Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended March 31, 2015

Or

 

¨ Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period from                      to                     

Commission File Number 33-16820-D

 

 

ARÊTE INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Colorado   84-1508638

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

7260 Osceola Street, Westminster, Colorado   80030
(Address of Principal Executive Offices)   (Zip Code)

303-427-8688

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ¨  Yes    x  No(1)

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

As of May 15, 2015, the Registrant had 12,714,599 shares of common stock issued and outstanding.

 

1  Explanatory Note: The Company is a voluntary filer with the Securities and Exchange Commission but it has filed all Exchange Act reports for the preceding 12 months.

 

 

 


Table of Contents

ARÊTE INDUSTRIES, INC.

Table of Contents

 

     Page  

Part 1 - Financial Information

  

Item 1 - Financial Statements

     3   

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

     13   

Item 3 - Quantitative and Qualitative Disclosures about Market Risk

     22   

Item 4 - Controls and Procedures

     22   

Part 2 - Other Information

  

Item 1 - Legal Proceedings

     23   

Item 2 - Sales of Unregistered Equity Securities and Use of Proceeds

     23   

Item 3 - Defaults upon Senior Securities

     23   

Item 4 - Mine Safety Disclosures

     23   

Item 5 - Other Information

     23   

Item 6 - Exhibits

     23   

Signatures

     24   


Table of Contents

Part 1 – FINANCIAL INFORMATION

Item 1 - Financial Statements

ARÊTE INDUSTRIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

December 31, 2014 and March 31, 2015

 

     2014     2015  
ASSETS     

Current Assets:

    

Cash and equivalents

   $ 30,755      $ 21,216   

Receivable from DNR Oil & Gas, Inc.:

    

Oil and gas sales, net of production costs

     103,668        96,979   

Other

     78,273        7,653   

Prepaid expenses and other

     34,222        43,571   
  

 

 

   

 

 

 

Total Current Assets

  246,918      169,419   
  

 

 

   

 

 

 

Property and Equipment:

Oil and gas properties, at cost, successful efforts method:

Proved properties

  10,222,668      10,261,750   

Unevaluated properties

  348,836      348,836   

Natural gas gathering system

  442,195      442,195   

Furniture and equipment

  22,522      22,522   
  

 

 

   

 

 

 

Total property and equipment

  11,036,221      11,075,303   

Less accumulated depreciation, depletion and amortization

  (2,840,173   (3,042,398
  

 

 

   

 

 

 

Net Property and Equipment

  8,196,048      8,032,905   
  

 

 

   

 

 

 

TOTAL ASSETS

$ 8,442,966    $ 8,202,324   
  

 

 

   

 

 

 

 

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ARÊTE INDUSTRIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEETS

December 31, 2014 and March 31, 2015

 

     2014     2015  
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current Liabilities:

    

Accounts payable:

    

Payable to DNR Oil & Gas, Inc.:

    

Operator fees and other

   $ 36,000      $ 64,541   

Unrelated parties

     43,365        13,995   

Notes and advances payable - current portion:

    

Directors and affiliates

     288,258        288,567   

Unrelated parties

     872,239        872,400   

Accrued interest expense

     3,279        13,370   

Accrued consulting - related party

     21,800        23,700   

Director fees payable in common stock

     20,900        10,000   

Current portion of asset retirement obligations

     191,843        192,282   

Other accrued costs and expenses

     63,642        89,398   
  

 

 

   

 

 

 

Total Current Liabilities

  1,541,326      1,568,253   
  

 

 

   

 

 

 

Long-Term Liabilities:

Contingent acquisition costs payable to DNR Oil & Gas, Inc.

  250,000      250,000   

Notes and advances payable, net of current portion:

DNR Oil & Gas, Inc.

  792,151      792,151   

Directors and affiliates

  62,440      57,863   

Unrelated parties

  63,534      61,150   

Asset retirement obligations, net of current portion

  557,170      573,672   
  

 

 

   

 

 

 

Total Long-Term Liabilities

  1,725,295      1,734,836   
  

 

 

   

 

 

 

Total Liabilities

  3,266,621      3,303,089   
  

 

 

   

 

 

 

Commitments and Contingencies

Stockholders’ Equity:

Convertible Class A preferred stock; $10,000 face value per share, authorized 1,000,000 shares:

Series 1; authorized 30,000 shares, issued and outstanding 0 shares in 2013 and 2014

  —        —     

Series 2; authorized 2,500 shares, no shares issued and outstanding in 2014 and 2015

  —        —     

Common stock, no par value; authorized 499,000,000 shares, issued and outstanding 12,558,459 in 2014 and 12,714,599 in 2015

  21,294,887      21,322,287   

Accumulated deficit

  (16,118,542   (16,423,052
  

 

 

   

 

 

 

Total Stockholders’ Equity

  5,176,345      4,899,235   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

$ 8,442,966    $ 8,202,324   
  

 

 

   

 

 

 

The Accompanying Notes are an Integral Part of These Financial Statements.

 

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ARÊTE INDUSTRIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

Quarters Ended March 31, 2014 and 2015

 

 

 

     2014     2015  

Revenues:

    

Oil and natural gas sales

   $ 495,751      $ 242,665   

Sale of oil and natural gas properties

     163,657        27,120   

Royalty revenue

     807        941   
  

 

 

   

 

 

 

Total revenues

  660,215      270,726   
  

 

 

   

 

 

 

Operating Expenses:

Oil and gas producing activities:

Lease operating expenses

  161,368      216,799   

Production taxes

  33,057      18,425   

Depreciation, depletion, amortization and accretion

  129,663      207,969   

Gas gathering:

Operating expenses

  3,985      1,406   

Depreciation

  11,055      11,055   

General and administrative expenses:

Director fees

  —        10,000   

Investor relations

  5,565      3,163   

Legal, auditing and professional services

  44,048      12,565   

Consulting and executive services:

Related parties

  30,000      47,400   

Unrelated parties

  —        —     

Other administrative expenses

  21,775      19,154   

Depreciation

  143      142   
  

 

 

   

 

 

 

Total operating expenses

  440,659      548,078   
  

 

 

   

 

 

 

Operating loss

  219,556      (277,352

Other income (expense):

Interest income

  —        —     

Interest expense

  (35,170   (27,158
  

 

 

   

 

 

 

Income (loss) before income taxes

  184,386      (304,510

Income tax benefit (expense)

  —        —     
  

 

 

   

 

 

 

Net income (loss)

$ 184,386    $ (304,510
  

 

 

   

 

 

 

Net Income (Loss) Applicable to Common Stockholders:

Net income (loss)

$ 184,386    $ (304,510

Accrued preferred stock dividends

  (3,750   —     
  

 

 

   

 

 

 

Net income (loss) applicable to common stockholders

$ 180,636    $ (304,510
  

 

 

   

 

 

 

Earnings (Loss) Per Share Applicable to Common Stockholders:

Basic

$ 0.01    $ (0.02
  

 

 

   

 

 

 

Diluted

$ 0.01    $ (0.02
  

 

 

   

 

 

 

Weighted Average Number of Common Shares Outstanding:

Basic

  12,810,000      12,810,000   
  

 

 

   

 

 

 

Diluted

  12,810,000      12,810,000   
  

 

 

   

 

 

 

The Accompanying Notes are an Integral Part of These Financial Statements.

 

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ARÊTE INDUSTRIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Quarter Ended March 31, 2015

 

     Common Stock      Accumulated        
     Shares      Amount      Deficit     Total  

Balances, December 31, 2014

     12,558,459       $ 21,294,887       $ (16,118,542   $ 5,176,345   

Common stock issued for services (related party)

     50,000         6,500           6,500   

Common stock issued for directors fees

     106,140         20,900           20,900   

Net (loss)

     —           —           (304,510     (304,510
  

 

 

    

 

 

    

 

 

   

 

 

 

Balances, March 31, 2015

  12,714,599    $ 21,322,287    $ (16,423,052 $ 4,899,235   
  

 

 

    

 

 

    

 

 

   

 

 

 

The Accompanying Notes are an Integral Part of These Financial Statements.

 

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ARÊTE INDUSTRIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

Quarters Ended March 31, 2014 and 2015

 

     2014     2015  

Cash Flows from Operating Activities:

    

Net income (loss)

   $ 184,386      $ (304,510

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Depreciation, depletion and amortization

     124,322        202,225   

Accretion of discount on asset retirement obligations

     16,538        16,941   

Gain on sale of oil and gas properties

     (163,657     (27,120

Changes in operating assets and liabilities:

    

Accounts receivable

     66,616        77,309   

Prepaid expenses and other

     (21,782     (9,349

Accounts payable

     44,108        (829

Accrued costs and expenses

     15,345        54,249   
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

  265,876      8,916   
  

 

 

   

 

 

 

Cash Flows from Investing Activities:

Capital expenditures for property and equipment

  (177,456   (61,962

Proceeds from sale of oil and gas properties

  109,753      50,000   
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

  (67,703   (11,962
  

 

 

   

 

 

 

Cash Flows from Financing Activities:

Proceeds from notes and advance payable

  497,641      —     

Principal payments on notes payable

  (815,569   (6,493

Redemption of common stock

  (228,000   —     
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

  (545,928   (6,493
  

 

 

   

 

 

 

Net increase (decrease) in cash and equivalents

  (347,755   (9,539

Cash and equivalents, beginning of period

  476,323      30,755   
  

 

 

   

 

 

 

Cash and equivalents, end of period

$ 128,568    $ 21,216   
  

 

 

   

 

 

 

Supplemental Disclosure of Cash Flow Information:

Cash paid for interest

$ 28,108    $ 17,067   
  

 

 

   

 

 

 

Cash paid for income taxes

$ —      $ —     
  

 

 

   

 

 

 

Supplemental Disclosure of Non-cash Investing and Financing Activities:

Preferred stock dividends declared

$ —      $ —     
  

 

 

   

 

 

 

The Accompanying Notes are an Integral Part of These Financial Statements.

 

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ARÊTE INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2015

 

1. Organization and Nature of Operations

Arête Industries, Inc. (“Arête” or the “Company”), is a Colorado corporation that was incorporated on July 21, 1987. The Company owns 100% of Arete Energy, Inc. which is an inactive subsidiary which has no assets, liabilities or operations. Arête has operated a natural gas gathering system in Wyoming since 2006 and on July 29, 2011 the Company purchased oil & natural gas properties in Colorado, Montana, Kansas, and Wyoming.

The Company seeks to focus on acquiring interests in traditional oil and gas ventures, and seek properties that offer profit potential from overlooked and by-passed reserves of oil and natural gas, which may include shut-in wells, in-field development, stripper wells, re-completion and re-working projects. In addition, the Company’s strategy includes purchase and sale of acreage prospective for oil and natural gas and seeking to obtain cash flow from the sale and farm out of such prospects.

 

2. Summary of Significant Accounting Policies

Basis of presentation

The accompanying unaudited consolidated financial statements have been prepared by the Company. In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring accruals) necessary for a fair presentation of the financial position as of December 31, 2014 and March 31, 2015, and the results of operations, changes in stockholders’ equity, and cash flows for the quarters ended March 31, 2014 and 2015. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for a full year. The Company’s 2014 Annual Report on Form 10-K includes certain definitions and a summary of significant accounting policies and should be read in conjunction with this Form 10-Q. Except as disclosed herein, there have been no material changes to the information disclosed in the notes to the consolidated financial statements included in the Company’s 2014 Annual Report on Form 10-K.

Use of Estimates

Preparation of the Company’s financial statements in accordance with GAAP requires management to make various assumptions, judgments and estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Changes in these assumptions, judgments and estimates will occur as a result of the passage of time and the occurrence of future events and, accordingly, actual results could differ from amounts initially established.

The most significant areas requiring the use of assumptions, judgments and estimates relate to the volumes of natural gas and oil reserves used in calculating depreciation, depletion and amortization (“DD&A”), the amount of expected future cash flows used in determining possible impairments of oil and gas properties and the amount of future capital costs used in these calculations. Assumptions, judgments and estimates also are required in determining future asset retirement obligations, impairments of undeveloped properties, and in valuing stock-based payment awards.

The only component of comprehensive income that is applicable to the Company is net income (loss). Accordingly, a separate statement of comprehensive income (loss) is not included in these financial statements.

Principles of Consolidation

The consolidated financial statements of the Company include the accounts of Arête and its inactive subsidiary, Arete Energy, Inc. All intercompany accounts and transactions have been eliminated in consolidation.

Reclassifications

The Company has condensed certain line items within the current period financial statements, and certain prior period balances were reclassified to conform to the current year presentation. Reclassifications did not have any impact on the Company’s previously reported working capital, results of operations or cash flows.

Earnings per share

Basic net income (loss) per share of common stock is calculated by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during each period. Diluted net income (loss) attributable to common stockholders is calculated by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding and other dilutive securities.

 

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ARÊTE INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2015

 

New Accounting Pronouncements

In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”). The amendments in ASU 2014-12 require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Accounting Standards Codification Topic No. 718, “Compensation – Stock Compensation” (“ASC 718”), as it relates to awards with performance conditions that affect vesting to account for such awards. The amendments in ASU 2014-12 are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted. Entities may apply the amendments in ASU 2014-12 either: (a) prospectively to all awards granted or modified after the effective date; or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. The adoption of ASU 2014-12 is not expected to have a material effect on the Company’s consolidated financial statements or disclosures.

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” ASU 2014-08 changes the criteria for reporting a discontinued operation. Under the new pronouncement, a disposal of a part of an organization that has a major effect on its operations and financial results is a discontinued operation. The Company is required to adopt ASU 2014-08 prospectively for all disposals or components of its business classified as held for sale during fiscal periods beginning after December 15, 2014. The adoption of ASU 2014-08 is not expected to have a material effect on the Company’s consolidated financial statements or disclosures.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which provides guidance for revenue recognition. ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets and supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition,” and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, “Revenue Recognition- Construction-Type and Production-Type Contracts.” ASU 2014-09’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 is effective for the Company beginning January 1, 2017 and, at that time, the Company may adopt the new standard under the full retrospective approach or the modified retrospective approach. Early adoption is not permitted. The Company is currently evaluating the method and impact the adoption of ASU 2014-09 will have on the Company’s consolidated financial statements and disclosures.

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 will explicitly require management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosure in certain circumstances. The new standard will be effective for all entities in the first annual period ending after December 15, 2016. Earlier adoption is permitted. We are currently evaluating the impact of the adoption of ASU 2014-15.

Other accounting standards that have been issued or proposed by the FASB, or other standards-setting bodies, that do not require adoption until a future date are not expected to have a material impact on the Company’s financial statements upon adoption.

 

3. Oil and Gas Properties

The Company has participated as a working interest owner in the four horizontal wells which were drilled and completed in Campbell County, Wyoming in the Turner zone and one well in Converse County, Wyoming in the Turner Zone during 2014. The fees received as part of this participation for the quarter ended March 31, 2014 was $163,657. The Company had no participation fees for the quarter ended March 31, 2015. The following is a description of the wells:

 

  1) The Thielen #1-21 is in Section 21 Township 43N Campbell County Wyoming. This well was drilled to a total depth of approximately 15,350 including the lateral. The Company has an approximate 1.06% working interest and in full production.

 

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ARÊTE INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2015

 

  2) The Thielen #2-21 is in Section 21 Township 43N Campbell County Wyoming. This well was drilled to a total depth of approximately 15,330 feet including the lateral. The Company has an approximate 1.06% working interest and in full production.

 

  3) The Starlight Federal 28H is located in Section 7, Township 43N Campbell County Wyoming. This well was drilled to a total depth of approximately 15,310 including the lateral. The Company has an approximate 0.7025% working interest and in full production.

 

  4) The Starlight Federal 30H is located in Section 7, Township 43N Campbell County Wyoming. This well was drilled to a total depth of approximately 15,310 including the lateral. The Company has an approximate 1.450088% working interest and in full production.

 

  5) The Wibaux Gold Federal 4076-10-03-1SH is located in Section 10, Township 43N Converse County Wyoming. This well was drilled to a total depth of approximately 20,185 including the lateral. The Company has an approximate 0.2697755% working interest and in full production.

 

4. Income taxes

The book to tax temporary differences resulting in deferred tax assets and liabilities are primarily net operating loss carry forwards of approximately $7.9 million which expire in 2018 through 2030. A 100% valuation allowance has been established against the deferred tax assets, as utilization of the loss carry forwards and realization of other deferred tax assets cannot be reasonably assured. For the quarter ended March 31, 2015, the Company did not recognize any income tax benefit due to the valuation allowance.

 

5. Stock transactions and preferred stock dividends

During the quarter ended March 31, 2015, the Company issued 156,140 shares of common stock for compensation or services; 106,140 shares of common stock were issued for board service in 2013 and 2014, and 50,000 shares of common stock were issued for service and consulting by two related parties.

 

6. Notes and advances payable

Notes payable consist of the following as of December 31, 2014 and March 31, 2015:

 

     2014      2015  

Officers, directors and affiliates:

     

Note payable, interest at 7.5%, due March 2016

   $ 150,000       $ 150,000   

Notes payable, interest 7.0%, due January 2017

     79,970         75,702   

Notes payable, interest varies (see explanation below)

     792,151         792,151   

Collateralized note payable (see below)

     120,728         120,728   
  

 

 

    

 

 

 

Total officers, directors and affiliates

  1,142,849      1,138,581   

Less: Current portion of officers, directors, and affiliates

  288,258      288,567   
  

 

 

    

 

 

 

Long-term portion of officers, directors, and affiliates

$ 854,591    $ 850,014   
  

 

 

    

 

 

 

Unrelated parties:

Notes payable, interest at 7.5%, due March 2016

$ 100,000    $ 100,000   

Note payable, interest variable (see below)

  549,105      549,105   

Note payable, interest at 7.0%, due August 2016

  62,000      62,000   

Notes payable, interest at 7.0%, due January 2017

  41,668      39,445   

Notes payable, interest at 7.0%, due August 2015

  183,000      183,000   
  

 

 

    

 

 

 

Total unrelated parties

  935,773      933,550   

Less: Current portion of unrelated parties

  872,239      872,400   
  

 

 

    

 

 

 

Long-term portion of unrelated parties

$ 63,534    $ 61,150   
  

 

 

    

 

 

 

On April 29, 2013, the Company executed a promissory note under which the Company agreed to pay Apex Financial Services Corp, a Colorado corporation, (“Apex”) the principal sum of $1,000,000, with interest accruing at an annual rate of 7.5%, with principal and interest due on May 31, 2014 paid and renewed to April 28, 2015. The Company also agreed to assign 75% of its operating income from its oil and gas operations and any lease or well sale

 

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ARÊTE INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2015

 

or any other assets sales to Apex to secure the debt. Apex is 100% owned by the CEO, director, and shareholder of the Company, Nicholas L. Scheidt. The Company borrowed the full amount of principal on the note, and also paid a loan fee of $10,000. In the event of default on the note and failure to cure the default in ten days, Apex may accelerate payment and the annual interest rate on the note will accrue at 18%. Default includes failure to pay the note when due or if the Company borrows any other monies or offers security in the Company or in the collateral securing the note prior to the note being paid in full. The outstanding principal balance as of March 31, 2015 was $120,728.

On January 28, 2014, we entered into a line of credit loan agreement for $1,500,000 due January 15, 2015 extended to July 28, 2015. The terms of the note are as follows: 1) the accrued interest is payable monthly starting February 28, 2014, 2) the interest rate is variable based on an index calculated based on a prime rate as published by the Wall Street Journal index (currently 3.25%) plus an add on index with the current and minimum rate of 6.5%., the note has draw provisions, with the first draw of $479,701 4) the note is secured by seven wells and leases owned by the Company, a certificate of deposit for $500,000 at CityWide Bank pledged by a related party, and 5) the personal guarantee of the Nicholas Scheidt, Chief Executive Officer. The amount eligible for borrowing on the Credit Facility is limited to the lesser of (i) 65% of the Company’s PV10 value of its carbon reserves based upon the most current engineering reserve report or (ii) 48 month cumulative cash flow based upon the most current engineering reserve report. In addition to the borrowing base limitation, the Company is required to maintain and meet certain affirmative and negative covenants and conditions in order to draw advances on the Credit Facility. The Credit Facility contains certain representations, warranties, and affirmative and negative covenants applicable to the Company, which are customarily applicable to senior secured loan facilities. Key covenants include limitations on indebtedness, restricted payments, creation of liens on oil and gas properties, hedging transactions, mergers and consolidations, sales of assets, use of loan proceeds, change in business, and change in control. The above-referenced promissory notes contain customary default and acceleration provisions and provide for a default interest rate of 21% per annum. In addition, the Credit Facility contains customary events of default, including: (a) failure to pay any obligations when due; (b) failure to comply with certain restrictive covenants; (c) false or misleading representations or warranties; (d) defaults of other indebtedness; (e) specified events of bankruptcy, insolvency or similar proceedings; (f) one or more final, non-appealable judgments in excess of $50,000 that is not covered by insurance; (g) change in control (25% threshold); (h) negative events affecting the Guarantor; and (i) lender in good faith believes itself insecure. In an event of default arising from the specified events, the Credit Facility provides that the commitments thereunder will terminate and the Lender may take such other actions as permitted including, declaring any principal and accrued interest owed on the line of credit to become immediately due and payable. The Credit Facility is secured by a security interest in substantially all of the assets of the Company, pursuant to a Security Agreement, Deed of Trust and Assignment of As-Extracted Collateral entered into between the Company and Citywide Banks. The outstanding principal balance as of March 31, 2015 was $549,105.

On January 1, 2014, we memorialized our short-term liabilities into formal promissory notes. These certain outstanding advances and other notes payable are now included in single promissory notes, all have been reported previously in our financial statements. Information concerning these promissory notes is set forth in the table below.

 

Name of Holder

 

Position

   Principal
Amount
     Interest
Rate
    Monthly P&I
Payment
Amount
     Number
of
Monthly
Payments
 

Donald W. Prosser

  CFO & Director    $ 28,500         7.00   $ 564.33         60   

Charles B. Davis

  COO & Director    $ 66,500         7.00   $ 1,316.78         60   

William Stewart (Sold to an unrelated party)

  Director    $ 49,500         7.00   $ 980.16         36   

The above-referenced promissory notes contain customary default and acceleration provisions and provide for a default interest rate of 18% per annum. The outstanding principal balances as of March 31, 2015 was $75,702.

In addition, we also issued an unsecured promissory note in the amount of $792,151 on January 1, 2014 to DNR Oil & Gas, Inc. (“DNR”). DNR is a company controlled by one of our directors, Charles B. Davis. The DNR note accrues interest at the rate of 2.50% for the calendar years 2014 and 2015, 4.00% for the calendar year 2016, 6.00% for the calendar

 

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ARÊTE INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2015

 

year 2017 and 8.00% for the remainder of the term of the DNR note. The DNR note matures on January 1, 2019. The DNR note requires payments as follows:

 

    One payment of $250,000 in 2016;

 

    One payment of $250,000 in 2017;

 

    One payment of $250,000 in 2018; and

 

    The balance of principal and accrued interest on or before January 1, 2019.

The DNR note contains customary default and acceleration provisions and provides for a default interest rate of 18% per annum. The note is subordinated to the Bank Line of Credit. The outstanding principal balance as of March 31, 2015 was $792,151.

In June 2013, in connection with the conversions of Series A1 Preferred Stock by Burlingame Equity Investors II, LP and Burlingame Equity Investors Master Fund, LP, the Company issued unsecured promissory notes in the original principal amounts of $48,000 and $552,000, respectively, with interest at 7% per annum payable quarterly and all unpaid interest and principal due on July 23, 2014. In connection with our new line of credit, we have agreed with the holders of these two existing notes to make a partial prepayment on the principal balance of the Notes in exchange for an extension of the maturity date to January 27, 2015. This note was extended to July 28, 2015. Information concerning the principal pay down and new maturity date is set forth in the following table.

 

Name of Holder

   Principal Balance
Before Pay down
     Principal
Pay down
     Remaining
Principal Balance
 

Burlingame Equity Investors II, LP

   $ 44,000       $ 26,251       $ 17,749   

Burlingame Equity Investors Master Fund, LP

     506,000       $ 340,749       $ 165,251   

On August 15, 2014 the Company executed a Promissory Note to an individual for the redemption of 10 shares of Series A-1 Preferred Stock. The terms of the Promissory Note are as follows: $62,000 with an interest rate of 7% payable in two payments of $31,000 each plus interest, due August 15, 2015 and August 15, 2016 respectively.

All of the notes payable shown above are unsecured, except the Apex note. Accrued interest on notes amounted to $3,279 as of December 31, 2014 and $13,700 as of March 31, 2015.

 

7. Asset retirement obligations (ARO)

A reconciliation of the Company’s asset retirement obligations for the quarter ended March 31, 2015, is as follows:

 

Balance, December 31, 2014

   $ 749,013   

Liabilities incurred

     —    

Accretion expense

     16,941  

Revisions to estimate

     —    
  

 

 

 

Balance, March 31, 2015

  765,954  

Less current asset retirement obligations

  (192,282 )
  

 

 

 

Long-term asset retirement obligations

$ 573,672  
  

 

 

 

 

8. Subsequent events

There are no material subsequent events after March 31, 2015

 

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Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking information

This report contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934, as amended, that are based on management’s exercise of business judgment as well as assumptions made by, and information currently available to, management. When used in this document, the words “may”, “will”, “anticipate”, “believe”, “estimate”, “expect”, “intend”, and words of similar import, are intended to identify any forward-looking statements. You should not place undue reliance on these forward-looking statements. These statements reflect our current view of future events and are subject to certain risks and uncertainties as noted below. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, our actual results could differ materially from those anticipated in these forward-looking statements. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance that our expectations will materialize.

Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read together with our audited financial statements and related notes included in our Annual Report on Form 10-K and the financial statements and footnotes included in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q, including the following discussion, contains trend analysis and other forward-looking statements within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements in this Quarterly Report on Form 10-Q that are not statements of historical facts are forward-looking statements. These forward-looking statements made herein are based on our current expectations, involve a number of risks and uncertainties and should not be considered as guarantees of future performance. The factors that could cause actual results to differ materially include without limitation:

 

    unsuccessful drilling and completion activities and the possibility of resulting write-downs;

 

    capital requirements and uncertainty of obtaining additional funding on terms acceptable to us;

 

    price volatility of oil and natural gas prices, and the effect that lower prices may have on our earnings and stockholders’ equity;

 

    a decline in oil or natural gas production or oil or natural gas prices, and the impact of general economic conditions on the demand for oil and natural gas and the availability of capital;

 

    geographical concentration of our operations;

 

    increases in the cost of drilling, completion and gas gathering or other costs of production and operations;

 

    our ability to successfully drill wells that produce oil or natural gas in commercially viable quantities;

 

    failure to meet our proposed drilling schedule;

 

    adverse variations from estimates of reserves, production, production prices and expenditure requirements, and our inability to replace our reserves through acquisition, exploration and development activities;

 

    our current level of indebtedness and the effect of any increase in our level of indebtedness;

 

    limited control over non-operated properties;

 

    reliance on limited number of customers;

 

    title defects to our properties and inability to retain our leases;

 

    our ability to retain key members of our senior management and key consulting resources;

 

    federal, state and tribal regulations and laws;

 

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    impact of environmental, health and safety, and other governmental regulations, and of current or pending legislation;

 

    federal and state legislation and regulatory initiatives relating to hydraulic fracturing;

 

    risks in connection with evaluating potential acquisitions, integration of significant acquisitions, and difficulty managing our growth and the related demands on our resources;

 

    developments in the global economy;

 

    financing and interest rate exposure;

 

    effects of competition;

 

    effect of seasonal factors;

 

    lack of availability of drilling rigs, equipment, supplies, insurance, personnel and oil field services; and

 

    further sales or issuances of common stock.

Finally, our future results will depend upon various other risks and uncertainties, including, but not limited to, those detailed in the section entitled “Risk Factors” included in our Annual Report on Form 10-K. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements in this section and elsewhere in this report. Other than as required under securities laws, we do not assume a duty to update these forward-looking statements, whether as a result of new information, subsequent events or circumstances, changes in expectations or otherwise

General Overview

It is our desire to provide an understanding of the Company’s past performance, its financial condition and its prospects for the future. Accordingly, we will discuss and provide our analysis of the following:

 

    Critical accounting policies;

 

    Results of operations;

 

    Liquidity and capital resources;

 

    Contractual obligations

 

    New accounting pronouncements.

In the third quarter of 2011, we completed an acquisition of producing oil and natural gas properties in Montana, Wyoming, Colorado and Kansas. These properties include several proved undeveloped and probable drilling opportunities. While we have made good progress to implement our business strategy over the past year, we believe our primary challenge over the next few months is to obtain additional financing to exploit existing drilling opportunities and to possibly acquire additional properties. We have sold some of our properties while retaining overriding royalty interests for future upside upon further development of the properties. In addition, we are in the process of reviewing several opportunities for the purchase of production and undeveloped oil and gas leases for future development. In order to purchase properties or begin substantive drilling activities we must obtain additional financing, which cannot be assured. We rely heavily on the skills of our board members in the fields of business development, capital acquisition, corporate visibility, oil and gas development, geology and operations.

 

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Critical Accounting Policies

The following discussion and analysis of the results of operations and financial condition are based on the our consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America. Our significant accounting policies are more fully described in Note 2 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K, as supplemented by the Unaudited Notes to Consolidated Financial Statements included herein. However, certain accounting policies and estimates are particularly important to the understanding of our financial position and results of operations and require the application of significant judgment by our management or can be materially affected by changes from period to period in economic factors or conditions that are outside of our control. As a result, they are subject to uncertainty. In applying these policies, our management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical experience, our future business plans and projected financial results, the terms of existing contracts, our observance of trends in the oil and gas industry, information provided by our customers and information available from other outside sources, as appropriate. Actual results may differ from these estimates. We believe the following critical accounting policies affect our most significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

We record revenue from the sale of natural gas, natural gas liquids (“NGL”) and crude oil when delivery to the purchaser has occurred and title has transferred. We use the sales method to account for gas imbalances. Under this method, revenue is recorded on the basis of gas actually sold by us. In addition, we will record revenue for our share of gas sold by other owners that cannot be volumetrically balanced in the future due to insufficient remaining reserves. We also reduce revenue for other owners’ gas sold by us that cannot be volumetrically balanced in the future due to insufficient remaining reserves. Our remaining over- and under-produced gas balancing positions are considered in our proved oil and gas reserves. Gas imbalances at March 31, 2015 were not material.

Property and equipment

In January 2010, the Financial Accounting Standards Board (“FASB”) issued authoritative oil and gas reserve estimation and disclosure guidance that was effective for the Company beginning in 2010. This guidance was issued to align the accounting oil and gas reserve estimation and disclosure requirements with the requirements in the SEC final rule, “Modernization of Oil and Gas Reporting ”, which was also effective in 2010.

Our oil and gas exploration and production activities are accounted for using the successful efforts method. Under this method, all property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending determination of whether the well has found proved reserves. If an exploratory well does not find proved reserves, the costs of drilling the well are charged to expense and included within cash flows from investing activities in the consolidated statements of cash flows. The costs of development wells are capitalized whether productive or nonproductive. Oil and gas lease acquisition costs are also capitalized.

Other exploration costs, including certain geological and geophysical expenses and delay rentals for oil and gas leases, are charged to expense as incurred. The sale of a partial interest in a proved property is accounted for as a cost recovery and no gain or loss is recognized as long as this treatment does not significantly affect the unit-of-production DD&A rate. A gain or loss is recognized for all other sales of proved properties and is classified in other operating revenues. Maintenance and repairs are charged to expense, and renewals and betterments are capitalized to the appropriate property and equipment accounts.

 

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Unevaluated oil and gas property costs are transferred to proved oil and gas properties if the properties are subsequently determined to be productive. Proceeds from sales of partial interests in unproved leases are accounted for as a recovery of cost without recognizing any gain until all costs are recovered. Unevaluated oil and gas properties are assessed periodically for impairment on a property-by-property basis based on remaining lease terms, drilling results, reservoir performance, commodity price outlooks or future plans to develop acreage.

We review our proved oil and gas properties and our gas gathering system for impairment whenever events and circumstances indicate that a decline in the recoverability of their carrying value may have occurred. We estimate the expected undiscounted future cash flows of assets evaluated for impairment and compare such undiscounted future cash flows to the carrying amount of the respective asset to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, we will adjust the carrying amount of the asset to fair value. The factors used to determine fair value include, but are not limited to, recent sales prices of comparable properties, the present value of estimated future cash flows, net of estimated operating and development costs using estimates of reserves, future commodity pricing, future production estimates, anticipated capital expenditures and various discount rates commensurate with the risk and current market conditions associated with realizing the expected cash flows projected.

The provision for DD&A of oil and gas properties is calculated on a field-by-field basis using the unit-of-production method. Natural gas is converted to barrel of oil equivalents (“BOE”) at the rate of six Mcf of natural gas to one barrel of oil. Estimated future dismantlement, restoration and abandonment costs, which are net of estimated salvage values, are taken into consideration.

Asset Retirement Obligations

The estimated fair value of the future costs associated with dismantlement, abandonment and restoration of oil and gas properties is recorded generally upon acquisition or completion of a well. The net estimated costs are discounted to present values using a credit-adjusted, risk-free rate over the estimated economic life of the oil and gas properties. Such costs are capitalized as part of the related asset. The asset is depleted on the units-of-production method on a field-by-field basis. The associated liability is classified in current and long-term liabilities in the consolidated balance sheets. The liability is periodically adjusted to reflect (1) new liabilities incurred, (2) liabilities settled during the period, (3) accretion expense and (4) revisions to estimated future cash flow requirements. The accretion expense is recorded as a component of depreciation, depletion and amortization expense in the consolidated statements of operations.

Stock-based Compensation

We have not granted any stock options or warrants during the quarters ended March 31, 2014 and 2015, and no options or warrants were outstanding at any time during 2014 and 2015. We issued shares of common stock for services performed by officers, directors and unrelated parties during 2015 and we expect to issue shares for services in the future. We recorded these transactions based on the value of the services or the value of the common stock, whichever was more readily determinable.

Results of Operations for the Quarters Ended March 31, 2014 and 2015

To date, inflation has not had a material impact on our operations. Presented below is a discussion of our results of operations for the Quarters Ended March 31, 2014 and 2015.

 

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Oil and Gas Producing Activities

The results of our producing oil and gas properties in Wyoming, Colorado, Kansas and Montana are presented below is a summary of our oil and gas operations for the quarters ended March 31, 2014 and 2015:

 

     2014      2015  

Oil Sales

   $ 385,072       $ 187,149   

Natural Gas Sales

     110,679         55,515   
  

 

 

    

 

 

 

Total Revenue

  495,751      242,664   

Production Taxes

  (33,057   (18,425

Lease Operating Expense

  (161,368   (216,799

Depreciation, depletion, amortization and accretion

  (129,663   (207,969
  

 

 

    

 

 

 

Net

$ 171,663    $ (200,529
  

 

 

    

 

 

 

Net barrels of oil sold

  4,978      4,937   

Net mcf of gas sold

  18,066      20,060   

Average price for oil

$ 77.45    $ 37.91   
  

 

 

    

 

 

 

Average price for gas

$ 6.13    $ 2.77   
  

 

 

    

 

 

 

Lease operating expense per BOE

$ 20.20    $ 26.18   
  

 

 

    

 

 

 

DD&A per BOE

$ 16.23    $ 25.12   
  

 

 

    

 

 

 

Our oil sales are primarily attributable to our properties in Kansas and Wyoming. The average oil price for the first quarter of 2014 was $77.45 per barrel but ranged from a low of $72.68 for January and a high of $81.76 for February. The average oil price for the first quarter of 2015 was $37.91 per barrel but ranged from a low of $34.10 for January to a high of $41.52 for March. We produced 600 more barrels of oil in the first quarter of 2015 because of bad weather we were unable to sell oil and picked up. The average natural gas prices, including proceeds from sales of natural gas liquids, amounted to $6.13 per Mcf for the first quarter of 2014 but ranged from a low of $5.25 per Mcf for February to a high of $6.48 per Mcf for January. Our average natural gas prices, including proceeds from sales of natural gas liquids, amounted to $2.77 per Mcf for the first quarter of 2015 but ranged from a low of $1.98 per Mcf for February to a high of $3.03 per Mcf for March.

Production taxes were approximately 8% of our oil and gas sales for the first quarters of 2014 and 2015. Lease operating expense averaged $20.20 per Barrel of Oil Equivalent (“BOE”), whereby six Mcf of gas are equal to one barrel of oil, for the first quarter of 2014. Lease operating expense averaged $26.18 per Barrel of Oil Equivalent (“BOE”) for the same period 2015. Many of the wells included in our acreage have been producing for a decade or longer and the cost of workovers and normal maintenance are charged to expense in the period the costs are incurred. For the first quarter of 2014, we incurred approximately $98,800 for workovers, well service units and repairs which accounted for approximately $12.27 per BOE of our lease operating expenses that was capitalized based on increased production the wells. For the first quarter of 2015, we incurred approximately $36,000 for workovers, well service units and repairs which accounted for approximately $4.35 per BOE that were capitalized (see explanation below).

Under successful efforts accounting, DD&A expense is separately computed for each producing field based on geologic and reservoir delineation. The capital expenditures for proved properties for each field compared to the proved reserves corresponding to each producing field determine a weighted average DD&A rate for current production. Future DD&A rates will be adjusted to reflect future capital expenditures and proved reserve changes in specific areas.

 

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During the first quarter 2014 we signed a participation agreement for a share in the new wells for a promote fee of $163,657 and we are still participating in a part of each well. We did not have any participation fees for the first quarter 2015. We expect to periodically evaluate our portfolio of properties and sell additional properties if we believe a sale can be completed on terms that provide attractive returns.

Gas Gathering Activities

We have owned and operated a natural gas gathering system (pipeline and compressor station) for coal bed methane properties in the Powder River Basin of Wyoming since 2006. We had no revenues for the first quarters of 2014 and 2015, due to low natural gas prices which resulted in all wells in the field being shut-in since June 2011.

Presented below is a summary of operating costs for the quarters ended March 31, 2014 and 2015:

 

     2014      2015  

Related party- cost of production

   $ —         $ —     
  

 

 

    

 

 

 

Unrelated parties:

Compressor rental

  —        —     

Pumper costs

  —        —     

Transportation

  —        —     

Property taxes

  1,117      806   

Land rent, utilities, repairs and other

  2,868      600   
  

 

 

    

 

 

 

Total unrelated party costs

  3,985      1,406   
  

 

 

    

 

 

 

Total

$ 3,985    $ 1,406   
  

 

 

    

 

 

 

Depreciation expense related to the gas gathering system was $11,055 for the first quarter of both 2014 and 2015.

In July 2011, we acquired the entire field of coal bed methane wells as part of our $11 million acquisition. While these wells are not economic at current prices being received for natural gas related to the production capability from the existing geologic formation, we have geologic and engineering data that suggest substantial gas reserves exist on these properties by drilling new wells and/or recompleting the existing wells to several new geologic formations. We expect to further evaluate these properties and, if warranted, execute our development plans within the next three years is seeking to exploit the value of the properties and the gas gathering system. As of March 31, 2014, the capitalized cost of the coal bed methane leases was $248,295 and the net capitalized cost of the gas gathering system was $134,032. As of March 31, 2015, the capitalized cost of the coal bed methane leases is $248,295 and the net capitalized cost of the gas gathering system is $89,813.

 

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General and Administrative

Presented below is a summary of general and administrative expenses for the quarters ended March 31, 2014 and 2015:

 

     2014      2015      Change  

Director fees

   $ —         $  10,000       $ 10,000   

Investor relations

     5,565         3,163         (2,402

Legal, auditing and transfer agent

     44,048         12,565         (31,483

Consulting fees:

        

Related parties

     30,000         47,400         17,400   

Other administrative expense

     21,775         19,154         (2,621

Depreciation

     143         142         (1
  

 

 

    

 

 

    

 

 

 

Total general and administrative expenses

$ 101,531    $ 92,424    $ (9,107
  

 

 

    

 

 

    

 

 

 

General and administrative expenses decreased by $9,107 in 2015 compared to 2014, primarily due to an effort by management to cut costs. The management has provided accounting services and all needed administrative services for compliance with regulatory agencies and at no cash cost to the Company.

The monthly charge of $10,000 under an agreement with DNR, whereby executive level expertise is provided for our existing and prospective oil and properties. The total monthly charge under the operating agreement is $18,000, of which $8,000 is allocated to lease operating expense. DNR is an affiliate of Charles B. Davis, an executive officer and director of the Company.

Income (loss) from operations

Loss from operations for the first quarter of 2015 was $(277,352) compared to income of $219,556 for the first quarter of 2014. The decrease in income was primarily due to no participation of oil and gas properties, and more than a 50% decrease in oil and gas prices.

Interest Expense

Interest expense decreased $8,012 in the first quarter of 2015 to $27,158, from $35,170 in the first quarter of 2014. The decrease of interest expense was due from a decrease in debt over the last year.

Liquidity and Capital Resources

We had a working capital deficit as of March 31, 2015 of $1,398,834, compared to a working capital deficit of $1,294,408 at December 31, 2014. The approximate $100,000 increase in our working capital deficit resulted from the low price of oil and gas, although the impact of lower prices were offset by management’s efforts to reduce debt and expenses.

We generated positive operating cash flow of $8,916 for the first quarter of 2015 compared to operating cash flow of approximately $265,875 for the first quarter of 2014 the reduction in cash flow was due to the significantly lower oil and gas prices.

For the first quarter of 2015, we used $11,962 of cash flows related to investing activities for capital expenditures. For the first quarter of 2014, we used $67,703 of cash flows related to investing activities for capital expenditures.

For the first quarter of 2015, we paid $6,493 in debt and had no additional borrowings. For the first quarter of 2014, we had net cash financing activities use of $545,928 as we borrowed $497,641 and repaid borrowings of $815,569, and redeemed $228,000 in common stock of the Company.

Part of our strategy is to monitor the current production of our properties, seek to develop them with infield drilling, and explore sales and purchases of additional leases and operating wells with upside. We are currently evaluating several opportunities for drilling in Wyoming, Colorado, and Oklahoma. We also expect to evaluate

 

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acquisitions that are consistent with our business objective of acquiring interests in traditional oil and gas ventures, and seeking properties that offer profit potential from overlooked and by-passed reserves of oil and natural gas. The Company has participated as a working interest owner in the four horizontal wells which were drilled and completed in Campbell County, Wyoming in the Turner zone and one well in Converse County, Wyoming in the Turner Zone. The following is a description of the wells:

 

  1) The Thielen #1-21 is in Section 21 Township 43N Campbell County Wyoming. This well was drilled to a total depth of approximately 15,350 including the lateral. The Company has an approximate 1.06% working interest and in full production.

 

  2) The Thielen #2-21 is in Section 21 Township 43N Campbell County Wyoming. This well was drilled to a total depth of approximately 15,330 feet including the lateral. The Company has an approximate 1.06% working interest and in full production.

 

  3) The Starlight Federal 28H is located in Section 7, Township 43N Campbell County Wyoming. This well was drilled to a total depth of approximately 15,310 including the lateral. The Company has an approximate 0.7025% working interest and in full production.

 

  4) The Starlight Federal 30H is located in Section 7, Township 43N Campbell County Wyoming. This well was drilled to a total depth of approximately 15,310 including the lateral. The Company has an approximate 1.450088% working interest and in full production.

 

  5) The Wibaux Gold Federal 4076-10-03-1SH is located in Section 10, Township 43N Converse County Wyoming. This well was drilled to a total depth of approximately 20,185 including the lateral. The Company has an approximate 0.2697755% working interest and in full production.

In order to execute our development drilling plans and to acquire additional interests in oil and gas properties that meet our objectives, we need to obtain significant additional financing. We acquired our existing properties in July 2011, and from time to time we have sold our interests in some of those properties, which resulted in aggregate net proceeds from three sales of $6,377,000, which was used to repay acquisition indebtedness. We intend to only sell properties that can be liquidated for a premium and there can be no assurance that we will continue to generate any proceeds from the sale of our properties.

If oil and gas prices decrease materially from current levels and additional debt or equity funding is unavailable on acceptable terms, or at all, our strategy would include some or all of the following: (i) defer development drilling on our existing properties, (ii) forego additional oil and gas property acquisitions, (iii) shut-in any marginal or uneconomic wells, (iv) attempt to negotiate the issuance of common stock in exchange for services, and (v) review and implement other opportunities to reduce general, administrative and operating expenses.

Contractual Obligations and Commercial Commitments

As of March 31, 2015, we have future minimum lease payments of approximately $5,000. This amount is payable during the years ending March 31, 2016, 2017, 2018, 2019 and 2020 in the amounts of $1,000 each year respectively.

 

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Off-Balance Sheet Arrangements

In connection with the related party acquisition of oil and gas properties in the third quarter of 2011, we acquired interests in certain geologic zones of the properties. The Colorado and Kansas properties provide for additional consideration that is payable to the related party sellers if proved producing reserves are increased relating to these properties through drilling or recompletion activities over a period of ten years after the closing date. First to the extent that oil reserves increase, the sellers are entitled to additional consideration of $250,000 for each increase of 20,000 net barrels. Second, to the extent that oil and gas prices increase, the sellers are entitled to additional consideration as the targeted price thresholds are exceeded for periods of 61 days. The increase in purchase price for the Kansas and Colorado properties is limited to a maximum of $5 million.

The acquired properties that are located in Wyoming and Montana provide a similar formula as used for the Colorado and Kansas properties that could result in an obligation for additional purchase consideration to the extent that we perform future drilling or recompletion activities in formations that were not producing as of the September 29, 2011 closing date. Furthermore, if we sell properties where reserves have been proved up through drilling or recompletion, the sellers have retained an interest of 70% in the net sales proceeds (after we receive a recovery of 125% of the original purchase allocation in the amended and restated purchase agreement). The increase in purchase price for all properties (Colorado, Kansas, Wyoming and Montana) is limited to a maximum of $25 million.

Due to consideration retained by the related party sellers from sales of properties through the fourth quarter of 2014, and $250,000 of consideration payable in December 2014 due to a sustained increase in oil prices over $90 per barrel, the maximum future consideration has been reduced by approximately $5.8 million to $19.2 million as of March 31, 2015.

New Accounting Pronouncements

In June 2014, the FASB issued ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”). The amendments in ASU 2014-12 require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Accounting Standards Codification Topic No. 718, “Compensation – Stock Compensation” (“ASC 718”), as it relates to awards with performance conditions that affect vesting to account for such awards. The amendments in ASU 2014-12 are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted. Entities may apply the amendments in ASU 2014-12 either: (a) prospectively to all awards granted or modified after the effective date; or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. The adoption of ASU 2014-12 is not expected to have a material effect on the Company’s consolidated financial statements or disclosures.

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” ASU 2014-08 changes the criteria for reporting a discontinued operation. Under the new pronouncement, a disposal of a part of an organization that has a major effect on its operations and financial results is a discontinued operation. The Company is required to adopt ASU 2014-08 prospectively for all disposals or components of its business classified as held for sale during fiscal periods beginning after December 15, 2014. The adoption of ASU 2014-08 is not expected to have a material effect on the Company’s consolidated financial statements or disclosures.

 

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In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which provides guidance for revenue recognition. ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets and supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition,” and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, “Revenue Recognition- Construction-Type and Production-Type Contracts.” ASU 2014-09’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 is effective for the Company beginning January 1, 2017 and, at that time, the Company may adopt the new standard under the full retrospective approach or the modified retrospective approach. Early adoption is not permitted. The Company is currently evaluating the method and impact the adoption of ASU 2014-09 will have on the Company’s consolidated financial statements and disclosures.

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 will explicitly require management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosure in certain circumstances. The new standard will be effective for all entities in the first annual period ending after December 15, 2016. Earlier adoption is permitted. We are currently evaluating the impact of the adoption of ASU 2014-15.

Other accounting standards that have been issued or proposed by the FASB, or other standards-setting bodies, that do not require adoption until a future date are not expected to have a material impact on the financial statements upon adoption.

Item 3 - Quantitative and Qualitative Disclosures about Market Risk

The Company is a “Smaller Reporting Company” as defined by Rule 229.10 (f)(1) and is not required to provide or disclose the information required by this item.

Item 4 - Controls and Procedures

As of March 31, 2015, our Chief Executive Officer and Chief Financial Officer (the “Certifying Officers”) conducted evaluations of our disclosure controls and procedures. As defined under Sections 13a-15(e) and 15d-15(e) of the Exchange Act, the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including the Certifying Officers, to allow timely decisions regarding required disclosure. Based on this evaluation, the Certifying Officers have concluded that our disclosure controls and procedures were not effective to ensure that material information is recorded, processed, summarized and reported by our management on a timely basis in order to comply with our disclosure obligations under the Exchange Act and the rules and regulations promulgated thereunder. As discussed in our Annual Report on Form 10-K for the year ended December 31, 2014, the ineffectiveness of our disclosure controls and procedures is due primarily to (i) our Board of Directors does not currently have any independent members that qualify as an audit committee financial expert, (ii) we have not developed and effectively communicated our accounting policies and procedures, and (iii) our controls over financial statement disclosures were determined to be ineffective.

Further, there were no changes in our internal control over financial reporting during the first fiscal quarter that has materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II - OTHER INFORMATION

Item 1 - Legal Proceedings.

From time to time, the Company is a party to routine litigation and proceedings that are considered part of the ordinary course of its business. The Company is not aware of any material current, pending, or threatened litigation.

Item 1A - Risk Factors.

There have been no material changes to the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the SEC on April 15, 2015. The risk factors in our Annual Report on Form 10-K for the year ended December 31, 2014, in addition to the other information set forth in this quarterly report, could materially affect our business, financial condition or results of operations. Additional risks and uncertainties not currently known to us or that we deem to be immaterial could also materially adversely affect our business, financial condition or results of operations.

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds.

During the quarter ended March 31, 2015, the Company issued 156,140 shares of common stock for compensation or services; 106,140 shares of common stock were issued for board service in 2013 and 2014, and 50,000 shares of common stock were issued for service and consulting by two related parties.

Item 3 - Defaults upon Senior Securities.

None

Item 4 - Mine Safety Disclosures.

Not Applicable

Item 5 - Other Information.

None

Item 6 - Exhibits

The following documents are filed as exhibits to this report on Form 10-Q or incorporated by reference herein.

 

  31.1 Certification of the Principal Executive Officer pursuant to §302 of the Sarbanes-Oxley Act of 2002.
  31.2 Certification of the Principal Financial Officer pursuant to §302 of the Sarbanes-Oxley Act of 2002.
  32.1 Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350.
  32.2 Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350.
101 The following materials are filed herewith: (i) XBRL Instance, (ii) XBRL Taxonomy Extension Schema, (iii) XBRL Taxonomy Extension Calculation, (iv) XBRL Taxonomy Extension Labels, (v) XBRL Taxonomy Extension Presentation, and (vi) XBRL Taxonomy Extension Definition. In accordance with Rule 406T of Regulation S-T, the information in these exhibits is furnished and deemed not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Exchange Act of 1934, and otherwise is not subject to liability under these sections and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by the specific reference in such filing.

 

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ARÊTE INDUSTRIES, INC.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

By:

/s/ Nicholas Scheidt, CEO

Nicholas L Scheidt, Principal Executive Officer
Dated: May 15, 2015

 

By:

/s/ William W Stewart

William W Stewart, Principal Financial and Accounting Officer
Dated: May 15, 2015

 

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