset sales, with a person, or an affiliate or
associate of that person, who is an “affiliated shareholder”, for a period
of three years from the date that person became an affiliated shareholder, subject to
certain exceptions (described below). An “affiliated
|
|
None.
|
|
|
shareholder” is generally
defined as the holder of 20% or more of the corporation’s voting shares. The law’s
prohibitions do not apply if the business combination or the acquisition of shares by
the affiliated shareholder was approved by the board of directors of the corporation
before the affiliated shareholder became an affiliated shareholder; or the business combination
was approved by the affirmative vote of the holders of at least two-thirds of the outstanding
voting shares of the corporation not beneficially owned by the affiliated shareholder,
at a meeting of shareholders called for that purpose, not less than six months after
the affiliated shareholder became an affiliated shareholder.
Because
PEDEVCO has more than 100 of record shareholders, PEDEVCO is considered an “issuing public corporation” for
purposes of this law. The Texas Business Combination Law does not apply to the following:
●
the business combination of an issuing public corporation: where the corporation’s original charter or bylaws contain
a provision expressly electing not to be governed by the Texas Business Combination Law; or that adopts an amendment to
its charter or bylaws, by the affirmative vote of the holders, other than affiliated shareholders, of at least two-thirds
of the outstanding voting shares of the corporation, expressly electing not to be governed by the Texas Business Combination
Law and so long as the amendment does not take effect for 18 months following the date of the vote and does not apply
to a business combination with an affiliated shareholder who became affiliated on or before the effective date of the
amendment;
●
a business combination of an issuing public corporation with an affiliated shareholder that became an affiliated shareholder
inadvertently, if the affiliated shareholder divests itself, as soon as possible, of enough shares to no longer be an
affiliated shareholder and would not at any time within the three-year period preceding the announcement of the business
combination have been an affiliated shareholder but for the inadvertent acquisition;
●
a business combination with an affiliated shareholder who became an affiliated shareholder through a transfer of shares
by will or intestacy and continuously was
|
|
|
|
|
an affiliated shareholder until the announcement date of the business combination;
●
a business combination of a corporation with its wholly owned Texas subsidiary if the subsidiary is not an affiliate or
associate of the affiliated shareholder other than by reason of the affiliated shareholder’s beneficial ownership
of voting shares of the corporation.
|
|
|
Transactions
Involving Officers or Directors, Trustee and other persons
|
|
Section
21.418 of the TBOC provides that a contract or transaction between a corporation and:
●
one or more directors or officers, or one or more affiliates or associates of one or more directors or officers, of the
corporation; or
●
an entity or other organization in which one or more directors or officers, or one or more affiliates or associates of
one or more directors or officers, of the corporation is a managerial official; or has a financial interest.
That
is otherwise a valid and enforceable contract or transaction is valid and enforceable, and is not void or voidable, notwithstanding
any relationship or interest described above if any one of the following conditions is satisfied:
●
the material facts as to the relationship or interest and as to the contract or transaction are disclosed to or known
by: (1) the corporation's board of directors or a committee of the board of directors, and the board of directors or committee
in good faith authorizes the contract or transaction by the approval of the majority of the disinterested directors or
committee members, regardless of whether the disinterested directors or committee members constitute a quorum; or (2)
the shareholders entitled to vote on the authorization of the contract or transaction, and the contract or transaction
is specifically approved in good faith by a vote of the shareholders; or
●
the contract or transaction is fair to the corporation when the contract or transaction is authorized, approved, or ratified
by the board of directors, a committee of the board of directors, or the shareholders.
|
|
The
Trust Agreement provides that to the extent such conduct is not prohibited by applicable
law and except as otherwise provided in the Trust Agreement, each of the Trustee and
the Delaware Trustee is authorized in exercising its powers under this Agreement to make
contracts and have dealings with itself or its affiliates, directly and indirectly, in
any other fiduciary or individual capacity.
|
Mergers,
Consolidations or Certain Dispositions
|
|
PEDEVCO’s
Certificate of Formation provides that in addition to any vote of the holders of any
class or series of the stock of the Corporation required by law or by the PEDEVCO Certificate
of Formation, the affirmative vote of the holders of a majority of
|
|
Under
Section 3815(a) of the Delaware Trust Act, a statutory trust may merge or consolidate
with or into another business entities formed or organized or existing under the laws
of the State of Delaware or any other state or
|
|
|
the voting power of
all of the then outstanding shares of capital stock of PEDEVCO entitled to vote generally
in the election of directors, voting together as a single class, shall be required to
approve a Fundamental Action pursuant to Section 21.264 of the Texas Business Organizations
Code, except to the extent a greater vote is required by the PEDEVCO Certificate of Formation
any provision of law.
|
|
jurisdiction, with either the trust or
other business entity surviving. Section 3815(a) of the Delaware Trust Act further provides
that unless otherwise provided in the governing instrument of a statutory trust that
is not a registered investment company, an agreement of merger or consolidation shall
be approved by each such statutory trust which is to merge or consolidate by all of the
beneficial owners and all of the trustees.
Pursuant
to the Trust Agreement, the Trust may merge or consolidate with or into, or convert into, one or more limited partnerships,
general partnerships, corporations, business trusts, limited liability companies, or associations or unincorporated businesses
if such transaction is agreed to by the Trustee and approved by the vote of the holders of (i) a majority of the Trust
Common Units (excluding Trust Common Units owned by Avalon) and (ii) a majority of the Trust Common Units (including Trust
Common Units owned by Avalon), in each case voting in person or by proxy at a meeting of such holders at which a quorum
is present and such transaction is permitted under the Delaware Statutory Trust Act and any other applicable law. At any
time that Avalon owns less than 10% of the total Trust Common Units outstanding, however, the standard for approval will
be the vote of the holders of a majority of the Trust Common Units, including Trust Common Units owned by Avalon, voting
in person or by proxy at a meeting of such holders at which a quorum is present.
The
Trustee may sell the Royalty Interests under any of the following circumstances:
●
the sale is requested by Avalon in accordance with the provisions of the Trust Agreement; or
●
the sale is approved by the vote of the holders of (i) a majority of the Trust Common Units (excluding Trust Common Units
owned by Avalon) and (ii) a majority of the Trust Common Units (including Trust Common Units owned by Avalon), in each
case voting in person or by proxy at a meeting of such holders at which a quorum is present; except that at any time that
Avalon owns less than 10% of the total Trust Common Units outstanding, the standard for approval will be the vote of the
holders of a majority of the Trust Common Units, including Trust Common Units owned by Avalon, voting in person or by
proxy at a meeting of such holders at which a quorum is present.
|
|
|
|
|
Upon
dissolution of the Trust, the Trustee must sell those Royalty Interests that do not revert automatically to Avalon pursuant
to the terms of the Trust Agreement. No Trust unitholder approval is required in this event.
The
Trustee will distribute the net proceeds from any sale of the Royalty Interests and other assets to the holders of Trust
Common Units after payment or reasonable provision for payment of all liabilities of the Trust, including any amounts
owed to its agents (including Avalon acting in such capacity).
|
ADDITIONAL
NOTE REGARDING THE OFFER
The
offer is being made solely by this offer to exchange and the accompanying letter of transmittal and is being made to holders of
Trust Common Units. PEDEVCO is not aware of any jurisdiction where the making of the offer or the tender of Trust Common Units
in connection therewith would not be in compliance with the laws of such jurisdiction. If PEDEVCO becomes aware of any jurisdiction
in which the making of the offer or the tender of Trust Common Units in connection therewith would not be in compliance with applicable
law, PEDEVCO will make a good faith effort to comply with any such law. If, after such good faith effort, PEDEVCO cannot comply
with any such law, the offer will not be made to (nor will tenders be accepted from or on behalf of) the holders of Trust Common
Units in such jurisdiction.
LEGAL
MATTERS
The
legality of the PEDEVCO Common Stock offered by the offer will be passed upon by Jones Walker LLP.
EXPERTS
The
consolidated balance sheets of PEDEVCO Corp. as of December 31, 2019 and 2018, the related consolidated statements of operations,
shareholders’ equity and cash flows for the years ended December 31, 2019 and 2018, including the related notes, included
in this offer to exchange have been so included in reliance on the reports of Marcum LLP, an independent registered public accounting
firm, given on the authority of said firm as experts in auditing and accounting
The
information in this offer to exchange regarding PEDEVCO’s estimated quantities of proved developed producing reserves and
the future net revenues from those reserves as of December 31, 2019 is based on the proved reserve report prepared by Cawley,
Gillespie & Associates, PEDEVCO’s independent petroleum engineers. These estimates are included in this offer to exchange
in reliance upon the authority of such firm as an expert in these matters.
The
statements of assets and trust corpus of SandRidge Permian Trust as of December 31, 2019 and 2018, and the related statements
of distributable income and of changes in trust corpus for the years then ended, including the related notes and the Trustee’s
Report on Internal Control over Financial Reporting as of December 31, 2019 included therein, have been audited by an independent
registered public accounting firm, as set forth in their reports thereon, included in the Trust’s Annual Report on Form
10-K for the year ended December 31, 2019. Pursuant to Rule 436 under the Securities Act, PEDEVCO and Purchaser require the consent
of the Trust’s independent registered public accounting firm to include its audit report in this offer to exchange. PEDEVCO
has requested but has not, as of the date hereof, received such consent from the Trust’s independent registered public accounting
firm. If PEDEVCO receives this consent, PEDEVCO and Purchaser will promptly file it as an exhibit to PEDEVCO’s registration
statement of which this offer to exchange forms a part.
The
information included herein regarding the Trust’s estimated quantities of proved developed producing reserves and future
revenue, as of December 31, 2019, of the Trust’s royalty interest in certain oil and gas properties is based on the proved
reserve report prepared by the Trust’s independent reserve engineers, as set forth in their report included in the Trust’s
Annual Report on Form 10-K for the year ended December 31, 2019. Pursuant to Rule 436 under the Securities Act, PEDEVCO and Purchaser
require the consent of the Trust’s independent reserve engineers to include its report in this offer to exchange. PEDEVCO
has requested but has not, as of the date hereof, received such consent from the Trust’s independent reserve engineers.
If PEDEVCO receives this consent, PEDEVCO and Purchaser will promptly file it as an exhibit to PEDEVCO’s registration statement
of which this offer to exchange forms a part.
WHERE
YOU CAN FIND MORE INFORMATION
PEDEVCO
and the Trust file annual, quarterly and current reports, proxy statements and other information with the SEC under the Exchange
Act. The SEC maintains an Internet website, which is located at http://www.sec.gov that contains reports, proxy and information
statements and other information regarding issuers that file electronically with the SEC. You may access the registration statement,
of which this prospectus is a part, at the SEC’s Internet website. PEDEVCO also maintains a website at https://www.pacificenergydevelopment.com/;
however, the information contained on the website does not constitute part of this prospectus. You may also inspect reports, proxy
statements and other information about PEDEVCO at the offices of the New York Stock Exchange, 20 Broad Street, New York, New York
10005.
PEDEVCO
has filed a registration statement on Form S-4 to register with the SEC the PEDEVCO Common Stock to be issued in connection with
the offer and the second-step merger. This offer to exchange is a part of that registration statement. As allowed by SEC rules,
this offer to exchange does not contain all the information you can find in the registration statement or the exhibits to the
registration statement. In addition, PEDEVCO has also filed with the SEC a statement on Schedule TO pursuant to Rule 14d-3 under
the Exchange Act to furnish certain information about the offer. You may obtain copies of the Form S-4 and the Schedule TO (and
any amendments to those documents) in the manner described above.
Shareholders
may obtain any of these documents without charge upon written or oral request to the information agent at InvestorCom, 19 Old
Kings Highway S. – Suite 210, Darien, CT 06820, Toll Free (877) 972-0090 (Banks and Brokers call collect (203) 972-9300),
or info@investor-com.com.
IF
YOU WOULD LIKE TO REQUEST DOCUMENTS FROM PEDEVCO, PLEASE CONTACT THE INFORMATION AGENT NO LATER THAN FIVE BUSINESS DAYS BEFORE
THE EXPIRATION DATE TO RECEIVE THEM BEFORE THE EXPIRATION TIME OF THE OFFER. If you request any documents, the information agent
will mail them to you by first-class mail, or other equally prompt means, within one business day of receipt of your request.
PEDEVCO
has not authorized anyone to give any information or make any representation about the offer that is different from, or in addition
to, that contained in this offer to exchange. Therefore, if anyone does give you information of this sort, you should not rely
upon it. If you are in a jurisdiction where offers to exchange or sell, or solicitations of offers to exchange or purchase, the
securities offered by this document are unlawful, or if you are a person to whom it is unlawful to direct these types of activities,
then the offer presented in this document does not extend to you. The information contained in this document speaks only as of
the date of this document unless the information specifically indicates that another date applies.
NOTE
ON TRUST INFORMATION
All
information concerning the Trust, its businesses, operations, financial condition and management presented or incorporated by
reference in this offer to exchange is taken from publicly available information other than the description of the Trust’s
actions taken in response to the various PEDEVCO proposals as set forth in the section of this offer to exchange titled “Background
of the Offer.” This information may be examined and copies may be obtained at the places and in the manner set forth in
the section of this offer to exchange titled “Where You Can Find More Information.” PEDEVCO is not affiliated with
the Trust, and the Trust has not permitted PEDEVCO to have access to its books and records. Therefore, non-public information
concerning the Trust was not available to PEDEVCO for the purpose of preparing this offer to exchange. Although PEDEVCO has no
knowledge that would indicate that statements relating to the Trust contained or incorporated by reference in this offer to exchange
are inaccurate or incomplete, PEDEVCO was not involved in the preparation of those statements and cannot verify them. None of
PEDEVCO or any of its officers or directors assumes any responsibility for the accuracy or completeness of such information or
for any failure by the Trust to disclose events or facts which may have occurred or which may affect the significance or accuracy
of any such information but which are unknown to PEDEVCO.
Pursuant
to Rule 409 under the Securities Act and Rule 12b-21 under the Exchange Act, PEDEVCO is requesting that the Trust provide PEDEVCO
with information required for complete disclosure regarding the businesses, operations, financial condition and management of
the Trust. PEDEVCO will amend or supplement this offer to exchange to provide any and all information PEDEVCO receives from the
Trust, if PEDEVCO receives the information before the expiration time of the offer and PEDEVCO considers it to be material, reliable
and appropriate.
An
auditor’s report was issued on the Trust’s financial statements and included in the Trust’s filings with the
SEC. Similarly, the information included herein regarding the Trust’s estimated quantities of proved developed producing
reserves and future revenue, as of December 31, 2019, of the Trust’s royalty interest in certain oil and gas properties
is based on the proved reserve report prepared by the Trust’s independent reserve engineers, as set forth in their report
included in the Trust’s Annual Report on Form 10-K for the year ended December 31, 2019. Pursuant to Rule 436 under the
Securities Act, PEDEVCO requires the consent of the Trust’s independent registered public accounting firm to include their
audit report in this offer to exchange and requires the consent of the independent reserve engineers to include their report in
this offer to exchange. PEDEVCO is requesting but has not, as of the date of this offer to exchange, received such consent from
the Trust’s independent registered public accounting firm and independent reserve engineers. If PEDEVCO does not receive
these consents, PEDEVCO plans to request dispensation pursuant to Rule 437 under the Securities Act from this requirement. If
PEDEVCO receives the consent of the Trust’s independent registered public accounting firm or consent of the independent
reserve engineers, PEDEVCO will promptly file them as an exhibit to PEDEVCO’s registration statement of which this offer
to exchange forms a part. Because PEDEVCO has not been able to obtain the consent of the Trust’s independent registered
public accounting firm or independent reserve engineer, you may not be able to assert a claim against the Trust’s independent
registered public accounting firm or independent reserve engineer under Section 11 of the Securities Act for any untrue statements
of a material fact contained in the financial statements audited by the Trust’s independent registered public accounting
firm, certain of the Trust’s reserve information or any omissions to state a material fact required to be stated within
those documents and information.
GLOSSARY
OF OIL AND GAS TERMS
The
following is a description of the meanings of some of the oil and natural gas industry terms used in this offer to exchange.
2-D
seismic. The method by which a cross-section of the earth’s subsurface is created through the interpretation of reflecting
seismic data collected along a single source profile.
3-D
seismic. The method by which a three-dimensional image of the earth’s subsurface is created through the interpretation
of reflection seismic data collected over a surface grid. 3-D seismic surveys allow for a more detailed understanding of the subsurface
than do 2-D seismic surveys and contribute significantly to field appraisal, exploitation and production.
AFE
or Authorization for Expenditures. A document that lays out proposed expenses for a particular project and authorizes an individual
or group to spend a certain amount of money for that project.
Bbl.
One stock tank barrel, or 42 U.S. gallons liquid volume, used in this offer to exchange in reference to crude oil or other liquid
hydrocarbons.
Bcf.
An abbreviation for billion cubic feet. Unit used to measure large quantities of gas, approximately equal to 1 trillion Btu.
Boe.
Barrels of oil equivalent, determined using the ratio of one Bbl of crude oil, condensate or natural gas liquids, to six Mcf of
natural gas. Although an equivalent barrel of condensate or natural gas may be equivalent to a barrel of oil on an energy basis,
it is not equivalent on a value basis as there may be a large difference in value between an equivalent barrel and a barrel of
oil.
Boepd
or Boe/d. Barrels of oil equivalent per day.
Bopd.
Barrels of oil per day.
Boe.
Barrels of oil equivalent, with six thousand cubic feet of natural gas being equivalent to one barrel of oil.
Btu
or British thermal unit. The quantity of heat required to raise the temperature of one pound of water by one degree Fahrenheit.
Completion.
The operations required to establish production of oil or natural gas from a wellbore, usually involving perforations, stimulation
and/or installation of permanent equipment in the well or, in the case of a dry hole, the reporting of abandonment to the appropriate
agency.
Condensate.
Liquid hydrocarbons associated with the production of a primarily natural gas reserve.
Conventional
resources. Natural gas or oil that is produced by a well drilled into a geologic formation in which the reservoir and fluid
characteristics permit the natural gas or oil to readily flow to the wellbore.
Cushing/WTI.
Means the price of West Texas Intermediate oil at the hub located in Cushing, Oklahoma.
Developed
acreage. The number of acres that are allocated or assignable to productive wells.
Developed
oil and natural gas reserves. Reserves of any category that can be expected to be recovered (i) through existing wells with
existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost
of a new well and (ii) through installed extraction equipment and infrastructure operational at the time of the reserves estimate
if the extraction is by means not involving a well.
Development
well. A well drilled into a proved oil or natural gas reservoir to the depth of a stratigraphic horizon known to be productive.
Estimated
ultimate recovery or EUR. Estimated ultimate recovery is the sum of reserves remaining as of a given date and cumulative production
as of that date.
Exploratory
well. A well drilled to find and produce oil or natural gas reserves not classified as proved, to find a new reservoir in
a field previously found to be productive of oil or natural gas in another reservoir or to extend a known reservoir.
Frac
or fracking. A short name for hydraulic fracturing, a method for extracting oil and natural gas.
Farmin
or farmout. An agreement under which the owner of a working interest in an oil or natural gas lease assigns the working interest
or a portion of the working interest to another party who desires to drill on the leased acreage. Generally, the assignee is required
to drill one or more wells in order to earn its interest in the acreage. The assignor usually retains a royalty or reversionary
interest in the lease. The interest received by an assignee is a “farmin” while the interest transferred by the assignor
is a “farmout.”
FERC.
Federal Energy Regulatory Commission.
Field.
An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural
feature and/or stratigraphic condition.
Gross
acres or gross wells. The total acres or wells in which a working interest is owned.
Henry
Hub. A natural gas pipeline located in Erath, Louisiana that serves as the official delivery location for futures contracts
on the NYMEX. The settlement prices at the Henry Hub are used as benchmarks for the entire North American natural gas market.
Held
by production. An oil and natural gas property under lease in which the lease continues to be in force after the primary term
of the lease in accordance with its terms as a result of production from the property.
Horizontal
drilling or well. A drilling operation in which a portion of the well is drilled horizontally within a productive or potentially
productive formation. This operation typically yields a horizontal well that has the ability to produce higher volumes than a
vertical well drilled in the same formation. A horizontal well is designed to replace multiple vertical wells, resulting in lower
capital expenditures for draining like acreage and limiting surface disruption.
Hydraulic
Fracturing. Means the forcing open of fissures in subterranean rocks by introducing liquid at high pressure, especially to
extract oil or gas.
IP30.
Means the production of a well for the first full calendar month of production.
Liquids.
Liquids, or natural gas liquids, are marketable liquid products including ethane, propane, butane and pentane resulting from the
further processing of liquefiable hydrocarbons separated from raw natural gas by a natural gas processing facility.
LOE
or Lease operating expenses. The costs of maintaining and operating property and equipment on a producing oil and gas lease.
MBbl
or MBbls. One thousand barrels of crude oil or other liquid hydrocarbons.
MMBbl/d.
One thousand barrels of crude oil or other liquid hydrocarbons per day.
MBoe.
Thousand barrels of oil equivalent.
MBoe/d.
Thousand barrels of oil equivalent per day.
Mcf.
One thousand cubic feet of natural gas.
Mcfgpd.
Thousands of cubic feet of natural gas per day.
MMcf.
One million cubic feet of natural gas.
MMBtu.
One million British thermal units.
MMBoe.
Million barrels of oil equivalent.
Net
acres or net wells. The sum of the fractional working interest owned in gross acres or wells.
Net
revenue interest. The interest that defines the percentage of revenue that an owner of a well receives from the sale of oil,
natural gas and/or natural gas liquids that are produced from the well.
NGL.
Natural gas liquids.
NYMEX.
New York Mercantile Exchange.
Permeability.
A reference to the ability of oil and/or natural gas to flow through a reservoir.
Petrophysical
analysis. The interpretation of well log measurements, obtained from a string of electronic tools inserted into the borehole,
and from core measurements, in which rock samples are retrieved from the subsurface, then combining these measurements with other
relevant geological and geophysical information to describe the reservoir rock properties.
Play.
A set of known or postulated oil and/or natural gas accumulations sharing similar geologic, geographic and temporal properties,
such as source rock, migration pathways, timing, trapping mechanism and hydrocarbon type.
Plugging
and abandonment. Refers to the sealing off of fluids in the strata penetrated by a well so that the fluids from one stratum
will not escape into another or to the surface. Texas regulations require plugging of abandoned wells.
Possible
reserves. Additional reserves that are less certain to be recognized than probable reserves.
Present
value of future net revenues (“PV-10”). The present value of estimated future revenues to be generated from the
production of proved reserves, before income taxes, calculated in accordance with SEC guidelines, net of estimated production
and future development costs, using prices and costs as of the date of estimation without future escalation and without giving
effect to hedging activities, non-property related expenses such as general and administrative expenses, debt service and depreciation,
depletion and amortization. PV-10 is calculated using an annual discount rate of 10%.
Probable
reserves. Additional reserves that are less certain to be recognized than proved reserves but which, in sum with proved reserves,
are as likely as not to be recovered.
Producing
well, production well or productive well. A well that is found to be capable of producing hydrocarbons in sufficient quantities
such that proceeds from the sale of the well’s production exceed production-related expenses and taxes.
Production
costs. Costs incurred to operate and maintain wells and related equipment and facilities, including depreciation and applicable
operating costs of support equipment and facilities and other costs of operating and maintaining those wells and related equipment
and facilities that become part of the cost of oil, natural gas and NGL produced.
Properties.
Natural gas and oil wells, production and related equipment and facilities and natural gas, oil or other mineral fee, leasehold
and related interests.
Prospect.
A specific geographic area which, based on supporting geological, geophysical or other data and also preliminary economic analysis
using reasonably anticipated prices and costs, is considered to have potential for the discovery of commercial hydrocarbons.
Proved
developed reserves. Proved reserves that can be expected to be recovered through existing wells and facilities and by existing
operating methods. Reserves that are both proved and developed.
Proved
oil, natural gas and NGL reserves. Those quantities of oil, natural gas and NGL that, by analysis of geoscience and engineering
data, can be estimated with reasonable certainty to be economically producible from a given date forward, from known reservoirs,
and under existing economic conditions, operating methods, and government regulations, prior to the time at which contracts providing
the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic
or probabilistic methods are used for estimation. The project to extract the hydrocarbons must have commenced or the operator
must be reasonably certain that it will commence the project within a reasonable time.
The
area of a reservoir considered proved includes (i) the area identified by drilling and limited by fluid contacts, if any, and
(ii) adjacent undrilled portions of the reservoir that can, with reasonable certainty, be judged to be continuous with it and
to contain economically producible oil or natural gas on the basis of available geoscience and engineering data. In the absence
of data on fluid contacts, proved quantities in a reservoir are limited by the lowest known hydrocarbons as seen in a well penetration
unless geoscience, engineering or performance data and reliable technology establish a lower contact with reasonable certainty.
Where
direct observation from well penetrations has defined a highest known oil elevation and the potential exists for an associated
gas cap, proved oil reserves may be assigned in the structurally higher portions of the reservoir only if geoscience, engineering
or performance data and reliable technology establish the higher contact with reasonable certainty.
Reserves
that can be produced economically through application of improved recovery techniques (including, but not limited to, fluid injection)
are included in the proved classification when (i) successful testing by a pilot project in an area of the reservoir with properties
no more favorable than in the reservoir as a whole, the operation of an installed program in the reservoir, or an analogous reservoir,
or other evidence using reliable technology establishes the reasonable certainty of the engineering analysis on which the project
or program was based and (ii) the project has been approved for development by all necessary parties and entities, including governmental
entities.
Existing
economic conditions include prices and costs at which economic producibility from a reservoir is to be determined. The price shall
be the average price during the 12-month period prior to the ending date of the period covered by the report, determined as an
unweighted arithmetic average of the first-day-of-the-month price for each month within such period, unless prices are defined
by contractual arrangements, excluding escalations based upon future conditions.
Proved
undeveloped reserves or PUDs. Proved reserves that are expected to be recovered from new wells on undrilled acreage or from
existing wells where a relatively major expenditure is required for recompletion.
PV-10.
See “Present value of future net revenues” above.
Repeatability.
The potential ability to drill multiple wells within a prospect or trend.
Reserves.
Estimated remaining quantities of oil, natural gas and NGL and related substances anticipated to be economically producible by
application of development projects to known accumulations. In addition, there must exist, or there must be a reasonable expectation
that there will exist, the legal right to produce or a revenue interest in the production, installed means of delivering oil,
natural gas and NGL or related substances to market, and all permits and financing required to implement the project.
Reserves
should not be assigned to adjacent reservoirs isolated by major, potentially sealing, faults until those reservoirs are penetrated
and evaluated as economically producible. Reserves should not be assigned to areas that are clearly separated from a known accumulation
by a non-productive reservoir (i.e. absence of reservoir, structurally low reservoir, or negative test results). Such areas may
contain prospective resources (i.e. potentially recoverable resources from undiscovered accumulations).
Reservoir.
A porous and permeable underground formation containing a natural accumulation of producible oil and/or natural gas that is confined
by impermeable rock or water barriers and is individual and separate from other reservoirs.
Royalty
interest. An interest in an oil and natural gas lease that gives the owner of the interest the right to receive a portion
of the production from the leased acreage (or of the proceeds of the sale thereof), but generally does not require the owner to
pay any portion of the costs of drilling or operating the wells on the leased acreage. Royalties may be either landowner’s
royalties, which are reserved by the owner of the leased acreage at the time the lease is granted, or overriding royalties, which
are usually reserved by an owner of the leasehold in connection with a transfer to a subsequent owner.
Standardized
measure or standardized measure of discounted future net cash flows. The present value of estimated future cash inflows from
proved oil, natural gas and NGL reserves, less future development and production costs and future income tax expenses, discounted
at 10% per annum to reflect timing of future cash flows and using the same pricing assumptions as were used to calculate PV-10.
Standardized Measure differs from PV-10 because Standardized Measure includes the effect of future income taxes on future net
revenues.
Transition
Zone. The Transition Zone usually produces both oil and water at different ratios depending on the height above the Free Water
Level (FWL). In normal conditions wells that are drilled in the Transition Zone will produce at some water cut.
Trend.
A region of oil and/or natural gas production, the geographic limits of which have not been fully defined, having geological characteristics
that have been ascertained through supporting geological, geophysical or other data to contain the potential for oil and/or natural
gas reserves in a particular formation or series of formations.
Unconventional
resource play. A set of known or postulated oil and or natural gas resources or reserves warranting further exploration which
are extracted from (a) low-permeability sandstone and shale formations and (b) coalbed methane. These plays require the application
of advanced technology to extract the oil and natural gas resources.
Undeveloped
acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial
quantities of oil and natural gas, regardless of whether such acreage contains proved reserves. Undeveloped acreage is usually
considered to be all acreage that is not allocated or assignable to productive wells.
Undeveloped
oil, natural gas and NGL reserves. Reserves of any category that are expected to be recovered from new wells on undrilled
acreage, or from existing wells where a relatively major expenditure is required for recompletion.
|
●
|
Reserves
on undrilled acreage are limited to those directly offsetting development spacing areas that are reasonably certain of production
when drilled, unless evidence using reliable technology exists that establishes reasonable certainty of economic producibility
at greater distances.
|
|
●
|
Undrilled
locations are classified as having undeveloped reserves only if a development plan has been adopted indicating that they are scheduled
to be drilled within five years, unless the specific circumstances justify a longer time.
|
|
●
|
Under
no circumstances shall estimates for undeveloped reserves be attributable to any acreage for which an application of fluid injection
or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual projects in
the same reservoir or an analogous reservoir or by other evidence using reliable technology establishing reasonable certainty.
|
Unproved
and unevaluated properties. Refers to properties where no drilling or other actions have been undertaken that permit such
property to be classified as proved.
USACE.
United States Army Corps of Engineers.
Vertical
well. A hole drilled vertically into the earth from which oil, natural gas or water flows is pumped.
Volumetric
reserve analysis. A technique used to estimate the amount of recoverable oil and natural gas. It involves calculating the
volume of reservoir rock and adjusting that volume for the rock porosity, hydrocarbon saturation, formation volume factor and
recovery factor.
Wellbore.
The hole made by a well.
WTI
or West Texas Intermediate. A grade of crude oil used as a benchmark in oil pricing. This grade is described as light because
of its relatively low density, and sweet because of its low sulfur content.
Working
interest. The operating interest that gives the owner the right to drill, produce and conduct operating activities on the
property and receive a share of production.
INDEX
TO FINANCIAL STATEMENTS
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of
PEDEVCO Corp.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets
of PEDEVCO Corp. (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of
operations, shareholders’ equity and cash flows for the years ended December 31, 2019 and 2018, and the related notes
(collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly,
in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations
and its cash flows for the years ended December 31, 2019 and 2018, in conformity with accounting principles generally accepted
in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public
accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and
are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable
rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of
the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged
to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding
of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks
of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to
those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as
well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis
for our opinion.
/s/ Marcum llp
Marcum llp
We have served as the Company’s auditor since 2008.
Houston, Texas
March 30, 2020
PEDEVCO CORP.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except share and
per share data)
|
|
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Assets
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
22,415
|
|
|
$
|
3,463
|
|
Restricted cash – current
|
|
|
—
|
|
|
|
2,316
|
|
Accounts receivable – oil and gas
|
|
|
4,602
|
|
|
|
842
|
|
Prepaid expenses and other current assets
|
|
|
73
|
|
|
|
204
|
|
Total current assets
|
|
|
27,090
|
|
|
|
6,825
|
|
|
|
|
|
|
|
|
|
|
Oil and gas properties:
|
|
|
|
|
|
|
|
|
Oil and gas properties, subject to amortization, net
|
|
|
76,952
|
|
|
|
51,946
|
|
Oil and gas properties, not subject to amortization, net
|
|
|
14,896
|
|
|
|
8,516
|
|
Total oil and gas properties, net
|
|
|
91,848
|
|
|
|
60,462
|
|
|
|
|
|
|
|
|
|
|
Operating lease – right-of-use asset
|
|
|
360
|
|
|
|
—
|
|
Other assets
|
|
|
3,598
|
|
|
|
238
|
|
Total assets
|
|
$
|
122,896
|
|
|
$
|
67,525
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholders’ Equity
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
12,099
|
|
|
$
|
4,509
|
|
Accrued expenses
|
|
|
1,972
|
|
|
|
3,391
|
|
Revenue payable
|
|
|
827
|
|
|
|
831
|
|
Operating lease liabilities – current
|
|
|
97
|
|
|
|
—
|
|
Asset retirement obligations – current
|
|
|
225
|
|
|
|
119
|
|
Total current liabilities
|
|
|
15,220
|
|
|
|
8,850
|
|
|
|
|
|
|
|
|
|
|
Long-term liabilities:
|
|
|
|
|
|
|
|
|
Accrued expenses
|
|
|
—
|
|
|
|
14
|
|
Accrued expenses – related party
|
|
|
—
|
|
|
|
943
|
|
Notes payable – Subordinated
|
|
|
—
|
|
|
|
400
|
|
Notes payable – Subordinated – related party
|
|
|
—
|
|
|
|
30,200
|
|
Notes payable – related party, net of debt discount of $-0- and $161, respectively
|
|
|
—
|
|
|
|
7,694
|
|
Operating lease liabilities, net of current portion
|
|
|
300
|
|
|
|
—
|
|
Asset retirement obligations, net of current portion
|
|
|
1,874
|
|
|
|
2,452
|
|
Total liabilities
|
|
|
17,394
|
|
|
|
50,553
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ equity
|
|
|
|
|
|
|
|
|
Common stock, $0.001 par value, 200,000,000 shares authorized; 71,061,328 and
15,808,445 shares issued and outstanding, respectively
|
|
|
71
|
|
|
|
16
|
|
Additional paid-in capital
|
|
|
201,027
|
|
|
|
101,450
|
|
Accumulated deficit
|
|
|
(95,596
|
)
|
|
|
(84,494
|
)
|
Total shareholders’ equity
|
|
|
105,502
|
|
|
|
16,972
|
|
Total liabilities and shareholders’ equity
|
|
$
|
122,896
|
|
|
$
|
67,525
|
|
See accompanying notes to consolidated financial
statements.
PEDEVCO CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except share and
per share data)
|
|
December 31,
|
|
Revenue:
|
|
2019
|
|
|
2018
|
|
Oil and gas sales
|
|
$
|
12,972
|
|
|
$
|
4,523
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Lease operating costs
|
|
|
6,817
|
|
|
|
2,821
|
|
Exploration expense
|
|
|
110
|
|
|
|
47
|
|
Selling, general and administrative expense
|
|
|
5,785
|
|
|
|
4,140
|
|
Depreciation, depletion, amortization and accretion
|
|
|
11,031
|
|
|
|
6,519
|
|
Loss on settlement of asset retirement obligations
|
|
|
496
|
|
|
|
—
|
|
Total operating expenses
|
|
|
24,239
|
|
|
|
13,527
|
|
|
|
|
|
|
|
|
|
|
Gain on sale of oil and gas properties
|
|
|
1,040
|
|
|
|
—
|
|
Operating income (loss)
|
|
|
(10,227
|
)
|
|
|
(9,004
|
)
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(824
|
)
|
|
|
(7,699
|
)
|
Interest income
|
|
|
55
|
|
|
|
1
|
|
Other expense
|
|
|
(106
|
)
|
|
|
—
|
|
Gain on debt restructuring
|
|
|
—
|
|
|
|
70,309
|
|
Total other income (expense)
|
|
|
(875
|
)
|
|
|
62,611
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(11,102
|
)
|
|
$
|
53,607
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per common share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.22
|
)
|
|
$
|
4.80
|
|
Diluted
|
|
$
|
(0.22
|
)
|
|
$
|
4.74
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
51,214,986
|
|
|
|
11,168,490
|
|
Diluted
|
|
|
51,214,986
|
|
|
|
11,313,246
|
|
See accompanying notes to consolidated financial
statements.
PEDEVCO CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Cash Flows From Operating Activities:
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(11,102
|
)
|
|
$
|
52,797
|
|
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
Depreciation, depletion and amortization
|
|
|
11,031
|
|
|
|
7,329
|
|
Share-based compensation expense
|
|
|
1,557
|
|
|
|
862
|
|
Interest expense deferred and capitalized in debt restructuring
|
|
|
—
|
|
|
|
3,958
|
|
Gain on debt restructuring
|
|
|
—
|
|
|
|
(70,309
|
)
|
Gain on sale of oil and gas properties
|
|
|
(1,040
|
)
|
|
|
—
|
|
Amortization of debt discount
|
|
|
161
|
|
|
|
1,415
|
|
Amortization of right-of-use asset
|
|
|
37
|
|
|
|
—
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable – oil and gas
|
|
|
(3,760
|
)
|
|
|
(541
|
)
|
Prepaid expenses and other current assets
|
|
|
131
|
|
|
|
(28
|
)
|
Accounts payable
|
|
|
5,414
|
|
|
|
408
|
|
Accrued expenses
|
|
|
(1,413
|
)
|
|
|
1,231
|
|
Accrued expenses – related parties
|
|
|
657
|
|
|
|
1,110
|
|
Revenue payable
|
|
|
(4
|
)
|
|
|
274
|
|
Net cash provided by (used in) operating activities
|
|
|
1,669
|
|
|
|
(1,494
|
)
|
|
|
|
|
|
|
|
|
|
Cash Flows From Investing Activities:
|
|
|
|
|
|
|
|
|
Cash paid for the acquisition of oil and gas properties, net of restricted cash received of $0 and $2,316, respectively
|
|
|
(1,120
|
)
|
|
|
(19,693
|
)
|
Cash paid for drilling and completion costs
|
|
|
(39,700
|
)
|
|
|
(43
|
)
|
Cash paid for other property and equipment
|
|
|
(81
|
)
|
|
|
(3,270
|
)
|
Cash paid for oil and gas security bonds
|
|
|
—
|
|
|
|
(112
|
)
|
Proceeds from the sale of oil and gas property
|
|
|
1,175
|
|
|
|
—
|
|
Cash paid for security deposit
|
|
|
(10
|
)
|
|
|
—
|
|
Net cash used in investing activities
|
|
|
(39,736
|
)
|
|
|
(23,118
|
)
|
|
|
|
|
|
|
|
|
|
Cash Flows From Financing Activities:
|
|
|
|
|
|
|
|
|
Proceeds from notes payable
|
|
|
—
|
|
|
|
400
|
|
Proceeds from notes payable – related parties
|
|
|
15,000
|
|
|
|
37,900
|
|
Proceeds from the issuance of common stock
|
|
|
43,000
|
|
|
|
—
|
|
Repayment of notes payable
|
|
|
—
|
|
|
|
(7,795
|
)
|
Cash paid for warrant repurchase
|
|
|
—
|
|
|
|
(1,095
|
)
|
Proceeds from warrant exercise for common stock
|
|
|
—
|
|
|
|
64
|
|
Net cash provided by financing activities
|
|
|
58,000
|
|
|
|
29,474
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and restricted cash
|
|
|
19,933
|
|
|
|
4,862
|
|
Cash and restricted cash at beginning of year
|
|
|
5,779
|
|
|
|
917
|
|
Cash and restricted cash at end of year
|
|
$
|
25,712
|
|
|
$
|
5,779
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Flow Information
|
|
|
|
|
|
|
|
|
Cash paid for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
—
|
|
|
$
|
—
|
|
Income taxes
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Noncash investing and financing activities:
|
|
|
|
|
|
|
|
|
Change in accrued oil and gas development costs
|
|
$
|
2,056
|
|
|
$
|
7,000
|
|
Acquisition of asset retirement obligations
|
|
$
|
54
|
|
|
$
|
2,061
|
|
Change in estimates of asset retirement costs
|
|
$
|
695
|
|
|
$
|
133
|
|
Common stock issued for debt conversion
|
|
$
|
55,075
|
|
|
$
|
—
|
|
Common stock issued as debt inducement
|
|
$
|
—
|
|
|
$
|
185
|
|
Common stock issued for debt interest
|
|
$
|
—
|
|
|
$
|
167
|
|
Issuance of restricted common stock
|
|
$
|
1
|
|
|
$
|
1
|
|
Conversion of Series A preferred stock
|
|
$
|
—
|
|
|
$
|
7
|
|
See accompanying notes to consolidated financial
statements.
PEDEVCO CORP.
CONSOLIDATED STATEMENT CHANGES IN SHAREHOLDERS’
EQUITY
For the Years Ended December 31, 2019
and 2018
(amounts in thousands, except share amounts)
|
|
Series A Convertible
Preferred Stock
|
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Additional
Paid-in
Capital
|
|
|
Accumulated
Deficit
|
|
|
Totals
|
|
Balances at December 31, 2017
|
|
|
66,625
|
|
|
$
|
—
|
|
|
|
7,278,754
|
|
|
$
|
7
|
|
|
$
|
100,954
|
|
|
$
|
(138,101
|
)
|
|
$
|
(37,140
|
)
|
Conversion of Series A Preferred Stock to common stock
|
|
|
(66,625
|
)
|
|
|
—
|
|
|
|
6,662,500
|
|
|
|
7
|
|
|
|
(7
|
)
|
|
|
—
|
|
|
|
—
|
|
Conversion of accrued interest on notes payable – related party to common stock
|
|
|
—
|
|
|
|
—
|
|
|
|
75,118
|
|
|
|
—
|
|
|
|
167
|
|
|
|
—
|
|
|
|
167
|
|
Conversion of stock options
|
|
|
—
|
|
|
|
—
|
|
|
|
95,865
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Issuance of warrants for
debt repayment
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
322
|
|
|
|
—
|
|
|
|
322
|
|
Issuance of restricted
common stock
|
|
|
—
|
|
|
|
—
|
|
|
|
904,000
|
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
—
|
|
|
|
—
|
|
Issuance of common stock for
exercise of warrants
|
|
|
—
|
|
|
|
—
|
|
|
|
192,208
|
|
|
|
—
|
|
|
|
64
|
|
|
|
—
|
|
|
|
64
|
|
Issuance of common stock for
debt inducement
|
|
|
—
|
|
|
|
—
|
|
|
|
600,000
|
|
|
|
1
|
|
|
|
184
|
|
|
|
—
|
|
|
|
185
|
|
Warrants repurchased
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(1,095
|
)
|
|
|
—
|
|
|
|
(1,095
|
)
|
Share-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
862
|
|
|
|
—
|
|
|
|
862
|
|
Net income
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
53,607
|
|
|
|
53,607
|
|
Balances
at December 31, 2018
|
|
|
—
|
|
|
|
—
|
|
|
|
15,808,445
|
|
|
|
16
|
|
|
|
101,450
|
|
|
|
(84,494
|
)
|
|
|
16,972
|
|
Issuance of common stock for
debt conversion
|
|
|
—
|
|
|
|
—
|
|
|
|
29,480,383
|
|
|
|
29
|
|
|
|
55,046
|
|
|
|
—
|
|
|
|
55,075
|
|
Issuance of restricted
common stock
|
|
|
—
|
|
|
|
—
|
|
|
|
430,000
|
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
—
|
|
|
|
—
|
|
Issuance of common stock to
non-affiliates
|
|
|
—
|
|
|
|
—
|
|
|
|
10,150,000
|
|
|
|
10
|
|
|
|
14,990
|
|
|
|
—
|
|
|
|
15,000
|
|
Issuance of common stock
to affiliate
|
|
|
—
|
|
|
|
—
|
|
|
|
15,122,662
|
|
|
|
15
|
|
|
|
27,985
|
|
|
|
—
|
|
|
|
28,000
|
|
Warrants exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
60,056
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Cashless exercise of stock options
|
|
|
—
|
|
|
|
—
|
|
|
|
9,782
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Share-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,557
|
|
|
|
—
|
|
|
|
1,557
|
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(11,102
|
)
|
|
|
(11,102
|
)
|
Balances
at December 31, 2019
|
|
|
—
|
|
|
$
|
—
|
|
|
|
71,061,328
|
|
|
$
|
71
|
|
|
$
|
201,027
|
|
|
$
|
(95,596
|
)
|
|
$
|
105,502
|
|
See accompanying notes to consolidated financial
statements.
PEDEVCO CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – BASIS OF PRESENTATION
The accompanying consolidated financial statements of PEDEVCO
Corp. (“PEDEVCO” or the “Company”), have been prepared in accordance with accounting principles generally
accepted in the United States of America (“GAAP”) and the rules of the Securities and Exchange Commission (“SEC”).
The Company’s consolidated financial statements include
the accounts of the Company, its wholly-owned subsidiaries and subsidiaries in which the Company has a controlling financial interest.
All significant inter-company accounts and transactions have been eliminated in consolidation.
NOTE 2 – DESCRIPTION OF BUSINESS
PEDEVCO is an oil and gas company focused on the development,
acquisition and production of oil and natural gas assets where the latest in modern drilling and completion techniques and technologies
have yet to be applied. In particular, the Company focuses on legacy proven properties where there is a long production history,
well defined geology and existing infrastructure that can be leveraged when applying modern field management technologies. The
Company’s current properties are located in the San Andres formation of the Permian Basin situated in West Texas and eastern
New Mexico (the “Permian Basin”) and in the Denver-Julesberg Basin (“D-J Basin”) in Colorado.
The Company holds its Permian Basin acres located in Chaves and Roosevelt Counties, New Mexico, through its wholly-owned operating
subsidiary, Pacific Energy Development Corp. (“PEDCO”), which asset the Company refers to as its “Permian Basin
Asset,” and it holds its D-J Basin acres located in Weld and Morgan Counties, Colorado, through its wholly-owned operating
subsidiary, Red Hawk Petroleum, LLC (“Red Hawk”), which asset the Company refers to as its “D-J Basin Asset.”
The Company believes that horizontal development and exploitation
of conventional assets in the Permian Basin and development of the Wattenberg and Wattenberg Extension in the D-J Basin represent
among the most economic oil and natural gas plays in the United States (“U.S.”). Moving forward, the Company
plans to optimize its existing assets and opportunistically seek additional acreage proximate to its currently held core acreage,
as well as other attractive onshore U.S. oil and gas assets that fit the Company’s acquisition criteria, that Company management
believes can be developed using its technical and operating expertise and be accretive to shareholder value.
NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation.
The consolidated financial statements herein have been prepared in accordance with accounting principles generally accepted in
the United States (“US GAAP”) and include the accounts of the Company and those of its wholly and partially-owned subsidiaries
as follows: (i) Blast AFJ, Inc., a Delaware corporation; (ii) PEDCO, a Nevada corporation; (iii) Red Hawk, a Nevada
limited liability company; (iv) Ridgeway Arizona Oil Corp., an Arizona corporation (“RAOC”), acquired by PEDCO
effective September 1, 2018 in connection with the Company’s acquisition of the Permian Basin Asset; (v) EOR Operating
Company, a Texas corporation (“EOR”) acquired by PEDCO effective September 1, 2018 in connection with the Company’s
acquisition of the Permian Basin Asset; and (vi) Condor Energy Technology LLC, a Nevada limited liability company (“Condor”),
acquired by Red Hawk on August 1, 2018 in connection with the Company’s acquisition of part of its D-J Basin Asset, which
was dissolved on October 30, 2019. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates in Financial Statement Preparation. The
preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenues and expenses, as well as certain financial statement disclosures. While management
believes that the estimates and assumptions used in the preparation of the financial statements are appropriate, actual results
could differ from these estimates. Significant estimates generally include those with respect to the amount of recoverable oil
and gas reserves, the fair value of financial instruments, oil and gas depletion, asset retirement obligations, and stock-based
compensation.
Cash and Cash Equivalents. The Company considers
all highly liquid investments with original maturities of three months or less to be cash equivalents. As of December 31, 2019,
and December 31, 2018, cash equivalents consisted of money market funds and cash on deposit.
In November 2016, the Financial Accounting Standards Board (“FASB”) issued
an Accounting Standards Update (“ASU”) amending the presentation of restricted cash within the consolidated statements
of cash flows. The new guidance requires that restricted cash be added to cash and cash equivalents on the consolidated statements
of cash flows. The Company adopted this ASU on January 1, 2018 on a retrospective basis with no impact to the consolidated statements
of cash flows for the year ended December 31, 2019 and 2018, respectively.
Concentrations of Credit Risk. Financial instruments
which potentially subject the Company to concentrations of credit risk include cash deposits placed with financial institutions.
The Company periodically assesses the financial condition of its financial institutions and considers any possible credit risk
to be minimal.
Sales to one customer comprised 54% of the Company’s
total oil and gas revenues for the year ended December 31, 2019. The Company believes that, in the event that its primary
customers are unable or unwilling to continue to purchase the Company’s production, there are a substantial number of alternative
buyers for its production at comparable prices.
Accounts Receivable. Accounts receivable typically
consist of oil and gas receivables. The Company has classified these as short-term assets in the balance sheet because the Company
expects repayment or recovery within the next 12 months. The Company evaluates these accounts receivable for collectability considering
the results of operations of these related entities and, when necessary, records allowances for expected unrecoverable amounts.
To date, no allowances have been recorded. Included in accounts receivable – oil and gas are $106,000 related to receivables
from joint interest owners.
Bad Debt Expense. The Company’s ability to collect
outstanding receivables is critical to its operating performance and cash flows. Accounts receivable are stated at an amount management
expects to collect from outstanding balances. The Company extends credit in the normal course of business. The Company regularly
reviews outstanding receivables and when the Company determines that a party may not be able to make required payments, a charge
to bad debt expense in the period of determination is made. Though the Company’s bad debts have not historically been significant,
the Company could experience increased bad debt expense should a financial downturn occur.
Equipment. Equipment is stated at cost less accumulated
depreciation and amortization. Maintenance and repairs are charged to expense as incurred. Renewals and betterments which extend
the life or improve existing equipment are capitalized. Upon disposition or retirement of equipment, the cost and related accumulated
depreciation are removed and any resulting gain or loss is reflected in operations. Depreciation is provided using the straight-line
method over the estimated useful lives of the assets, which are 3 to 10 years.
Oil and Gas Properties, Successful Efforts Method. The
successful efforts method of accounting is used for oil and gas exploration and production activities. Under this method, all costs
for development wells, support equipment and facilities, and proved mineral interests in oil and gas properties are capitalized.
Geological and geophysical costs are expensed when incurred. Costs of exploratory wells are capitalized as exploration and evaluation
assets pending determination of whether the wells find proved oil and gas reserves. Proved oil and gas reserves are the estimated
quantities of crude oil and natural gas which geological and engineering data demonstrate with reasonable certainty to be recoverable
in future years from known reservoirs under existing economic and operating conditions, (i.e., prices and costs as of the date
the estimate is made). Prices include consideration of changes in existing prices provided only by contractual arrangements, but
not on escalations based upon future conditions.
Exploratory wells in areas not requiring major capital expenditures
are evaluated for economic viability within one year of completion of drilling. The related well costs are expensed as dry holes
if it is determined that such economic viability is not attained. Otherwise, the related well costs are reclassified to oil and
gas properties and subject to impairment review. For exploratory wells that are found to have economically viable reserves in areas
where major capital expenditure will be required before production can commence, the related well costs remain capitalized only
if additional drilling is under way or firmly planned. Otherwise the related well costs are expensed as dry holes.
Exploration and evaluation expenditures incurred subsequent
to the acquisition of an exploration asset in a business combination are accounted for in accordance with the policy outlined above.
Depreciation, depletion and amortization of capitalized oil
and gas properties is calculated on a field by field basis using the unit of production method. Lease acquisition costs are amortized
over the total estimated proved developed and undeveloped reserves and all other capitalized costs are amortized over proved developed
reserves. Costs specific to developmental wells for which drilling is in progress or uncompleted are capitalized as wells in progress
and not subject to amortization until completion and production commences, at which time amortization on the basis of production
will begin.
Impairment of Long-Lived Assets. The Company
reviews the carrying value of its long-lived assets annually or whenever events or changes in circumstances indicate that the historical
cost-carrying value of an asset may no longer be appropriate. The Company assesses recoverability of the carrying value of the
asset by estimating the future net undiscounted cash flows expected to result from the asset, including eventual disposition. If
the future net undiscounted cash flows are less than the carrying value of the asset, an impairment loss is recorded equal to the
difference between the asset’s carrying value and estimated fair value.
Asset Retirement Obligations. If a reasonable estimate
of the fair value of an obligation to perform site reclamation, dismantle facilities or plug and abandon wells can be made, the
Company will record a liability (an asset retirement obligation or “ARO”) on its consolidated balance sheet and
capitalize the present value of the asset retirement cost in oil and gas properties in the period in which the retirement obligation
is incurred. In general, the amount of an ARO and the costs capitalized will be equal to the estimated future cost to satisfy the
abandonment obligation assuming the normal operation of the asset, using current prices that are escalated by an
assumed inflation
factor up to the estimated settlement date, which is then discounted back to the date that the abandonment obligation was incurred
using an assumed cost of funds for the Company. After recording these amounts, the ARO will be accreted to its future estimated
value using the same assumed cost of funds and the capitalized costs are depreciated on a unit-of-production basis over the estimated
proved developed reserves. Both the accretion and the depreciation will be included in depreciation, depletion and amortization
expense on our consolidated statements of operations.
Revenue Recognition. ASU 2014-09, “Revenue
from Contracts with Customers (Topic 606)”, supersedes the revenue recognition requirements and industry-specific guidance
under Revenue Recognition (Topic 605). Topic 606 requires an entity to recognize revenue when it transfers promised goods
or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for those
goods or services. The Company adopted Topic 606 on January 1, 2018, using the modified retrospective method applied to contracts
that were not completed as of January 1, 2018. Under the modified retrospective method, prior period financial positions and results
will not be adjusted. The cumulative effect adjustment recognized in the opening balances included no significant changes as a
result of this adoption. Topic 606 requires certain changes to the presentation of revenues and related expenses beginning January
1, 2018. Refer to “Note 5 – Revenue from Contracts with Customers” for additional information.
The Company’s revenue is comprised entirely of revenue
from exploration and production activities. The Company’s oil is sold primarily to marketers, gatherers, and refiners. Natural
gas is sold primarily to interstate and intrastate natural-gas pipelines, direct end-users, industrial users, local distribution
companies, and natural-gas marketers. NGLs are sold primarily to direct end-users, refiners, and marketers. Payment is generally
received from the customer in the month following delivery.
Contracts with customers have varying terms, including month-to-month
contracts, and contracts with a finite term. The Company recognizes sales revenues for oil, natural gas, and NGLs based on the
amount of each product sold to a customer when control transfers to the customer. Generally, control transfers at the time of delivery
to the customer at a pipeline interconnect, the tailgate of a processing facility, or as a tanker lifting is completed. Revenue
is measured based on the contract price, which may be index-based or fixed, and may include adjustments for market differentials
and downstream costs incurred by the customer, including gathering, transportation, and fuel costs.
Revenues are recognized for the sale of the Company’s
net share of production volumes. Sales on behalf of other working interest owners and royalty interest owners are not recognized
as revenues.
Income Taxes. The Company utilizes the asset and
liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating
loss and tax credit carry-forwards and for the future tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of
operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of
deferred tax assets unless it is more likely than not that the value of such assets will be realized.
Uncertain Tax Positions. The Company evaluates uncertain
tax positions to recognize a tax benefit from an uncertain tax position only if it is more likely than not that the tax position
will be sustained on examination by the taxing authorities based on the technical merits of the position. Those tax positions failing
to qualify for initial recognition are recognized in the first interim period in which they meet the more likely than not standard,
or are resolved through negotiation or litigation with the taxing authority, or upon expiration of the statute of limitations.
De-recognition of a tax position that was previously recognized occurs when an entity subsequently determines that a tax position
no longer meets the more likely than not threshold of being sustained.
The Company is subject to ongoing tax exposures, examinations
and assessments in various jurisdictions. Accordingly, the Company may incur additional tax expense based upon the outcomes of
such matters. In addition, when applicable, the Company will adjust tax expense to reflect the Company’s ongoing assessments
of such matters, which require judgment and can materially increase or decrease its effective rate as well as impact operating
results.
Stock-Based Compensation. The Company utilizes the
Black-Scholes option pricing model to estimate the fair value of employee stock option awards at the date of grant, which requires
the input of highly subjective assumptions, including expected volatility and expected life. Changes in these inputs and assumptions
can materially affect the measure of estimated fair value of our share-based compensation. These assumptions are subjective and
generally require significant analysis and judgment to develop. When estimating fair value, some of the assumptions will be based
on, or determined from, external data and other assumptions may be derived from our historical experience with stock-based payment
arrangements. The appropriate weight to place on historical experience is a matter of judgment, based on relevant facts and circumstances.
The Company estimates volatility by considering the historical
stock volatility. The Company has opted to use the simplified method for estimating expected term, which is generally equal to
the midpoint between the vesting period and the contractual term.
Earnings (Loss) per Common Share. Basic earnings
(loss) per share (“EPS”) is computed by dividing net income (loss) available to common shareholders
(numerator) by the weighted average number of shares outstanding (denominator) during the period. Diluted EPS give effect
to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred
stock using the if-converted method. In computing diluted EPS, the average stock price for the period is used to determine the
number of shares assumed to be purchased from the exercise of stock options and/or warrants. Diluted EPS excluded all dilutive
potential shares if their effect is anti-dilutive. For the year ended December 31, 2019, potentially dilutive securities related
to options and warrants were not included in the calculation of diluted net loss per share because to do so would be anti-dilutive.
Recently Issued Accounting Pronouncements.
In February 2016, the Financial Accounting Standards Board (“FASB”) issued
ASU No. 2016-02, “Leases (Topic 842)”. The new lease guidance supersedes Topic 840. The core principle
of the guidance is that entities should recognize the assets and liabilities that arise from leases. Topic 840 does not apply to
leases to explore for or use minerals, oil, natural gas and similar nonregenerative resources, including the intangible right to
explore for those natural resources and rights to use the land in which those natural resources are contained. In July 2018, the
FASB issued ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements”, which provides entities with an alternative
modified transition method to elect not to recast the comparative periods presented when adopting Topic 842. The Company adopted
Topic 842 as of January 1, 2019, using the alternative modified transition method, for which, comparative periods, including the
disclosures related to those periods, are not restated.
In addition, the Company elected practical expedients provided
by the new standard whereby, the Company has elected to not reassess its prior conclusions about lease identification, lease classification,
and initial direct costs and to retain off-balance sheet treatment of short-term leases (i.e., 12 months or less and does not contain
a purchase option that the Company is reasonably certain to exercise). Refer to “Note 10 - Commitments and Contingencies”
for additional information.
In June 2018, the FASB issued ASU 2018-07, “Compensation—Stock
Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting”. The amendments in this update maintain
or improve the usefulness of the information provided to the users of financial statements while reducing cost and complexity in
financial reporting. The areas for simplification in this update involve several aspects of the accounting for nonemployee share-based
payment transactions resulting from expanding the scope of Topic 718, to include share-based payment transactions for acquiring
goods and services from nonemployees. Some of the areas for simplification apply only to nonpublic entities. The amendments in
this update are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within
those fiscal years. The Company adopted the standard as of January 1, 2019. There was no impact of the standard on its consolidated
financial statements.
The Company does not expect the adoption of any other recently
issued accounting pronouncements to have a significant impact on its financial position, results of operations, or cash flows.
Subsequent Events. The Company has evaluated all
transactions through the date the consolidated financial statements were issued for subsequent event disclosure consideration.
NOTE 4 – CASH
The following table provides a reconciliation of cash and restricted
cash reported within the balance sheets on December 31, 2019 and 2018, which sum to the total of such amounts shown in the accompanying
audited consolidated statements of cash flows (in thousands):
|
|
2019
|
|
|
2018
|
|
Cash
|
|
$
|
22,415
|
|
|
$
|
3,463
|
|
Restricted cash
|
|
|
—
|
|
|
|
2,316
|
|
Restricted cash included in other assets
|
|
|
3,297
|
|
|
|
—
|
|
Total cash and restricted cash as shown in the consolidated statements of cash flows
|
|
$
|
25,712
|
|
|
$
|
5,779
|
|
NOTE 5 – REVENUE FROM CONTRACTS
WITH CUSTOMERS
Disaggregation of Revenue from Contracts with Customers.
The following table disaggregates revenue by significant product type for the years ended December 31, 2019 and 2018 (in thousands):
|
|
2019
|
|
|
2018
|
|
Oil sales
|
|
$
|
12,518
|
|
|
$
|
4,153
|
|
Natural gas sales
|
|
|
372
|
|
|
|
230
|
|
Natural gas liquids sales
|
|
|
82
|
|
|
|
140
|
|
Total revenue from customers
|
|
$
|
12,972
|
|
|
$
|
4,523
|
|
There were no significant contract liabilities or transaction
price allocations to any remaining performance obligations as of December 31, 2019 or 2018, respectively.
NOTE 6 – OIL AND GAS PROPERTIES
The following tables summarize the Company’s oil and gas
activities by classification for the years ended December 31, 2019 and 2018, respectively (in thousands):
|
|
Balance at December 31,
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31,
|
|
|
|
2018
|
|
|
Additions
|
|
|
Disposals
|
|
|
Transfers
|
|
|
2019
|
|
Oil and gas properties, subject to amortization
|
|
$
|
70,803
|
|
|
$
|
29,900
|
|
|
$
|
(135
|
)
|
|
$
|
6,596
|
|
|
$
|
107,164
|
|
Oil and gas properties, not subject to amortization
|
|
|
8,516
|
|
|
|
12,976
|
|
|
|
—
|
|
|
|
(6,596
|
)
|
|
|
14,896
|
|
Asset retirement costs
|
|
|
2,188
|
|
|
|
(641
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
1,547
|
|
Accumulated depreciation and depletion
|
|
|
(21,045
|
)
|
|
|
(10,714
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(31,759
|
)
|
Total oil and gas assets
|
|
$
|
60,462
|
|
|
$
|
31,521
|
|
|
$
|
(135
|
)
|
|
$
|
—
|
|
|
$
|
91,848
|
|
|
|
Balance at December 31,
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31,
|
|
|
|
2017
|
|
|
Additions
|
|
|
Disposals
|
|
|
Transfers
|
|
|
2018
|
|
Oil and gas properties, subject to amortization
|
|
$
|
49,356
|
|
|
$
|
21,447
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
70,803
|
|
Oil and gas properties, not subject to amortization
|
|
|
—
|
|
|
|
8,516
|
|
|
|
—
|
|
|
|
—
|
|
|
|
8,516
|
|
Asset retirement costs
|
|
|
260
|
|
|
|
1,928
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,188
|
|
Accumulated depreciation and depletion
|
|
|
(14,694
|
)
|
|
|
(6,351
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(21,045
|
)
|
Total oil and gas assets
|
|
$
|
34,922
|
|
|
$
|
25,540
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
60,462
|
|
For the year ended December 31, 2019, the Company incurred $26,362,000
in drilling and completion costs relating to the drilling of nine wells and corresponding facility costs in its Permian Basin Asset,
in addition to amounts incurred for the participation (non-operated working interest) in the drilling of 11 total wells in
the DJ Basin ($2,500,000 noted below), and the acquisition of oil and gas assets from Manzano LLC and Manzano Energy Partners II,
LLC (“Manzano”) ($764,000 noted below) and from a private operator ($350,000 noted below). Also, the Company transferred
$6,596,000 in capital costs from four wells which were not completed at the beginning of the period from unproved properties to
proved properties when production began in March and April of 2019. At December 31, 2019, drilling and completion costs of $12,976,000
had been incurred for four of the nine wells in its Permian Asset; however, as production had not yet commenced, this amount was
included in the amount not subject to amortization at December 31, 2019.
The depletion recorded for production on proved properties for
the year ended December 31, 2019 and 2018, amounted to $10,714,000 and $6,351,000, respectively.
On February 1, 2019, for consideration of $743,000, plus $21,000
in acquisition costs, the Company completed an asset purchase from Manzano, whereby the Company purchased approximately 18,000
net leasehold acres, ownership and operated production from one horizontal well currently producing from the San Andres play in
the Permian Basin, ownership of three additional shut-in wells, and ownership of one saltwater disposal well. The Company subsequently
drilled one Manzano well in Phase Two of its 2019 development plan, which has yet to be completed.
On March 7, 2019, Red Hawk sold rights to 85.5 net acres of
oil and gas leases located in Weld County, Colorado, to a third party, for aggregate proceeds of $1.2 million and recognized a
gain on sale of oil and gas properties of $920,000 on the Statement of Operations. The sale agreement included a provision whereby
the purchaser was required to assign Red Hawk 85 net acres of leaseholds in an area located where the Company already owns other
leases in Weld County, Colorado, within nine months from the date of the sale, or to repay the Company up to $200,000 (proportionally
adjusted for the amount of leasehold delivered). In December 2019, the purchaser assigned Red Hawk 121 net acres of leaseholds
with a value of $121,000, which the Company recognized as an additional gain on the Statement of Operations.
On June 10, 2019, for consideration of $350,000, the Company
completed an asset purchase from a private operator, whereby the Company purchased approximately 2,076 net leasehold acres, ownership
and operated production from 22 vertical wells currently producing from the San Andres play in the Permian Basin and ownership
of three injection wells.
The Company participated in the drilling and completion of 11
horizontal wells in the DJ-Basin by third-party outside operators and incurred $2.5 million in net participation costs.
For the year ended December 31, 2018, the Company incurred $9,975,000
in drilling and completion costs, in addition to amounts incurred for the participation (non-operated working interest) in
the drilling of two wells in the DJ Basin ($295,000), the acquisition of Condor ($693,000 as detailed below) and the acquisition
of the New Mexico assets ($19,000,000 as detailed below). At December 31, 2018, drilling and completion costs of $8,516,000 had
been incurred for wells that had not been completed. Therefore, this amount was included in the amount not subject to amortization
at December 31, 2018.
Acquisition of New Mexico Properties
On August 1, 2018, the Company entered into a Purchase and Sale
Agreement with Milnesand Minerals Inc., Chaveroo Minerals Inc., Ridgeway Arizona Oil Corp. (“RAOC”), and EOR Operating
Company (“EOR”) (collectively the “Seller”)(the “Purchase Agreement”). The transaction
closed on August 31, 2018, and the effective date of the acquisition was September 1, 2018. Pursuant to the Purchase Agreement,
the Company acquired certain oil and gas assets described in greater detail below (the “New Mexico Assets”) from
the Seller in consideration for $18,500,000 (of which $500,000 was held back to provide for potential indemnification of the Company
under the Purchase Agreement and Stock Purchase Agreement (described below), with one-half ($250,000) to be released to Seller
90 days after closing and the balance ($250,000) to be released 180 days after closing (provided that if a court of competent
jurisdiction determines that any part of the amount withheld by the Company subsequent to 180 days after closing was in fact due
to the Seller, the Company is required to pay the Seller 200%, instead of 100%, of the amount so retained).
The New Mexico Assets represent approximately 23,000 net leasehold
acres, current operated production, and all the Seller’s leases and related rights, oil and gas and other wells, equipment,
easements, contract rights, and production (effective as of the effective date) as described in the Purchase Agreement. The
New Mexico Assets are located in the San Andres play in the Permian Basin situated in West Texas and Eastern New Mexico, with all
acreage and production 100% operated, and substantially all acreage held by production (“HBP”).
Also on August 31, 2018, the Company closed the transactions
under the August 1, 2018 Stock Purchase Agreement with Hunter Oil Production Corp. (“Hunter Oil”), and acquired all
the stock of RAOC and EOR (the “Acquired Companies”) for net cash paid of $500,000 (an aggregate purchase price
of $2,816,000, less $2,316,000 in restricted cash which the Acquired Companies are required to maintain as of the closing date).
The Stock Purchase Agreement contains customary representations and warranties of the parties, post-closing adjustments, and indemnification
requirements requiring Hunter Oil to indemnify us for certain items.
On December 17, 2018, the Company and Seller agreed that the
Company would pay to Seller $25,000 for all post-closing adjustments and post-closing support under the Purchase Agreement and
accelerate the payment by the Company to Seller of the final $250,000 to be released 180 days after closing, which payments were
made by the Company to Seller on December 17, 2018.
The following table summarizes the allocation of the purchase
price to the net assets acquired (in thousands):
Purchase price at September 1, 2018
|
|
|
|
Cash paid
|
|
$
|
20,816
|
|
Contingent consideration
|
|
|
500
|
|
Total consideration paid
|
|
$
|
21,316
|
|
|
|
|
|
|
Fair value of net assets acquired at September 1, 2018
|
|
|
|
|
Restricted cash for bonds
|
|
$
|
2,316
|
|
Oil and gas properties
|
|
|
21,012
|
|
Total assets
|
|
|
23,328
|
|
|
|
|
|
|
Asset retirement obligations
|
|
|
2,012
|
|
Total liabilities
|
|
|
2,012
|
|
Net assets acquired
|
|
$
|
21,316
|
|
The following table presents the Company’s supplemental
unaudited consolidated pro forma total revenues, lease operating costs, net income (loss) and net income (loss) per common
share for the year ended December 31, 2018 as if the acquisition of the New Mexico assets had occurred on January 1, 2018 (in thousands
except for share and per share amounts):
|
|
PEDEVCO
|
|
|
New
Mexico Asset Acquisition(1)
|
|
|
Proforma
Combined
|
|
Revenue
|
|
$
|
4,523
|
|
|
$
|
1,222
|
|
|
$
|
5,745
|
|
Lease operating costs
|
|
$
|
(2,821
|
)
|
|
$
|
(931
|
)
|
|
$
|
(3,752
|
)
|
Net income (loss)
|
|
|
53,607
|
|
|
$
|
(1,481
|
)
|
|
$
|
52,126
|
|
Net income (loss) per common share (diluted)
|
|
$
|
4.74
|
|
|
$
|
(0.15
|
)
|
|
$
|
4.59
|
|
|
(1)
|
Amount are based on Company estimates.
|
Acquisition of Condor Properties
from MIE Jurassic Energy Corporation
On August 1, 2018, the Company entered into a Membership Interest
Purchase Agreement (the “Membership Purchase Agreement”) with MIE Jurassic Energy Corporation (“MIEJ”) to
acquire 100% of the outstanding membership interests of Condor from MIEJ in exchange for cash paid of $537,000. Condor owns approximately
2,340 net leasehold acres, 100% held by production (HBP), located in Weld and Morgan Counties, Colorado, with four operated, producing
wells.
The following table summarizes the allocation of the purchase
price to the net assets acquired (in thousands):
Purchase price at August 1, 2018
|
|
|
|
Cash paid
|
|
$
|
537
|
|
|
|
|
|
|
Fair value of net assets acquired at August 1, 2018
|
|
|
|
|
Cash
|
|
$
|
2
|
|
Accounts receivable – oil and gas
|
|
|
59
|
|
Other current assets
|
|
|
39
|
|
Oil and gas properties
|
|
|
742
|
|
Bonds
|
|
|
105
|
|
Total assets
|
|
|
947
|
|
|
|
|
|
|
Current liabilities
|
|
|
361
|
|
Asset retirement obligations
|
|
|
49
|
|
Total liabilities
|
|
|
410
|
|
Final Purchase price
|
|
$
|
537
|
|
NOTE 7 – OTHER CURRENT ASSETS
On September 11, 2013, the Company entered into a Shares Subscription
Agreement (“SSA”) to acquire an approximate 51% ownership in Asia Sixth Energy Resources Limited (“Asia
Sixth”), which held an approximate 60% ownership interest in Aral Petroleum Capital Limited Partnership (“Aral”),
a Kazakhstan entity. In August 2014 the SSA was restructured (the “Aral Restructuring”), in connection with which the
Company received a promissory note in the principal amount of $10.0 million from Asia Sixth (the “A6 Promissory Note”),
which was to be converted into a 10.0% interest in Caspian Energy, Inc. (“Caspian Energy”), an Ontario, Canada company
listed at that time on the NEX Board of the TSX Venture Exchange, upon the consummation of the Aral Restructuring. The Aral Restructuring
was consummated on May 20, 2015, upon which date the A6 Promissory Note was converted into 23,182,880 shares of common stock
of Caspian Energy.
In February 2015, the Company expanded its D-J Basin position
through the acquisition of acreage from Golden Globe Energy (US), LLC (“GGE”)(the “GGE Acquisition” and
the “GGE Acquired Assets”). In connection with the GGE Acquisition, on February 23, 2015, the Company provided GGE
an option to acquire its interest in Caspian Energy for $100,000 payable upon exercise of the option (with an expiration date of
May 12, 2019) recorded in prepaid expenses and other current assets. As a result, the carrying value of the 23,182,880 shares
of common stock of Caspian Energy which were issued upon conversion of the A6 Promissory Note at December 31, 2015 was $100,000.
The shares of Caspian Energy underlying the option were classified as part of other current assets. The option expired without
being exercised on May 12, 2019. The Company fully reserved the $100,000 and recognized no value related to the shares of Caspian
Energy on the Company’s balance sheet as of December 31, 2019, as the Company determined the value of the shares to be $0
as a result of such shares being delisted from the NEX Board of the TSX Venture Exchange.
NOTE 8 – NOTES PAYABLE
The Company’s notes payable consisted of the following
for the years ended December 31, 2019 and 2018, respectively (in thousands):
|
|
2019
|
|
|
2018
|
|
Notes Payable – Subordinated
|
|
$
|
—
|
|
|
$
|
400
|
|
Notes Payable – Subordinated Related Party
|
|
|
—
|
|
|
|
30,200
|
|
Notes Payable – Related Party
|
|
|
—
|
|
|
|
7,855
|
|
|
|
|
—
|
|
|
|
38,455
|
|
Unamortized Debt Discount
|
|
|
—
|
|
|
|
(161
|
)
|
Total Notes Payable
|
|
$
|
—
|
|
|
$
|
38,294
|
|
Convertible Note Issuances
On June 26, 2018, the Company borrowed $7.7 million from SK
Energy under a Promissory Note dated June 25, 2018, in the amount of $7.7 million (the “June 2018 SK Energy Note”) and
shown on the December 31, 2018 Balance Sheet as Note Payable – Related Party, net of debt discount from the issuance of 600,000
shares of common stock (as described below) with a fair value of $185,000 based on the market price at the issuance date.
The June 2018 SK Energy Note accrues interest monthly at 8% per annum, payable quarterly, in either cash or shares of common stock
(at the option of the Company), or, with the consent of SK Energy, such interest may be accrued and capitalized.
As additional consideration for SK Energy agreeing to the terms
of the June 2018 SK Energy Note, the Company agreed to issue SK Energy 600,000 shares of common stock (the “Loan Shares”),
with a fair value of $185,000 based on the market price on the date of issuance that was accounted for as a debt discount and is
being amortized over the term of the note.
Based on a conversion price equal to $2.18 per share, pursuant
to the conversion terms of the June 2018 SK Energy Note, the amount of interest under the June 2018 SK Energy Note as of December
31, 2018 equaled $155,000 and was included in the outstanding principal balance of $7,855,000, for interest not paid or issued
in common stock when due, the amount is recapitalized into the face value of the note, per the terms of the June 2018 SK Energy
Note. The total amount of the remaining debt discount reflected on the accompanying balance sheet as of December 31, 2018 was $161,000,
which was amortized in full as of December 31, 2019, due to the note conversions, which included $107,000 of additional interest
that was included in the principal balance, noted below under “Convertible Notes Amendment and Conversion” and “SK
Energy Note Amendment; Note Purchases and Conversion”.
On August 1, 2018, the Company received total proceeds of $23,600,000
from the sale of multiple Convertible Promissory Notes (the “Convertible Notes”). A total of $22,000,000 in Convertible
Notes were purchased by SK Energy (the “August 2018 SK Energy Note”); $200,000 in Convertible Notes were purchased
by an executive officer of SK Energy; $500,000 in Convertible Notes were purchased by a trust affiliated with John J. Scelfo, a
director of the Company; $500,000 in Convertible Notes were purchased by an entity affiliated with Ivar Siem, our director, and
J. Douglas Schick, President of the Company; $200,000 in Convertible Notes was purchased by H. Douglas Evans (who became a Director
and related party on September 27, 2018); and $200,000 in Convertible Notes were purchased by an unaffiliated party (the “Unaffiliated
Holder”). The $23,600,000 is accounted for on the balance sheet as $23,200,000 of subordinated notes payable – related
party and $400,000 as subordinated notes, as these notes are subordinated to the original June 2018 SK Energy Note.
The Convertible Notes accrue interest monthly at 8.5% per annum,
which interest is payable on the maturity date unless otherwise converted into our common stock. The principal and interest due
under the Convertible Notes are convertible into shares of our common stock, from time to time after August 29, 2018, at the option
of the holders thereof, at a conversion price equal to $2.13 per share, per terms of the Convertible Notes.
The accrued interest is accounted for on the balance sheet as
of December 31, 2018 as $943,000 of accrued interest – related party and $14,000 of accrued interest. As of December 31,
2019, there was no accrued interest – related party or accrued interest associated with the Convertible Notes on the Balance
Sheet, as $347,000 of accrued interest – related party and $6,000 of accrued interest, incurred during 2019 together with
the accrued interest outstanding as of December 31, 2018, was converted into shares of common stock due to the note conversions
described below.
On October 25, 2018, the Company borrowed an additional $7.0
million from SK Energy, through the sale of a convertible promissory note in the amount of $7.0 million (the “October 2018
SK Energy Note”). The October 2018 SK Energy Note had substantially similar terms as the August 2018 SK Energy Note, except
that it had a conversion price of $1.79 per share. The October 2018 SK Energy Note is due and payable on October 25, 2021 but may
be prepaid at any time without penalty. The accrued interest expense related to this note for the year ended December 31, 2018
was $109,000 and is accounted for on the balance sheet as accrued interest – related party. As of December 31, 2019, there
was no accrued interest – related party associated with the August 2018 SK Energy Note on the Balance Sheet, as accrued interest
of $78,000 incurred during 2019 together with the accrued interest outstanding as of December 31, 2018 was converted into shares
of common stock due to the note conversions described below.
January 2019 SK Energy Convertible Note
On January 11, 2019, the Company borrowed an additional $15.0
million from SK Energy, through the sale of a convertible promissory note in the amount of $15.0 million (the “January 2019
SK Energy Note”). The January 2019 SK Energy Note had substantially similar terms as the August 2018 SK Energy Note, except
that it had a conversion price of $1.50 per share. The January 2019 SK Energy Note is due and payable on January 11, 2022 but may
be prepaid at any time without penalty. As of December 31, 2019, there was no outstanding principal or accrued interest –
related party associated with the January 2019 SK Energy Note on the Balance Sheet, due to the note conversions described below.
Accrued interest-related party for this note prior to the conversion totaled $126,000.
Convertible Notes Amendment and Conversion
On February 15, 2019, the Company and SK Energy agreed to amend
the Convertible Notes (including the August 2018 SK Energy Note), October 2018 SK Energy Note, and the January 2019 SK Energy Note,
to remove the conversion limitation that previously prevented SK Energy from converting any portion of the notes into common stock
of the Company if such conversion would have resulted in SK Energy beneficially owning more than 49.9% of the Company’s outstanding
shares of common stock.
Immediately following the entry into the amendment, on February
15, 2019, SK Energy elected to convert (i) all $15,000,000 of the outstanding principal and all $126,000 of accrued interest
then owed under the January 2019 SK Energy Note into common stock of the Company at a conversion price of $1.50 per share, as set
forth in the January 2019 SK Energy Note into 10,083,819 shares of restricted common stock of the Company, and (ii) all $7,000,000
of the outstanding principal and all $187,000 of accrued interest under the October 2018 SK Energy Note into common stock of the
Company at a conversion price of $1.79 per share, as set forth in the October 2018 SK Energy Note, into 4,014,959 shares of restricted
common stock of the Company.
On March 1, 2019, the Company and SK Energy amended the
June 2018 SK Energy Note, to provide SK Energy the right, at any time, at its option, to convert the principal and interest owed
under such June 2018 SK Energy Note, into shares of the Company’s common stock, at a conversion price of $2.13 per share.
In addition, on March 1, 2019, the holders of $1,500,000 in
aggregate principal amount of Convertible Notes sold their Convertible Notes at face value plus accrued and unpaid interest through
March 1, 2019 to SK Energy (the “Convertible Note Sale”). Holders which sold their Convertible Notes pursuant to the
Convertible Note Sale to SK Energy, included an executive officer of SK Energy ($200,000 in principal amount of Convertible Notes);
a trust affiliated with John J. Scelfo, a director of the Company ($500,000 in principal amount of Convertible Notes); an entity
affiliated with Ivar Siem, a director of the Company, and J. Douglas Schick the President of the Company ($500,000 in principal
amount of Convertible Notes); and Harold Douglas Evans, a director of the Company ($200,000 in principal amount of Convertible
Notes).
Immediately following the effectiveness of the SK Energy Note
Amendment and Convertible Note Sale, on March 1, 2019, SK Energy and the Unaffiliated Holder elected to convert all $31,300,000
of outstanding principal and an aggregate of $1,460,000 of accrued interest under the June 2018 SK Energy Note, SK Energy’s
$22 million Convertible Note and all other Convertible Notes, into common stock of the Company at a conversion price of $2.13 per
share (the “Conversion Price” and the “Conversions”) as set forth in the June 2018 SK Energy Note,
as amended, and the Convertible Notes (including SK Energy’s $22 million Convertible Note (collectively, the “Notes”),
into an aggregate of 15,381,605 shares of restricted common stock of the Company (the “Conversion Shares”).
NOTE 9 – ASSET RETIREMENT OBLIGATION
Activity related to the Company’s asset retirement obligations
is as follows for the year ended December 31, 2019 (in thousands):
|
|
2019
|
|
Balance at the beginning of the period(1)
|
|
$
|
2,571
|
|
Accretion expense
|
|
|
289
|
|
Obligations incurred for acquisition
|
|
|
54
|
|
Liabilities settled
|
|
|
(120
|
)
|
Changes in estimates
|
|
|
(695
|
)
|
Balance
at end of period(2)
|
|
$
|
2,099
|
|
|
(1)
|
Includes $119,000 of current asset retirement obligations at December 31, 2018.
|
|
(2)
|
Includes $225,000 of current asset retirement obligations at December 31, 2019.
|
NOTE 10 – COMMITMENTS AND CONTINGENCIES
Lease Agreements
The Company determines if an arrangement is a lease at inception
of the arrangement. To the extent that the Company determines an arrangement represents a lease, that lease is classified as an
operating lease or a finance lease. The Company currently does not have any finance leases. In accordance with Accounting Standards
Codification (ASC) Topic 842-Accounting for Leases, operating leases are capitalized on the Company’s consolidated balance
sheet through an asset and a corresponding lease liability. Recorded assets represent the Company’s right to use an underlying
asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Short-term
leases that have an initial term of one year or less are not capitalized. Currently, the Company has one operating lease for office
space that requires ASC Topic 842 treatment, discussed below.
Discount Rate
The Company’s leases typically do not provide an implicit
rate. Accordingly, the Company is required to use its incremental borrowing rate in determining the present value of lease payments
based on the information available at commencement date. The Company’s incremental borrowing rate would reflect the estimated
rate of interest that it would pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments
in a similar economic environment. However, the Company currently maintains no debt, and in order to apply an appropriate discount
rate, the Company used an average discount rate of eight publicly traded peer group companies similar to it based on size, geographic
location, asset types and/or operating characteristics.
Office Leases
In June 2018, the Company assumed the lease for its corporate
office space located in Houston, Texas from American Resources, Inc., an entity beneficially owned and controlled by Ivar Siem,
a director of the Company, and J. Douglas Schick, the Company’s President. The term of the lease ended on August 31, 2019.
Effective September 1, 2019, the Company moved its corporate
headquarters from 1250 Wood Branch Park Dr., Suite 400, Houston, Texas 77079 to 575 N. Dairy Ashford, Energy Center II, Suite 210,
Houston, Texas 77079 in connection with the expiration of its former office space lease. The Company entered into a sublease on
approximately 5,200 square feet of office space that expires on August 31, 2023, and has a base monthly rent of approximately $10,000
with the first month rent due beginning on January 1, 2020. The Company paid a security deposit of $9,600.
The Company also leased space for its former corporate headquarters
in Danville, California that was scheduled to expire July 31, 2019, but was terminated in January 2019, without penalty or other
amounts due. In February 2019, the Company entered into a six-month lease agreement for 187 square feet of new office space located
in Danville, California for the Company’s General Counsel. The monthly rent is $1,200, and the Company paid a $1,200 security
deposit. In August 2019, the lease was extended for an additional six months on the same terms. The Company did not apply ASC Topic
842 to this lease, as the lease term and extension period are for 12-months or less and we cannot currently conclude if the lease
will be renewed or extended beyond a 12-month period. The lease was subsequently extended for an additional six months in February
2020 at the same rate. The total current obligation for the remainder of this lease through July 2020 is $8,400.
For the year ended December 31, 2019 and 2018, the Company incurred
lease expense of $139,000 and $98,000, respectively, for the combined leases.
Supplemental cash flow information related to the Company’s
operating lease is included in the table below for the year ended December 31, 2019:
|
|
2019
|
|
Cash paid for amounts included in the measurement of lease liabilities
|
|
$
|
—
|
|
Supplemental balance sheet information related to operating
leases is included in the table below for the year ended December 31, 2019 (in thousands):
|
|
2019
|
|
Operating lease – right-of-use asset
|
|
$
|
360
|
|
|
|
|
|
|
Operating lease liabilities – current
|
|
$
|
97
|
|
Operating lease liabilities – long-term
|
|
|
300
|
|
Total lease liability
|
|
$
|
397
|
|
The weighted-average remaining lease term for the Company’s
operating lease is 3.7 years as of December 31, 2019, with a weighted-average discount rate of 5.35%.
Lease liability with enforceable contract terms that have greater
than one-year terms are as follows (in thousands):
2020
|
|
|
$
|
115
|
|
2021
|
|
|
|
118
|
|
2022
|
|
|
|
121
|
|
2023
|
|
|
|
82
|
|
Thereafter
|
|
|
|
—
|
|
Total lease payments
|
|
|
|
436
|
|
Less
imputed interest
|
|
|
|
(39
|
)
|
Total
lease liability
|
|
|
$
|
397
|
|
Leasehold Drilling Commitments
The Company’s oil and gas leasehold acreage is subject
to expiration of leases if the Company does not drill and hold such acreage by production or otherwise exercises options to extend
such leases, if available, in exchange for payment of additional cash consideration. In the D-J Basin Asset, 202 net acres expire
during the remainder of 2020, and no net acres expire thereafter (net to our direct ownership interest only). In the Permian Basin
Asset, 8,835 acres are set to expire without meeting drilling commitments or term assignment extensions (net to our direct ownership
interest only). The Company plans to hold significantly all of this acreage through a program of drilling and completing producing
wells. If the Company is not able to drill and complete a well before term assignment expiration, the Company may seek to extend
terms of contractual assignments.
Other Commitments
Although the Company may, from time to time, be involved in
litigation and claims arising out of its operations in the normal course of business, the Company is not currently a party to any
material legal proceeding. In addition, the Company is not aware of any material legal or governmental proceedings against it or
contemplated to be brought against it.
As part of its regular operations, the Company may become party
to various pending or threatened claims, lawsuits and administrative proceedings seeking damages or other remedies concerning its
commercial operations, products, employees and other matters.
Although the Company provides no assurance about the outcome
of these or any other pending legal and administrative proceedings and the effect such outcomes may have on the Company, the Company
believes that any ultimate liability resulting from the outcome of such proceedings, to the extent not otherwise provided for or
covered by insurance, will not have a material adverse effect on the Company’s financial condition or results of operations.
NOTE 11 – SHAREHOLDERS’ EQUITY
Common Stock
On February 15, 2019 and March 1, 2019, $22.3 million and $32.8
million of outstanding note payables and accrued interest were converted into 14,098,778 and 15,381,605 shares of the Company’s
common stock, respectively (see “Note 8- Notes Payable” above for further discussion of the note conversions).
On May 16, 2019, the Company sold an aggregate of 1,500,000
shares of its restricted common stock to two third-party purchasers at a price of $2.00 per share, or $3 million in aggregate,
pursuant to subscription agreements, and on September 17, 2019, the Company sold an aggregate of 8,400,000 shares of its restricted
common stock to an additional third-party purchaser, Viktor Tkachev, who became an affiliate of the Company, after the issuance,
at a price of $1.43 per share, or $12 million in aggregate, pursuant to a subscription agreement.
On May 21, 2019, SK Energy, which is owned and controlled by
Dr. Kukes, the Company’s Chief Executive Officer and a member of the Board of Directors, purchased 6,818,181 shares of restricted
common stock from the Company at a price of $2.20 per share, or $15 million in aggregate, pursuant to a subscription agreement,
and on September 17, 2019, SK Energy purchased an additional 8,204,481 shares of restricted common stock from the Company at a
price of $1.58 per share, or $13 million in aggregate, pursuant to a subscription agreement.
As a result of the purchases above, SK Energy, which beneficially
owned 78.2% of the Company’s outstanding common stock prior to the May 16, 2019 subscription agreement, beneficially owned
73.2% of the Company’s outstanding common stock after all of the subscriptions discussed above. Currently, SK Energy beneficially
owns 71.8% of the Company’s outstanding common stock as of the date of this report.
During the year ended December 31, 2018, SK Energy converted
all of its 66,625 outstanding shares of Series A Convertible Preferred Stock into 6,662,500 shares of the Company’s common
stock. SK Energy also converted an aggregate of $167,000 of interest accrued under the March 2019 SK Energy Note into 75,118 shares
of the Company’s common stock, based on a conversion price equal to $2.18 per share, pursuant to the conversion terms of
the March 2019 SK Energy Note.
Warrants
During the year ended December 31, 2019, no warrants were granted,
and warrants to purchase 470,077 shares of common stock expired. Additionally, on April 1, 2019, the Company issued 60,056 total
shares of common stock upon the cashless exercise of two warrants to purchase an aggregate of 596,280 shares of common stock with
an exercise price of $2.50 per share, based on a current market value of $2.78 per share, under the terms of each warrant.
During the year ended December 31, 2018, warrants to purchase
an aggregate of 1,448,472 shares of common stock were granted to certain holders of Company debt in connection with the Company’s
June 2018 debt restructuring. These warrants have a term of three years, an exercise price of $0.322, and the estimated fair value
of $322,000 was based on the Black-Scholes option pricing model and was recognized as warrant expense, which was included in the
net gain on debt restructuring. Variables used in the Black-Scholes option-pricing model for the warrants issued include: (1) a
discount rate of 2.50%, (2) expected term of 3.0 years, (3) expected volatility of 125.4%, and (4) zero expected
dividends. Additionally, 192,208 shares were issued in connection with the exercise of warrants (in exchange for cash received
of $64,000), 165,017 warrants expired and 1,105,935 were cancelled and re-purchased at a total price of $1,095,000.
The intrinsic value of outstanding as well as exercisable warrants
at December 31, 2019 and 2018 was $201,000 and $65,000, respectively.
Warrant activity during the years ended December 31, 2019 and
2018 was:
|
|
|
2019
|
|
|
2018
|
|
|
|
|
Number
of Warrants
|
|
|
Weighted
Average Exercise Price
|
|
|
Weighted
Average Remaining Contract Term (Years)
|
|
|
Number
of Warrants
|
|
|
Weighted
Average Exercise Price
|
|
|
Weighted
Average Remaining Contract Term (Years)
|
|
Outstanding at Beginning of Period
|
|
|
|
1,216,686
|
|
|
$
|
6.36
|
|
|
|
0.8
|
|
|
|
1,231,373
|
|
|
$
|
7.44
|
|
|
|
1.4
|
|
Granted
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
1,448,472
|
|
|
|
0.32
|
|
|
|
|
|
Expired/Cancelled
|
|
|
|
(470,077
|
)
|
|
|
13.19
|
|
|
|
|
|
|
|
(1,270,951
|
)
|
|
|
1.44
|
|
|
|
|
|
Exercised
|
|
|
|
(596,280
|
)
|
|
|
2.50
|
|
|
|
|
|
|
|
(192,208
|
)
|
|
|
0.32
|
|
|
|
|
|
Outstanding
at End of Period
|
|
|
|
150,329
|
|
|
$
|
0.32
|
|
|
|
1.5
|
|
|
|
1,216,686
|
|
|
$
|
6.36
|
|
|
|
0.8
|
|
Exercisable at End of Period
|
|
|
|
150,329
|
|
|
$
|
0.32
|
|
|
|
1.5
|
|
|
|
1,216,686
|
|
|
$
|
6.36
|
|
|
|
0.8
|
|
NOTE 12 – SHARE-BASED COMPENSATION
2012 Incentive Plan
On July 27, 2012, the shareholders of the Company approved the
2012 Equity Incentive Plan (the “2012 Incentive Plan”), which was previously approved by the Board of Directors on
June 27, 2012, and authorizes the issuance of various forms of stock-based awards, including incentive or non-qualified options,
restricted stock awards, performance shares and other securities as described in greater detail in the 2012 Incentive Plan, to
the Company’s employees, officers, directors and consultants. The 2012 Incentive Plan was amended on June 27, 2014, October
7, 2015 and December 28, 2016, December 28, 2017, September 27, 2018 and August 28, 2019 to increase by 500,000, 300,000, 500,000,
1,500,000, 3,000,000 and 2,000,000 (to 8,000,000 currently), respectively, the number of shares of common stock reserved for issuance
under the 2012 Incentive Plan.
A total of 8,000,000 shares of common stock are eligible to
be issued under the 2012 Incentive Plan as of December 31, 2019, of which 3,980,130 shares have been issued as restricted stock,
678,000 shares are subject to issuance upon exercise of issued and outstanding options, and 3,341,870 shares remain available for
future issuance as of December 31, 2019.
PEDCO 2012 Equity Incentive Plan
As a result of the July 27, 2012 merger by and between
the Company, Blast Acquisition Corp., a wholly-owned Nevada subsidiary of the Company (“MergerCo”), and Pacific Energy
Development Corp., a privately-held Nevada corporation (“PEDCO”) pursuant to which MergerCo was merged with and
into PEDCO, with PEDCO continuing as the surviving entity and becoming a wholly-owned subsidiary of the Company, in a transaction
structured to qualify as a tax-free reorganization (the “Merger”), the Company assumed the PEDCO 2012 Equity Incentive
Plan (the “PEDCO Incentive Plan”), which was adopted by PEDCO on February 9, 2012. The PEDCO Incentive Plan authorized
PEDCO to issue an aggregate of 100,000 shares of common stock in the form of restricted shares, incentive stock options, non-qualified
stock options, share appreciation rights, performance shares, and performance units under the PEDCO Incentive Plan. As of December
31, 2019, options to purchase an aggregate of 21,635 shares of the Company’s common stock and 55,168 shares of the Company’s
restricted common stock have been granted under this plan (all of which were granted by PEDCO prior to the closing of the merger
with the Company, with such grants being assumed by the Company and remaining subject to the PEDCO Incentive Plan following the
consummation of the merger). The Company does not plan to grant any additional awards under the PEDCO Incentive Plan.
Common Stock
In April 2019, restricted stock awards were granted to three
new employees and one consultant for an aggregate of 160,000 shares of the Company’s common stock, under the Company’s
Amended and Restated 2012 Equity Incentive Plan. The grant for a total of 50,000 of the restricted stock awards vests as follows:
100% on the one-year anniversary of the grant date, subject to the recipient’s continued service with the Company. These
shares have a total fair value of $135,000 based on the market price on the issuance date. The grants for 110,000 shares of restricted
stock vest as follows: 50% on the one-year anniversary of the grant date and 50% on the second-year anniversary of the grant date,
subject to the recipient’s continued service with the Company. These shares have a total fair value of $253,000 based on
the market price on the issuance date.
On July 18, 2019, 50,000 shares of restricted stock were awarded
to an advisor under the Company’s Amended and Restated 2012 Equity Incentive Plan. The restricted stock vests as follows:
100% on the six-month anniversary of the grant date, subject to the recipient’s continued service with the Company. These
shares have a total fair value of $83,000, based on the market price on the issuance date.
On August 28, 2019, restricted stock awards were granted to
three directors for an aggregate of 170,000 shares of the Company’s common stock, under the Company’s Amended and Restated
2012 Equity Incentive Plan. The grant for a total of 120,000 of the restricted stock awards vests as follows: 100% on July 12,
2020, subject to the recipient’s continued service with the Company. These shares have a total fair value of $187,000 based
on the market price on the issuance date. The grants for 50,000 shares of restricted stock vest as follows: 100% on September 27,
2020, subject to the recipient’s continued service with the Company. These shares have a total fair value of $78,000 based
on the market price on the issuance date. Additionally, 50,000 shares of restricted stock were awarded to a director for advisory
services provided to the Company under the Company’s Amended and Restated 2012 Equity Incentive Plan. The restricted stock
vests as follows: 100% on July 12, 2020, subject to the recipient’s continued service with the Company. These shares have
a total fair value of $78,000, based on the market price on the issuance date.
On October 5, 2019, 250,000 shares of restricted stock were
awarded to an advisor under the Company’s Amended and Restated 2012 Equity Incentive Plan. The restricted stock vests as
follows: 100% on the six-month anniversary of the grant date, subject to the recipient’s continued service with the Company.
These shares have a total fair value of $350,000, based on the market price on the issuance date.
On November 8, 2019, the Company entered into an Advisory Agreement
and Restricted Shares Grant Agreement with Viktor Tkachev, a greater than 10% shareholder of the Company (who acquired $12 million
of shares of common stock on September 17, 2019), under which Mr. Tkachev agreed to provide strategic planning and business
development services, and pursuant to which 100,000 shares of restricted common stock were awarded to Mr. Tkachev under the Company’s
Amended and Restated 2012 Equity Incentive Plan, 100% of which vest on the six-month anniversary of the grant date, subject to
the recipient’s continued service with the Company and the terms and conditions of these agreements. These shares have a
total fair value of $128,000 based on the market price on the issuance date.
Also on November 8, 2019, the Company entered into an Advisory
Agreement with Ivar Siem, a member of the Board of Directors, pursuant to which the 50,000 restricted shares of common stock previously
awarded to Mr. Siem on August 28, 2019 under the Plan continue to vest, with 100% vesting on July 12, 2020, subject to Mr. Siem
continuing to provide advisory services to the Company on such vesting date, and subject to the terms and conditions of a Restricted
Shares Grant Agreement entered into by and between the Company and Mr. Siem on August 28, 2019. The Advisory Agreement contains
customary confidentiality, indemnification and no conflict language; and may be terminated by the Company or the advisor with 15
days prior written notice for any reason.
During the year ended December 31, 2018, the Company issued
shares of common stock and restricted common stock as follows: 600,000 shares of common stock issued to SK Energy with a fair value
of $185,000 based on the market price on the date of issuance, 80,000 shares of restricted stock were issued to our former CEO
(Mr. Ingriselli) with a fair value of $27,000 based on the market price on the date of issuance, and 30,848 shares were issued
to employees for the cashless exercise of options. The 80,000 shares of restricted stock were issued in consideration for Mr. Ingriselli
rejoining the Company as its President and Chief Executive Officer in May 2018. Mr. Ingriselli subsequently resigned as President
and Chief Executive Officer on September 27, 2018 and the shares of restricted stock fully vested on October 1, 2018 pursuant to
a separation agreement entered into with him.
Also, restricted stock awards were granted to Messrs. Frank
C. Ingriselli (then President) and Clark R. Moore (Executive Vice President, General Counsel and Secretary) of 60,000
and 50,000 shares, respectively, under the Company’s Amended and Restated 2012 Equity Incentive Plan during the year ended
December 31, 2018. The restricted stock awards vest as follows: 100% on the six-month anniversary of the grant date. These shares
have a total fair value of $164,000 based on the market price on the issuance date. Upon Mr. Ingriselli’s resignation, noted
above, the 60,000 shares of restricted stock fully vested on October 1, 2018 pursuant to a separation agreement entered into with
him.
Subsequent restricted stock awards were granted to 12 employees
and two directors totaling an aggregate of 714,000 shares (90,000 shares on September 27, 2018 and 624,000 shares on December 12,
2018), under the Company’s Amended and Restated 2012 Equity Incentive Plan. The grants for a total of 40,000 of the restricted
stock awards vest as follows: 100% on the one-year anniversary of the grant date. These shares have a total fair value of $88,000
based on the market price on the issuance date. The grant for 50,000 shares of restricted stock vest as follows: 50% on the one-year
anniversary of the grant date and 50% on the second-year anniversary of the grant date. These shares have a total fair value of
$109,000 based on the market price on the issuance date. The grant for 624,000 shares of restricted stock vest as follows: 33.3%
on the one-year anniversary of the grant date, 33.3% on the two-year anniversary of the grant date and 33.3% on the third-year
anniversary of the grant date. These shares have a total fair value of $830,000 based on the market price on the issuance date.
In each case above the restricted shares are subject to the recipient of the shares being an employee of or consultant to the Company
on such vesting date, and subject to the terms and conditions of a Restricted Shares Grant Agreement, as applicable, entered into
by and between the Company and the recipient. In addition, 65,017 shares were issued to an employee for the cashless exercise of
options, and 192,208 shares were issued for the exercise of warrants at an exercise price of $0.322 per share for an aggregate
exercise price of $64,000.
The awarded shares above are subject to trading restrictions,
and forfeiture, subject to the vesting terms described above. When such securities are vested in accordance with their terms, the
trading restrictions are lifted.
Stock-based compensation expense recorded related to restricted
stock during the years ended December 31, 2019 and 2018 was $1,259,000 and $659,000, respectively. The remaining amount of unamortized
stock-based compensation expense related to restricted stock at December 31, 2019 and 2018 was $999,000 and $967,000, respectively.
Options
On August 14, 2019, the Company issued 9,782 total shares of
common stock upon the cashless exercise of stock options to purchase an aggregate of 12,500 shares of common stock with an exercise
price of $0.31 per share, based on a then current market value of $1.42 per share, under the terms of the options. The options
had an intrinsic value of $14,000 on the exercise date.
On September 27, 2018, the Company granted options to purchase
an aggregate of 120,000 and 100,000 shares of common stock an exercise price of $2.19 per share to John J. Scelfo, our Chairman,
and H. Douglas Evans, a Director, respectively, all pursuant to the Company’s 2012 Amended and Restated Equity Incentive
Plan and in consideration for their joining the Company’s board of directors and committees thereof. The options have a term
of five years and fully vest on the one-year anniversary of the vesting commencement date contingent upon the recipient’s
continued service with the Company. The aggregate fair value of the options on the date of grant, using the Black-Scholes model,
was $417,000. Variables used in the Black-Scholes option-pricing model for the options issued include: (1) a discount rate
of 2.75%, (2) expected term of 3.0 years, (3) expected volatility of 171%, and (4) zero expected dividends.
On December 12, 2018, the Company granted options to purchase
an aggregate of 50,000 shares of common stock to an employee at an exercise price of $1.33 per share. The options have a term of
five years and fully vest in December 2021. 33.3% vest each subsequent year from the date of grant contingent upon the recipient’s
continued service with the Company. The aggregate fair value of the options on the date of grant, using the Black-Scholes model,
was $59,000. Variables used in the Black-Scholes option-pricing model for the options issued include: (1) a discount rate
of 2.75%, (2) expected term of 3.5 years, (3) expected volatility of 164%, and (4) zero expected dividends.
During the year ended December 31, 2019 and 2018, the Company
recognized stock option based compensation expense related to options of $298,000 and $203,000, respectively.
The remaining amount of unamortized stock options expense at
December 31, 2019 and 2018 was $22,000 and $320,000, respectively.
The intrinsic value of outstanding and exercisable options at
December 31, 2019 and 2018 was $197,000 and $36,000, respectively.
Option activity during the year-ended December 31, 2019 and
2018 was:
|
|
|
2019
|
|
|
2018
|
|
|
|
|
Number
of Stock Options
|
|
|
Weighted
Average Grant Price
|
|
|
Weighted
Average Remaining Contract Term (Years)
|
|
|
Number
of Stock Options
|
|
|
Weighted
Average Grant Price
|
|
|
Weighted
Average Remaining Contract Term (Years)
|
|
Outstanding at Beginning of Period
|
|
|
|
890,232
|
|
|
$
|
3.26
|
|
|
|
3.3
|
|
|
|
743,727
|
|
|
$
|
3.45
|
|
|
|
3.8
|
|
Granted
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
270,000
|
|
|
|
2.03
|
|
|
|
4.8
|
|
Expired/Cancelled
|
|
|
|
(124,383
|
)
|
|
|
6.13
|
|
|
|
|
|
|
|
(3,495
|
)
|
|
|
45.67
|
|
|
|
|
|
Exercised
|
|
|
|
(12,500
|
)
|
|
|
0.31
|
|
|
|
|
|
|
|
(120,000
|
)
|
|
|
0.44
|
|
|
|
|
|
Outstanding
at End of Period
|
|
|
|
753,349
|
|
|
$
|
2.93
|
|
|
|
2.5
|
|
|
|
890,232
|
|
|
$
|
3.26
|
|
|
|
3.3
|
|
Exercisable at End of Period
|
|
|
|
720,016
|
|
|
$
|
3.00
|
|
|
|
2.4
|
|
|
|
575,232
|
|
|
$
|
4.19
|
|
|
|
2.5
|
|
NOTE 13 – EARNINGS (LOSS) PER COMMON SHARE
Earnings (loss) per common share-basic is calculated by
dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Net income
(loss) per common share-diluted assumes the conversion of all potentially dilutive securities and is calculated by dividing
net (loss) income by the sum of the weighted average number of shares of common stock, as defined above, outstanding plus
potentially dilutive securities. Net (loss) income per common share-diluted considers the impact of potentially dilutive securities
except in periods in which there is a loss because the inclusion of the potential common shares, as defined above, would have an
anti-dilutive effect.
The calculation of earnings (loss) per share for the years
ended December 31, 2019 and 2018 were as follows (amounts in thousands, except share and per share data):
Numerator:
|
|
2019
|
|
|
2018
|
|
Net income (loss)
|
|
$
|
(11,102
|
)
|
|
$
|
53,607
|
|
Effect of common stock equivalents
|
|
|
—
|
|
|
|
—
|
|
Net income (loss) adjusted for common stock equivalents
|
|
$
|
(11,102
|
)
|
|
$
|
53,607
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average common shares – basic
|
|
|
51,214,986
|
|
|
|
11,168,490
|
|
|
|
|
|
|
|
|
|
|
Dilutive effect of common stock equivalents:
|
|
|
|
|
|
|
|
|
Options and Warrants
|
|
|
—
|
|
|
|
144,756
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average common shares – diluted
|
|
|
51,214,986
|
|
|
|
11,313,246
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per common share – basic
|
|
$
|
(0.22
|
)
|
|
$
|
4.80
|
|
Earnings (loss) per common share – diluted
|
|
$
|
(0.22
|
)
|
|
$
|
4.74
|
|
For the years ended December 31, 2019 and 2018, the following
share equivalents related to convertible debt and preferred stock, and options and warrants to purchase shares of common stock
were excluded from the computation of diluted net income (loss) per share as the inclusion of such shares would be anti-dilutive.
|
|
2019
|
|
|
2018
|
|
Common Shares Issuable for:
|
|
|
|
|
|
|
|
|
Convertible Debt
|
|
|
—
|
|
|
|
15,449,559
|
|
Options and Warrants
|
|
|
903,678
|
|
|
|
1,491,589
|
|
Total
|
|
|
903,678
|
|
|
|
16,941,148
|
|
NOTE 14 – RELATED PARTY TRANSACTIONS
The following table reflects the related party amounts for SK
Energy, Directors and Officers included in the balance sheets of the years ended December 31, 2019 and 2018 (in thousands):
|
|
2019
|
|
|
2018
|
|
Long-term accrued expenses
|
|
|
—
|
|
|
$
|
943
|
|
Long-term notes payable – subordinated
|
|
|
—
|
|
|
|
30,200
|
|
Long-term notes payable, net of discount of $-0- and $161, respectively
|
|
|
—
|
|
|
|
7,694
|
|
Total related party liabilities
|
|
$
|
—
|
|
|
$
|
38,837
|
|
See “Note 8 – Notes Payable” above
for a further discussion of the debt conversions and subsequent retirement of all related party debt.
On May 21, 2019, SK Energy, which is owned and controlled by
Dr. Kukes, our Chief Executive Officer and a member of the Board of Directors, purchased 6,818,181 shares of restricted common
stock from the Company at a price of $2.20 per share, or $15 million in aggregate, and on September 17, 2019, SK Energy purchased
8,204,481 additional shares of restricted common stock from the Company at a price of $1.5845 per share, or $13 million in aggregate
(see “Note 11 – Shareholders’ Equity” above for a further discussion of the issuance of the restricted
common stock).
On August 28, 2019, 50,000 shares of restricted stock were awarded
to a director for advisory services provided to the Company, which shares have a total fair value of $78,000, based on the market
price on the issuance date (see “Note 12 – Share-Based Compensation” above for a further discussion of
the issuance of the share-based compensation).
Also, on August 28, 2019, the Company granted an aggregate of
170,000 shares of restricted stock to three directors of the Company, which have a total fair value of $265,000, based on the market
price on the issuance date (see “Note 12 – Share-Based Compensation” above for a further discussion of
the issuance of the share-based compensation).
On November 1, 2019, the Company subleased approximately 300
square feet of office space at its current headquarters to SK Energy, which is owned and controlled by Dr. Kukes, our Chief Executive
Officer and a member of the Board of Directors. The lease renews on a monthly basis, may be terminated by either party at any time
upon prior written notice delivered to the other party, and has a monthly base rent of $1,200.
On November 8, 2019, 100,000 shares of restricted stock were
awarded to a greater than 10% shareholder of the Company for strategic planning and business development services provided to the
Company, which shares have a total fair value of $128,000, based on the market price on the issuance date (see “Note 12
– Share-Based Compensation” above for a further discussion of the issuance of the share-based compensation).
NOTE 15 – INCOME TAXES
Due to the Company’s net taxable losses for both years,
there were no provisions for income taxes for the years ended December 31, 2019 and 2018.
The following table reconciles the U.S. federal statutory income
tax rate in effect for the years ended December 1, 2019 and 2018, and the Company’s effective tax rate:
|
|
2019
|
|
|
2018
|
|
U.S. federal statutory income tax (benefit)
|
|
|
21.00
|
%
|
|
|
21.00
|
%
|
State and local income tax, net of benefits
|
|
|
6.64
|
%
|
|
|
6.64
|
%
|
Amortization of debt discount
|
|
|
-2.05
|
%
|
|
|
0.73
|
%
|
Officer life insurance and D&O insurance
|
|
|
-0.05
|
%
|
|
|
0.01
|
%
|
Stock-based compensation
|
|
|
-0.62
|
%
|
|
|
0.08
|
%
|
Utilization of net operating loss carryforwards
|
|
|
0.03
|
%
|
|
|
0.44
|
%
|
Tax rate changes and other
|
|
|
0.00
|
%
|
|
|
-30.18
|
%
|
Valuation allowance for deferred income tax assets
|
|
|
-24.95
|
%
|
|
|
1.28
|
%
|
Effective income tax rate
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
Deferred income tax assets as of December
31, 2019 and 2018 are as follows (in thousands):
Deferred Tax Assets
|
|
2019
|
|
|
2018
|
|
Difference in depreciation, depletion, and capitalization methods – oil and natural gas properties
|
|
$
|
529
|
|
|
$
|
4,334
|
|
Accretion
|
|
|
80
|
|
|
|
—
|
|
Share-based compensation
|
|
|
584
|
|
|
|
—
|
|
Net operating loss – federal taxes
|
|
|
23,183
|
|
|
|
30,324
|
|
Net operating loss – state taxes
|
|
|
3,139
|
|
|
|
5,397
|
|
Total deferred tax asset
|
|
|
27,515
|
|
|
|
40,055
|
|
Less valuation allowance
|
|
|
(27,515
|
)
|
|
|
(40,055
|
)
|
Total deferred tax assets
|
|
$
|
—
|
|
|
$
|
—
|
|
In assessing the realization of deferred tax assets, management
considers whether it is more likely than not that some portion or all of deferred assets will not be realized. The ultimate realization
of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary
differences become deductible.
Utilization of NOL and tax credit carryforwards may be subject
to a substantial annual limitation due to ownership change limitations that may have occurred or that could occur in the future,
as required by the Internal Revenue Code (the “Code”), as amended, as well as similar state provisions. In general,
an “ownership change” as defined by the Code results from a transaction or series of transactions over a three-year
period resulting in an ownership change of more than 50 percent of the outstanding stock of a company by certain shareholders or
public groups.
Based on the available objective evidence, management believes
it is more likely than not that the net deferred tax assets will not be fully realizable. Accordingly, management has applied a
full valuation allowance against its net deferred tax assets at December 31, 2019 and 2018. The net change in the total valuation
allowance from December 31, 2018 to December 31, 2019 was a decrease of $12,500,000.
The Company’s policy is to recognize interest and penalties
accrued on any unrecognized tax benefits as a component of income tax expense. As of December 31, 2019 and 2018, the Company did
not have any significant uncertain tax positions or unrecognized tax benefits. The Company did not have associated accrued interest
or penalties, nor was any interest expense or penalties recognized for the years ended December 31, 2019 and 2018.
As of December 31, 2019, the Company has federal net operating
loss carryforwards of approximately $110,000,000, which if not utilized approximately $95,000,000 will expire beginning
in 2023 and ending 2037, respectively, and $15,000,000. carried forward indefinitely limited to 80% of a given years taxable income.
The Company currently has tax returns open for examination by
the Internal Revenue Service for all years since 2015.
NOTE 16 – SUBSEQUENT EVENTS
On January 13, 2020, the Company granted options to purchase
an aggregate of 733,000 shares of common stock to various Company employees at an exercise price of $1.68 per share. The options
have a term of five years and fully vest in January 2023. 33.3% vest each subsequent year from the date of grant, contingent upon
the recipient’s continued service with the Company. The aggregate fair value of the options on the date of grant, using the
Black-Scholes model, was $1,053,000. Variables used in the Black-Scholes option-pricing model for the options issued include: (1)
a discount rate of 1.63%, (2) expected term of 3.5 years, (3) expected volatility of 155%, and (4) zero expected dividends.
Additionally on January 13, 2020, restricted stock awards were
granted to various employees and one consultant for an aggregate of 1,049,000 (including 924,000 restricted stock awards to officers
of the Company) and 70,000 shares, respectively, of the Company’s common stock, under the Company’s Amended and Restated
2012 Equity Incentive Plan. The grant for the 1,049,000 shares of restricted stock vest as follows: 33.3% vest each subsequent
year from the date of grant contingent upon the recipient’s continued service with the Company. These shares have a total
fair value of $1,172,000 based on the market price on the issuance date. The grant for the 70,000 shares of restricted stock vest
as follows: 100% on the one-year anniversary of the grant date, subject to the recipient’s continued service with the Company.
These shares had a total fair value of $118,000 based on the market price on the issuance date.
In February 2020, 55,000 shares of restricted common stock were
rescinded due to an employee termination. As a result, these shares were canceled and returned to the Company’s Amended and
Restated 2012 Equity Incentive Plan.
SUPPLEMENTAL
INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES
(UNAUDITED)
The following disclosures for the Company are made in accordance
with authoritative guidance regarding disclosures about oil and natural gas producing activities. Users of this information should
be aware that the process of estimating quantities of “proved,” “proved developed,” and “proved undeveloped”
crude oil, natural gas liquids and natural gas reserves is complex, requiring significant subjective decisions in the evaluation
of all available geological, engineering and economic data for each reservoir. The data for a given reservoir may also change substantially
over time as a result of numerous factors including, but not limited to, additional development activity, evolving production history
and continual reassessment of the viability of production under varying economic conditions. Consequently, material revisions (upward
or downward) to existing reserve estimates may occur from time to time. Although reasonable effort is made to ensure that
reserve estimates reported represent the most accurate assessments possible, the significance of the subjective decisions required
and variances in available data for various reservoirs make these estimates generally less precise than other estimates presented
in connection with financial statement disclosures.
Proved reserves represent estimated quantities of crude oil,
natural gas liquids and natural gas that geoscience and engineering data can estimate, with reasonable certainty, to be economically
producible from a given day forward from known reservoirs under economic conditions, operating methods and government regulation
before the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably
certain, regardless of whether deterministic or probabilistic methods are used for the estimation.
Proved developed reserves are proved reserves expected to be
recovered under operating methods being utilized at the time the estimates were made, through wells and equipment in place or if
the cost of any required equipment is relatively minor compared to the cost of a new well.
Proved undeveloped reserves are reserves that are expected to
be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required. Reserves
on undrilled acreage are limited to those directly offsetting development spacing areas that are reasonably certain of production
when drilled, unless evidence using reliable technology exists that establishes reasonable certainty of economic producibility
at greater distances. Undrilled locations can be classified as having undeveloped reserves only if a development plan has been
adopted indicating that they are scheduled to be drilled within five years, unless the specific circumstances justify a longer
time. Estimates for proved undeveloped reserves are not attributed to any acreage for which an application of fluid injection or
other improved recovery technique is contemplated, unless such techniques have been proved effective by actual projects in the
same reservoir or an analogous reservoir, or by other evidence using reliable technology establishing reasonable certainty.
PROVED
RESERVE SUMMARY
All of the Company’s reserves are located in the United
States. The following tables sets forth the changes in the Company’s net proved reserves (including developed and undeveloped
reserves) for the years ended December 31, 2019 and 2018. Reserves estimates as of December 31, 2019 were estimated by the
independent petroleum consulting firm Cawley, Gillespie & Associates, Inc. The reserve report has been incorporated by reference
herein as Exhibit 99.1 to the Annual Report on Form 10-K which these financial statements are filed with.
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Crude Oil (MBbls)
|
|
|
|
|
|
|
|
|
Net proved reserves at beginning of year
|
|
|
11,538
|
|
|
|
1,942
|
|
Revisions of previous estimates
|
|
|
105
|
|
|
|
(1,556
|
)
|
Purchases in place
|
|
|
1,083
|
|
|
|
—
|
|
Extensions, discoveries and other additions
|
|
|
—
|
|
|
|
—
|
|
Sales in place
|
|
|
(52
|
)
|
|
|
—
|
|
Production
|
|
|
(315
|
)
|
|
|
(74
|
)
|
Net proved reserves at end of year
|
|
|
12,359
|
|
|
|
11,538
|
|
Natural Gas (Mmcf)
|
|
|
|
|
|
|
|
|
Net proved reserves at beginning of year
|
|
|
5,283
|
|
|
|
6,354
|
|
Revisions of previous estimates
|
|
|
4,071
|
|
|
|
(5,874
|
)
|
Purchases in place
|
|
|
742
|
|
|
|
4,942
|
|
Extensions, discoveries and other additions
|
|
|
—
|
|
|
|
—
|
|
Sales in place
|
|
|
(123
|
)
|
|
|
—
|
|
Production
|
|
|
(227
|
)
|
|
|
(139
|
)
|
Net proved reserves at end of year
|
|
|
9,746
|
|
|
|
5,283
|
|
NGL (MBbbls)
|
|
|
|
|
|
|
|
|
Net proved reserves at beginning of year
|
|
|
17
|
|
|
|
673
|
|
Revisions of previous estimates
|
|
|
49
|
|
|
|
(645
|
)
|
Purchases in place
|
|
|
—
|
|
|
|
—
|
|
Extensions, discoveries and other additions
|
|
|
—
|
|
|
|
—
|
|
Sales in place
|
|
|
(3
|
)
|
|
|
—
|
|
Production
|
|
|
(15
|
)
|
|
|
(11
|
)
|
Net proved reserves at end of year
|
|
|
48
|
|
|
|
17
|
|
Oil Equivalents (MBoe)
|
|
|
|
|
|
|
|
|
Net proved reserves at beginning of year
|
|
|
12,435
|
|
|
|
3,674
|
|
Revisions of previous estimates
|
|
|
832
|
|
|
|
(3,180
|
)
|
Purchases in place
|
|
|
1,207
|
|
|
|
12,050
|
|
Extensions, discoveries and other additions
|
|
|
—
|
|
|
|
—
|
|
Sales in place
|
|
|
(75
|
)
|
|
|
—
|
|
Production
|
|
|
(367
|
)
|
|
|
(108
|
)
|
Net proved reserves at end of year
|
|
|
14,032
|
|
|
|
12,436
|
|
RESERVES
During the year ended December 31, 2019, the Company increased
its reserves by approximately 1.6 MBoe of proved reserves. We had a 1.8 MBoe increase in proved developed and non-producing reserves
primarily due to the drilling and completion of nine new productive wells in the Permian Basin, as well as our participation (non-operated
working interest) in 11 productive wells in the DJ-Basin representing 1.7 MBoe of proved developed reserves, coupled with
our acquisition of 0.1 MBoe in proved developed and non-producing reserves in the Permian Basin, offset by a 0.2 MBoe reduction
of proved undeveloped reserves, noted below.
We also had a transfer to proved non-producing reserves on existing
wells of 1.1 MBoe due to one well which was previously producing, being shut-in, due to water injection capacity restrictions,
and four new wells completed by December 31, 2019, for which production had not yet commenced.
The following table sets forth the Company’s proved developed
and undeveloped reserves at December 31, 2019 and 2018, respectively:
|
|
2019
|
|
|
2018
|
|
Proved Developed Reserves
|
|
|
|
|
|
|
|
|
Crude Oil (MBbls)
|
|
|
938
|
|
|
|
435
|
|
Natural Gas (Mmcf)
|
|
|
983
|
|
|
|
341
|
|
NGL (MBbls)
|
|
|
48
|
|
|
|
17
|
|
Oil Equivalents (MBoe)
|
|
|
1,151
|
|
|
|
509
|
|
Proved Developed Non-Producing Reserves
|
|
|
|
|
|
|
|
|
Crude Oil (MBbls)
|
|
|
1,045
|
|
|
|
—
|
|
Natural Gas (Mmcf)
|
|
|
619
|
|
|
|
—
|
|
NGL (MBbls)
|
|
|
—
|
|
|
|
—
|
|
Oil Equivalents (MBoe)
|
|
|
1,148
|
|
|
|
—
|
|
Proved Undeveloped Reserves
|
|
|
|
|
|
|
|
|
Crude Oil (MBbls)
|
|
|
10,376
|
|
|
|
11,103
|
|
Natural Gas (Mmcf)
|
|
|
8,144
|
|
|
|
4,942
|
|
NGL (MBbls)
|
|
|
—
|
|
|
|
—
|
|
Oil Equivalents (MBoe)
|
|
|
11,733
|
|
|
|
11,927
|
|
Proved Reserves
|
|
|
|
|
|
|
|
|
Crude Oil (MBbls)
|
|
|
12,359
|
|
|
|
11,538
|
|
Natural Gas (Mmcf)
|
|
|
9,747
|
|
|
|
5,283
|
|
NGL (MBbls)
|
|
|
48
|
|
|
|
17
|
|
Oil Equivalents (MBoe)
|
|
|
14,032
|
|
|
|
12,436
|
|
Proved Undeveloped Reserves
For the year ended December 31, 2019, total proved undeveloped
reserves (PUDs) decreased by 0.2 million MBoe to 11.7 million MBoe. The change in proved understated reserves was:
|
●
|
transfer of 1,324 MBoe from PUD to proved developed reserves based on total capital expenditures of $43.0 million during 2019;
|
|
●
|
819 MBoe addition from four San Andres PUDs acquired in the Chaveroo bolt-on acquisition; and
|
|
●
|
312 MBoe addition from five gross Niobrara PUDs, ~1 net Niobrara PUD.
|
Our plan is to convert our remaining PUD balance as of December
31, 2019 to proved developed reserves within five years or prior to the end of fiscal year 2024, provided that we are able to obtain
adequate funding and capital over the time period.
Capitalized Costs Relating to Oil and Natural Gas Producing
Activities. The following table sets forth the capitalized costs relating to the Company’s crude oil and natural gas
producing activities at December 31, 2019 and 2018 (in thousands):
|
|
2019
|
|
|
2018
|
|
Proved oil and gas properties
|
|
$
|
123,607
|
|
|
$
|
81,507
|
|
Unproved oil and gas properties
|
|
|
—
|
|
|
|
—
|
|
Total oil and gas properties
|
|
|
123,607
|
|
|
|
81,507
|
|
Accumulated depreciation and depletion
|
|
|
(31,759
|
)
|
|
|
(21,045
|
)
|
Net Capitalized Costs
|
|
$
|
91,848
|
|
|
$
|
60,462
|
|
Costs Incurred in Oil and Natural Gas Property Acquisition,
Exploration and Development Activities. The following table sets forth the costs incurred in the Company’s oil and natural
gas property acquisition, exploration and development activities for the years ended December 31, 2019 and 2018 (in thousands):
|
|
2019
|
|
|
2018
|
|
Acquisition of properties:
|
|
|
|
|
|
|
|
|
Proved
|
|
$
|
1,120
|
|
|
$
|
18,867
|
|
Unproved
|
|
|
—
|
|
|
|
—
|
|
Exploration costs
|
|
|
—
|
|
|
|
—
|
|
Development costs
|
|
|
41,810
|
|
|
|
11,096
|
|
Total
|
|
$
|
42,930
|
|
|
$
|
29,963
|
|
Results of Operations for Oil and Natural Gas Producing Activities.
The following table sets forth the results of operations for oil and natural gas producing activities for the years ended December
31, 2019 and 2018 (in thousands):
|
|
2019
|
|
|
2018
|
|
Crude oil and natural gas revenues
|
|
$
|
12,972
|
|
|
$
|
4,523
|
|
Production costs
|
|
|
(6,817
|
)
|
|
|
(2,821
|
)
|
Depreciation, depletion and accretion
|
|
|
(11,031
|
)
|
|
|
(6,519
|
)
|
Results
of operations for producing activities, excluding corporate overhead and interest costs
|
|
$
|
(4,876
|
)
|
|
$
|
(4,817
|
)
|
Standardized Measure of Discounted Future Net Cash Flows
Relating to Proved Oil and Natural Gas Reserves. The following information has been developed utilizing procedures prescribed
by ASC Topic 932 and based on crude oil and natural gas reserves and production volumes estimated by the independent petroleum
consultants of the Company. The estimates were based on a 12-month average of first-of-the-month commodity prices for the years
ended December 31, 2019 and 2018. The following information may be useful for certain comparison purposes, but should
not be solely relied upon in evaluating the Company or its performance. Further, information contained in the following table should
not be considered as representative of realistic assessments of future cash flows, nor should the Standardized Measure of Discounted
Future Net Cash Flows be viewed as representative of the current value of the Company.
The future cash flows presented below are based on cost rates
and statutory income tax rates in existence as of the date of the projections and average prices over the preceding twelve months.
It is expected that material revisions to some estimates of crude oil and natural gas reserves may occur in the future, development
and production of the reserves may occur in periods other than those assumed, and actual prices realized and costs incurred may
vary significantly from those used.
Management does not rely upon the following information in making
investment and operating decisions. Such decisions are based upon a wide range of factors, including estimates of probable and
possible as well as proved reserves, and varying price and cost assumptions considered more representative of a range of possible
economic conditions that may be anticipated.
The following table sets forth the standardized measure of discounted
future net cash flows from projected production of the Company’s oil and natural gas reserves as of December 31, 2019 and
2018 (in thousands):
|
|
2019
|
|
|
2018
|
|
Future cash inflows
|
|
$
|
696,130
|
|
|
$
|
691,921
|
|
Future production costs
|
|
|
(272,623
|
)
|
|
|
(203,418
|
)
|
Future development costs
|
|
|
(174,401
|
)
|
|
|
(214,437
|
)
|
Future income taxes
|
|
|
(47,797
|
)
|
|
|
(79,315
|
)
|
Future net cash flows
|
|
|
201,309
|
|
|
|
194,751
|
|
Discount to present value at 10% annual rate
|
|
|
(97,546
|
)
|
|
|
(63,933
|
)
|
Standardized measure of discounted future net cash flows relating to proved oil and gas reserves
|
|
$
|
103,763
|
|
|
$
|
130,818
|
|
Changes in Standardized Measure of Discounted Future Net
Cash Flows. The following table sets forth the changes in the standardized measure of discounted future net cash flows for
each of the years ended December 31, 2019 and 2018 (in thousands):
|
|
2019
|
|
|
2018
|
|
Standardized measure, beginning of year
|
|
$
|
130,818
|
|
|
$
|
31,223
|
|
Crude oil and natural gas sales, net of production costs
|
|
|
(3,406
|
)
|
|
|
(2,636
|
)
|
Net changes in prices and production costs
|
|
|
(64,318
|
)
|
|
|
1,953
|
|
Extensions, discoveries, additions and improved recovery
|
|
|
—
|
|
|
|
—
|
|
Changes in estimated future development costs
|
|
|
37,149
|
|
|
|
341
|
|
Development costs incurred
|
|
|
—
|
|
|
|
—
|
|
Revisions of previous quantity estimates
|
|
|
(2,622
|
)
|
|
|
(30,096
|
)
|
Accretion of discount
|
|
|
(37,109
|
)
|
|
|
3,123
|
|
Net change in income taxes
|
|
|
31,494
|
|
|
|
(50,467
|
)
|
Purchases of reserves in place
|
|
|
12,343
|
|
|
|
180,122
|
|
Sales of reserves in place
|
|
|
(1,483
|
)
|
|
|
—
|
|
Change in timing of estimated future production
|
|
|
897
|
|
|
|
(2,745
|
)
|
Standardized measure, end of year
|
|
$
|
103,763
|
|
|
$
|
130,818
|
|
PEDEVCO CORP.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(amounts in thousands, except share and
per share data)
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2020
|
|
|
2019
|
|
Assets
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
10,209
|
|
|
$
|
22,415
|
|
Accounts receivable – oil and gas
|
|
|
646
|
|
|
|
4,602
|
|
Prepaid expenses and other current assets
|
|
|
33
|
|
|
|
73
|
|
Total current assets
|
|
|
10,888
|
|
|
|
27,090
|
|
|
|
|
|
|
|
|
|
|
Oil and gas properties:
|
|
|
|
|
|
|
|
|
Oil and gas properties, subject to amortization, net
|
|
|
83,744
|
|
|
|
76,952
|
|
Oil and gas properties, not subject to amortization, net
|
|
|
8,090
|
|
|
|
14,896
|
|
Total oil and gas properties, net
|
|
|
91,834
|
|
|
|
91,848
|
|
|
|
|
|
|
|
|
|
|
Operating lease – right-of-use asset
|
|
|
316
|
|
|
|
360
|
|
Other assets
|
|
|
3,557
|
|
|
|
3,598
|
|
Total assets
|
|
$
|
106,595
|
|
|
$
|
122,896
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholders’ Equity
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
2,729
|
|
|
$
|
12,099
|
|
Accrued expenses
|
|
|
299
|
|
|
|
1,972
|
|
Revenue payable
|
|
|
799
|
|
|
|
827
|
|
PPP loan – current
|
|
|
165
|
|
|
|
—
|
|
Operating lease liabilities – current
|
|
|
101
|
|
|
|
97
|
|
Asset retirement obligations – current
|
|
|
—
|
|
|
|
225
|
|
Total current liabilities
|
|
|
4,093
|
|
|
|
15,220
|
|
|
|
|
|
|
|
|
|
|
Long-term liabilities:
|
|
|
|
|
|
|
|
|
PPP loan
|
|
|
205
|
|
|
|
—
|
|
Operating lease liabilities
|
|
|
248
|
|
|
|
300
|
|
Asset retirement obligations
|
|
|
1,973
|
|
|
|
1,874
|
|
Total liabilities
|
|
|
6,519
|
|
|
|
17,394
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ equity:
|
|
|
|
|
|
|
|
|
Common stock, $0.001 par value, 200,000,000 shares
authorized; 72,125,328 and 71,061,328 shares issued and outstanding, respectively
|
|
|
72
|
|
|
|
71
|
|
Additional paid-in capital
|
|
|
202,598
|
|
|
|
201,027
|
|
Accumulated deficit
|
|
|
(102,594
|
)
|
|
|
(95,596
|
)
|
Total shareholders’ equity
|
|
|
100,076
|
|
|
|
105,502
|
|
Total liabilities and shareholders’ equity
|
|
$
|
106,595
|
|
|
$
|
122,896
|
|
See accompanying notes to unaudited consolidated
financial statements.
PEDEVCO CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(amounts in thousands, except share and
per share data)
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June
30,
|
|
|
June
30,
|
|
Revenue:
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Oil and gas sales
|
|
$
|
656
|
|
|
$
|
4,070
|
|
|
$
|
3,488
|
|
|
$
|
5,638
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease operating costs
|
|
|
750
|
|
|
|
2,095
|
|
|
|
2,272
|
|
|
|
3,065
|
|
Exploration expense
|
|
|
—
|
|
|
|
13
|
|
|
|
30
|
|
|
|
23
|
|
Selling, general and administrative expense
|
|
|
1,422
|
|
|
|
1,644
|
|
|
|
3,545
|
|
|
|
2,972
|
|
Depreciation, depletion, amortization and accretion
|
|
|
1,912
|
|
|
|
2,784
|
|
|
|
5,349
|
|
|
|
5,033
|
|
Total operating expenses
|
|
|
4,084
|
|
|
|
6,536
|
|
|
|
11,196
|
|
|
|
11,093
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on sale of oil and gas properties
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(3,428
|
)
|
|
|
(2,466
|
)
|
|
|
(7,708
|
)
|
|
|
(4,535
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(826
|
)
|
Interest income
|
|
|
8
|
|
|
|
9
|
|
|
|
32
|
|
|
|
9
|
|
Other income (expense)
|
|
|
679
|
|
|
|
(3
|
)
|
|
|
678
|
|
|
|
(103
|
)
|
Total other income (expense)
|
|
|
687
|
|
|
|
6
|
|
|
|
710
|
|
|
|
(920
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,741
|
)
|
|
$
|
(2,460
|
)
|
|
$
|
(6,998
|
)
|
|
$
|
(5,455
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
(0.04
|
)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.14
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
|
72,125,328
|
|
|
|
49,198,625
|
|
|
|
72,060,812
|
|
|
|
38,572,537
|
|
See accompanying notes to unaudited consolidated
financial statements.
PEDEVCO CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(amounts in thousands)
|
|
Six Months Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Cash Flows From Operating Activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(6,998
|
)
|
|
$
|
(5,455
|
)
|
Adjustments to reconcile net loss to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation, depletion, amortization and accretion
|
|
|
5,349
|
|
|
|
5,033
|
|
Share-based compensation expense
|
|
|
1,572
|
|
|
|
697
|
|
Loss on disposal of fixed asset
|
|
|
24
|
|
|
|
—
|
|
Amortization of right-of-use asset
|
|
|
44
|
|
|
|
—
|
|
Gain on sale of oil and gas properties
|
|
|
—
|
|
|
|
(920
|
)
|
Amortization of debt discount
|
|
|
—
|
|
|
|
161
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable – oil and gas
|
|
|
3,956
|
|
|
|
(539
|
)
|
Prepaid expenses and other current assets
|
|
|
40
|
|
|
|
142
|
|
Accounts payable
|
|
|
(2,199
|
)
|
|
|
4,373
|
|
Accrued expenses
|
|
|
(1,673
|
)
|
|
|
(450
|
)
|
Accrued expenses – related parties
|
|
|
—
|
|
|
|
(943
|
)
|
Revenue payable
|
|
|
(28
|
)
|
|
|
(14
|
)
|
Net cash provided by operating activities
|
|
|
87
|
|
|
|
2,085
|
|
|
|
|
|
|
|
|
|
|
Cash Flows From Investing Activities:
|
|
|
|
|
|
|
|
|
Cash paid for the acquisition of oil and gas properties
|
|
|
—
|
|
|
|
(1,056
|
)
|
Cash paid for property and equipment
|
|
|
—
|
|
|
|
(47
|
)
|
Cash paid for drilling and completion costs
|
|
|
(12,663
|
)
|
|
|
(24,269
|
)
|
Proceeds from the sale of oil and gas property
|
|
|
—
|
|
|
|
1,175
|
|
Net cash used in investing activities
|
|
|
(12,663
|
)
|
|
|
(24,197
|
)
|
|
|
|
|
|
|
|
|
|
Cash Flows From Financing Activities:
|
|
|
|
|
|
|
|
|
Proceeds from PPP loan
|
|
|
740
|
|
|
|
—
|
|
Repayment of PPP loan
|
|
|
(370
|
)
|
|
|
—
|
|
Proceeds from the issuance of shares
|
|
|
—
|
|
|
|
18,000
|
|
Proceeds from notes payable – related parties
|
|
|
—
|
|
|
|
15,000
|
|
Net cash provided by financing activities
|
|
|
370
|
|
|
|
33,000
|
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in cash and restricted cash
|
|
|
(12,206
|
)
|
|
|
10,888
|
|
Cash and restricted cash at beginning of period
|
|
|
25,712
|
|
|
|
5,779
|
|
Cash and restricted cash at end of period
|
|
$
|
13,506
|
|
|
$
|
16,667
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Flow Information
|
|
|
|
|
|
|
|
|
Cash paid for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
—
|
|
|
$
|
—
|
|
Income taxes
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Noncash investing and financing activities:
|
|
|
|
|
|
|
|
|
Change in accrued oil and gas development costs
|
|
$
|
7,261
|
|
|
$
|
6,039
|
|
Changes in estimates of asset retirement costs
|
|
$
|
230
|
|
|
$
|
129
|
|
Issuance of restricted common stock
|
|
$
|
1
|
|
|
$
|
—
|
|
Acquisition of asset retirement obligations
|
|
$
|
—
|
|
|
$
|
33
|
|
Common stock issued for debt conversion
|
|
$
|
—
|
|
|
$
|
55,075
|
|
See accompanying notes to unaudited consolidated
financial statements.
PEDEVCO CORP.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’
EQUITY
FOR THE THREE AND SIX MONTHS ENDED JUNE
30, 2020 AND 2019
(Unaudited)
(amounts in thousands, except share amounts)
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Additional Paid-in
Capital
|
|
|
Accumulated Deficit
|
|
|
Totals
|
|
Balances at January 1, 2020
|
|
|
71,061,328
|
|
|
$
|
71
|
|
|
$
|
201,027
|
|
|
$
|
(95,596
|
)
|
|
$
|
105,502
|
|
Issuance of restricted common stock
|
|
|
1,119,000
|
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
—
|
|
|
|
—
|
|
Rescinded restricted common stock
|
|
|
(55,000
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Share-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
853
|
|
|
|
—
|
|
|
|
853
|
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(4,257
|
)
|
|
|
(4,257
|
)
|
Balances at March 31, 2020
|
|
|
72,125,328
|
|
|
|
72
|
|
|
|
201,879
|
|
|
|
(99,853
|
)
|
|
|
102,098
|
|
Share-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
719
|
|
|
|
—
|
|
|
|
719
|
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(2,741
|
)
|
|
|
(2,741
|
)
|
Balances
at June 30, 2020
|
|
|
72,125,328
|
|
|
$
|
72
|
|
|
$
|
202,598
|
|
|
$
|
(102,594
|
)
|
|
$
|
100,076
|
|
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Additional Paid-in
Capital
|
|
|
Accumulated Deficit
|
|
|
Total
|
|
Balances at January 1, 2019
|
|
|
15,808,445
|
|
|
$
|
16
|
|
|
$
|
101,450
|
|
|
$
|
(84,494
|
)
|
|
$
|
16,972
|
|
Issuance of common stock for debt conversion
|
|
|
29,480,383
|
|
|
|
29
|
|
|
|
55,046
|
|
|
|
—
|
|
|
|
55,075
|
|
Share-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
299
|
|
|
|
—
|
|
|
|
299
|
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(2,995
|
)
|
|
|
(2,995
|
)
|
Balances at March 31, 2019
|
|
|
45,288,828
|
|
|
|
45
|
|
|
|
156,795
|
|
|
|
(87,489
|
)
|
|
|
69,351
|
|
Issuance of restricted common stock
|
|
|
160,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Issuance of common stock to non-affiliates
|
|
|
1,500,000
|
|
|
|
1
|
|
|
|
2,999
|
|
|
|
—
|
|
|
|
3,000
|
|
Issuance of common stock to affiliate
|
|
|
6,818,181
|
|
|
|
7
|
|
|
|
14,993
|
|
|
|
—
|
|
|
|
15,000
|
|
Warrants exercised
|
|
|
60,056
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Share-based compensation
|
|
|
—
|
|
|
|
—
|
|
|
|
398
|
|
|
|
—
|
|
|
|
398
|
|
Net loss
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(2,460
|
)
|
|
|
(2,460
|
)
|
Balances
at June 30, 2019
|
|
|
53,827,065
|
|
|
$
|
53
|
|
|
$
|
175,185
|
|
|
$
|
(89,949
|
)
|
|
$
|
85,289
|
|
See accompanying notes to unaudited consolidated
financial statements.
PEDEVCO CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – BASIS OF PRESENTATION
The accompanying interim unaudited consolidated financial statements
of PEDEVCO Corp. (“PEDEVCO” or the “Company”), have been prepared in accordance with generally accepted
accounting principles in the United States of America (“GAAP”) and the rules of the Securities and Exchange Commission
(“SEC”) and should be read in conjunction with the audited financial statements and notes thereto contained in
PEDEVCO’s latest Annual Report filed with the SEC on Form 10-K. In the opinion of management, all adjustments, consisting
of normal recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for
the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative
of the results to be expected for the full year. Notes to the financial statements that would substantially duplicate disclosures
contained in the audited financial statements for the most recent fiscal year, as reported in the Annual Report on Form 10-K for
the year ended December 31, 2019, filed with the SEC on March 30, 2020, have been omitted.
The Company’s consolidated financial statements include
the accounts of the Company, its wholly-owned subsidiaries and subsidiaries in which the Company has a controlling financial interest.
All significant inter-company accounts and transactions have been eliminated in consolidation.
The Company’s future financial condition and liquidity will
be impacted by, among other factors, the success of our drilling program, the number of commercially viable oil and natural gas
discoveries made and the quantities of oil and natural gas discovered, the speed with which we can bring such discoveries to production,
the actual cost of exploration, appraisal and development of our prospects, the prevailing prices for, and demand for, oil and
natural gas.
NOTE 2 – DESCRIPTION OF BUSINESS
PEDEVCO is an oil and gas company focused on the development,
acquisition and production of oil and natural gas assets where the latest in modern drilling and completion techniques and technologies
have yet to be applied. In particular, the Company focuses on legacy proven properties where there is a long production history,
well defined geology and existing infrastructure that can be leveraged when applying modern field management technologies. The
Company’s current properties are located in the San Andres formation of the Permian Basin situated in West Texas and eastern
New Mexico (the “Permian Basin”) and in the Denver-Julesberg Basin (“D-J Basin”) in Colorado.
The Company holds its Permian Basin acres located in Chaves and Roosevelt Counties, New Mexico, through its wholly-owned operating
subsidiary, Pacific Energy Development Corp. (“PEDCO”), which asset the Company refers to as its “Permian Basin
Asset,” and it holds its D-J Basin acres located in Weld and Morgan Counties, Colorado, through its wholly-owned operating
subsidiary, Red Hawk Petroleum, LLC (“Red Hawk”), which asset the Company refers to as its “D-J Basin Asset.”
The Company believes that horizontal development and exploitation
of conventional assets in the Permian Basin and development of the Wattenberg and Wattenberg Extension in the D-J Basin represent
among the most economic oil and natural gas plays in the United States (“U.S.”). Moving forward, the Company
plans to optimize its existing assets and opportunistically seek additional acreage proximate to its currently held core acreage,
as well as other attractive onshore U.S. oil and gas assets that fit the Company’s acquisition criteria, that Company management
believes can be developed using its technical and operating expertise and be accretive to shareholder value.
In December 2019, a novel strain of coronavirus, which causes
the infectious disease known as COVID-19, was reported in Wuhan, China. The World Health Organization declared COVID-19 a “Public
Health Emergency of International Concern” on January 30, 2020 and a global pandemic on March 11, 2020. As a result of the
recent COVID-19 outbreak, and the recent sharp decline in oil prices which occurred partially as a result of the decreased demand
for oil caused by such outbreak and the actions taken globally to stop the spread of such virus, in mid-April 2020, the Company
temporarily shut-in all of its operated producing wells in its Permian Basin Asset and D-J Basin Asset to preserve the Company’s
oil and gas reserves for production during a more favorable oil price environment, noting that most of the Company’s acreage
is held by production with no drilling obligations, which provides the Company with flexibility to hold back on production and
development during periods of low oil and gas prices. Following partial recovery in oil prices, commencing in early June 2020,
the Company reactivated over 90% of its operated wells in the Permian Basin and the D-J Basin that the Company shut-in in mid-April
2020, and is now working to complete several carryover projects from 2019’s Phase II Permian Basin Asset development plan
which it had put on hold due to the COVID-19 outbreak. The Company will continue to monitor oil prices with a view to reactivating
all of its shut-in production and fully completing its 2019 carryover development plan.
The outbreak of COVID-19 and decreases in commodity prices resulting
from oversupply, government-imposed travel restrictions and other constraints on economic activity have caused a significant decrease
in the demand for oil and has created disruptions and volatility in the global marketplace for oil and gas beginning in the first
quarter of 2020, which negatively affected our results of operations and cash flows. These conditions persisted throughout the
second quarter and continue to negatively affect our results of operations and cash flows. While demand and commodity prices have
shown signs of recovery, they are not back to pre-pandemic levels, and financial results may continue to be depressed in future
quarters. The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors
we cannot reliably predict, including the duration and scope of the pandemic; governmental, business, and individuals’ actions
in response to the pandemic; and the impact on economic activity including the possibility of recession or financial market instability.
These factors may adversely impact the supply and demand for oil and gas and our ability to produce and transport oil and gas and
perform operations at and on our properties. This uncertainty also affects management’s accounting estimates and assumptions,
which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments,
receivables, and forward-looking guidance. Refer to “Risk Factors” of this Form 10-Q) for a discussion of these factors
and other risks.
NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company has provided a discussion of significant accounting
policies, estimates and judgments in its 2019 Annual Report. There have been no changes to the Company’s significant accounting
policies since December 31, 2019.
Recently Issued Accounting Pronouncements
The Company does not expect the adoption of any other recently
issued accounting pronouncements to have a significant impact on its financial position, results of operations, or cash flows.
Subsequent Events
The Company has evaluated all transactions through the date
the consolidated financial statements were issued for subsequent event disclosure consideration.
NOTE 4 – REVENUE FROM CONTRACTS WITH CUSTOMERS
Disaggregation of Revenue from Contracts with Customers.
The following table disaggregates revenue by significant product type in the periods indicated (in thousands):
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Oil sales
|
|
$
|
605
|
|
|
$
|
4,037
|
|
|
$
|
3,307
|
|
|
$
|
5,490
|
|
Natural gas sales
|
|
|
41
|
|
|
|
26
|
|
|
|
131
|
|
|
|
135
|
|
Natural gas liquids sales
|
|
|
10
|
|
|
|
7
|
|
|
|
50
|
|
|
|
13
|
|
Total revenue from customers
|
|
$
|
656
|
|
|
$
|
4,070
|
|
|
$
|
3,488
|
|
|
$
|
5,638
|
|
There were no significant contract liabilities or transaction
price allocations to any remaining performance obligations as of June 30, 2020.
NOTE 5 – CASH
The following table provides a reconciliation of cash and restricted
cash reported within the balance sheets, which sum to the total of such amounts as of June 30, 2020 and December 31, 2019 (in thousands):
|
|
June 30,
2020
|
|
|
December 31,
2019
|
|
Cash
|
|
$
|
10,209
|
|
|
$
|
22,415
|
|
Restricted cash included in other assets
|
|
|
3,297
|
|
|
|
3,297
|
|
Total cash and restricted cash
|
|
$
|
13,506
|
|
|
$
|
25,712
|
|
NOTE 6 – OIL AND GAS PROPERTIES
The following table summarizes the Company’s oil and gas
activities by classification for the six months ended June 30, 2020 (in thousands):
|
|
Balance at
December 31,
2019
|
|
|
Additions
|
|
|
Disposals
|
|
|
Transfers
|
|
|
Balance at
June 30,
2020
|
|
Oil and gas properties, subject to amortization
|
|
$
|
107,164
|
|
|
$
|
4,924
|
|
|
$
|
—
|
|
|
$
|
7,284
|
|
|
$
|
119,372
|
|
Oil and gas properties, not subject to amortization
|
|
|
14,896
|
|
|
|
478
|
|
|
|
—
|
|
|
|
(7,284
|
)
|
|
|
8,090
|
|
Asset retirement costs
|
|
|
1,547
|
|
|
|
(230
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
1,317
|
|
Accumulated depreciation and depletion
|
|
|
(31,759
|
)
|
|
|
(5,186
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(36,945
|
)
|
Total oil and gas assets
|
|
$
|
91,848
|
|
|
$
|
(14
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
91,834
|
|
For the six-month period ended June 30, 2020, the Company incurred
$5,402,000 in capital costs primarily related to the drilling of a salt water disposal well (“SWD”) in our Permian
Basin Asset in order to increase the produced water injection capacity for the Company’s Chaveroo field and, in turn, increase
production of the corresponding wells therein. The drilling and completion of the SWD was postponed due to the downturn in the
economic conditions in the oil and gas industry during the first quarter of 2020, but with the recent increases in oil prices,
the Company now plans to complete the SWD in September 2020. The Company will continue to monitor the environment for future completion
opportunities.
Also, the Company transferred $7,284,000 in capital costs from
three recently completed wells, for which production had not commenced, from unproved properties to proved properties, when production
began during the early part of 2020. Additionally, drilling and completion costs of $8,090,000, the majority of which were incurred
in the prior year and for the uncompleted SWD noted above, and one well in the Permian Asset, for which production had not yet
commenced; were therefore included in the amount not subject to amortization at June 30, 2020.
The depletion recorded for production on proved properties for
the three and six months ended June 30, 2020 and 2019, amounted to $1,808,000 compared to $2,715,000, and $5,186,000, compared
to $4,855,000, respectively.
NOTE 7 – PPP LOAN
On April 22, 2020, the Company received loan proceeds of $370,000
(the “Original PPP Loan”) under the U. S. Small Business Administration’s (“SBA”) Paycheck Protection
Program (“PPP”) established as part of the Coronavirus Aid, Relief and Economic
Security Act (“CARES Act”), and on April 23, 2020, the SBA issued guidance
that cast doubt on the ability of public companies to qualify for a PPP loan. As a result, out of an abundance of caution, on May
1, 2020, the Company repaid the full amount of the Original PPP Loan to Texas Capital Bank, N.A.
Upon the issuance of further guidance from the SBA, on June
2, 2020, the Company again received loan proceeds of $370,000 (the “New PPP Loan”) under the SBA PPP. The New PPP Loan
is evidenced by a promissory note, dated as of May 28, 2020 (the “Note”), between the Company and Texas Capital Bank,
N.A. The Note has a two-year term, bears interest at the rate of 1.00% per annum, and may be prepaid at any time without payment
of any premium. No payments of principal or interest are due during the six-month period beginning on the date of the
Note. The principal and accrued interest under the Note are forgivable after eight weeks if the Company uses the New PPP Loan proceeds
for eligible purposes, including payroll, benefits, rent and utilities, and otherwise complies with PPP requirements, with the
full principal and accrued interest expected to be forgiven in full by the Company. As of June 30, 2020, the Company has accrued
$300 in interest.
NOTE 8 – ASSET RETIREMENT OBLIGATIONS
Activity related to the Company’s asset retirement obligations
is as follows (in thousands):
|
|
Six
Months
Ended
June 30, 2020
|
|
Balance at the beginning of the period *
|
|
$
|
2,099
|
|
Accretion expense
|
|
|
146
|
|
Liabilities settled
|
|
|
(42
|
)
|
Changes in estimates
|
|
|
(230
|
)
|
Balance at end of period
|
|
$
|
1,973
|
|
|
*
|
Includes $225,000 of current asset retirement obligations at December 31, 2019. There were
no obligations due within the 12 months from June 30, 2020.
|
NOTE 9 – COMMITMENTS AND CONTINGENCIES
Lease Agreements
Currently, the Company has one operating lease for office space
that requires Accounting Standards Codification (ASC) Topic 842 treatment, discussed below.
The Company’s leases typically do not provide an implicit
rate. Accordingly, the Company is required to use its incremental borrowing rate in determining the present value of lease payments
based on the information available at commencement date. The Company’s incremental borrowing rate would reflect the estimated
rate of interest that it would pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments
in a similar economic environment. However, the Company currently maintains no debt, and in order to apply an appropriate discount
rate, the Company used an average discount rate of eight publicly-traded peer group companies similar to it based on size, geographic
location, asset types and/or operating characteristics.
The Company has a sublease for its corporate offices in Houston,
Texas on approximately 5,200 square feet of office space that expires on August 31, 2023 and has a base monthly rent of approximately
$10,000.
The Company also has a lease for 187 square feet of office space
located in Danville, California for the Company’s Executive Vice President and General Counsel. The monthly rent is $1,200,
and the lease expires on August 28, 2020. The Company does not plan to renew this lease upon expiration in an effort to further
reduce Company expenses. The Company did not apply ASC Topic 842 to this lease, as the lease term and extension period are for
12-months or less, and we cannot currently conclude if the lease will be renewed or extended beyond a 12-month period. In April
2020, the Company was granted a 20% discount on the remaining lease term. Therefore, the total current obligation for the remainder
of this lease through August 2020 is $1,000.
For the six months ended June 30, 2020, the Company incurred
lease expense of $55,000, for the combined leases.
Supplemental cash flow information related to the Company’s
operating lease is included in the table below (in thousands):
|
|
Six Months
Ended
June 30, 2020
|
|
Cash paid for amounts included in the measurement of lease liabilities
|
|
$
|
58
|
|
Supplemental balance sheet information related to operating
leases is included in the table below (in thousands):
|
|
June
30, 2020
|
|
Operating lease – right-of-use asset
|
|
$
|
316
|
|
|
|
|
|
|
Operating lease liabilities – current
|
|
$
|
101
|
|
Operating lease liabilities – long-term
|
|
|
248
|
|
Total lease liability
|
|
$
|
349
|
|
The weighted-average remaining lease term for the Company’s
operating lease is 3.2 years as of June 30, 2020, with a weighted-average discount rate of 5.35%.
Lease liability with enforceable contract terms that have greater
than one-year terms are as follows (in thousands):
Remainder of 2020
|
|
$
|
58
|
|
2021
|
|
|
118
|
|
2022
|
|
|
121
|
|
2023
|
|
|
82
|
|
Thereafter
|
|
|
—
|
|
Total lease payments
|
|
|
379
|
|
Less
imputed interest
|
|
|
(30
|
)
|
Total
lease liability
|
|
$
|
349
|
|
Leasehold Drilling Commitments
The Company’s oil and gas leasehold acreage is subject
to expiration of leases if the Company does not drill and hold such acreage by production or otherwise exercises options to extend
such leases, if available, in exchange for payment of additional cash consideration. In the D-J Basin Asset, 170 net acres expire
during the remainder of 2020, and no significant net acres expire thereafter (net to our direct ownership interest only). In the
Permian Basin Asset, 12 acres are due to expire in 2020 and 4,940 net acres expire thereafter (net to our direct ownership interest
only). The Company plans to hold significantly all of this acreage through a program of drilling and completing producing wells.
If the Company is not able to drill and complete a well before lease expiration, the Company may seek to extend leases where able.
Other Commitments
Although the Company may, from time to time, be involved in
litigation and claims arising out of its operations in the normal course of business, the Company is not currently a party to any
material legal proceeding. In addition, the Company is not aware of any material legal or governmental proceedings against it or
contemplated to be brought against it.
As part of its regular operations, the Company may become party
to various pending or threatened claims, lawsuits and administrative proceedings seeking damages or other remedies concerning its
commercial operations, products, employees and other matters.
Although the Company provides no assurance about the outcome
of these or any other pending legal and administrative proceedings and the effect such outcomes may have on the Company, the Company
believes that any ultimate liability resulting from the outcome of such proceedings, to the extent not otherwise provided for or
covered by insurance, will not have a material adverse effect on the Company’s financial condition or results of operations.
NOTE 10 – SHAREHOLDERS’
EQUITY
Common Stock
During the six months ended June 30, 2020, the Company granted
an aggregate of 1,119,000 restricted stock awards to various employees and a consultant of the Company. Additionally, 55,000 shares
of restricted common stock were forfeited to the Company and cancelled due to an employee termination (see Note 11 below).
Warrants
During the six months ended June 30, 2020, no warrants were
granted, exercised or cancelled, and as of June 30, 2020, the Company had warrants to purchase 150,329 shares of common stock
outstanding, with an exercise price of $0.32 per share and a June 25, 2021 expiration date. The intrinsic value of these outstanding,
as well as exercisable, warrants on June 30, 2020 was $73,000.
NOTE 11 – SHARE-BASED COMPENSATION
The Company measures the cost of employee services received
in exchange for an award of equity instruments based on the grant-date fair value of the award over the vesting period.
Common Stock
On January 13, 2020, restricted stock awards were granted to
various employees and one consultant for an aggregate of 1,049,000 (including 924,000 restricted stock awards to officers of the
Company) and 70,000 shares, respectively, of the Company’s common stock, under the Company’s Amended and Restated 2012
Equity Incentive Plan. The grant of the 1,049,000 shares of restricted stock vest as follows: 33.3% vest each subsequent year from
the date of grant, contingent upon the recipient’s continued service with the Company. These shares have a total fair value
of $1,172,000, based on the market price on the issuance date. The grant of the 70,000 shares of restricted stock vest as follows:
100% on the one-year anniversary of the grant date, subject to the recipient’s continued service with the Company. These
consultant shares have a total fair value of $118,000, based on the market price on the issuance date.
In February 2020, 55,000 shares of restricted common stock were
forfeited to the Company and cancelled due to an employee termination. As a result, these shares are once again eligible to be
awarded under the Company’s Amended and Restated 2012 Equity Incentive Plan.
Share-based compensation expense recorded related to the vesting
of restricted stock for the six months ended June 30, 2020 was $1,282,000. The remaining unamortized share-based compensation expense
at June 30, 2020 related to restricted stock was $1,492,000.
Options
During the six months ended June 30, 2020, no options were exercised,
options to purchase 733,000 shares of common stock were granted (discussed below), options to purchase 34,000 shares of common
stock expired, and options to purchase 90,000 shares of common stock were cancelled.
On January 13, 2020, the Company granted options to purchase
an aggregate of 733,000 shares of common stock to various Company employees at an exercise price of $1.68 per share. The options
have a term of five years and fully vest in January 2023, with 33.3% of each grant vesting each subsequent year from the date of
grant, contingent upon each recipient’s continued service with the Company. The aggregate fair value of the options on the
date of grant, using the Black-Scholes model, was $1,053,000. Variables used in the Black-Scholes option-pricing model for the
options issued include: (1) a discount rate of 1.63%, (2) expected term of 3.5 years, (3) expected volatility of 155%, and (4)
zero expected dividends.
During the six months ended June 30, 2020, the Company recognized
stock option expense of $290,000. The remaining amount of unamortized stock options expense at June 30, 2020, was $655,000.
The intrinsic value of outstanding and exercisable options on
June 30, 2020 was $56,000.
Option activity during the six months ended June 30, 2020 was:
|
|
Number of
Options
|
|
|
Weighted
Average
Exercise Price
|
|
|
Weighted
Average
Remaining
Contract Term
(Years)
|
|
Outstanding at December 31, 2019
|
|
|
753,349
|
|
|
$
|
3.30
|
|
|
|
2.4
|
|
Granted
|
|
|
733,000
|
|
|
$
|
1.68
|
|
|
|
|
|
Expired/Canceled
|
|
|
(124,000
|
)
|
|
$
|
2.23
|
|
|
|
|
|
Outstanding at June 30, 2020
|
|
|
1,362,349
|
|
|
$
|
2.32
|
|
|
|
3.3
|
|
Exercisable at June 30, 2020
|
|
|
686,016
|
|
|
$
|
2.97
|
|
|
|
2.1
|
|
NOTE 12 – INCOME TAXES
The Company has estimated that its effective tax rate for U.S.
purposes will be zero for the 2020 and 2019 fiscal years as a result of net losses and a full valuation allowance against the net
deferred tax assets. Consequently, the Company has recorded no provision or benefit for income taxes for the three months ended
June 30, 2020 and 2019.
NOTE 13 – SUBSEQUENT EVENTS
The recent outbreak of COVID-19, which has been declared by
the World Health Organization to be a pandemic, has spread across the globe and is impacting worldwide economic activity. A pandemic,
including COVID-19, or other public health epidemic poses the risk that the Company or its employees, vendors, and other partners
may be prevented from conducting business activities at full capacity for an indefinite period of time, including due to spread
of the disease within these groups or due to shutdowns that may be requested or mandated by governmental authorities. While it
is not possible at this time to estimate the full impact that COVID-19 will have on the Company’s business, the continued
spread of COVID-19 and the measures taken by the governments of countries affected and in which the Company operates has disrupted,
and may continue to disrupt, the operation of the Company’s business for a prolonged period of time. The COVID-19 outbreak
and mitigation measures have also had an adverse impact on global economic conditions, as well as an adverse effect on the Company’s
business and financial condition, and may continue to have an adverse effect on the Company, including on its potential to conduct
financings on terms acceptable to the Company, if at all. In addition, the Company has taken temporary precautionary measures intended
to help minimize the risk of the virus to its employees, vendors and guests, including limiting the number of occupants at the
Company’s Houston headquarters and requiring all others to work remotely, and discouraging employee attendance at in-person
work-related meetings, which could negatively affect the Company’s business. The extent to which the COVID-19 outbreak will
continue to impact the Company’s results will depend on future developments that are highly uncertain and cannot be predicted,
including new information that may emerge concerning the severity of the virus, the availability and efficacy of vaccines, and
the actions to contain its impact.
In August, 2020, restricted stock awards were granted to three board members, an affiliate and an advisor for an aggregate of 240,000, 70,000 and 70,000 shares, respectively, of the Company's common stock, under the Company's Amended and Restated 2012 Equity Incentive Plan. The grant of the 240,000 shares of restricted stock vest as follows: 100% of 170,000 shares and 100% of 70,000 shares vesting on July 12, 2021 and September 21, 2021, respectively, contingent upon the recipient's continued service with the Company. These shares have a total fair value of $506,000, based on the market price on the issuance date. The grant of the remaining aggregate of 140,000 shares of restricted stock vest as follows: 100% on the six-month anniversary of the grant date, subject to the recipient's continued service with the Company. These affiliate and advisor shares have a total fair value of $295,000, based on the market price on the issuance date.
In August 2020, the Company issued 32,012 total shares of common stock upon the cashless exercise of stock options to purchase an aggregate of 37,500 shares of common stock with an exercise price of $0.3088 per share, based on a then current market value of $2.11 per share, under the terms of the options. The options had an intrinsic value of $68,000 on the exercise date.
In August 2020, 74,000 shares of restricted common stock were forfeited to the Company and cancelled due to an employee termination. As a result, these shares are once again eligible to be awarded under the Company's Amended and Restated 2012 Equity Incentive Plan.
SANDRIDGE
PERMIAN TRUST
STATEMENTS OF ASSETS AND TRUST CORPUS
(In thousands, except unit data)
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
ASSETS
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
4,698
|
|
|
$
|
2,367
|
|
Investment in royalty interests
|
|
|
549,831
|
|
|
|
549,831
|
|
Less: accumulated amortization and impairment
|
|
|
(447,373
|
)
|
|
|
(436,973
|
)
|
Net investment in royalty interests
|
|
|
102,458
|
|
|
|
112,858
|
|
Total assets
|
|
$
|
107,156
|
|
|
$
|
115,225
|
|
TRUST CORPUS
|
|
|
|
|
|
|
|
|
Trust corpus, 52,500,000 common units issued and
outstanding at December 31, 2019 and 2018
|
|
$
|
107,156
|
|
|
$
|
115,225
|
|
The accompanying notes are an integral part
of these financial statements.
SANDRIDGE
PERMIAN TRUST
STATEMENTS OF DISTRIBUTABLE INCOME
(In thousands, except unit and per unit
data)
|
|
Years Ended December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Revenues
|
|
|
|
|
|
|
Royalty income
|
|
$
|
22,442
|
|
|
$
|
29,857
|
|
Total revenues
|
|
|
22,442
|
|
|
|
29,857
|
|
Expenses
|
|
|
|
|
|
|
|
|
Post-production expenses
|
|
|
50
|
|
|
|
46
|
|
Property taxes
|
|
|
—
|
|
|
|
1,559
|
|
Production taxes
|
|
|
1,061
|
|
|
|
1,423
|
|
Franchise taxes
|
|
|
47
|
|
|
|
47
|
|
Trust administrative expenses
|
|
|
1,734
|
|
|
|
1,402
|
|
Cash reserves withheld, net of amounts used for current Trust expenses
|
|
|
2,261
|
|
|
|
54
|
|
Total expenses
|
|
|
5,153
|
|
|
|
4,531
|
|
Distributable income available to unitholders
|
|
|
17,289
|
|
|
|
25,326
|
|
Distributable income per unit
|
|
$
|
0.329
|
|
|
$
|
0.482
|
|
The accompanying notes are an integral part
of these financial statements.
SANDRIDGE
PERMIAN TRUST
STATEMENTS OF CHANGES IN TRUST CORPUS
(In thousands)
|
|
Years Ended December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Trust corpus, beginning of year
|
|
$
|
115,225
|
|
|
$
|
126,168
|
|
Amortization of investment in royalty interests
|
|
|
(10,399
|
)
|
|
|
(11,018
|
)
|
Net cash reserves withheld
|
|
|
2,261
|
|
|
|
54
|
|
Distributable income
|
|
|
17,289
|
|
|
|
25,326
|
|
Distributions paid or payable to unitholders
|
|
|
(17,220
|
)
|
|
|
(25,305
|
)
|
Trust corpus, end of year
|
|
$
|
107,156
|
|
|
$
|
115,225
|
|
The accompanying notes are an integral part
of these financial statements.
SANDRIDGE
PERMIAN TRUST
NOTES TO FINANCIAL STATEMENTS
1. Organization of the Trust
Nature of Business. SandRidge Permian Trust (the “Trust”)
is a statutory trust formed under the Delaware Statutory Trust Act pursuant to a trust agreement, as amended and restated, by and
among SandRidge Energy, Inc. (“SandRidge”), as Trustor, The Bank of New York Mellon Trust Company, N.A., as Trustee
(the “Trustee”), and The Corporation Trust Company, as Delaware Trustee (the “Delaware Trustee”) (such
amended and restated trust agreement, as amended to date, the “trust agreement”).
The Trust holds royalty interests conveyed by SandRidge from
its interests in specified oil and natural gas properties located in Andrews County, Texas (the “Underlying Properties”).
These royalty interests were conveyed by SandRidge to the Trust (the “Royalty Interests”) concurrent with the initial
public offering of the Trust’s common units (“Trust units”) in August 2011. As consideration for conveyance of
the Royalty Interests, the Trust remitted the proceeds of the offering, along with 4,875,000 Trust units and 13,125,000 subordinated
units of the Trust (“subordinated units”), to certain wholly owned subsidiaries of SandRidge. At December 31, 2019,
SandRidge owned 13,125,000 Trust units, or 25% of all Trust units.
Pursuant to a development agreement between the Trust and SandRidge,
SandRidge was obligated to drill, or cause to be drilled, 888 development wells within an area of mutual interest (“AMI”)
by March 31, 2016 (the “Trust Development Wells”). SandRidge fulfilled this obligation in November 2014, and, as a
result, the subordinated units converted to Trust units in January 2016.
On November 1, 2018, SandRidge sold all of its interests in
the Underlying Properties and all of its outstanding Trust units (the “Sale Transaction”) to Avalon Energy, LLC, a
Texas limited liability company (“Avalon”). The Conveyances permitted SandRidge to sell all or any part of its interest
in the Underlying Properties, where the Underlying Properties were sold subject to and burdened by the Royalty Interests. In connection
with the transaction (the “Sale Transaction”), Avalon and its affiliates assumed all of SandRidge’s obligations
under the conveyances and the trust agreement and the administrative services agreement between SandRidge and the Trust pursuant
to which SandRidge and Avalon have provided accounting, tax preparation, bookkeeping and informational services to the Trust. In
addition, SandRidge assigned its rights to Avalon under the registration rights agreement between SandRidge and the Trust. As of
December 31, 2019, Avalon holds 13,125,000 Trust units, or 25% of all Trust units.
The Trust is passive in nature and neither the Trust nor the
Trustee has any control over, or responsibility for, any operating or capital costs related to the Underlying Properties. The business
and affairs of the Trust are administered by the Trustee. The trust agreement generally limits the Trust’s business activities
to owning the Royalty Interests and certain activities reasonably related thereto, including activities required or permitted by
the terms of the conveyances related to the Royalty Interests.
Distributions. The Trust makes quarterly cash distributions
of substantially all of its cash receipts, after deducting amounts for the Trust’s administrative expenses, property tax
and Texas franchise tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter.
Due to the timing of the payment of production proceeds to the Trust, each distribution covers production from a three-month period
consisting of the first two months of the most recently ended quarter and the final month of the quarter preceding it.
Dissolution. The Trust will dissolve and begin to liquidate
on March 31, 2031 (the “Termination Date”), unless sooner dissolved in accordance with the terms of the trust agreement
as described below, and will soon thereafter wind up its affairs and terminate. At the Termination Date, 50% of the Royalty Interests
will revert automatically to Avalon. The remaining 50% of the Royalty Interests will be sold at that time, with the net proceeds
of the sale, as well as any remaining Trust cash reserves, distributed to the unitholders on a pro rata basis, subject to Avalon’s
right of first refusal to purchase the Royalty Interests retained by the Trust at the Termination Date. The Trust may also dissolve
should one of the following events occur prior to the Termination Date: (a) the Trust sells all of the Royalty Interests; (b) cash
available for distribution for any four consecutive quarters, on a cumulative basis, is less than $5.0 million; (c) the Trust unitholders
approve an earlier dissolution of the Trust; or (d) the Trust is judicially dissolved pursuant to the provisions of the Delaware
Statutory Trust Act. In the case of any of the foregoing, the Trustee would then sell all of the Trust’s assets (subject
to Avalon’s right of first refusal to purchase the Royalty Interests retained by the Trust as of the date of such event),
either by private sale or public auction, and distribute the net proceeds of the sale to the Trust unitholders after payment, or
reasonable provision for payment, of all Trust liabilities.
2. Significant Accounting Policies
Basis of Accounting. The financial statements of the
Trust differ from financial statements prepared in accordance with accounting principles generally accepted in the United States
of America (“GAAP”) as the Trust records revenues when cash is received (rather than when earned) and expenses when
paid (rather than when incurred) and may also establish cash reserves for contingencies, which would not be accrued in financial
statements prepared in accordance with GAAP. This comprehensive basis of accounting other than GAAP corresponds to the accounting
permitted for royalty trusts by the United States Securities and Exchange Commission (“SEC”) as specified by Staff
Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts. Amortization of investment in the Royalty Interests,
calculated on a unit-of-production basis, and any impairments are charged directly to trust corpus. Distributions to unitholders
are recorded when declared.
Significant Accounting Policies. Most accounting pronouncements
apply to entities whose financial statements are prepared in accordance with GAAP, which may require such entities to accrue or
defer revenues and expenses in a period other than when such revenues are received or expenses are paid. Because the Trust’s
financial statements are prepared on the modified cash basis as described above, most accounting pronouncements are not applicable
to the Trust’s financial statements.
Use of Estimates. The preparation of financial statements
requires the Trust to make estimates and assumptions that affect the reported amounts of assets and trust corpus and the reported
amounts of revenues and expenses during the reporting period. Significant estimates that impact the Trust’s financial statements
include estimates of proved oil, natural gas and natural gas liquids (“NGL”) reserves, which are used to compute the
Trust’s amortization of investment in the Royalty Interests and, as necessary, to evaluate potential impairment of its investment
in the Royalty Interests. Actual results could differ from those estimates.
Distributable Income Per Unit. Distributable income per
unit amounts as calculated for the periods presented in the accompanying statements of distributable income may differ from declared
distribution amounts per unit due to rounding and interest income. All Trust unitholders share on a pro rata basis in the Trust’s
distributable income (See Note 1).
Cash and Cash Equivalents. Cash and cash equivalents
consist of all highly-liquid instruments with original maturities of three months or less.
Investment in Royalty Interests. Significant dispositions
or abandonments of the Underlying Properties are charged to investment in the Royalty Interests and the trust corpus. Amortization
of investment in the Royalty Interests is calculated on a calendar-based units-of-production basis, whereby the Trust’s cost
basis is divided by the proved reserves attributable to the Royalty Interests to derive an amortization rate per reserve unit.
Amortization is recorded when units are produced. Such amortization does not reduce distributable income, rather it is charged
directly to trust corpus. Revisions to estimated future units-of-production are treated on a prospective basis beginning on the
date significant revisions are known.
Impairment of Investment in Royalty Interests. On a quarterly
basis, the Trust evaluates the carrying value of the Investment in Royalty Interests by comparing the undiscounted cash flows expected
to be realized from the Royalty Interest to the carrying value. If the expected future undiscounted cash flows are less than the
carrying value, the Trust recognizes an impairment loss for the difference between the carrying value and the estimated fair value
of the Royalty Interest, which is determined using future cash flows of the net oil, natural gas and NGL reserves attributable
to the Royalty Interests, discounted at a rate based upon the weighted average cost of capital of publicly traded royalty trusts.
The weighted average cost of capital is based upon inputs that are readily available in the public market. The future cash flows
of the net oil, natural gas and NGL reserves attributable to the Royalty Interests utilizes the oil and natural gas futures prices
readily available in the public market adjusted for differentials and estimated quantities of oil, natural gas and NGL reserves
that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs
under existing economic and operating conditions. As there are numerous uncertainties inherent in estimating quantities of proved
reserves, these quantities are a significant unobservable input resulting in the fair value measurement being considered a level
3 measurement within the fair value hierarchy. There were no impairments in the carrying value of the Investment in Royalty Interests
during 2019 or 2018. Material write-downs in subsequent periods may occur if commodity prices decline. Any impairment would result
in a non-cash charge to trust corpus and would not affect the Trust’s distributable income. See “Risks and Uncertainties”
in Note 5 below for further discussion.
Revenue and Expenses. Revenues received by the Trust
are reduced by post-production expenses, production taxes and general and administrative expenses paid and are adjusted for cash
reserves withheld by the Trustee in order to determine distributable income. The Royalty Interests are not burdened by field and
lease operating expenses.
Concentration of Risk. The Trust maintains cash balances
at one financial institution which are insured by the Federal Deposit Insurance Corporation up to $250,000. The Trust typically
has balances in these accounts that substantially exceed the federally insured limit. The Trust does not anticipate any loss associated
with balances exceeding the federally insured limit.
3. Income Taxes; Property Taxes
The Trust is treated as a partnership for federal and applicable
state income tax purposes. For U.S. federal income tax purposes, a partnership is not a taxable entity and incurs no U.S. federal
income tax liability. With respect to state taxation, a partnership is typically treated in the same manner as it is for U.S. federal
income tax purposes. However, the Trust’s activities result in the Trust having nexus in Texas and, therefore, make it subject
to Texas franchise tax. Texas franchise tax is treated as an income tax for financial statement purposes. The Trust is required
to pay Texas franchise tax each year at a maximum effective rate (subject to changes in the statutory rate) of 0.525% of its gross
income, all of which is realized from activities in Texas. The Trust records Texas franchise tax when paid. The Trust paid its
2018 Texas franchise tax of approximately $0.1 million during the year ended December 31, 2019. The Trust paid its 2017 Texas franchise
tax of approximately $0.1 million during the year ended December 31, 2018. The Trust expects to pay its estimated 2019 Texas franchise
tax liability of approximately $0.1 million during the year ending December 31, 2020. Further, the Trust’s tax years 2015
to present remain open for examination with respect to Texas franchise tax.
The Trust records Texas property taxes when paid. The Trust
paid its 2018 property taxes of approximately $1.6 million during the year ended December 31, 2018. Due to timing issues, the Trust
did not make any property tax payments during the year ended December 31, 2019, as it paid its 2019 property taxes of approximately
$1.7 million in January 2020.
4. Distributions to Unitholders
The Trust makes quarterly cash distributions of substantially
all of its cash receipts, after deducting amounts for the Trust’s administrative expenses, property tax and Texas franchise
tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter. Distributions
cover a three-month production period consisting of the first two months of the most recently ended quarter and the final month
of the preceding quarter. A summary of the Trust’s distributions to unitholders is as follows:
|
|
Covered Production Period
|
|
|
Date Declared
|
|
Date Paid
|
|
Total Distribution Paid
|
|
|
Distribution Per Common Unit
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
|
|
|
|
Calendar Quarter 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
September 1, 2018 - November 30, 2018
|
|
|
January 24, 2019
|
|
February 22, 2019
|
|
$
|
5.0
|
|
|
$
|
0.095
|
|
Second Quarter
|
|
December 1, 2018 - February 28, 2019
|
|
|
April 25, 2019
|
|
May 24, 2019
|
|
$
|
3.7
|
|
|
$
|
0.071
|
|
Third Quarter
|
|
March 1, 2019 - May 31, 2019
|
|
|
July 24, 2019
|
|
August 23, 2019
|
|
$
|
4.7
|
|
|
$
|
0.089
|
|
Fourth Quarter
|
|
June 1, 2019 - August 31, 2019
|
|
|
October 24, 2019
|
|
November 24, 2019
|
|
$
|
3.8
|
|
|
$
|
0.073
|
|
Calendar Quarter 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
September 1, 2017 - November 30, 2017
|
|
|
January 25, 2018
|
|
February 23, 2018
|
|
$
|
5.9
|
|
|
$
|
0.113
|
|
Second Quarter
|
|
December 1, 2017 - February 28, 2018
|
|
|
April 26, 2018
|
|
May 25, 2018
|
|
$
|
6.6
|
|
|
$
|
0.125
|
|
Third Quarter
|
|
March 1, 2018 - May 31, 2018
|
|
|
July 26, 2018
|
|
August 24, 2018
|
|
$
|
6.8
|
|
|
$
|
0.129
|
|
Fourth Quarter
|
|
June 1, 2018 - August 31, 2018
|
|
|
October 25, 2018
|
|
November 23, 2018
|
|
$
|
6.0
|
|
|
$
|
0.115
|
|
On February 28, 2020, the Trust paid a
cash distribution of $4.2 million covering production for the period from September 1, 2019 to November 30, 2019. See Note 8 for
further discussion.
5. Commitments and Contingencies
Loan Commitment. Pursuant to the trust agreement, if
at any time the Trust’s cash on hand (including available cash reserves) is not sufficient to pay the Trust’s ordinary
course administrative expenses as they become due, Avalon will, at the Trustee’s request, loan funds to the Trust necessary
to pay such expenses. Any funds loaned by Avalon pursuant to this commitment will be limited to the payment of current accounts
payable or other obligations to trade creditors in connection with obtaining goods or services or the payment of other current
liabilities arising in the ordinary course of the Trust’s business, and may not be used to satisfy Trust indebtedness, or
to make distributions. If Avalon loans funds pursuant to this commitment, unless Avalon agrees otherwise, no further distributions
will be made to unitholders (except in respect of any previously determined quarterly cash distribution amount) until such loan
is repaid. Any such loan will be on an unsecured basis, and the terms of such loan will be substantially the same as those which
would be obtained in an arm’s length transaction between Avalon and an unaffiliated third party. No such loan from Avalon
was outstanding at December 31, 2019 or 2018.
Risks and Uncertainties. The Trust’s revenue and
distributions are substantially dependent upon the prevailing and future prices for oil and natural gas, each of which depends
on numerous factors beyond the Trust’s control such as overall oil and natural gas production and inventories in relevant
markets, economic conditions, the global political environment, regulatory developments and competition from other energy sources.
Oil and natural gas prices historically have been volatile, and may be subject to significant fluctuations in the future. Low levels
of future production and continued low commodity prices would continue to reduce the Trust’s revenues and distributable income
available to unitholders.
The Trust is highly dependent on Avalon for multiple services,
including the operation of the Trust wells, remittance of net proceeds from the sale of associated production to the Trust, administrative
services such as accounting, tax preparation, bookkeeping and informational services performed on behalf of the Trust, and potentially
for loans to pay Trust administrative expenses. Avalon is a relatively new oil and gas company formed in August 2018 with no prior
operating history. Avalon’s ability to continue operating the properties depends on its future financial condition and economic
performance, access to capital, and other factors, many of which are out of Avalon’s control.
6. Related Party Transactions
Trustee Administrative Fee. Under the terms of the trust
agreement, the Trust pays an annual administrative fee to the Trustee, which prior to 2017 was $150,000. The annual administrative
fee can be adjusted for inflation by no more than 3% in any year. The Trustee’s administrative fees paid during the years
ended December 31, 2019 and 2018 totaled approximately $158,000 and $155,000, respectively.
Registration Rights Agreement. The Trust is party to
a registration rights agreement pursuant to which the Trust has agreed to register the offering of the Trust units now held by
Avalon upon request by Avalon. The holders have the right to require the Trust to file no more than five registration statements
in aggregate, one of which has been filed to date. The Trust does not bear any expenses associated with such transactions.
Administrative Services Agreement. The Trust is party
to an Administrative Services Agreement with Avalon (as the assignee of SandRidge) that obligates the Trust to pay Avalon an annual
administrative services fee for accounting, tax preparation, bookkeeping and informational services performed by Avalon on behalf
of the Trust. For its services under the Administrative Services Agreement, Avalon receives an annual fee of $300,000, which is
payable in equal quarterly installments and will remain fixed for the life of the Trust. Avalon is also entitled to receive reimbursement
for its out-of-pocket fees, costs and expenses incurred in connection with the provision of any of the services under the Administrative
Services Agreement. The Administrative Services Agreement will terminate on the earliest to occur of: (i) the date the Trust shall
have dissolved and commenced winding up in accordance with the Trust Agreement, (ii) the date that all of the Royalty Interests
have been terminated or are no longer held by the Trust, (iii) pertaining to services to be provided with respect to any Underlying
Properties transferred by Avalon, the date that either Avalon or the Trustee may designate by delivering 90-days’ prior written
notice, provided that the transferee of such Underlying Properties assumes responsibility to perform the services in place of Avalon
and (iv) a date mutually agreed by Avalon and the Trustee. During the year ended December 31, 2019 the Trust paid administrative
fees in the amount of $75,000 to SandRidge, as provided under the Transition Services Agreement between SandRidge and Avalon, and
$225,000 to Avalon. During the year ended December 31, 2018, the Trust paid administrative fees in the amount of $300,000 to SandRidge.
7. Major Customers
For the years ended December 31, 2019 and 2018, sales of production
attributable to the Royalty Interests exceeding 10% of the Trust’s total revenues were made to the following oil or natural
gas purchasers:
|
|
Sales
|
|
|
% of Revenue
|
|
|
|
(in thousands)
|
|
|
|
|
2019
|
|
|
|
|
|
|
Enterprise Crude Oil LLC
|
|
$
|
17,063
|
|
|
|
81.2
|
%
|
ConocoPhillips Company
|
|
$
|
3,951
|
|
|
|
18.8
|
%
|
2018
|
|
|
|
|
|
|
|
|
Enterprise Crude Oil LLC
|
|
$
|
22,685
|
|
|
|
76.0
|
%
|
ConocoPhillips Company
|
|
$
|
4,917
|
|
|
|
16.5
|
%
|
In October 2019, Avalon entered into a crude oil purchasing
agreement with Ace Gathering Inc., a Texas corporation doing business as Ace Energy Solutions (“ACE”). Pursuant
to the terms of the contract, Avalon is required to deliver all crude oil produced from wells it operates, including the Underlying
Properties, beginning November 1, 2019. As a result, all production from the Underlying Properties is committed to ACE under the
contract through December 31, 2021. The price for each barrel of crude oil delivered under the contract is NYMEX West Texas Intermediate
averaged over the month of delivery, subject to certain adjustments as set forth in the contract. Avalon entered into this contract,
together with an agreement whereby Avalon can purchase condensate from ACE to use in its well workover program, in order to maximize
the price of production, as well as the transparency of pricing, from the Underlying Properties and other properties operated by
Avalon. Transportation of crude oil sold by Avalon will continue to utilize existing pipeline systems and suppliers, including
Enterprise Crude Oil LLC and ConocoPhillips Company.
8.
Subsequent Events
On
January 23, 2020, the Trust declared a cash distribution of $0.080 per unit covering production for the three-month period from
September 1, 2019 to November 30, 2019 for record unitholders as of February 14, 2020. A distribution of $4.2 million was paid
on February 28, 2020. Distributable income for September 1, 2019 to November 30, 2019 was calculated as follows (in thousands,
except for unit and per unit amounts):
Revenues
|
|
|
|
|
Royalty
income
|
|
$
|
5,273
|
|
Total
revenues
|
|
|
5,273
|
|
Expenses
|
|
|
|
|
Post-production
expenses
|
|
|
15
|
|
Production
taxes
|
|
|
254
|
|
Cash
reserves withheld by Trustee(1)
|
|
|
620
|
|
Total
expenses
|
|
|
889
|
|
Distributable
income
|
|
$
|
4,384
|
|
Additional
cash reserve(2)
|
|
|
190
|
|
Distributable
income available to unitholders
|
|
$
|
4,194
|
|
Distributable
income per unit (52,500,000 units issued and outstanding)
|
|
$
|
0.080
|
|
|
(1)
|
Includes
amounts withheld for payment of future Trust administrative expenses.
|
|
(2)
|
Cash
reserve increase for the payment of future known, anticipated or contingent expenses
or liabilities.
|
9.
Supplemental Information on Oil and Natural Gas Producing Activities (Unaudited)
The
following supplemental information includes capitalized costs related to oil and natural gas producing activities; costs incurred
in oil and natural gas property acquisition, exploration and development; and the results of operations for oil and natural gas
producing activities. Supplemental information is also provided for oil, natural gas and NGL production and average sales prices;
the estimated quantities of proved oil, natural gas and NGL reserves; the standardized measure of discounted future net cash flows
associated with proved oil, natural gas and NGL reserves; and a summary of the changes in the standardized measure of discounted
future net cash flows associated with proved oil, natural gas and NGL reserves. This supplemental information was prepared on
an accrual basis, which is the basis upon which Avalon, SandRidge, and the Underlying Properties maintained their records and
is different from the modified cash basis on which the Trust’s financial statements are prepared. A reconciliation of information
presented on the modified cash basis to the accrual basis for the years ended December 31, 2019 and 2018 is as follows:
|
|
Year
Ended December 31, 2019
|
|
|
|
|
|
|
For
the period
|
|
|
|
|
|
|
Modified
Cash
Basis(1)
|
|
|
September
1, 2018 to
December 31, 2018
|
|
|
September
1, 2019 to
December 31, 2019
|
|
|
Accrual
Basis(2)
|
|
Production
Data (Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
(MBbls)
|
|
|
422.0
|
|
|
|
(146.1
|
)
|
|
|
138.7
|
|
|
|
415.0
|
|
NGL
(MBbls)
|
|
|
57.0
|
|
|
|
(21.2
|
)
|
|
|
13.8
|
|
|
|
49.6
|
|
Natural
Gas (MMcf)
|
|
|
181.2
|
|
|
|
(67.2
|
)
|
|
|
48.2
|
|
|
|
162.2
|
|
Combined
equivalent volumes (MBoe)(3)
|
|
|
509.2
|
|
|
|
(178.5
|
)
|
|
|
160.6
|
|
|
|
491.3
|
|
Royalty
Income (in thousands)
|
|
$
|
22,374
|
|
|
$
|
(7,887
|
)
|
|
$
|
7,109
|
|
|
$
|
21,596
|
|
Expenses
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Post-production
costs
|
|
|
50
|
|
|
|
2
|
|
|
|
2
|
|
|
|
54
|
|
Property
taxes
|
|
|
—
|
|
|
|
(43
|
)
|
|
|
1,719
|
|
|
|
1,676
|
|
Production
taxes
|
|
|
1,061
|
|
|
|
(375
|
)
|
|
|
335
|
|
|
|
1,021
|
|
|
|
$
|
21,263
|
|
|
$
|
(7,471
|
)
|
|
$
|
5,053
|
|
|
$
|
18,845
|
|
|
|
Year
Ended December 31, 2018
|
|
|
|
|
|
|
For
the period
|
|
|
|
|
|
|
Modified
Cash
Basis(4)
|
|
|
September
1, 2017 to
December 31, 2017
|
|
|
September
1, 2018 to
December 31, 2018
|
|
|
Accrual
Basis(2)
|
|
Production
Data (Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
(MBbls)
|
|
|
485.0
|
|
|
|
(168.3
|
)
|
|
|
146.1
|
|
|
|
462.8
|
|
NGL
(MBbls)
|
|
|
72.3
|
|
|
|
(25.4
|
)
|
|
|
21.2
|
|
|
|
68.1
|
|
Natural
Gas (MMcf)
|
|
|
227.3
|
|
|
|
(82.3
|
)
|
|
|
67.2
|
|
|
|
212.2
|
|
Combined
equivalent volumes (MBoe)(3)
|
|
|
595.2
|
|
|
|
(207.4
|
)
|
|
|
178.5
|
|
|
|
566.3
|
|
Royalty
Income (in thousands)
|
|
$
|
29,806
|
|
|
$
|
(9,472
|
)
|
|
$
|
7,887
|
|
|
$
|
28,221
|
|
Expenses
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Post-production
costs
|
|
|
46
|
|
|
|
(1
|
)
|
|
|
(2
|
)
|
|
|
45
|
|
Property
taxes
|
|
|
1,559
|
|
|
|
(43
|
)
|
|
|
43
|
|
|
|
1,559
|
|
Production
taxes
|
|
|
1,423
|
|
|
|
(451
|
)
|
|
|
375
|
|
|
|
1,347
|
|
|
|
$
|
26,778
|
|
|
$
|
(8,977
|
)
|
|
$
|
7,471
|
|
|
$
|
25,270
|
|
|
(1)
|
Production
volumes attributable to the Royalty Interests and related revenues and expenses included
in Avalon’s net revenue distributions to the trust represents production from September
1, 2018 to August 31, 2019.
|
|
(2)
|
Production
volumes attributable to the Royalty Interests and related revenues and expenses, presented
on an accrual basis for the years ended December 31, 2019 and 2018 respectively.
|
|
(3)
|
Barrel
of oil equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of
oil, which approximates the relative energy content of oil as compared to natural gas.
|
|
(4)
|
Production
volumes attributable to the Royalty Interests and related revenues and expenses included
in SandRidge’s 2018 net revenue distributions to the Trust represents production
from September 1, 2017 to August 31, 2018.
|
Capitalized
Costs Related to Oil and Natural Gas Producing Activities
The
Trust’s capitalized costs consisted of the following (in thousands):
|
|
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Investment
in royalty interests
|
|
|
|
|
|
|
|
|
Proved(1)
|
|
$
|
549,831
|
|
|
$
|
549,831
|
|
Unproved
|
|
|
—
|
|
|
|
—
|
|
Total
investment in royalty interests
|
|
|
549,831
|
|
|
|
549,831
|
|
Less
accumulated amortization and impairment
|
|
|
(447,373
|
)
|
|
|
(436,973
|
)
|
Net
investment in royalty interests
|
|
$
|
102,458
|
|
|
$
|
112,858
|
|
|
(1)
|
Royalty
Interests conveyed to the Trust by Avalon were in proved properties only.
|
Costs
Incurred in Oil and Natural Gas Property Acquisition, Exploration and Development
The
Trust is not responsible for any costs incurred related to the Underlying Properties. As such, the Trust did not incur any costs
in the exploration or development of oil and natural gas properties during the years ended December 31, 2019 or 2018.
Results
of Operations for Oil and Natural Gas Producing Activities (Unaudited)
The
Trust’s results of operations from oil and natural gas producing activities for each of the years ended 2019 and 2018 are
shown in the following table (in thousands):
|
|
December
31,(1)
|
|
|
|
2019
|
|
|
2018
|
|
Revenues
|
|
$
|
21,663
|
|
|
$
|
28,272
|
|
Expenses(2)
|
|
|
|
|
|
|
|
|
Post-production
costs
|
|
|
54
|
|
|
|
45
|
|
Property
taxes
|
|
|
1,676
|
|
|
|
1,559
|
|
Production
taxes
|
|
|
1,021
|
|
|
|
1,347
|
|
Amortization
expense(3)
|
|
|
10,399
|
|
|
|
11,018
|
|
Income
before income taxes
|
|
|
8,513
|
|
|
|
14,303
|
|
Income
taxes(4)
|
|
|
36
|
|
|
|
47
|
|
Results
of operations for oil and natural gas producing activities (excluding general and administrative costs and derivative settlements
of the Trust)
|
|
$
|
8,477
|
|
|
$
|
14,256
|
|
|
(1)
|
Revenues
and post-production costs attributable to volumes produced from January 1 to December
31 of the respective year, regardless of whether proceeds from the sale of production
have been remitted to the Trust by Avalon and SandRidge, respectively.
|
|
(2)
|
The
Trust does not bear any well operating costs.
|
|
(3)
|
Amortization
is recorded by the Trust as volumes are produced and does not reduce distributable income,
but rather, is recorded directly to trust corpus.
|
|
(4)
|
Reflect
Trust’s effective state income tax rate of 0.1655%. The Trust is not required to
pay federal income tax.
|
Oil,
Natural Gas and NGL Reserve Quantities (Unaudited)
Proved
reserves are those quantities of oil, natural gas and NGL, which, by analysis of geoscience and engineering data, can be estimated
with reasonable certainty to be economically producible, based on prices used to estimate reserves, from a given date forward
from known reservoirs, and under existing economic conditions, operating methods, and government regulation before the time of
which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain. Proved developed
reserves are proved reserves expected to be recovered through existing wells with existing equipment and operating methods or
in which the cost of the required equipment is relatively minor compared with the cost of a new well. Proved undeveloped reserves
are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively
large major expenditure is required for recompletion.
Netherland,
Sewell & Associates, Inc. (“Netherland Sewell”), independent oil and natural gas consultants, prepared the estimates
of proved reserves of oil, natural gas and NGL attributable to the Royalty Interests. Netherland Sewell are independent petroleum
engineers, geologists, geophysicists and petrophysicists and do not own an interest in the Trust or its properties and are not
employed on a contingent basis.
Based
on its review of the estimates of proved reserves made by the independent petroleum engineers, SandRidge has advised the Trustee
that the geoscience and engineering data examined provides reasonable assurance that the proved reserves are economically producible
in future years from known reservoirs, and under existing economic conditions, operating methods and governmental regulations.
Estimates of proved reserves are subject to change, either positively or negatively, as additional information is available and
contractual and economic conditions change.
The
table below represents the estimate of proved reserves attributable to the Trust’s net interest in oil and natural gas properties,
all of which are located in the continental United States, based upon the evaluation by the Trustee and its independent petroleum
engineers of pertinent geoscience and engineering data in accordance with the SEC’s regulations. Estimates of the Trust’s
proved reserves have been prepared by independent reservoir engineers and geoscience professionals and are reviewed by members
of SandRidge’s senior management with professional training in petroleum engineering to ensure that rigorous professional
standards and the reserve definitions prescribed by the SEC are consistently applied.
The
summary below presents changes in the Trust’s estimated reserves during the years ended December 31, 2019 and 2018.
|
|
Oil
(MBbls)
|
|
|
NGL
(MBbls)
|
|
|
Natural
Gas
(MMcf)(1)
|
|
Proved
developed and undeveloped reserves
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2017
|
|
|
4,999.9
|
|
|
|
758.9
|
|
|
|
2,544.4
|
|
Revisions
of previous estimates
|
|
|
30.4
|
|
|
|
1.0
|
|
|
|
(168.4
|
)
|
Extensions
and discoveries
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Production(2)
|
|
|
(462.8
|
)
|
|
|
(68.1
|
)
|
|
|
(212.2
|
)
|
As
of December 31, 2018
|
|
|
4,567.5
|
|
|
|
691.8
|
|
|
|
2,163.8
|
|
Revisions
of previous estimates
|
|
|
(233.8
|
)
|
|
|
(230.7
|
)
|
|
|
(642.5
|
)
|
Extensions
and discoveries
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Production(2)
|
|
|
(415.0
|
)
|
|
|
(49.6
|
)
|
|
|
(162.2
|
)
|
As
of December 31, 2019
|
|
|
3,918.7
|
|
|
|
411.5
|
|
|
|
1,359.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proved
developed reserves(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2018
|
|
|
4,567.5
|
|
|
|
691.8
|
|
|
|
2,163.8
|
|
As
of December 31, 2019
|
|
|
3,918.7
|
|
|
|
411.5
|
|
|
|
1,359.1
|
|
Proved
undeveloped reserves(3)
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2018
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
As
of December 31, 2019
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
(1)
|
Natural
gas reserves are computed at 14.65 pounds per square inch absolute and 60 degrees Fahrenheit.
|
|
(2)
|
Volumes
produced from January 1 to December 31 of the respective year, regardless of whether
proceeds from the sale of such production have been remitted to the Trust by SandRidge
or Avalon, as applicable.
|
|
(3)
|
Estimated
proved reserves were determined using a 12-month average price for oil, natural gas and
NGL.
|
The
Trust recognized net reductions to reserves associated with proved properties of approximately 571.6 MBoe as a result of pricing
during 2019. The Trust recognized net additions to reserves associated with proved properties of approximately 3.3 MBoe due to
pricing and well performance during 2018.
Standardized
Measure of Discounted Future Net Cash Flows (Unaudited)
The
assumptions underlying the computation of the standardized measure of discounted cash flows are summarized as follows:
|
●
|
the
standardized measure includes estimates of proved oil, natural gas and NGL reserves and
projected future production volumes based upon economic conditions;
|
|
●
|
pricing
is applied based upon 12-month average market prices at December 31, 2019 and 2018. The
calculated weighted average per unit prices for the Trust’s proved reserves and
future net revenues were as follows;
|
|
|
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Oil
(per barrel)
|
|
$
|
51.58
|
|
|
$
|
59.12
|
|
NGL
(per barrel)
|
|
$
|
19.55
|
|
|
$
|
24.91
|
|
Natural
Gas (per Mcf)
|
|
$
|
0.88
|
|
|
$
|
1.89
|
|
|
●
|
a
discount factor of 10% per year is applied annually to the future net cash flows; and
|
|
●
|
future
income tax expenses are computed based upon the estimated effective state income tax
rates of 0.1655%. The Trust is not required to pay federal income taxes.
|
The
summary below presents the Trust’s future net cash flows relating to proved oil, natural gas and NGL reserves based on the
standardized measure in ASC Topic 932 (in thousands).
|
|
As
of December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Future
cash inflows from production
|
|
$
|
211,362
|
|
|
$
|
291,358
|
|
Future
production costs(1)
|
|
|
(16,434
|
)
|
|
|
(22,896
|
)
|
Future
income taxes
|
|
|
(350
|
)
|
|
|
(482
|
)
|
Undiscounted
future net cash flows
|
|
|
194,578
|
|
|
|
267,980
|
|
10%
annual discount
|
|
|
(90,764
|
)
|
|
|
(132,493
|
)
|
Standardized
measure of discounted future net cash flows
|
|
$
|
103,814
|
|
|
$
|
135,487
|
|
|
(1)
|
Includes
the Trust’s proportionate share of production taxes and post-production costs.
The Trust does not bear any development or operational costs related to wells.
|
The
following table represents the Trust’s estimate of changes in the standardized measure of discounted future net cash flows
from proved reserves (in thousands):
Present
value as of December 31, 2017
|
|
$
|
122,983
|
|
Revenues
less post-production and other costs
|
|
|
(25,269
|
)
|
Net
changes in prices, production and other costs
|
|
|
27,269
|
|
Revisions
of previous quantity estimates
|
|
|
716
|
|
Accretion
of discount
|
|
|
11,217
|
|
Net
changes in income taxes
|
|
|
(22
|
)
|
Timing
differences and other(1)
|
|
|
(1,407
|
)
|
Net
change for the year
|
|
|
12,504
|
|
Present
value as of December 31, 2018
|
|
$
|
135,487
|
|
Revenues
less post-production and other costs
|
|
|
(18,843
|
)
|
Net
changes in prices, production and other costs
|
|
|
(18,032
|
)
|
Revisions
of previous quantity estimates
|
|
|
(10,641
|
)
|
Accretion
of discount
|
|
|
12,396
|
|
Net
changes in income taxes
|
|
|
57
|
|
Timing
differences and other(1)
|
|
|
3,390
|
|
Net
change for the year
|
|
|
(31,673
|
)
|
Present
value as of December 31, 2019
|
|
$
|
103,814
|
|
|
(1)
|
Changes
in timing differences and other are related to revisions in the estimated timing of production
and, as applicable, development.
|
10.
Quarterly Financial Results (Unaudited)
The
Trust’s operating results for each calendar quarter of 2019 and 2018 are summarized below (in thousands, except per unit
data).
|
|
First
Quarter
|
|
|
Second
Quarter
|
|
|
Third
Quarter
|
|
|
Fourth
Quarter
|
|
|
|
(1)
|
|
|
(2)
|
|
|
(3)
|
|
|
(4)
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalty
income
|
|
$
|
6,257
|
|
|
$
|
4,901
|
|
|
$
|
6,068
|
|
|
$
|
5,216
|
|
Distributable
income available to unitholders
|
|
$
|
4,981
|
|
|
$
|
3,780
|
|
|
$
|
4,671
|
|
|
$
|
3,857
|
|
Distributable
income per common unit
|
|
$
|
0.095
|
|
|
$
|
0.071
|
|
|
$
|
0.089
|
|
|
$
|
0.073
|
|
|
|
First
Quarter
|
|
|
Second
Quarter
|
|
|
Third
Quarter
|
|
|
Fourth
Quarter
|
|
|
|
(5)
|
|
|
(6)
|
|
|
(7)
|
|
|
(8)
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalty
income
|
|
$
|
6,925
|
|
|
$
|
7,737
|
|
|
$
|
7,984
|
|
|
$
|
7,211
|
|
Distributable
income available to unitholders
|
|
$
|
5,935
|
|
|
$
|
6,568
|
|
|
$
|
6,781
|
|
|
$
|
6,042
|
|
Distributable
income per common unit
|
|
$
|
0.113
|
|
|
$
|
0.125
|
|
|
$
|
0.129
|
|
|
$
|
0.115
|
|
|
(1)
|
Includes
proceeds attributable to production from the wells burdened by the Royalty Interests
from September 1, 2018 to November 30, 2018.
|
|
(2)
|
Includes
proceeds attributable to production from the wells burdened by the Royalty Interests
from December 1, 2018 to February 28, 2019.
|
|
(3)
|
Includes
proceeds attributable to production from the wells burdened by the Royalty Interests
from March 1, 2019 to May 31, 2019.
|
|
(4)
|
Includes
proceeds attributable to production from the wells burdened by the Royalty Interests
from June 1, 2019 to August 31, 2019.
|
|
(5)
|
Includes
proceeds attributable to production from the wells burdened by the Royalty Interests
from September 1, 2017 to November 30, 2017.
|
|
(6)
|
Includes
proceeds attributable to production from the wells burdened by the Royalty Interests
from December 1, 2017 to February 28, 2018.
|
|
(7)
|
Includes
proceeds attributable to production from the wells burdened by the Royalty Interests
from March 1, 2018 to May 31, 2018.
|
|
(8)
|
Includes
proceeds attributable to production from the wells burdened by the Royalty Interests
from June 1, 2018 to August 31, 2018.
|
SANDRIDGE
PERMIAN TRUST
STATEMENTS
OF ASSETS AND TRUST CORPUS
(In
thousands, except unit data)
|
|
June
30,
2020
|
|
|
December
31,
2019
|
|
|
|
(Unaudited)
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
2,763
|
|
|
$
|
4,698
|
|
Investment
in royalty interests
|
|
|
549,831
|
|
|
|
549,831
|
|
Less:
accumulated amortization and impairment
|
|
|
(527,293
|
)
|
|
|
(447,373
|
)
|
Net
investment in royalty interests
|
|
|
22,538
|
|
|
|
102,458
|
|
Total
assets
|
|
$
|
25,301
|
|
|
$
|
107,156
|
|
TRUST
CORPUS
|
|
|
|
|
|
|
|
|
Trust
corpus, 52,500,000 units issued and outstanding at June 30, 2020 and
December 31, 2019
|
|
$
|
25,301
|
|
|
$
|
107,156
|
|
The
accompanying notes are an integral part of these financial statements.
SANDRIDGE
PERMIAN TRUST
STATEMENTS
OF DISTRIBUTABLE INCOME (Unaudited)
(In
thousands, except per unit data)
|
|
Three
Months Ended
June 30,
|
|
|
Six
Months Ended
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalty
income
|
|
$
|
3
|
|
|
$
|
4,901
|
|
|
$
|
5,292
|
|
|
$
|
11,158
|
|
Total
revenues
|
|
|
3
|
|
|
|
4,901
|
|
|
|
5,292
|
|
|
|
11,158
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Post-production
expenses
|
|
|
—
|
|
|
|
8
|
|
|
|
15
|
|
|
|
20
|
|
Production
taxes
|
|
|
—
|
|
|
|
233
|
|
|
|
254
|
|
|
|
533
|
|
Property
taxes
|
|
|
—
|
|
|
|
—
|
|
|
|
1,676
|
|
|
|
—
|
|
Franchise
taxes
|
|
|
36
|
|
|
|
47
|
|
|
|
36
|
|
|
|
47
|
|
Trust
administrative expenses
|
|
|
338
|
|
|
|
609
|
|
|
|
1,046
|
|
|
|
1,042
|
|
Cash
reserves (used) withheld for current Trust expenses,
net of amounts withheld (used)
|
|
|
(371
|
)
|
|
|
224
|
|
|
|
(1,945
|
)
|
|
|
755
|
|
Total
expenses
|
|
|
3
|
|
|
|
1,121
|
|
|
|
1,082
|
|
|
|
2,397
|
|
Distributable
income available to unitholders
|
|
$
|
—
|
|
|
$
|
3,780
|
|
|
$
|
4,210
|
|
|
$
|
8,761
|
|
Distributable
income per unit (52,500,000 units issued and outstanding)
|
|
$
|
—
|
|
|
$
|
0.071
|
|
|
$
|
0.080
|
|
|
$
|
0.166
|
|
The
accompanying notes are an integral part of these financial statements.
SANDRIDGE
PERMIAN TRUST
STATEMENTS
OF CHANGES IN TRUST CORPUS (Unaudited)
(In
thousands)
|
|
Three
Months Ended
June 30,
|
|
|
Six
Months Ended
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Trust
corpus, beginning of period
|
|
$
|
26,233
|
|
|
$
|
113,190
|
|
|
$
|
107,156
|
|
|
$
|
115,225
|
|
Amortization
of investment in royalty interests
|
|
|
(561
|
)
|
|
|
(2,655
|
)
|
|
|
(2,826
|
)
|
|
|
(5,215
|
)
|
Impairment
of investment in royalty interests
|
|
|
—
|
|
|
|
—
|
|
|
|
(77,094
|
)
|
|
|
—
|
|
Net
cash reserves (used) withheld
|
|
|
(371
|
)
|
|
|
224
|
|
|
|
(1,945
|
)
|
|
|
755
|
|
Distributable
income
|
|
|
—
|
|
|
|
3,780
|
|
|
|
4,210
|
|
|
|
8,761
|
|
Distributions
paid to unitholders
|
|
|
—
|
|
|
|
(3,728
|
)
|
|
|
(4,200
|
)
|
|
|
(8,715
|
)
|
Trust
corpus, end of period
|
|
$
|
25,301
|
|
|
$
|
110,811
|
|
|
$
|
25,301
|
|
|
$
|
110,811
|
|
The
accompanying notes are an integral part of these financial statements.
SANDRIDGE
PERMIAN TRUST
NOTES
TO FINANCIAL STATEMENTS
(Unaudited)
1.
Organization of Trust
SandRidge
Permian Trust (the “Trust”) is a statutory trust formed under the Delaware Statutory Trust Act pursuant to
a trust agreement, as amended and restated, by and among SandRidge Energy, Inc. (“SandRidge”), as Trustor,
The Bank of New York Mellon Trust Company, N.A., as Trustee (the “Trustee”), and The Corporation Trust Company,
as Delaware Trustee (the “Delaware Trustee”) (such amended and restated trust agreement, as amended to date,
the “Trust Agreement”).
The
Trust holds royalty interests conveyed by SandRidge from its interests in specified oil and natural gas properties located in
Andrews County, Texas (the “Underlying Properties”). These royalty interests were conveyed by SandRidge to
the Trust (the “Royalty Interests”) concurrent with the initial public offering of the Trust’s common
units (“Trust units”) in August 2011 pursuant to the terms set forth in conveyancing documents effective April
1, 2011 (the “Conveyances”). As consideration for conveyance of the Royalty Interests, the Trust remitted the
proceeds of the offering, along with 4,875,000 Trust units and 13,125,000 subordinated units of the Trust (“subordinated
units”), to certain wholly-owned subsidiaries of SandRidge.
Pursuant
to a development agreement between the Trust and SandRidge, SandRidge was obligated to drill, or cause to be drilled, 888 development
wells within an area of mutual interest (“AMI”) by March 31, 2016 (the “Trust Development Wells”).
SandRidge fulfilled this obligation in November 2014. As no additional development wells will be drilled, the Trust’s production
is expected to decline each quarter during the remainder of its life. As a result of SandRidge fulfilling its drilling obligation,
the subordinated units converted to Trust units in January 2016. At October 31, 2018, SandRidge owned 13,125,000 Trust units,
or 25% of all Trust units.
On
November 1, 2018, SandRidge sold all of its interests in the Underlying Properties and all of its outstanding Trust units (the
“Sale Transaction”) to Avalon Energy, LLC, a Texas limited liability company (“Avalon”).
The Conveyances permitted SandRidge to sell all or any part of its interest in the Underlying Properties, where the Underlying
Properties were sold subject to and burdened by the Royalty Interests. In connection with the Sale Transaction, Avalon and its
affiliates assumed all of SandRidge’s obligations under the Conveyances, the Trust Agreement and the administrative services
agreement between SandRidge and the Trust pursuant to which SandRidge and Avalon have provided accounting, tax preparation, bookkeeping
and informational services to the Trust (the “Administrative Services Agreement”). In addition, SandRidge assigned
its rights under the registration rights agreement between SandRidge and the Trust to Avalon. As of June 30, 2020, Avalon holds
13,125,000 Trust units, or 25% of all Trust units.
In
connection with the Sales Transaction, Avalon obtained a revolving line of credit from Washington Federal, National Association
(“WaFed”) pursuant to the terms of a Loan Agreement and related security documents (the “WaFed Loan”).
Avalon used the proceeds of the WaFed Loan to fund a portion of the purchase price for the interests in the Underlying Properties
and Trust units acquired in the Sale Transaction. The WaFed Loan is secured by a first lien mortgage on Avalon’s interest
in the Underlying Properties and a pledge of the Avalon Trust units (the “WaFed Collateral”). The Royalty Interests
are not part of the WaFed Collateral.
The
Trust is passive in nature and neither the Trust nor the Trustee has any control over, or responsibility for, any operating or
capital costs related to the Underlying Properties. The business and affairs of the Trust are administered by the Trustee. The
Trust Agreement generally limits the Trust’s business activities to owning the Royalty Interests and certain activities
reasonably related thereto, including activities required or permitted by the terms of the Conveyances.
The
Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s
administrative expenses, property taxes and Texas franchise taxes, and cash reserves withheld by the Trustee, on or about the
60th day following the completion of each quarter. Due to the timing of the payment of production proceeds to the Trust, each
distribution covers production from a three-month period consisting of the first two months of the most recently ended quarter
and the final month of the quarter preceding it.
The
Trust will dissolve and begin to liquidate on March 31, 2031 (the “Termination Date”), unless sooner dissolved
in accordance with the terms of the Trust Agreement as described below, and will soon thereafter wind up its affairs and terminate.
At the Termination Date, 50% of the Royalty Interests will revert automatically to Avalon. The remaining 50% of the Royalty Interests
will be sold at that time, with the net proceeds of the sale, as well as any remaining Trust cash reserves, distributed to the
unitholders on a pro rata basis, subject to Avalon’s right of first refusal to purchase the Royalty Interests retained by
the Trust at the Termination Date. In addition, the Trust will dissolve if one of the following events occurs prior to the Termination
Date: (a) the Trust sells all of the Royalty Interests; (b) cash available for distribution for any four consecutive quarters,
on a cumulative basis, is less than $5.0 million; (c) the Trust unitholders approve an earlier dissolution of the Trust; or (d)
the Trust is judicially dissolved pursuant to the provisions of the Delaware Statutory Trust Act. In the case of any of the foregoing,
the Trustee would then sell all of the Trust’s assets (subject to Avalon’s right of first refusal to purchase the
Royalty Interests retained by the Trust as of the date of such event), either by private sale or public auction, and distribute
the net proceeds of the sale to the Trust unitholders after payment, or reasonable provision for payment, of all Trust liabilities.
2.
Going Concern and Potential Early Termination of the Trust
The
accompanying financial statements have been prepared assuming that the Trust will continue as a going concern. As
discussed under “Distributions to Unitholders” in Note 4 below, during April 2020, as a result of increased production
costs necessary to operate the Underlying Properties, coupled with the sharp decline in oil and gas prices since the beginning
of 2020, Avalon informed the Trustee that Avalon would be unable to pay on a timely basis the quarterly distribution amount it
owes to the Trust for the three-month period ended March 31, 2020 and believes it will be unable to generate sufficient cash for
quarterly payments to the Trust for the foreseeable future. Although the Trust has since announced a quarterly distribution for
the three-month period ended June 30, 2020 (which primarily relates to production attributable to the Trust’s Royalty Interests
from March 1, 2020 to May 31, 2020) of approximately $652,000, there is no assurance that Avalon will be able to make distributions
in subsequent calendar quarters or pay the quarterly payment amount it owes the Trust for the three-month period ended March 31,
2020 as discussed in Note 4 below. Assuming that Avalon is unable to make the quarterly payment to the Trust for the three-month
period ended March 31, 2020 or future quarterly payments, cash available for distribution for the four consecutive quarters ending
December 31, 2020, on a cumulative basis, may fall below $5.0 million, which would require the Trust to commence termination shortly
after the quarterly cash distribution would be required to be made in February 2021. If that early termination event occurs, the
Trustee will be required to sell all of the Trust’s remaining assets and liquidate the Trust. Due
to this uncertainty, there is substantial doubt regarding the Trust’s ability to continue as a going concern within one
year after the date that the financial statements are issued. The Trust’s financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Avalon’s
Financial Condition. The reduced demand for crude oil in the global market resulting from the economic effects of the COVID-19
pandemic and the dramatic reduction from mid-February to late April 2020 in the benchmark price of crude oil, which continued
to fluctuate throughout the second quarter of 2020, have had a negative impact on Avalon’s financial condition. Avalon has
informed the Trustee that during 2020 it has shut in oil and gas wells subject to the Royalty Interests (“Trust Wells”)
that are not capable of producing oil and natural gas in paying quantities, as permitted under the Conveyances, in an effort to
further reduce LOE. These Trust Wells were not necessary to hold the leasehold interests burdened by the Trust’s Royalty
Interests. Avalon shut in 23 Trust Wells and 79 Trust Wells during the first and second quarters of 2020, respectively.
Due
to the reduction in the number of producing wells (both Trust Wells and other wells owned by Avalon) and the resulting expected
reduction in the proved reserves attributable to Avalon’s net revenue interest in the Underlying Properties and other oil
and gas assets, Avalon notified the Trust in April 2020 that it expected WaFed to notify Avalon (concurrent with WaFed’s
redetermination of the borrowing base under the terms of the WaFed Loan) that the borrowing base would be reduced to less than
the outstanding principal amount of the WaFed Loan. As Avalon has indicated to the Trust that Avalon does not presently have sufficient
cash available to pay down the principal amount of the WaFed Loan to come into compliance with any adjustment to the borrowing
base, it is possible that WaFed could foreclose on the collateral securing the WaFed Loan or take other steps to protect its interest
in such collateral. Since April 2020, Avalon has been in discussions with WaFed regarding forbearance of certain breached financial
covenants and an extension of the WaFed Loan. On July 30, 2020, Avalon and WaFed entered into an amendment to the WaFed Loan that,
among other things (i) extends the date on which Avalon is obligated to provide a reserve report to WaFed (regarding the redetermination
of the borrowing base) to September 15, 2020, (ii) provides for additional collateral for the WaFed Loan, (iii) requires increased
financial and operations reporting, and (iv) requires Avalon to pay off the WaFed Loan by October 15, 2020. In addition, WaFed
and a third party entered into a Participation Agreement with respect to the WaFed Loan where such third party has the right to
purchase the WaFed Loan in the event Avalon does not meet the conditions of the amended WaFed Loan. Avalon has informed the Trust
that if it is unsuccessful in its efforts to pay off the WaFed Loan, it anticipates that WaFed will call the WaFed Loan and foreclose
on its collateral, which could occur as early as late October 2020. If such foreclosure were to occur, Avalon would lose its working
interest in the Underlying Properties and could be replaced as operator of the Underlying Properties. See “Risk Factors
- The value of the Royalty Interests is highly dependent on the performance and financial condition of Avalon” in, Item
1A of Part II of the Trust’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 for a discussion of additional
risks relating to the WaFed Loan and Avalon’s financial condition. The Trustee intends to continue to monitor this situation
closely and will take any appropriate action to protect its Royalty Interests, including legal action to enforce its rights under
the Conveyance.
3.
Basis of Presentation and Summary of Significant Accounting Policies
Basis
of Accounting. The financial statements of the Trust differ from financial statements prepared in accordance with accounting
principles generally accepted in the United States of America (“GAAP”) as the Trust records revenues when cash
is received (rather than when earned) and expenses when paid (rather than when incurred) and may also establish cash reserves
for contingencies, which would not be accrued in financial statements prepared in accordance with GAAP. This comprehensive basis
of accounting other than GAAP corresponds to the accounting permitted for royalty trusts by the United States Securities and Exchange
Commission (“SEC”) as specified by Staff Accounting Bulletin Topic 12: E, Financial Statements of Royalty
Trusts. Amortization of investment in the Royalty Interests, calculated on a unit-of-production basis, and any impairments
are charged directly to the trust corpus. Distributions to unitholders are recorded when declared.
Significant
Accounting Policies. Most accounting pronouncements apply to entities whose financial statements are prepared in accordance
with GAAP, which may require such entities to accrue or defer revenues and expenses in a period other than when such revenues
are received, or expenses are paid. Because the Trust’s financial statements are prepared on the modified cash basis as
described above, most accounting pronouncements are not applicable to the Trust’s financial statements.
The
Trust is treated for federal and applicable state income tax purposes as a partnership. For U.S. federal income tax purposes,
a partnership is not a taxable entity and incurs no U.S. federal income tax liability.
With
respect to state taxation, a partnership is typically treated in the same manner as it is for U.S. federal income tax purposes.
However, the Trust’s activities result in the Trust having nexus in Texas and, therefore, make it subject to Texas franchise
tax. Texas franchise tax is treated as an income tax for financial statement purposes. The Trust is required to pay Texas franchise
tax each year at a maximum effective rate (subject to changes in the statutory rate) of 0.525% of its gross income, all of which
is realized from activities in Texas. The Trust records Texas franchise tax when paid.
Impairment
of Investment in Royalty Interests. On a quarterly basis, the Trust evaluates the carrying value of the investment in Royalty
Interests by comparing the undiscounted cash flows expected to be realized from the Royalty Interests to the carrying value. If
the expected future undiscounted cash flows are less than the carrying value, the Trust recognizes an impairment loss for the
difference between the carrying value and the estimated fair value of the Royalty Interests, which is determined using future
cash flows of the net oil, natural gas and natural gas liquids (“NGL”) reserves attributable to the Royalty
Interests, discounted at a rate based upon the weighted average cost of capital of publicly traded royalty trusts. The weighted
average cost of capital is based upon inputs that are available in the public market. The future cash flows of the net oil, natural
gas and NGL reserves attributable to the Royalty Interests utilizes the oil and natural gas futures prices readily available in
the public market adjusted for differentials and estimated quantities of oil, natural gas and NGL reserves that geological and
engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under existing
economic and operating conditions. As there are numerous uncertainties inherent in estimating quantities of proved reserves, these
quantities are a significant unobservable input resulting in the fair value measurement being considered a level 3 measurement
within the fair value hierarchy. During the six-month period ended June 30, 2020, due to the sharp decline in oil and gas prices
since the beginning of 2020, the Trust recorded an impairment in the carrying value of the Investment in Royalty Interests of
$77.1 million. The impairment resulted in a non-cash charge to trust corpus and did not affect the Trust’s distributable
income. There were no impairments in the carrying value of the investment in Royalty Interests during the three- or six-month
periods ended June 30, 2019. Material write-downs in subsequent periods may occur if commodity prices continue to decline. Any
impairment would result in a non-cash charge to trust corpus and would not affect the Trust’s distributable income. See
“Risks and Uncertainties” in Note 6 below for further discussion.
Distributable
Income Per Unit. Distributable income per unit amounts as calculated for the periods presented in the accompanying unaudited
statements of distributable income may differ from declared distribution amounts per unit due to rounding and the timing of the
Trust’s payment of Trust administrative expenses and other costs.
Interim
Financial Statements. The accompanying unaudited interim financial statements have been prepared in accordance with the accounting
policies stated in the audited financial statements contained in the 2019 Form 10-K and reflect all adjustments that are, in the
opinion of the Trustee, necessary to state fairly the information in the Trust’s unaudited interim financial statements.
The accompanying statement of assets and trust corpus as of December 31, 2019 has been derived from audited financial statements.
The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes thereto
included in the 2019 Form 10-K.
4.
Distributions to Unitholders
The
Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s
administrative expenses, property tax and Texas franchise tax, and cash reserves withheld by the Trustee, on or about the 60th
day following the completion of each quarter. Distributions cover a three-month production period consisting of the first two
months of the most recently ended quarter and the final month of the preceding quarter. A summary of the Trust’s distributions
to unitholders during the three- and six-month periods ended June 30, 2020 and the year ended December 31, 2019 is as follows:
|
|
Covered
Production Period
|
|
|
Date Declared
|
|
Date Paid
|
|
|
Total
Distribution
Paid
|
|
|
Distribution
Per Common
Unit
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
|
|
|
|
|
Calendar Quarter 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
September
1, 2019 — November 30, 2019
|
|
|
January 23, 2020
|
|
February 28, 2020
|
|
|
$
|
4.2
|
|
|
$
|
0.080
|
|
Second Quarter
|
|
December 1, 2019
— February 29, 2020
|
|
|
April 23, 2020
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Calendar Quarter 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
September 1, 2018
— November 30, 2018
|
|
|
January 24, 2019
|
|
February 22, 2019
|
|
|
$
|
5.0
|
|
|
$
|
0.095
|
|
Second Quarter
|
|
December 1, 2018
— February 28, 2019
|
|
|
April 25, 2019
|
|
May 24, 2019
|
|
|
$
|
3.7
|
|
|
$
|
0.071
|
|
Third Quarter
|
|
March 1, 2019
— May 31, 2019
|
|
|
July 25, 2019
|
|
August 23, 2019
|
|
|
$
|
4.7
|
|
|
$
|
0.089
|
|
Fourth Quarter
|
|
June 1, 2019 —
August 31, 2019
|
|
|
October 24, 2019
|
|
November 24, 2019
|
|
|
$
|
3.8
|
|
|
$
|
0.073
|
|
As
reported in the Trust’s Form 8-K filed on April 23, 2020 (the “April 2020 Form 8-K”), Avalon informed
the Trustee that Avalon would be unable to pay on a timely basis the approximately $4.65 million it owes the Trust, which reflects
the quarterly distribution amount for the three-month period ended March 31, 2020 (which primarily relates to production attributable
to the Trust’s interests from December 1, 2019 to February 29, 2020) of approximately $3.73 million, or $0.071 per unit,
together with approximately $0.73 million of Trust expenses and $0.19 million to be withheld by the Trustee for the Trust’s
previously disclosed cash reserve for future known, anticipated or contingent expenses or liabilities of the Trust. Consequently,
the Trustee was unable to make the quarterly distribution to unitholders. In accordance with the terms of the Conveyances, the
unpaid amount owed the Trust will accrue interest at the rate of interest per annum publicly announced from time to time by The
Bank of New York Mellon Trust Company, N.A. at its “prime rate” in effect at its principal office in New York City
until paid to the Trust. The accrued interest from May 15, 2020 to June 30, 2020 was approximately $19,000. Avalon has informed
the Trustee that Avalon intends to make the payment of the distribution to the Trust, with interest in accordance with the Conveyances,
when funds are available to do so; however, as discussed below, Avalon believes it will be unable to generate sufficient cash
to make all future quarterly payments to the Trust on a timely basis.
Avalon
has informed the Trustee that Avalon is using its commercially reasonable efforts to preserve the oil and gas leases burdened
by the Royalty Interests so that in the future, assuming that oil prices return to a profitable level, the Trust will still hold
its Royalty Interests, and Trust unitholders may have the opportunity to receive future quarterly distributions. Avalon also has
informed the Trustee that it believes that continuing production from those Trust Wells required to preserve such leases is preferable
to stopping production, as the failure to continue production would result in a termination of Avalon’s working interest
in such Trust Wells and, therefore, the Royalty Interests, which would have a material adverse effect on the Trust’s financial
condition. Avalon has reported to the Trustee that Avalon therefore used revenues it received during the production period from
December 1, 2019 to February 29, 2020 to pay the operating expenses necessary to maintain production from the Trust Wells and
to pay oil and gas lessor royalties, as the proceeds attributable to Avalon’s net revenue interest in the Underlying Properties
was insufficient to cover all such costs. Avalon had anticipated that revenues from current period production would be sufficient
to fund the quarterly payment to the Trust; however, revenues from current period production have been insufficient to generate
the cash needed to make the quarterly payment to the Trust for the quarter ended March 31, 2020 due to the sharp drop in crude
oil prices during the first quarter of 2020. In April 2020, Avalon informed the Trustee that due to Avalon’s decision to
prioritize the preservation of oil and gas leases burdened by the Royalty Interests, coupled with the sharp decline in oil and
gas prices since the beginning of 2020, as discussed elsewhere, at that time Avalon did not believe it would be able to generate
sufficient cash for quarterly payments to the Trust for the foreseeable future. However, with the recovery of crude oil prices
since the end of April 2020 and with increased cost-cutting efforts, Avalon has informed the Trust that it will make a payment
of approximately $1.7 million to the Trust for the three-month period ended June 30, 2020 (which primarily relates to production
attributable to the Trust’s Royalty Interests from March 1, 2020 to May 31, 2020), and the Trust has announced a quarterly
distribution to Trust unitholders of $652,000 for that period. As the COVID pandemic continues to show no signs of abating and
has recently resurged in the United States, Avalon has informed the Trust that it believes crude oil prices will continue to fluctuate
dramatically and cannot assure the Trust of its ability to generate sufficient cash to make all future quarterly payments to the
Trust on a timely basis.
5.
Related Party Transactions
Trustee
Administrative Fee. Under the terms of the Trust Agreement, the Trust pays an annual administrative fee to the Trustee, which
prior to 2017 was $150,000. The annual administrative fee can be adjusted for inflation by no more than 3% in any year. The Trustee’s
administrative fees paid during the three-month periods ended June 30, 2020 and 2019 totaled approximately $40,000 and $39,000,
respectively. The Trustee’s administrative fees paid during the six-month periods ended June 30, 2020 and 2019 totaled approximately
$80,000 and $78,000, respectively.
Registration
Rights Agreement. The Trust is party to a registration rights agreement pursuant to which the Trust has agreed to register
the offering of the Trust units now held by Avalon upon request by Avalon. The holders have the right to require the Trust to
file no more than five registration statements in aggregate, one of which has been filed to date. The Trust does not bear any
expenses associated with such transactions.
Administrative
Services Agreement. The Trust is party to an Administrative Services Agreement with Avalon (as the assignee of SandRidge)
that obligates the Trust to pay Avalon an annual administrative services fee for accounting, tax preparation, bookkeeping and
informational services performed by Avalon on behalf of the Trust. For its services under the Administrative Services Agreement,
Avalon receives an annual fee of $300,000, which is payable in equal quarterly installments and will remain fixed for the life
of the Trust. Avalon is also entitled to receive reimbursement for its out-of-pocket fees, costs and expenses incurred in connection
with the provision of any of the services under the Administrative Services Agreement. The Administrative Services Agreement will
terminate on the earliest to occur of: (i) the date the Trust shall have dissolved and commenced winding up in accordance with
the Trust Agreement, (ii) the date that all of the Royalty Interests have been terminated or are no longer held by the Trust,
(iii) pertaining to services to be provided with respect to any Underlying Properties transferred by Avalon, the date that either
Avalon or the Trustee may designate by delivering 90-days’ prior written notice, provided that the transferee of such Underlying
Properties assumes responsibility to perform the services in place of Avalon and (iv) a date mutually agreed by Avalon and the
Trustee. During each of the three-month periods ended June 30, 2020 and 2019, the Trust paid administrative fees in the amount
of $75,000 to Avalon. During each of the six-month periods ended June 30, 2020 and 2019, the Trust paid administrative fees in
the amount of $150,000 to Avalon and SandRidge, respectively. During the six-month period ended June 30, 2020, the Trust reimbursed
Avalon for approximately $124,000 for out-of-pocket fees, costs and expenses that Avalon had incurred in prior periods.
6.
Commitments and Contingencies
Loan
Commitment. Pursuant to the Trust Agreement, if at any time the Trust’s cash on hand (including available cash reserves)
is not sufficient to pay the Trust’s ordinary course administrative expenses as they become due, Avalon (as the assignee
of SandRidge) will, at the Trustee’s request, loan funds to the Trust necessary to pay such expenses. Any funds loaned by
Avalon pursuant to this commitment will be limited to the payment of current accounts payable or other obligations to trade creditors
in connection with obtaining goods or services or the payment of other current liabilities arising in the ordinary course of the
Trust’s business, and may not be used to satisfy Trust indebtedness, or to make distributions. If Avalon were to loan funds
pursuant to this commitment, no further distributions will be made to unitholders (except in respect of any previously determined
quarterly cash distribution amount) until such loan is repaid in full, with interest, unless Avalon consents to any further distributions.
Any such loan will be on an unsecured basis, and the terms of such loan will be substantially the same as that which would be
obtained in an arm’s length transaction between Avalon and an unaffiliated third party. No such loan from Avalon was outstanding
at June 30, 2020 or December 31, 2019, and given Avalon’s current financial condition, as further discussed under “Avalon’s
Financial Condition” in Note 2 above, it is unlikely such loan could be made.
Risks
and Uncertainties. The Trust’s revenue and distributions are substantially dependent upon the prevailing and future
prices for oil, natural gas and NGL, each of which depends on numerous factors beyond the Trust’s control such as overall
oil, natural gas and NGL production and inventories in the Permian Basin, economic conditions impacting the energy industry generally,
the global political environment, regulatory developments and competition from other energy sources. Oil, natural gas and NGL
prices historically have been volatile, reached a historical low during April 2020 due to the reduced demand for crude oil products
as a result of the COVID-19 pandemic and the inability of Russia and Saudi Arabia to agree on reduction in crude oil production,
and may be subject to significant fluctuations in the future. In the absence of derivative arrangements, continuing low levels
of future production and record low commodity prices will reduce the Trust’s revenues and distributable income available
to unitholders.
Following
the closing of the Sale Transaction, the Trust is highly dependent on Avalon for multiple services, including the operation of
the Trust Wells, remittance of net proceeds from the sale of production from the Trust Wells to the Trust, administrative services
such as accounting, tax preparation, and bookkeeping, and information services performed on behalf of the Trust. Avalon is a relatively
new oil and gas company formed in August 2018 with no prior operating history. Avalon’s ability to continue operating the
Underlying Properties depends on its financial condition and economic performance, access to capital, and other factors, many
of which are out of Avalon’s control.
As
previously reported in the April 2020 Form 8-K, Avalon informed the Trustee that during 2019, Avalon repaired 29 producing Trust
Wells to increase production. Avalon has reported that this effort, combined with higher-than-expected lease operating expenses
(“LOE”) and declining oil prices, contributed to an operating loss for Avalon in 2019 despite Avalon’s
efforts to reduce LOE (including shutting in some non-economic Trust Wells, alternating production to reduce electrical and other
field operating costs, and staff lay-offs). Avalon also informed the Trustee that Avalon is likely to shut in additional Trust
Wells that are not capable of producing oil and natural gas in paying quantities, as permitted under the Conveyances. Avalon shut
in 23 Trust Wells and 79 Trust Wells during the first and second quarters of 2020, respectively. Avalon has not repaired any Trust
Wells to increase production during the first two quarters of 2020. As a result of its operating loss in 2019, Avalon has informed
the Trustee that Avalon’s independent public accounting firm included a going concern qualification in its audit report
on Avalon’s financial statements for the fiscal year ended December 31, 2019. This negative impact could affect Avalon’s
ability to operate the Trust Wells and provide services to the Trust in the future.
7.
Subsequent Events
Distribution
to Unitholders. On July 23, 2020, the Trust declared a cash distribution of $0.012 per unit covering production for the three-month
period from March 1, 2020 to May 31, 2020. The distribution will be paid on or about August 31, 2020 to record holders as of August
17, 2020. Distributable income for March 1, 2020 to May 31, 2020 was calculated as follows (in thousands, except for unit and
per unit amounts):
Revenues
|
|
|
|
Royalty income
|
|
$
|
1,663
|
|
Total revenues
|
|
|
1,663
|
|
Expenses
|
|
|
|
|
Post-production expenses
|
|
|
11
|
|
Production taxes
|
|
|
80
|
|
Cash reserves withheld by Trustee(1)
|
|
|
730
|
|
Total expenses
|
|
|
821
|
|
Distributable income to unitholders
|
|
$
|
842
|
|
Additional cash reserve(2)
|
|
|
190
|
|
Distributable income available to unitholders
|
|
$
|
652
|
|
Distributable income per unit (52,500,000 units issued and outstanding)
|
|
$
|
0.012
|
|
|
(1)
|
Includes
amounts withheld for payment of future Trust administrative expenses.
|
|
(2)
|
Cash
reserve increase for the payment of future known, anticipated or contingent expenses or liabilities.
|
The
Exchange Agent for the Offer is:
|
|
|
If
delivering by hand, express mail, courier, or other expedited service:
American
Stock Transfer & Trust Co., LLC
Operations
Center
Attn:
Reorganization Department
6201
15th Avenue
Brooklyn,
New York 11219
|
|
By
mail:
American
Stock Transfer & Trust Co., LLC
Operations
Center
Attn:
Reorganization Department
P.O.
BOX 2042
New
York, NY 10272-2042
|
Any
questions or requests for assistance or additional copies of this offer to exchange, the letter of transmittal, the notice of
guaranteed delivery and related offer materials may be directed to the information agent at the telephone number and location
listed below. Stockholders may also contact their local broker, commercial bank, trust company or nominee for assistance concerning
the offer.
The
Information Agent for the Offer is:
19
Old Kings Highway S. – Suite 210
Darien,
CT 06820
Toll
Free (877) 972-0090
Banks
and Brokers call collect (203) 972-9300
info@investor-com.com
PART
II.
INFORMATION NOT REQUIRED IN PROSPECTUS
Limitation
of Liability and Indemnification of Officers and Directors
Section
7.001 of the TBOC permits a Texas corporation to limit the personal liability of directors to it or its shareholders for monetary
damages for any act or omission in a director’s capacity as director. Under the provisions of Chapter 8 of the TBOC, PEDEVCO
may indemnify its directors, officers, employees and agents and purchase and maintain liability insurance for those persons. Chapter
8 of the TBOC provides that any director or officer of a Texas corporation may be indemnified against judgments, penalties, fines,
settlements and reasonable expenses actually incurred by him or her in connection with or in defending any action, suit or proceeding
in which he or she is a party by reason of his or her position. With respect to any proceeding arising from actions taken in his
or her official capacity as a director or officer, he or she may be indemnified so long as it shall be determined that he or she
conducted himself in good faith and that he or she reasonably believed that such conduct was in the corporation’s best interests.
In cases not concerning conduct in his or her official capacity as a director or officer, a director may be indemnified as long
as he or she reasonably believed that his or her conduct was not opposed to the corporation’s best interests. In the case
of any criminal proceeding, a director or officer may be indemnified if he or she had no reasonable cause to believe his or her
conduct was unlawful. If a director or officer is wholly successful, on the merits or otherwise, in connection with such a proceeding,
such indemnification is mandatory.
The
PEDEVCO Certificate of Formation provides that its directors are not personally liable to PEDEVCO or its shareholders for monetary
damages for an act or omission in their capacity as a director. A director may, however, be found liable for, and PEDEVCO may
be prohibited from indemnifying them against:
|
●
|
any
breach of the director’s duty of loyalty to PEDEVCO or its shareholders;
|
|
●
|
acts
or omissions not in good faith that constitute a breach of the director’s duty
to PEDEVCO;
|
|
●
|
acts
or omissions that involve intentional misconduct or a knowing violation of law;
|
|
●
|
any
transaction from which the director receives an improper benefit; or
|
|
●
|
acts
or omissions for which the liability is expressly provided by an applicable statute.
|
PEDEVCO’s
Certificate of Formation also provides that it will indemnify its directors, and may indemnify its agents, to the fullest extent
permitted by applicable Texas law from any expenses, liabilities or other matters. Insofar as indemnification for liabilities
arising under the Securities Act may be permitted for directors, officers and controlling persons of PEDEVCO under the PEDEVCO
Certificate of Formation, it is the position of the SEC that such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable.
Indemnification
Agreements
PEDEVCO
has entered into indemnification agreements with each of its officers and directors pursuant to which PEDEVCO has agreed, to the
maximum extent permitted by applicable law and subject to the specified terms and conditions set forth in each agreement, to indemnify
a director or officer who acts on PEDEVCO’s behalf and is made or threatened to be made a party to any action or proceeding
against expenses, judgments, fines and amounts paid in settlement that are incurred by such officer or director in connection
with the action or proceeding. The indemnification provisions apply whether the action was instituted by a third party or by PEDEVCO.
PEDEVCO also maintains insurance on behalf of its officers and directors that provides coverage for expenses and liabilities incurred
by them in their capacities as officers and directors.
Exhibits
and Financial Statements
EXHIBIT
INDEX
|
|
|
|
|
|
Incorporated
By Reference
|
Exhibit No.
|
|
Description
|
|
Filed
With
This Annual
Registration
Statement
|
Form
|
|
Exhibit
|
|
Filing
Date/
Period End Date
|
|
File
Number
|
2.1#
|
|
Purchase
and Sale Agreement dated August 1, 2018, by and between Milnes and Minerals Inc., Chaveroo Minerals Inc., Ridgeway Arizona
Oil Corp., and EOR Operating Company, as sellers and Pacific Energy Development Corp., as purchaser
|
|
|
|
8-K
|
|
2.1
|
|
August
1, 2018
|
|
001-35922
|
2.2#
|
|
Purchase and Sale
Agreement dated January 11, 2019, by and between Manzano, LLC and Manzano Energy Partners, II, LLC, as seller and Pacific
Energy Development Corp., as purchaser
|
|
|
|
8-K
|
|
2.1
|
|
January
14, 2019
|
|
001-35922
|
3.1
|
|
Amended and Restated
Certificate of Formation and Designation by Blast Acquisition Corp. and Pacific Energy Development Corp.
|
|
|
|
8-K
|
|
3.1
|
|
August
2, 2012
|
|
000-53725
|
3.2
|
|
Certificate of Amendment
of Amended and Restated Certificate of Formation
|
|
|
|
8-K
|
|
3.1
|
|
April
23, 2013
|
|
000-53725
|
3.3
|
|
Amended and Restated
Certificate of Designations of PEDEVCO Corp. Establishing the Designations, Preferences, Limitations and Relative Rights of
its Series A Convertible Preferred Stock
|
|
|
|
8-K
|
|
3.1
|
|
February
24, 2015
|
|
001-35922
|
3.4
|
|
Certificate of Amendment
to Certificate of Formation (1-for-10 Reverse Stock Split of Common Stock)
|
|
|
|
8-K
|
|
3.1
|
|
March
27, 2017
|
|
333-64122
|
3.5
|
|
Amendment to Amended
and Restated Certificate of Designations of PEDEVCO Corp. Establishing the Designations, Preferences, Limitations and Relative
Rights of Its Series A Convertible Preferred Stock filed with the Secretary of State of Texas on June 26, 2018
|
|
|
|
8-K
|
|
3.1
|
|
June
26, 2018
|
|
001-35922
|
3.6
|
|
Bylaws of PEDEVCO
Corp. (formerly Blast Energy Services, Inc.)
|
|
|
|
8-K
|
|
3.3
|
|
March
6, 2008
|
|
333-64122
|
3.7
|
|
Amendment to the
Bylaws (December 3, 2012)
|
|
|
|
8-K
|
|
3.1
|
|
December
6, 2012
|
|
000-53725
|
3.8
|
|
Amendment to Bylaws
(October 25, 2016)
|
|
|
|
8-K
|
|
3.1
|
|
October
21, 2016
|
|
001-35922
|
4.2
|
|
Form of Common Stock
Certificate for PEDEVCO Corp.
|
|
|
|
S-3
|
|
4.1
|
|
October
23, 2013
|
|
333-191869
|
4.3
|
|
Form of PEDEVCO
Corp. Series A Preferred Stock Certificate
|
|
|
|
10-K
|
|
4.2
|
|
March
31, 2014
|
|
001-35922
|
4.4
|
|
Employee Stock Option
Agreement, dated June 18, 2012, entered into by and between Frank C. Ingriselli and the Registrant**
|
|
|
|
S-8
|
|
4.13
|
|
October
31, 2013
|
|
333-192002
|
4.5
|
|
Employee Stock Option
Agreement, dated June 18, 2012, entered into by and between Clark R. Moore and the Registrant**
|
|
|
|
S-8
|
|
4.14
|
|
October
31, 2013
|
|
333-192002
|
5.1
|
|
Opinion of Jones
Walker LLP
|
|
X
|
|
|
|
|
|
|
|
|
8.1
|
|
Opinion of Jones
Walker LLP (tax matters)
|
|
X
|
|
|
|
|
|
|
|
|
10.1
|
|
PEDEVCO Corp. 2012
Equity Incentive Plan**
|
|
|
|
8-K
|
|
4.1
|
|
August
2, 2012
|
|
000-53725
|
10.2
|
|
PEDEVCO Corp. 2012
Equity Incentive Plan - Form of Restricted Shares Grant Agreement **
|
|
|
|
S-8
|
|
4.2
|
|
October
31, 2013
|
|
333-192002
|
|
|
|
|
|
|
Incorporated
By Reference
|
Exhibit No.
|
|
Description
|
|
Filed
With
This Annual
Registration
Statement
|
Form
|
|
Exhibit
|
|
Filing
Date/
Period End Date
|
|
File
Number
|
10.3
|
|
PEDEVCO
Corp. 2012 Equity Incentive Plan - Form of Stock Option Agreement**
|
|
|
|
S-8
|
|
4.3
|
|
October
31, 2013
|
|
333-192002
|
10.4
|
|
Pacific Energy Development
Corp. 2012 Equity Incentive Plan **
|
|
|
|
S-8
|
|
4.4
|
|
October
31, 2013
|
|
333-192002
|
10.5
|
|
PEDEVCO Corp. Amended
and Restated 2012 Equity Incentive Plan **
|
|
|
|
S-8
|
|
4.1
|
|
December
28, 2017
|
|
333-222335
|
10.6
|
|
Pacific Energy Development
Corp. 2012 Plan - Form of Restricted Shares Grant Agreement**
|
|
|
|
S-8
|
|
4.5
|
|
October
31, 2013
|
|
333-192002
|
10.7
|
|
Pacific Energy Development
Corp. 2012 Plan - Form of Stock Option Agreement **
|
|
|
|
S-8
|
|
4.6
|
|
October
31, 2013
|
|
333-192002
|
10.8
|
|
Pacific Energy Development
Corp. - Form of Restricted Shares Grant Agreement **
|
|
|
|
S-8
|
|
4.7
|
|
October
31, 2013
|
|
333-192002
|
10.9
|
|
Pacific Energy Development
Corp. - Form of Stock Option Agreement **
|
|
|
|
S-8
|
|
4.8
|
|
October
31, 2013
|
|
333-192002
|
10.10
|
|
PEDEVCO Corp. -
Form of Indemnification Agreement **
|
|
|
|
10-K
|
|
10.11
|
|
March
31, 2014
|
|
001-35922
|
10.11
|
|
Executive Employment
Agreement, dated June 10, 2011, by Pacific Energy Development Corp and Clark Moore **
|
|
|
|
10-K
|
|
10.20
|
|
March
31, 2014
|
|
001-35922
|
10.12
|
|
Gas Purchase Contract,
dated December 1, 2011, by and between DCP Midstream, LP and Continental Resources, Inc., assigned to Red Hawk Petroleum,
LLC by Continental Resources, Inc. effective March 7, 2014
|
|
|
|
10-K
|
|
10.43
|
|
March
31, 2014
|
|
001-35922
|
10.13
|
|
Gas Purchase Contract,
dated April 1, 2012, as amended, by and between Sterling Energy Investments LLC and Continental Resources, Inc., assigned
to Red Hawk Petroleum, LLC by Continental Resources, Inc. effective March 7, 2014
|
|
|
|
10-K
|
|
10.44
|
|
March
31, 2014
|
|
001-35922
|
10.14
|
|
Amendment No. 1
to Employment Agreement, dated January 11, 2013, by and between PEDEVCO Corp. and Clark R. Moore **
|
|
|
|
10-K
|
|
10.58
|
|
March
31, 2014
|
|
001-35922
|
10.15
|
|
Amendment No. 2
to Employment Agreement dated April 25, 2016, by and between PEDEVCO Corp. and Michael L. Peterson**
|
|
|
|
8-K
|
|
10.3
|
|
April
27, 2016
|
|
001-35922
|
10.16
|
|
Employment Letter
Agreement dated June 16, 2012, by and between Pacific Energy Development Corp. and Gregory Overholtzer**
|
|
|
|
8-K
|
|
10.4
|
|
April
27, 2016
|
|
001-35922
|
10.17
|
|
Amendment No. 1
to Employment Agreement dated April 25, 2016, by and between PEDEVCO Corp. and Gregory Overholtzer**
|
|
|
|
8-K
|
|
10.5
|
|
April
27, 2016
|
|
001-35922
|
10.18
|
|
Form of Amended
and Restated Vesting Agreement dated April 25, 2016**
|
|
|
|
8-K
|
|
10.6
|
|
April
27, 2016
|
|
001-35922
|
10.19
|
|
Form of Warrant
for Purchase of Common Stock (Investor Warrants)
|
|
|
|
8-K
|
|
10.5
|
|
May
17, 2016
|
|
001-35922
|
10.20
|
|
Form of Amended
and Restated Warrant for Purchase of Common Stock (Investor Warrants)
|
|
|
|
8-K
|
|
10.6
|
|
May
17, 2016
|
|
001-35922
|
10.21
|
|
Call Option Agreement
dated as of May 12, 2016, by and between PEDEVCO Corp. and Golden Globe Energy (US), LLC
|
|
|
|
8-K
|
|
10.12
|
|
May
17, 2016
|
|
001-35922
|
10.22
|
|
Employment Agreement,
dated May 10, 2018, by and between Frank C. Ingriselli and Pacific Energy Development Corp.**
|
|
|
|
8-K
|
|
10.1
|
|
May
10, 2018
|
|
001-35922
|
|
|
|
|
|
|
Incorporated
By Reference
|
Exhibit No.
|
|
Description
|
|
Filed
With
This Annual
Registration
Statement
|
Form
|
|
Exhibit
|
|
Filing
Date/
Period End Date
|
|
File
Number
|
10.23
|
|
Employee
Separation and Release, dated May 10, 2018, by and between Michael L. Peterson and PEDEVCO Corp.**
|
|
|
|
8-K
|
|
10.2
|
|
May
10, 2018
|
|
001-35922
|
10.24
|
|
Independent Contractor
Agreement, dated May 10, 2018, by and between Michael L. Peterson and PEDEVCO Corp.**
|
|
|
|
8-K
|
|
10.3
|
|
May
10, 2018
|
|
001-35922
|
10.25
|
|
$7.7 Million Promissory
Note between PEDEVCO Corp., as borrower and SK Energy LLC, as lender, dated June 25, 2018
|
|
|
|
8-K
|
|
10.1
|
|
June
26, 2018
|
|
001-35922
|
10.26
|
|
Tranche A Note Repayment
Agreement dated June 25, 2018, by and between PEDEVCO Corp. and the Tranche A Noteholders name therein
|
|
|
|
8-K
|
|
10.2
|
|
June
26, 2018
|
|
001-35922
|
10.27
|
|
Junior Notes Repayment
Agreement dated June 25, 2018, by and between PEDEVCO Corp. and the Junior Noteholders name therein
|
|
|
|
8-K
|
|
10.3
|
|
June
26, 2018
|
|
001-35922
|
10.28
|
|
Bridge Note Repayment
Agreement dated June 25, 2018, between PEDEVCO Corp. and the Bridge Noteholders name therein
|
|
|
|
8-K
|
|
10.4
|
|
June
26, 2018
|
|
001-35922
|
10.29
|
|
Form of Warrant
for the Purchase of Common Stock dated June 25, 2018 (Tranche B Noteholders)
|
|
|
|
8-K
|
|
10.5
|
|
June
26, 2018
|
|
001-35922
|
10.30
|
|
PEDEVCO Corp. 2012
Equity Incentive Plan, as amended
|
|
|
|
S-8
|
|
4.1
|
|
September
27, 2018
|
|
333-227566
|
10.31
|
|
Form of Convertible
Promissory Note between PEDEVCO Corp., as borrower and various lenders (including SK Energy LLC), dated August 1, 2018
|
|
|
|
8-K
|
|
10.1
|
|
August
1, 2018
|
|
001-35922
|
10.32
|
|
Stock Purchase Agreement
dated August 1, 2018, by and between Pacific Energy Development Corp. and Hunter Oil Production Corp.
|
|
|
|
8-K
|
|
10.2
|
|
August
1, 2018
|
|
001-35922
|
10.33
|
|
Membership Interest
Purchase Agreement dated August 1, 2018, by and between Pacific Energy Development Corp., as buyer, and MIE Jurassic Energy
Corporation, as seller
|
|
|
|
8-K
|
|
10.3
|
|
August
1, 2018
|
|
001-35922
|
10.34
|
|
Offer Letter with
J. Douglas Schick as President dated August 1, 2018**
|
|
|
|
8-K
|
|
10.4
|
|
August
1, 2018
|
|
001-35922
|
10.35
|
|
Warrant Repurchase
Agreement between PEDEVCO Corp., Principal Growth Strategies, LLC, and RJ Credit LLC dated August 31, 2018
|
|
|
|
8-K
|
|
10.1
|
|
September
4, 2018
|
|
001-35922
|
10.36
|
|
Warrant Repurchase
Agreement between PEDEVCO Corp. and Senior Health Insurance Company of Pennsylvania dated August 31, 2018
|
|
|
|
8-K
|
|
10.2
|
|
September
4, 2018
|
|
001-35922
|
10.37
|
|
Separation and General
Release Agreement, dated September 6, 2018, between Pacific Energy Development Corp. and Frank C. Ingriselli**
|
|
|
|
8-K
|
|
10.1
|
|
September
10, 2018
|
|
001-35922
|
10.38
|
|
Agreement, dated
September 6, 2018, between Global Venture Investments Inc. and Pacific Energy Development Corp.**
|
|
|
|
8-K
|
|
10.2
|
|
September
10, 2018
|
|
001-35922
|
|
|
|
|
|
|
Incorporated
By Reference
|
Exhibit No.
|
|
Description
|
|
Filed
With
This Annual
Registration
Statement
|
Form
|
|
Exhibit
|
|
Filing
Date/
Period End Date
|
|
File
Number
|
10.39
|
|
Convertible
Promissory Note between PEDEVCO Corp., as borrower and SK Energy LLC, dated October 25, 2018
|
|
|
|
8-K
|
|
10.1
|
|
October
26, 2018
|
|
001-35922
|
10.40
|
|
Offer Letter with
Paul A. Pinkston as Chief Accounting Officer, dated October 16, 2018**
|
|
|
|
8-K
|
|
10.1
|
|
December
3, 2018
|
|
001-35922
|
10.41
|
|
Separation and General
Release Agreement, dated December 31, 2018, between Pacific Energy Development Corp. and Gregory Overholtzer**
|
|
|
|
8-K
|
|
10.1
|
|
January
4, 2019
|
|
001-35922
|
10.42
|
|
Consulting Agreement,
dated January 1, 2019, between Gregory Overholtzer and Pacific Energy Development Corp.**
|
|
|
|
8-K
|
|
10.2
|
|
January
4, 2019
|
|
001-35922
|
10.43
|
|
$15,000,000 Convertible
Promissory Note between PEDEVCO Corp., as borrower and SK Energy LLC as lender, dated January 11, 2019
|
|
|
|
8-K
|
|
10.1
|
|
January
14, 2019
|
|
001-35922
|
10.44
|
|
First Amendment
to Convertible Promissory Notes, dated February 15, 2019, entered into by and between PEDEVCO Corp. and SK Energy LLC
|
|
|
|
8-K
|
|
10.4
|
|
February
19, 2019
|
|
001-35922
|
10.45
|
|
First Amendment
to Promissory Note, dated March 1, 2019, entered into by and between PEDEVCO Corp. and SK Energy LLC
|
|
|
|
8-K
|
|
10.1
|
|
March
4, 2019
|
|
001-35922
|
10.46
|
|
$14,999,998.20 Common
Stock Subscription Agreement between PEDEVCO Corp. and SK Energy LLC, dated May 21, 2019
|
|
|
|
8-K/A
|
|
10.1
|
|
August
12, 2019
|
|
001-35922
|
10.47
|
|
PEDEVCO Corp. 2012
Amended and Restated Equity Incentive Plan**
|
|
|
|
S-8
|
|
4.1
|
|
August
29, 2019
|
|
333-233525
|
10.48
|
|
$12,000,000 Common
Stock Subscription Agreement between PEDEVCO Corp. and Viktor Tkachev, dated September 17, 2019
|
|
|
|
8-K
|
|
10.1
|
|
September
18, 2019
|
|
001-35922
|
10.49
|
|
$13,000,000.14 Common
Stock Subscription Agreement between PEDEVCO Corp. and SK Energy LLC, dated September 17, 2019
|
|
|
|
8-K
|
|
10.1
|
|
September
18, 2019
|
|
001-35922
|
10.50
|
|
Advisory Agreement,
dated November 8, 2019, entered into by and between PEDEVCO Corp. and Ivar Siem
|
|
|
|
10-Q
|
|
10.12
|
|
November
8, 2019
|
|
001-35922
|
10.51
|
|
Sublease Letter
Agreement, dated November 8, 2019, entered into by and between PEDEVCO Corp. and SK Energy, LLC
|
|
|
|
10-Q
|
|
10.13
|
|
November
8, 2019
|
|
001-35922
|
10.52
|
|
Advisory Agreement,
dated November 8, 2019, entered into by and between PEDEVCO Corp. and Viktor Tkachev
|
|
|
|
10-Q
|
|
10.14
|
|
November
8, 2019
|
|
001-35922
|
10.53
|
|
Amendment No. 2
to Employment Agreement, effective April 1, 2020, entered into by and between Clark R. Moore and PEDEVCO Corp.
|
|
|
|
8-K
|
|
10.3
|
|
March
31, 2020
|
|
001-35922
|
10.54
|
|
Amendment No. 1
to Offer Letter, effective April 1, 2020, entered into by and between J. Douglas Schick and PEDEVCO Corp.
|
|
|
|
8-K
|
|
10.5
|
|
March
31, 2020
|
|
001-35922
|
14.1
|
|
Code of Ethics and
Business Conduct
|
|
|
|
8-K/A
|
|
14.1
|
|
August
8, 2012
|
|
000-53725
|
16.1
|
|
Letter dated July
30, 2018 from GBH CPAs, PC to the Securities and Exchange Commission
|
|
|
|
8-K
|
|
16.1
|
|
August
1, 2018
|
|
001-35922
|
21.1
|
|
List of Subsidiaries
of PEDEVCO CORP.
|
|
X
|
|
|
|
|
|
|
|
|
23.1
|
|
Consent of Marcum
LLP
|
|
X
|
|
|
|
|
|
|
|
|
23.2
|
|
Consent of Cawley,
Gillespie & Associates, Inc.
|
|
X
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incorporated
By Reference
|
Exhibit No.
|
|
Description
|
|
Filed
With
This Annual
Registration
Statement
|
Form
|
|
Exhibit
|
|
Filing
Date/
Period End Date
|
|
File
Number
|
24.1
|
|
Power
of Attorney (including on Signature Page)
|
|
X
|
|
|
|
|
|
|
|
|
99.1
|
|
Form of Letter of
Transmittal
|
|
X
|
|
|
|
|
|
|
|
|
99.2
|
|
Form of Notice of
Guaranteed Delivery
|
|
X
|
|
|
|
|
|
|
|
|
99.3
|
|
Form of Letter to
Brokers, Dealers, Banks, Trust Companies and Other Nominees
|
|
X
|
|
|
|
|
|
|
|
|
99.4
|
|
Form of Letter to
Clients for Use by Brokers, Dealers, Banks, Trust Companies and Other Nominees
|
|
X
|
|
|
|
|
|
|
|
|
99.5
|
|
Reserves Report
of Cawley, Gillespie & Associates, Inc. for reserves of PEDEVCO Corp. as of December 31, 2019
|
|
|
|
10-K
|
|
99.1
|
|
March
30, 2020
|
|
001-35922
|
|
|
|
|
|
|
|
|
|
|
|
|
|
101.INS
|
|
XBRL Instance Document
|
|
X
|
|
|
|
|
|
|
|
|
101.SCH
|
|
XBRL Taxonomy Extension
Schema Document
|
|
X
|
|
|
|
|
|
|
|
|
101.CAL
|
|
XBRL Taxonomy Extension
Calculation Linkbase Document
|
|
X
|
|
|
|
|
|
|
|
|
101.DEF
|
|
XBRL Taxonomy Extension
Definition Linkbase Document
|
|
X
|
|
|
|
|
|
|
|
|
101.LAB
|
|
XBRL Taxonomy Extension
Label Linkbase Document
|
|
X
|
|
|
|
|
|
|
|
|
101.PRE
|
|
XBRL Taxonomy Extension
Presentation Linkbase Document
|
|
X
|
|
|
|
|
|
|
|
|
|
**
|
Indicates
management contract or compensatory plan or arrangement.
|
|
#
|
Schedules
and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. A copy of any omitted schedule or exhibit will
be furnished supplementally to the Securities and Exchange Commission upon request; provided, however that PEDEVCO Corp. may request
confidential treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended, for any schedule or exhibit
so furnished.
|
Undertakings
The
undersigned Registrant hereby undertakes as follows: that prior to any public reoffering of the securities registered hereunder
through use of a prospectus which is a part of this registration statement, by any person or party who is deemed to be an underwriter
within the meaning of Rule 145(c), the issuer undertakes that such reoffering prospectus will contain the information called for
by the applicable registration form with respect to reofferings by persons who may be deemed underwriters, in addition to the
information called for by the other items of the applicable form.
The
Registrant undertakes that every prospectus: (i) that is filed pursuant to the immediately preceding paragraph, or (ii) that purports
to meet the requirements of Section 10(a)(3) of the Securities Act and is used in connection with an offering of securities subject
to Rule 415, will be filed as a part of an amendment to the registration statement and will not be used until such amendment is
effective, and that, for purposes of determining any liability under the Securities Act, each such post-effective amendment shall
be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at
that time shall be deemed to be the initial bona fide offering thereof.
Insofar
as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons
of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the
SEC such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding)
is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant
will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will
be governed by the final adjudication of such issue.
The
undersigned Registrant hereby undertakes that:
(1)
For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed
as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant
pursuant to Rule 424(b) (1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement
as of the time it was declared effective.
(2)
For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
The
undersigned Registrant hereby undertakes to respond to requests for information that is incorporated by reference into the prospectus
pursuant to Items 4, 10(b), 11, or 13 of this Form, within one business day of receipt of such request, and to send the incorporated
documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent
to the effective date of the registration statement through the date of responding to the request.
The
undersigned Registrant hereby undertakes to supply by means of a post-effective amendment all information concerning a transaction,
and the company being acquired involved therein, that was not the subject of and included in the registration statement when it
became effective.
SIGNATURES
Pursuant
to the requirements of the Securities Act, the registrant has duly caused this registration statement to be signed on its behalf
by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas, on October 13, 2020.
|
PEDEVCO CORP.
|
|
|
|
|
By:
|
/s/
Dr. Simon G. Kukes
|
|
|
Name: Dr. Simon
G. Kukes
|
|
|
Title:
Chief Executive Officer
(Principal
Executive Officer)
|
KNOW
ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dr. Simon G. Kukes and Clark
R. Moore, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him/her
and in his/her name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments)
to this Registration Statement, and any subsequent registration statements pursuant to Rule 462 of the Securities Act of 1933
and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as
he/she might or could do in person, hereby ratifying and confirming all that each of said attorney-in-fact or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant
to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
|
|
|
|
|
Name
|
|
Position
|
|
Date
|
|
|
|
/s/
Dr. Simon G. Kukes
|
|
Chief Executive
Officer and Director (Principal Executive Officer)
|
|
October
13, 2020
|
Dr. Simon G. Kukes
|
|
|
|
|
|
|
|
/s/
Paul A. Pinkston
|
|
Chief Accounting
Officer (Principal Financial and Accounting Officer)
|
|
October
13, 2020
|
Paul A. Pinkston
|
|
|
|
|
|
|
|
/s/
John Scelfo
|
|
Director
|
|
October
13, 2020
|
John Scelfo
|
|
|
|
|
|
|
|
/s/
Ivar Siem
|
|
Director
|
|
October
13, 2020
|
Ivar Siem
|
|
|
|
|
|
|
|
/s/
H. Douglas Evans
|
|
Director
|
|
October
13, 2020
|
H. Douglas Evans
|
|
|
|
|
PEDEVCO (AMEX:PED)
Graphique Historique de l'Action
De Juin 2024 à Juil 2024
PEDEVCO (AMEX:PED)
Graphique Historique de l'Action
De Juil 2023 à Juil 2024