UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
⌧ Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2018.
☐ Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 (No fee required)
For the transition period from _______ to _______.
Commission file number 000-53473
Torchlight Energy Resources, Inc.
(Exact name of registrant in its charter)
Nevada
(State or other jurisdiction of incorporation or
Organization)
74-3237581
(I.R.S. Employer Identification No.)
5700 W. Plano Parkway, Suite 3600
Plano, Texas 75093
(Address of principal executive offices)
(214) 432-8002
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Common Stock ($0.001 Par Value)
(Title of Each Class)
The NASDAQ Stock Market LLC
(Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Exchange Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes ☐ No ⌧
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ⌧
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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 ⌧ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to
Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was
required to submit such files). Yes ⌧ No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. ☐
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. (Check one):
Large accelerated filer
Non-accelerated filer
☐
☐ (Do not check if a smaller reporting company)
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 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ⌧
The aggregate market value of the common stock held by non-affiliates of the registrant on June 30, 2018, the last business day of the
registrant’s most recently completed second fiscal quarter, based on the closing price on that date of $1.36 on the Nasdaq Stock Market,
was approximately $73,042,665.
At March 15, 2019, there were 71,695,865 shares of the registrant’s common stock outstanding (the only class of common stock).
DOCUMENTS INCORPORATED BY REFERENCE
None.
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NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements include, among other things, statements regarding plans, objectives, goals, strategies, future events or
performance and underlying assumptions and other statements, which are other than statements of historical facts. Forward-looking
statements may appear throughout this report, including without limitation, the following sections: Item 1 “Business,” Item 1A “Risk
Factors,” and Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking
statements generally can be identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,”
“projects,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current
expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those
reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those
discussed in this Annual Report on Form 10-K, and in particular, the risks discussed under the caption “Risk Factors” in Item 1A and those
discussed in other documents we file with the Securities and Exchange Commission (“SEC”). Important factors that in our view could
cause material adverse effects on our financial condition and results of operations include, but are not limited to, risks associated with the
company’s ability to obtain additional capital in the future to fund planned expansion, the demand for oil and natural gas, general economic
factors, competition in the industry and other factors that may cause actual results to be materially different from those described herein as
anticipated, believed, estimated or expected. We undertake no obligation to revise or publicly release the results of any revision to any
forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue
reliance on such forward-looking statements.
As used herein, the “Company,” “Torchlight,” “we,” “our,” and similar terms include Torchlight Energy Resources, Inc. and its
subsidiaries, unless the context indicates otherwise.
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TABLE OF CONTENTS
PART I
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
PART II
Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity
Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
PART III
Directors, Executive Officer, and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accountant Fees and Services
Exhibits, Financial Statement Schedules
Signatures
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Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Item 15.
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ITEM 1. BUSINESS
Corporate History and Background
PART I
Torchlight Energy Resources, Inc. was incorporated in October, 2007 under the laws of the State of Nevada as Pole Perfect Studios, Inc.
(“PPS”).
On November 23, 2010, we entered into and closed a Share Exchange Agreement (the “Exchange Agreement”) between the major
shareholders of PPS and the shareholders of Torchlight Energy, Inc. (“TEI”). As a result of the transactions effected by the Exchange
Agreement, at closing TEI became our wholly-owned subsidiary, and the business of TEI became our sole business. TEI is an energy
company, incorporated under the laws of the State of Nevada in June, 2010. We are engaged in the acquisition, exploration, exploitation,
and/or development of oil and natural gas properties in the United States. We operate our business through TEI and four other wholly-
owned subsidiaries, Torchlight Energy Operating, LLC, a Texas limited liability company, Hudspeth Oil Corporation, a Texas corporation,
Torchlight Hazel LLC, a Texas limited liability company, and Warwink Properties LLC, a Texas limited liability company.
Business Overview
We are an energy company engaged in the acquisition, exploration, exploitation and/or development of oil and natural gas properties in the
United States. We are primarily focused on the acquisition of early stage projects, the development and delineation of these projects, and
then the monetization of those assets once these activities are completed.
Since 2010, our primary focus has been the development of interests in oil and gas projects we hold in the Permian Basin in West Texas,
including the Orogrande Project in Hudspeth County, Texas, the Hazel Project in the Midland Basin and the recently acquired project in
Winkler County, Texas in the Delaware Basin. Within these three projects, we drilled seven gross wells (horizontal and vertical) in 2018 in
the Wolfcamp A, B, C Upper and Lower Second Bone Spring, Third Bone Spring, and the Pennsylvanian in the Orogrande. We also hold
interests in certain other oil and gas projects that we are in the process of divesting, including the Hunton wells project as part of a
partnership with Husky Ventures, Inc., or Husky, in Central Oklahoma.
Key Business Attributes
Experienced People. We build on the expertise and experiences of our management team, including John Brda and Roger Wurtele. We will
also receive guidance from outside advisors as well as our Board of Directors and will align with high quality exploration and technical
partners.
Project Focus. We are focusing primarily on exploitation projects by pursuing resources in areas where commercial production has already
been established but where opportunity for additional and nearby development is indicated. We may pursue high risk exploration prospects
which may appear less favored than low risk exploration. We will, however, consider these high risk-high reward exploration prospects in
connection with exploitation opportunities in a project that would reduce the overall project economic risk. We will consider such high risk-
high reward prospects on their individual merits.
Lower Cost Structure. We will attempt to maintain the lowest possible cost structure, enabling the greatest margins and providing
opportunities for investment that would not be feasible for higher cost competitors.
Limit Capital Risks. Limited capital exposure is planned initially to add value to a project and determine its economic viability. Projects are
staged and have options before additional capital is invested. We will limit our exposure in any one project by participating at reduced
working interest levels, thereby being able to diversify with limited capital. Management has experience in successfully managing risks of
projects, finance, and value.
Project Focus
Generally, we will focus on exploitation projects (primarily for oil, although gas projects will be considered if the economics are
favorable). Projects are first identified, evaluated, and followed by the engagement of third party operating or financial partners. Subject to
overall availability of capital, our interest in large capital projects will be limited. Each opportunity will be investigated on a standalone
basis for both technical and financial merit.
We will be actively seeking quality new investment opportunities to sustain our growth, and we believe we will have access to many new
projects. The sources of these opportunities will vary but all will be evaluated with the same criteria of technical and economic factors. It is
expected that projects will come from the many small producers who find themselves under-funded or over-extended and therefore
vulnerable to price volatility. The financial ability to respond quickly to opportunities will ensure a continuous stream of projects and will
enable us to negotiate from a stronger position to enhance value.
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ITEM 1. BUSINESS - continued
With emphasis on acquisitions and development strategies, the types of projects in which we will be involved vary from increased
production due to simple re-engineering of existing wellbores to step-out drilling, drilling horizontally, and extensions of known fields.
Recompletion of existing wellbores in new zones, development of deeper zones and detailing of structure, and stratigraphic traps with three-
dimensional seismic and utilization of new technologies will all be part of our anticipated program. Our preferred type of projects are in-
fills to existing production with nearly immediate cash flow and/or adjacent or on trend to existing production. We will prefer projects with
moderate to low risk, unrecognized upside potential, and geographic diversity.
Business Processes
We believe there are three principal business processes that we must follow to enable our operations to be profitable. Each major business
process offers the opportunity for a distinct partner or alliance as we grow. These processes are:
●
●
●
Investment Evaluation and Review;
Operations and Field Activities; and
Administrative and Finance Management.
Investment Evaluation and Review. This process is the key ingredient to our success. Recognition of quality investment opportunities is the
fuel that drives our engine. Broadly, this process includes the following activities: prospect acquisition, regional and local geological and
geophysical evaluations, data processing, economic analysis, lease acquisition and negotiations, permitting, and field supervision. We
expect these evaluation processes to be managed by our management team. Expert or specific technical support will be outsourced as
needed. Only if a project is taken to development, and only then, will additional staff be hired. New personnel will have very specific
responsibilities. We anticipate attractive investment opportunities to be presented from outside companies and from the large informal
community of geoscientists and engineers. Building a network of advisors is key to the pipeline of high quality opportunities.
Operations and Field Activities. This process begins following management approval of an investment. Well site supervision, construction,
drilling, logging, product marketing, and transportation are examples of some activities. We will prefer to be the operator, but when
operations are not possible, we will farm-out sufficient interests to third parties that will be responsible for these operating activities. We
provide personnel to monitor these activities and associated costs.
Administrative and Finance Management. This process coordinates our initial structuring and capitalization, general operations and
accounting, reporting, audit, banking and cash management, regulatory agencies reporting and interaction, timely and accurate payment of
royalties, taxes, leases rentals, vendor accounts and performance management that includes budgeting and maintenance of financial
controls, and interface with legal counsel and tax and other financial and business advisors.
Current Projects
As of December 31, 2018, we had interests in four oil and gas projects: the Orogrande Project in Hudspeth County, Texas, the Hazel Project
in Sterling, Tom Green, and Irion Counties, Texas, the Winkler Project in Winkler County, Texas and the Hunton wells in partnership with
Husky Ventures in central Oklahoma.
Orogrande Project, West Texas
On August 7, 2014, we entered into a Purchase Agreement with Hudspeth Oil Corporation (“Hudspeth”), McCabe Petroleum Corporation
(“MPC”), and Gregory McCabe, our Chairman. Mr. McCabe was the sole owner of both Hudspeth and MPC. Under the terms and
conditions of the Purchase Agreement, at closing, we purchased 100% of the capital stock of Hudspeth which holds certain oil and gas
assets, including a 100% working interest in approximately 172,000 mostly contiguous acres in the Orogrande Basin in West Texas. As of
December 31, 2017, leases covering approximately 133,000 acres remain in effect. This acreage is in the primary term under five-year
leases that carry additional five-year extension provisions. As consideration, at closing we issued 868,750 restricted shares of our common
stock to Mr. McCabe and paid a total of $100,000 in geologic origination fees to third parties. Additionally, Mr. McCabe has, at his option,
a 10% working interest back-in after payout and a reversionary interest if drilling obligations are not met, all under the terms and conditions
of a participation and development agreement among Hudspeth, MPC and Mr. McCabe. All drilling obligations through December 31,
2018 have been met.
On September 23, 2015, Hudspeth entered into a Farmout Agreement with Pandora Energy, LP (“Pandora”), Founders Oil & Gas, LLC
(“Founders”), and for the limited purposes set forth therein, MPC and Mr. McCabe, for the entire Orogrande Project in Hudspeth County,
Texas. The Farmout Agreement provided that Hudspeth and Pandora (collectively referred to as “Farmor”) would assign to Founders an
undivided 50% of the leasehold interest and a 37.5% net revenue interest in the oil and gas leases and mineral interests in the Orogrande
Project, which interests, except for any interests retained by Founders, would be reassigned to Farmor by Founders if Founders did not
spend a minimum of $45.0 million on actual drilling operations on the Orogrande Project by September 23, 2017. Under a joint operating
agreement also entered into on September 23, 2015, Founders was designated as operator of the leases.
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ITEM 1. BUSINESS - continued
On March 22, 2017, Founders, Founders Oil & Gas Operating, LLC, Founders’ operating partner, Hudspeth and Pandora signed a Drilling
and Development Unit Agreement (the “DDU Agreement”), with the Commissioner of the General Land Office, on behalf of the State of
Texas, and as approved by the Board for Lease of University Lands, or University Lands, on the Orogrande Project. The DDU Agreement
has an effective date of January 1, 2017 and required a payment from Founders, Hudspeth and Pandora, collectively, of $335,323 as the
initial consideration fee. The initial consideration fee was paid by Founders in April 2017 and was to be deducted from the required spud
fee payable to us at commencement of the next well drilled.
The DDU Agreement allows for all 192 existing leases covering approximately 133,000 net acres leased from University Lands to be
combined into one drilling and development unit for development purposes. The term of the DDU Agreement expires on December 31,
2023, and the time to drill on the drilling and development unit continues through December 2023. The DDU Agreement also grants the
right to extend the DDU Agreement through December 2028 if compliance with the DDU Agreement is met and the extension fee
associated with the additional time is paid. Our drilling obligations began with one well to be spudded and drilled on or before September 1,
2017, and increased to two wells in year 2018, three wells in year 2019, four wells in year 2020 and five wells per year in years 2021, 2022
and 2023. The drilling obligations are minimum yearly requirements and may be exceeded if acceleration is desired. The DDU Agreement
replaces all prior agreements, and will govern future drilling obligations on the drilling and development unit if the DDU Agreement is
extended. The Company drilled three wells during the fourth quarter of 2018.
There are two vertical tests wells in the Orogrande Project, the Orogrande Rich A-11 test well and the University Founders B-19 #1 test
well. The Orogrande Rich A-11 test well was spudded on March 31, 2015, drilled in the second quarter of 2015 and was evaluated and
numerous scientific tests were performed to provide key data for the field development thesis. We believe that future utility of this well
may be conversion to a salt water disposal well in the course of further development of the Orogrande acreage. The University Founders B-
19 #1 was spudded on April 24, 2016 and drilled in the second quarter of 2016. The well successfully pumped down completion fluid in
the third quarter of 2016 and indications of hydrocarbons were seen at the surface on this second Orogrande Project test well. We believe
that future utility of this well may be conversion to a salt water disposal well in the course of further development of the Orogrande
acreage.
During the fourth quarter of 2017, we took back operational control from Founders on the Orogrande Project. We were joined by Wolfbone
Investments, LLC, (“Wolfbone”), a company owned by Mr. McCabe. We, along with Hudspeth, Wolfbone and, for the limited purposes
set forth therein, Pandora, entered into an Assignment of Farmout Agreement with Founders, (the “Assignment of Farmout Agreement”),
pursuant to which we and Wolfbone will share the remaining commitments under the Farmout Agreement. All original provisions of our
carried interest were to remain in place including reimbursement to us on each wellbore. Founders was to remain a 9.5% working interest
owner in the Orogrande Project for the $9.5 million it had spent as of the date of the Assignment of Farmout Agreement, and such interests
were to be carried until $40.5 million is spent by Wolfbone and us, with each contributing 50% of such capital spend, under the existing
agreement. Our working interest in the Orogrande Project thereby increased by 20.25% to a total of 67.75% and Wolfbone then owned
20.25%.
Founders was to operate a newly drilled horizontal well called the University Founders #A25 (at 5,540’ depth in a 1,000’ lateral) with
supervision from us and our partners. The University Founders #A25 was spudded on November 28, 2017. During the month of April
2018, we, MPC and Mr. McCabe were to assume full operational control including managing drilling plans and timing for all future wells
drilled in the project.
On July 25, 2018, we and Hudspeth entered into a Settlement & Purchase Agreement (the “Settlement Agreement”) with Founders (and
Founders Oil & Gas Operating, LLC), Wolfbone and MPC, which agreement provides for Hudspeth and Wolfbone to each immediately pay
$625,000 and for Hudspeth or the Company and Wolfbone or MPC to each pay another $625,000 on July 20, 2019, as consideration for
Founders assigning all of its working interest in the oil and gas leases of the Orogrande Project to Hudspeth and Wolfbone equally. The
assignments to Hudspeth and Wolfbone were made in July when the first payments were made. The payments to Founders in 2019 are not
securitized. Future well capital spending obligations will require the same 50% contribution from Hudspeth and 50% from Wolfbone until
such time as the $40.5 million to be spent on the project (as per our Assignment of Farmout Agreement with Founders) is completed. The
Company estimates that there is still approximately $23 million remaining to be spent on the project until such time as the capital
expenditures revert back to the percentages of the working interest owners.
After the assignment by Founders (for which Hudspeth’s total consideration is $1,250,000), Hudspeth’s working interest increased to
72.5%. Additionally, the Settlement Agreement provides that the Founders parties will assign to the Company, Hudspeth, Wolfbone and
MPC their claims against certain vendors for damages, if any, against such vendors for negligent services or defective equipment. Further,
the Settlement Agreement has a mutual release and waivers among the parties.
Rich Masterson, our consulting geologist, is credited with originating the Orogrande Project in Hudspeth County in the Orogrande Basin.
With Mr. Masterson’s assistance, we have identified target payzone depths between 4,100’ and 6,100’ with primary pay, described as the
WolfPenn formation, located at depths of 5,300 to 5,900’. Based on our geologic analysis to date, the Wolfpenn formation is prospective
for oil and high British thermal unit (Btu) gas, with a 70/30 mix expected, respectively.
Recently, the Company drilled three additional test wells in the Orogrande in order to stay in compliance with University Lands D&D Unit
Agreement, as well as, to test for potential shallow pay zones and deeper pay zones that may be present on structural plays. At the time of
this writing, the results have not been published.
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ITEM 1. BUSINESS - continued
Hazel Project in the Midland Basin in West Texas
Effective April 4, 2016, TEI acquired from MPC a 66.66% working interest in approximately 12,000 acres in the Midland Basin in
exchange for 1,500,000 warrants to purchase shares of our common stock with an exercise price of $1.00 for five years and a back-in after
payout of a 25% working interest to MPC.
Initial development of the first well on the property, the Flying B Ranch #1, began July 9, 2016 and development continued through
September 30, 2016. This well is classified as a test well in the development pursuit of the Hazel Project. We believe that this wellbore will
be utilized as a salt water disposal well in support of future development.
In October 2016, the holders of all of our then-outstanding shares of Series C Preferred Stock (which were issued in July 2016) elected to
convert into a total 33.33% working interest in our Hazel Project, reducing our ownership from 66.66% to a 33.33% working interest. As of
December 31, 2018, no shares of our Series C Preferred Stock were outstanding.
On December 27, 2016, drilling activities commenced on the second Hazel Project well, the Flying B Ranch #2. The well is a vertical test
similar to our first Hazel Project well, the Flying B Ranch #1. Recompletion in an alternative geological formation for this well was
performed during the three months ended September 30, 2017; however, we believe that the results were uneconomic for continuing
production. We believe that this wellbore will be utilized as a salt water disposal well in support of future development.
We commenced planning to drill the Flying B Ranch #3 horizontal well in the Hazel Project in June 2017 in compliance with the
continuous drilling obligation. The well was spudded on June 10, 2017. The well was completed and began production in late September
2017.
Acquisition of Additional Interests in Hazel Project
On January 30, 2017, we and our then wholly-owned subsidiary, Torchlight Acquisition Corporation, a Texas corporation (“TAC”), entered
into and closed an Agreement and Plan of Reorganization and a Plan of Merger with Line Drive Energy, LLC, a Texas limited liability
company (“Line Drive”), and Mr. McCabe, under which agreements TAC merged with and into Line Drive and the separate existence of
TAC ceased, with Line Drive being the surviving entity and becoming our wholly-owned subsidiary. Line Drive, which was wholly-owned
by Mr. McCabe, owned certain assets and securities, including approximately 40.66% of 12,000 gross acres, 9,600 net acres, in the Hazel
Project and 521,739 warrants to purchase shares of our common stock (which warrants had been assigned by Mr. McCabe to Line Drive).
Upon the closing of the merger, all of the issued and outstanding shares of common stock of TAC automatically converted into a
membership interest in Line Drive, constituting all of the issued and outstanding membership interests in Line Drive immediately following
the closing of the merger, the membership interest in Line Drive held by Mr. McCabe and outstanding immediately prior to the closing of
the merger ceased to exist, and we issued Mr. McCabe 3,301,739 restricted shares of our common stock as consideration therefor.
Immediately after closing, the 521,739 warrants held by Line Drive were cancelled, which warrants had an exercise price of $1.40 per share
and an expiration date of June 9, 2020. A Certificate of Merger for the merger transaction was filed with the Secretary of State of Texas on
January 31, 2017. Subsequent to the closing the name of Line Drive Energy, LLC was changed to Torchlight Hazel, LLC. We are required
to drill one well every six months to hold the entire 12,000 acre block for eighteen months, and thereafter two wells every six months
starting June 2018. As of December 31, 2018 drilling commitments have been met.
Also on January 30, 2017, TEI entered into and closed a Purchase and Sale Agreement with Wolfbone. Under the agreement, TEI acquired
certain of Wolfbone’s Hazel Project assets, including its interest in the Flying B Ranch #1 well and the 40 acre unit surrounding the well,
for consideration of $415,000, and additionally, Wolfbone caused to be cancelled a total of 2,780,000 warrants to purchase shares of our
common stock, including 1,500,000 warrants held by MPC, and 1,280,000 warrants held by Green Hill Minerals, an entity owned by Mr.
McCabe’s son, which warrant cancellations were effected through certain Warrant Cancellation Agreements. The 1,500,000 warrants held
by MPC that were cancelled had an exercise price of $1.00 per share and an expiration date of April 4, 2021. The warrants held by Green
Hill Minerals that were cancelled included 100,000 warrants with an exercise price of $1.73 and an expiration date of September 30, 2018
and 1,180,000 warrants with an exercise price of $0.70 and an expiration date of February 15, 2020.
Since Mr. McCabe held the controlling interest in both Line Drive and Wolfbone, the transactions were combined for accounting purposes.
The working interest in the Hazel Project was the only asset held by Line Drive. The warrant cancellation was treated in the aggregate as
an exercise of the warrants with the transfer of the working interests as the consideration. We recorded the transactions as an increase in its
investment in the Hazel Project working interests of $3,644,431, which is equal to the exercise price of the warrants plus the cash paid to
Wolfbone.
Upon the closing of the transactions, our working interest in the Hazel Project increased by 40.66% to a total ownership of 74%.
Effective June 1, 2017, we acquired an additional 6% working interest from unrelated working interest owners in exchange for 268,656
shares of common stock valued at $373,430, increasing our working interest in the Hazel project to 80%, and an overall net revenue interest
of 74-75%.
Mr. Masterson is credited with originating the Hazel Project in the Midland Basin. With Mr. Masterson’s assistance, we are targeting
prospects in the Midland Basin that have 150 to 130 feet of thickness, are likely to require six to eight laterals per bench, have the potential
for twelve to sixteen horizontal wells per section, and 200 long lateral locations, assuming only two benches.
8
ITEM 1. BUSINESS - continued
In April 2018, we announced that we have commenced a process that could result in the monetization of the Hazel Project. We believe the
development activity at the Hazel Project, coupled with nearby activities of other oil and gas operators, suggests that this project has
achieved a level of value worth monetizing. We anticipate that the liquidity that would be provided from selling the Hazel Project could be
redeployed into the Orogrande Project. While this process is underway, we will take all necessary steps to maintain the leasehold as
required. In May 2018, the working interest partners in the Hazel Project drilled a shallow well to test a zone at 2500’. As of this filing, we
continue to maintain the leases in good standing and continue to market the acreage in an effort to focus on the Orogrande Project.
Winkler Project, Winkler County, Texas
On December 1, 2017, the Agreement and Plan of Reorganization that we and our then wholly-owned subsidiary, Torchlight Wolfbone
Properties, Inc., a Texas corporation (“TWP”), entered into with MPC and Warwink Properties, LLC (Warwink Properties) on November
14, 2017 closed. Under the agreement, TWP merged with and into Warwink Properties and the separate existence of TWP ceased, with
Warwink Properties being the surviving entity and becoming our wholly-owned subsidiary. Warwink Properties was wholly owned by
MPC. Warwink Properties owns certain assets, including a 10.71875% working interest in approximately 640 acres in Winkler County,
Texas. Upon the closing of the merger, all of the issued and outstanding shares of common stock of TWP converted into a membership
interest in Warwink Properties, constituting all of the issued and outstanding membership interests in Warwink Properties immediately
following the closing of the merger, the membership interest in Warwink Properties held by MPC and outstanding immediately prior to the
closing of the merger ceased to exist, and we issued MPC 2,500,000 restricted shares of our common stock as consideration. Also on
December 1, 2017, MPC closed its transaction with MECO IV, LLC (” MECO”), for the purchase and sale of certain assets as
contemplated by the Purchase and Sale Agreement dated November 9, 2017 among MPC, MECO and additional parties thereto (the
“MECO PSA”), to which we are not a party. Under the MECO PSA, Warwink Properties received a carry from MECO (through the tanks)
of up to $1,179,076 in the next well drilled on the Winkler County leases. A Certificate of Merger for the merger transaction was filed with
the Secretary of State of Texas on December 5, 2017.
Also on December 1, 2017, the transactions contemplated by the Purchase Agreement that TEI entered into with MPC closed. Under the
Purchase Agreement, which was entered into on November 14, 2017, TEI acquired beneficial ownership of certain of MPC’s assets,
including acreage and wellbores located in Ward County, Texas (the “Ward County Assets”). As consideration under the Purchase
Agreement, at closing TEI issued to MPC an unsecured promissory note in the principal amount of $3,250,000, payable in monthly
installments of interest only beginning on January 1, 2018, at the rate of 5% per annum, with the entire principal amount together with all
accrued interest due and payable on January 1, 2021. In connection with TEI’s acquisition of beneficial ownership in the Ward County
Assets, MPC sold those same assets, on behalf of TEI, to MECO at closing of the MECO PSA, and accordingly, TEI received $3,250,000
in cash for its beneficial interest in the Ward County Assets. Additionally, at closing of the MECO PSA, MPC paid TEI a performance fee
of $2,781,500 in cash as compensation for TEI’s marketing and selling the Winkler County assets of MPC and the Ward County Assets as a
package to MECO.
Addition to the Winkler Project
As of May 7, 2018 our Winkler project in the Delaware Basin had begun the drilling phase of the first Winkler Project well, the UL 21
War-Wink 47 #2H. Our operating partner, MECO had begun the pilot hole on the project. The plan is to evaluate the various potential
zones for a lateral leg to be drilled once logging is completed. We expect the most likely target to be the Wolfcamp A interval. The well is
on 320 newly acquired acres offsetting the original leasehold we entered into in December, 2017. The additional acreage was leased by our
operating partner under the Area of Mutual Interest Agreement (AMI) and we exercised its right to participate for its 12.5% in the
additional 1,080 gross acres at a cash cost of $447,847 in July, 2018. Our carried interest in the first well, as outlined in the agreement, was
originally planned to be on the first acreage acquired. That carried interest is being applied to this new well and will allow MECO to drill
and produce potential revenues sooner than originally planned. The primary leasehold is a 320-acre block directly west of the current
position and will allow for 5,000-foot lateral wells to be drilled. The well was completed and began production in October, 2018.
Two additional wells are planned for development by MECO in 2019.
In December, 2018, the Company began to take measures to market its working interest participation in the Warwink Project in an effort to
focus on the Orogrande.
Hunton Play, Central Oklahoma
As of December 31, 2018, we were producing from one well in the Viking Area of Mutual Interest and one well in Prairie Grove. All other
Oklahoma property interests including the lease interests previously held in the Viking, Rosedale, and Thunderbird AMI’s were abandoned
pursuant to the Settlement and Mutual Release Agreement executed on June 27, 2018.
9
ITEM 1. BUSINESS - continued
Industry and Business Environment
We are experiencing a time of fluctuating oil prices caused by lower demand, higher US Supply, and OPEC’s policies on production.
Unfortunately, this is the cyclical nature of the oil and gas industry. We experience highs and lows that seem to come in cycles. Fortunately,
advances in technology drive the US market and we feel this will drive the development costs down on our exploration and drilling
programs.
Competition
The oil and natural gas industry is intensely competitive, and we will compete with numerous other companies engaged in the exploration
and production of oil and gas. Some of these companies have substantially greater resources than we have. Not only do they explore for and
produce oil and natural gas, but also many carry on midstream and refining operations and market petroleum and other products on a
regional, national, or worldwide basis. The operations of other companies may be able to pay more for exploratory prospects and productive
oil and natural gas properties. They may also have more resources to define, evaluate, bid for, and purchase a greater number of properties
and prospects than our financial or human resources permit.
Our larger or integrated competitors may have the resources to be better able to absorb the burden of current and future federal, state, and
local laws and regulations more easily than we can, which would adversely affect our competitive position. Our ability to locate reserves
and acquire interests in properties in the future will be dependent upon our ability and resources to evaluate and select suitable properties
and consummate transactions in this highly competitive environment. In addition, we may be at a disadvantage in producing oil and natural
gas properties and bidding for exploratory prospects because we have fewer financial and human resources than other companies in our
industry. Should a larger and better financed company decide to directly compete with us, and be successful in its efforts, our business could
be adversely affected.
Marketing and Customers
The market for oil and natural gas that we will produce depends on factors beyond our control, including the extent of domestic production
and imports of oil and natural gas, the proximity and capacity of natural gas pipelines and other transportation facilities, demand for oil and
natural gas, the marketing of competitive fuels, and the effects of state and federal regulation. The oil and gas industry also competes with
other industries in supplying the energy and fuel requirements of industrial, commercial, and individual consumers.
Our oil production is expected to be sold at prices tied to the spot oil markets. Our natural gas production is expected to be sold under
short-term contracts and priced based on first of the month index prices or on daily spot market prices. We will rely on our operating
partners to market and sell our production.
Governmental Regulation and Environmental Matters
Our operations are subject to various rules, regulations, and limitations impacting the oil and natural gas exploration and production
industry as a whole.
Regulation of Oil and Natural Gas Production
Our oil and natural gas exploration, production, and related operations, when developed, will be subject to extensive rules and regulations
promulgated by federal, state, tribal, and local authorities and agencies. Certain states may also have statutes or regulations addressing
conservation matters, including provisions for the unitization or pooling of oil and natural gas properties, the establishment of maximum
rates of production from wells, and the regulation of spacing, plugging, and abandonment of such wells. Failure to comply with any such
rules and regulations can result in substantial penalties. The regulatory burden on the oil and gas industry will most likely increase our cost
of doing business and may affect our profitability. Although we believe we are currently in substantial compliance with all applicable laws
and regulations, because such rules and regulations are frequently amended or reinterpreted, we are unable to predict the future cost or
impact of complying with such laws. Significant expenditures may be required to comply with governmental laws and regulations and may
have a material adverse effect on our financial condition and results of operations.
Environmental Matters
Our operations and properties are and will be subject to extensive and changing federal, state, and local laws and regulations relating to
environmental protection, including the generation, storage, handling, emission, transportation, and discharge of materials into the
environment, and relating to safety and health. In the future, environmental legislation and regulation may trend toward stricter standards.
These laws and regulations may:
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require the acquisition of a permit or other authorization before construction or drilling commences and for certain other activities;
limit or prohibit construction, drilling, and other activities on certain lands lying within wilderness and other protected areas;
impose substantial liabilities for pollution resulting from operations; or
restrict certain areas from fracking and other stimulation techniques.
The permits required for our operations may be subject to revocation, modification, and renewal by issuing authorities. Governmental
authorities have the power to enforce their regulations, and violations are subject to fines or injunctions, or both. In the opinion of
management, we are and will be in substantial compliance with current applicable environmental laws and regulations, and have no material
commitments for capital expenditures to comply with existing environmental requirements. Nevertheless, changes in existing
environmental laws and regulations or in interpretations thereof could have a significant impact on our company, as well as the oil and
natural gas industry in general.
10
ITEM 1. BUSINESS - continued
The Comprehensive Environmental, Response, Compensation, and Liability Act (“CERCLA”) and comparable state statutes impose strict,
joint, and several liability on owners and operators of sites and on persons who disposed of or arranged for the disposal of “hazardous
substances” found at such sites. It is not uncommon for the 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. The Federal Resource Conservation and
Recovery Act (“RCRA”) and comparable state statutes govern the disposal of “solid waste” and “hazardous waste” and authorize the
imposition of substantial fines and penalties for noncompliance. Although CERCLA currently excludes petroleum from its definition of
“hazardous substance,” state laws affecting our operations may impose clean-up liability relating to petroleum and petroleum related
products. In addition, although RCRA classifies certain oil field wastes as “non-hazardous,” such exploration and production wastes could
be reclassified as hazardous wastes thereby making such wastes subject to more stringent handling and disposal requirements.
The Endangered Species Act (“ESA”) seeks to ensure that activities do not jeopardize endangered or threatened animal, fish, and plant
species, nor destroy or modify the critical habitat of such species. Under ESA, exploration and production operations, as well as actions by
federal agencies, may not significantly impair or jeopardize the species or its habitat. ESA provides for criminal penalties for willful
violations of the Act. Other statutes that provide protection to animal and plant species and that may apply to our operations include, but are
not necessarily limited to, the Fish and Wildlife Coordination Act, the Fishery Conservation and Management Act, the Migratory Bird
Treaty Act and the National Historic Preservation Act. Although we believe that our operations will be in substantial compliance with such
statutes, any change in these statutes or any reclassification of a species as endangered could subject our company to significant expenses to
modify our operations or could force our company to discontinue certain operations altogether.
Hydraulic fracturing is regulated by state and federal oil and gas regulatory authorities, including specifically the requirement to disclose
certain information related to hydraulic fracturing operations. Operators must follow applicable legal requirements for groundwater
protection in our operations that are subject to supervision by state and federal regulators (including the Bureau of Land Management on
federal acreage). Furthermore, well construction practices require the installation of multiple layers of protective steel casing surrounded by
cement that are specifically designed and installed to protect freshwater aquifers by preventing the migration of fracturing fluids into
aquifers. Regulatory proposals in some states and local communities have been initiated to require or make more stringent the permitting
and compliance requirements for hydraulic fracturing operations. Federal and state agencies have continued to assess the impacts of
hydraulic fracturing, which could spur further action toward federal and/or state legislation and regulation of hydraulic fracturing activities.
In addition, in light of concerns about seismic activity being triggered by the injection of produced waters into underground wells and
hydraulic fracturing, certain regulators are also considering additional requirements related to seismic safety for hydraulic fracturing
activities. Further restrictions on hydraulic fracturing could make it prohibitive to conduct our operations, and also reduce the amount of oil
and natural gas that we or our operators are ultimately able to produce in commercial quantities from our properties.
Climate Change
Significant studies and research have been devoted to climate change and global warming, and climate change has developed into a major
political issue in the United States and globally. Certain research suggests that greenhouse gas emissions contribute to climate change and
pose a threat to the environment. Recent scientific research and political debate has focused in part on carbon dioxide and methane
incidental to oil and natural gas exploration and production. Many states and the federal government have enacted legislation directed at
controlling greenhouse gas emissions, and future legislation and regulation could impose additional restrictions or requirements in
connection with our drilling and production activities and favor use of alternative energy sources, which could affect operating costs and
demand for oil products. As such, our business could be materially adversely affected by domestic and international legislation targeted at
controlling climate change.
Employees
We currently have two full time employees and no part time employees. We anticipate, as needed, we will add additional employees, and
we will continue using independent contractors, consultants, attorneys, and accountants as necessary to complement services rendered by
our employees. We presently have independent technical professionals under consulting agreements who are available to us on an as
needed basis.
Research and Development
We did not spend any funds on research and development activities during the years ended December 31, 2018 or 2017.
ITEM 1A. RISK FACTORS
An investment in us involves a high degree of risk and is suitable only for prospective investors with substantial financial means who have
no need for liquidity and can afford the entire loss of their investment in us. Prospective investors should carefully consider the following
risk factors, in addition to the other information contained in this report.
Risks Related to our Business and Industry
We have a limited operating history relative to larger companies in our industry, and may not be successful in developing
profitable business operations.
11
ITEM 1A. RISK FACTORS - continued
We have a limited operating history relative to larger companies in our industry. Our business operations must be considered in light of the
risks, expenses and difficulties frequently encountered in establishing a business in the oil and natural gas industries. As of the date of this
report, we have generated limited revenues and have limited assets. We have an insufficient history at this time on which to base an
assumption that our business operations will prove to be successful in the long-term. Our future operating results will depend on many
factors, including:
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our ability to raise adequate working capital;
the success of our development and exploration;
the demand for natural gas and oil;
the level of our competition;
our ability to attract and maintain key management and employees; and
our ability to efficiently explore, develop, produce or acquire sufficient quantities of marketable natural gas or oil in a highly
competitive and speculative environment while maintaining quality and controlling costs.
To achieve profitable operations in the future, we must, alone or with others, successfully manage the factors stated above, as well as
continue to develop ways to enhance our production efforts. Despite our best efforts, we may not be successful in our exploration or
development efforts, or obtain required regulatory approvals. There is a possibility that some, or all, of the wells in which we obtain
interests may never produce oil or natural gas.
We have limited capital and will need to raise additional capital in the future.
We do not currently have sufficient capital to fund both our continuing operations and our planned growth. We will require additional
capital to continue to grow our business via acquisitions and to further expand our exploration and development programs. We may be
unable to obtain additional capital when required. Future acquisitions and future exploration, development, production and marketing
activities, as well as our administrative requirements (such as salaries, insurance expenses and general overhead expenses, as well as legal
compliance costs and accounting expenses) will require a substantial amount of additional capital and cash flow.
We may pursue sources of additional capital through various financing transactions or arrangements, including joint venturing of projects,
debt financing, equity financing, or other means. We may not be successful in identifying suitable financing transactions in the time period
required or at all, and we may not obtain the capital we require by other means. If we do not succeed in raising additional capital, our
resources may not be sufficient to fund our planned operations.
Our ability to obtain financing, if and when necessary, may be impaired by such factors as the capital markets (both generally and in the oil
and gas industry in particular), our limited operating history, the location of our oil and natural gas properties and prices of oil and natural
gas on the commodities markets (which will impact the amount of asset-based financing available to us, if any) and the departure of key
employees. Further, if oil or natural gas prices on the commodities markets decline, our future revenues, if any, will likely decrease and
such decreased revenues may increase our requirements for capital. If the amount of capital we are able to raise from financing activities,
together with our revenues from operations, is not sufficient to satisfy our capital needs (even to the extent that we reduce our operations),
we may be required to cease our operations, divest our assets at unattractive prices or obtain financing on unattractive terms.
Any additional capital raised through the sale of equity may dilute the ownership percentage of our stockholders. Raising any such capital
could also result in a decrease in the fair market value of our equity securities because our assets would be owned by a larger pool of
outstanding equity. The terms of securities we issue in future capital transactions may be more favorable to our new investors, and may
include preferences, superior voting rights and the issuance of other derivative securities, and issuances of incentive awards under equity
employee incentive plans, which may have a further dilutive effect.
We may incur substantial costs in pursuing future capital financing, including investment banking fees, legal fees, accounting fees,
securities law compliance fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses
in connection with certain securities we may issue, which may adversely impact our financial condition.
Our auditor indicated that certain factors raise substantial doubt about our ability to continue as a going concern.
The financial statements included with this report are presented under the assumption that we will continue as a going concern, which
contemplates the realization of assets and the satisfaction of liabilities in the normal course of business over a reasonable length of time.
We had a net loss of approximately $5.8 million for the year ended December 31, 2018 and an accumulated deficit in aggregate of
approximately $89.3 million at year end. We are not generating sufficient operating cash flows to support continuing operations, and expect
to incur further losses in the development of our business.
12
ITEM 1A. RISK FACTORS - continued
In our financial statements for the year ended December 31, 2018, our auditor indicated that certain factors raised substantial doubt about
our ability to continue as a going concern. These factors included our accumulated deficit, as well as the fact that we were not generating
sufficient cash flows to meet our regular working capital requirements. Our ability to continue as a going concern is dependent upon our
ability to generate future profitable operations and/or to obtain the necessary financing to meet our obligations and repay our liabilities
arising from normal business operations when they come due. Management’s plan to address our ability to continue as a going concern
includes: (1) obtaining debt or equity funding from private placement or institutional sources; (2) obtaining loans from financial institutions,
where possible, or (3) participating in joint venture transactions with third parties. Although management believes that it will be able to
obtain the necessary funding to allow us to remain a going concern through the methods discussed above, there can be no assurances that
such methods will prove successful. The accompanying financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
The negative covenants contained in our outstanding unsecured promissory notes may limit our activities and make it difficult to
run our business.
On April 10, 2017, we sold to investors in a private transaction two 12% unsecured promissory notes with a total of $8,000,000 in principal
amount, or the 2017 Notes. In addition, on February 6, 2018, we sold to an investor in a private transaction a 12% unsecured promissory
note with a principal amount of $4,500,000, or the 2018 Note, containing substantially the same terms as the 2017 Notes. We refer to the
2017 Notes and the 2018 Note collectively as, the Notes. Interest only is due and payable on the Notes each month at the rate of 12% per
annum, with a balloon payment of the outstanding principal due and payable at maturity on April 10, 2020. The holders of the Notes will
also receive annual payments of common stock at the rate of 2.5% of principal amountoutstanding, based on a volume-weighted average
price. We sold the 2017 Notes at an original issue discount of 94.25% and accordingly, we received total proceeds of $7,540,000 from the
investors. We sold the 2018 Note at an original issue discount of 96.27% and accordingly, we received total proceeds of $4,332,150 from
the investor. The Notes allow for early redemption, provided that if we redeem before April 10, 2018 for the 2017 Notes and February 6,
2019 for the 2018 Note, we must pay the holder all unpaid interest and common stock payments on the portion of the Note redeemed that
would have been earned through April 10, 2018 and February 6, 2019, respectively.
The Notes contain negative covenants which may make it difficult for us to run our business. Under the Notes, we may not, directly or
indirectly, consolidate with or merge into another person or sell, lease, convey or transfer all or substantially all of our assets (computed on
a consolidated basis), unless either (i) in the case of a merger or consolidation, we are the surviving entity or (ii) the resulting, surviving or
transferee entity expressly assumes by supplemental agreement all of the obligations of us in connection with the Notes.
In addition, the Notes also contain certain covenants under which we have agreed that, except for financing arrangements with established
commercial banking or financial institutions and other debts and liabilities incurred in the normal course of business, we will not issue any
other notes or debt offerings which have a maturity date prior to the payment in full of the respective Note, unless consented to by the
holder. Further, our subsidiaries cannot sell or otherwise dispose of any shares of capital stock or assets unless the transaction is for fair
value and approved by our disinterested directors or is pursuant to any contractual obligation entered into by us in the ordinary course of
business in connection with drilling, exploration and development of our oil and gas properties.
The Notes also restrict us and our subsidiaries from (i) issuing any preferred stock or any other comparable equity interest which are
mandatorily redeemable at a date prior to the maturity date of the Notes, without the consent or approval of the holder, (ii) distributing any
cash or other assets to any holders of our common stock prior to payment in full of the Notes, without the consent of the holder, (iii)
entering into any transaction with an affiliate, subject to limited exceptions, and (iv) issuing any other notes or debt offerings which have a
maturity date prior to the payment in full of the Notes, unless consented to by the holder.
Failure to comply with the negative covenants could accelerate the repayment of any debt outstanding under the Notes. Additionally, as a
result of these negative covenants, we may be at a disadvantage compared to our competitors that have greater operating and financing
flexibility than we do.
Lastly, we may have difficulty securing additional sources of capital through debt financing. If we do not succeed in raising additional
capital, our resources may not be sufficient to fund our planned operations.
As a non-operator, our development of successful operations relies extensively on third-parties who, if not successful, could have a
material adverse effect on our results of operation.
We expect to primarily participate in wells operated by third-parties. As a result, we will not control the timing of the development,
exploitation, production and exploration activities relating to leasehold interests we acquire. We do, however, have certain rights as granted
in our joint operating agreements that allow us a certain degree of freedom such as, but not limited to, the ability to propose the drilling of
wells. If our drilling partners are not successful in such activities relating to our leasehold interests, or are unable or unwilling to perform,
our financial condition and results of operation could have an adverse material effect.
Further, financial risks are inherent in any operation where the cost of drilling, equipping, completing and operating wells is shared by more
than one person. We could be held liable for the joint activity obligations of the operator or other working interest owners such as
nonpayment of costs and liabilities arising from the actions of the working interest owners. In the event the operator or other working
interest owners do not pay their share of such costs, we would likely have to pay those costs. In such situations, if we were unable to pay
those costs, there could be a material adverse effect to our financial position.
13
We are mainly concentrated in one geographic area, which increases our exposure to many of the risks enumerated herein.
Operating in a concentrated area increases the potential impact that many of the risks stated herein may have upon our ability to perform.
For example, we have greater exposure to regulatory actions impacting Texas, natural disasters in the geographic area, competition for
equipment, services and materials available in the area and access to infrastructure and markets. In addition, the effect of fluctuations on
supply and demand may become more pronounced within specific geographic oil and gas producing areas such as the Permian Basin,
which may cause these conditions to occur with greater frequency or magnify the effect of these conditions. Due to the concentrated
nature of our portfolio of properties, a number of our properties could experience any of the same conditions at the same time, resulting in
a relatively greater impact on our results of operations than they might have on other companies that have a more diversified portfolio of
properties. Such delays or interruptions could have a material adverse effect on our financial condition and results of operations.
We may be unable to monetize the Hazel and Warwink Projects at an attractive price, if at all, and the disposition of such assets
may involve risks and uncertainties.
We have commenced a process that could result in the monetization of the Hazel and Warwink Projects. Such dispositions may result in
proceeds to us in an amount less than we expect or less than our assessment of the value of the assets. We do not know if we will be able to
successfully complete such disposition on favorable terms or at all. In addition, the sale of theseassets involves risks and uncertainties,
including disruption to other parts of our business, potential loss of customers or revenue, exposure to unanticipated liabilities or result in
ongoing obligations and liabilities to us following any such divestiture.
For example, in connection with a disposition, we may enter into transition services agreements or other strategic relationships, which may
result in additional expense. In addition, in connection with a disposition, we may be required to make representations about the business
and financial affairs of the business or assets. We may also be required to indemnify the purchasers to the extent that our representations
turn out to be inaccurate or with respect to certain potential liabilities. These indemnification obligations may require us to pay money to
the purchasers as satisfaction of their indemnity claims. It may also take us longer than expected to fully realize the anticipated benefits of
this transaction, and those benefits may ultimately be smaller than anticipated or may not be realized at all, which could adversely affect
our business and operating results. Any of the foregoing could adversely affect our financial condition and results of operations.
Because of the speculative nature of oil and gas exploration, there is risk that we will not find commercially exploitable oil and gas
and that our business will fail.
The search for commercial quantities of oil and natural gas as a business is extremely risky. We cannot provide investors with any
assurance that any properties in which we obtain a mineral interest will contain commercially exploitable quantities of oil and/or gas. The
exploration expenditures to be made by us may not result in the discovery of commercial quantities of oil and/or gas. Problems such as
unusual or unexpected formations or pressures, premature declines of reservoirs, invasion of water into producing formations and other
conditions involved in oil and gas exploration often result in unsuccessful exploration efforts. If we are unable to find commercially
exploitable quantities of oil and gas, and/or we are unable to commercially extract such quantities, we may be forced to abandon or curtail
our business plan, and as a result, any investment in us may become worthless.
Strategic relationships upon which we may rely are subject to change, which may diminish our ability to conduct our operations.
Our ability to successfully acquire oil and gas interests, to build our reserves, to participate in drilling opportunities and to identify and enter
into commercial arrangements with customers will depend on developing and maintaining close working relationships with industry
participants and our ability to select and evaluate suitable properties and to consummate transactions in a highly competitive environment.
These realities are subject to change and our inability to maintain close working relationships with industry participants or continue to
acquire suitable property may impair our ability to execute our business plan.
To continue to develop our business, we will endeavor to use the business relationships of our management to enter into strategic
relationships, which may take the form of joint ventures with other private parties and contractual arrangements with other oil and gas
companies, including those that supply equipment and other resources that we will use in our business. We may not be able to establish
these strategic relationships, or if established, we may not be able to maintain them. In addition, the dynamics of our relationships with
strategic partners may require us to incur expenses or undertake activities we would not otherwise be inclined to in order to fulfill our
obligations to these partners or maintain our relationships. If our strategic relationships are not established or maintained, our business
prospects may be limited, which could diminish our ability to conduct our operations.
The price of oil and natural gas has historically been volatile. If it were to decrease substantially, our projections, budgets, and
revenues would be adversely affected, potentially forcing us to make changes in our operations.
Our future financial condition, results of operations and the carrying value of any oil and natural gas interests we acquire will depend
primarily upon the prices paid for oil and natural gas production. Oil and natural gas prices historically have been volatile and likely will
continue to be volatile in the future, especially given current world geopolitical conditions. Our cash flows from operations are highly
dependent on the prices that we receive for oil and natural gas. This price volatility also affects the amount of our cash flows available for
capital expenditures and our ability to borrow money or raise additional capital. The prices for oil and natural gas are subject to a variety of
additional factors that are beyond our control. These factors include:
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the level of consumer demand for oil and natural gas;
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ITEM 1A. RISK FACTORS - continued
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the domestic and foreign supply of oil and natural gas;
the ability of the members of the Organization of Petroleum Exporting Countries (“OPEC”) to agree to and maintain oil price and
production controls;
the price of foreign oil and natural gas;
domestic governmental regulations and taxes;
the price and availability of alternative fuel sources;
weather conditions;
market uncertainty due to political conditions in oil and natural gas producing regions, including the Middle East; and
worldwide economic conditions.
These factors as well as the volatility of the energy markets generally make it extremely difficult to predict future oil and natural gas price
movements with any certainty. Declines in oil and natural gas prices affect our revenues, and could reduce the amount of oil and natural gas
that we can produce economically. Accordingly, such declines could have a material adverse effect on our financial condition, results of
operations, oil and natural gas reserves and the carrying values of our oil and natural gas properties. If the oil and natural gas industry
experiences significant price declines, we may be unable to make planned expenditures, among other things. If this were to happen, we may
be forced to abandon or curtail our business operations, which would cause the value of an investment in us to decline or become
worthless.
If oil or natural gas prices remain depressed or drilling efforts are unsuccessful, we may be required to record additional write
downs of our oil and natural gas properties.
If oil or natural gas prices remain depressed or drilling efforts are unsuccessful, we could be required to write down the carrying value of
certain of our oil and natural gas properties. Write downs may occur when oil and natural gas prices are low, or if we have downward
adjustments to our estimated proved reserves, increases in our estimates of operating or development costs, deterioration in drilling results
or mechanical problems with wells where the cost to re drill or repair is not supported by the expected economics.
Under the full cost method of accounting, capitalized oil and gas property costs less accumulated depletion and net of deferred income
taxes may not exceed an amount equal to the present value, discounted at 10%, of estimated future net revenues from proved oil and gas
reserves plus the cost of unproved properties not subject to amortization (without regard to estimates of fair value), or estimated fair value,
if lower, of unproved properties that are subject to amortization. Should capitalized costs exceed this ceiling, an impairment would be
recognized.
The Company recognized an impairment charge of $139,891 in 2018 and -0- in 2017.
During the year ended December 31, 2017 the Company performed assessments of evaluated and unevaluated costs in the cost pool to
conform the cumulative value of the Full Cost Pool to the combined amount of Reserve Value of evaluated, producing properties (as
determined by independent analysis at December 31, 2017), plus the lesser of cumulative historical cost or estimated realizable value of
unevaluated leases and projects expected to commence production in future operating periods. The Company identified impairment of
$2,300,626 in 2017 related to its unevaluated properties. Although we had no recognized impairment expense in 2017, the Company has
adjusted the separation of evaluated versus unevaluated costs within its full cost pool to recognize the value impairment related to the
expiration of unevaluated leases in 2017 in the amount of $2,300,626. The impact of this change will be to increase the basis for calculation
of future period’s depletion, depreciation and amortization to include $2,300,626 of cost which will effectively recognize the impairment on
the Statement of Operations over future periods. The $2,300,626 has also become an evaluated cost for purposes of future period’s Ceiling
Tests and which may further recognize the impairment expense recognized in future periods.
Because of the inherent dangers involved in oil and gas operations, there is a risk that we may incur liability or damages as we
conduct our business operations, which could force us to expend a substantial amount of money in connection with litigation and/or
a settlement.
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ITEM 1A. RISK FACTORS - continued
The oil and natural gas business involves a variety of operating hazards and risks such as well blowouts, pipe failures, casing collapse,
explosions, uncontrollable flows of oil, natural gas or well fluids, fires, spills, pollution, releases of toxic gas and other environmental
hazards and risks. These hazards and risks could result in substantial losses to us from, among other things, injury or loss of life, severe
damage to or destruction of property, natural resources and equipment, pollution or other environmental damage, cleanup responsibilities,
regulatory investigation and penalties and suspension of operations. In addition, we may be liable for environmental damages caused by
previous owners of property purchased and leased by us. In recent years, there has also been increased scrutiny on the environmental risk
associated with hydraulic fracturing, such as underground migration and surface spillage or mishandling of fracturing fluids including
chemical additives. This technology has evolved and continues to evolve and become more aggressive. We believe that new techniques can
increase estimated ultimate recovery per well to over 1.0 million barrels of oil equivalent, and have increased initial production two or three
fold. We believe that recent designs have seen improvement in, among other things, proppant per foot, barrels of water per stage, fracturing
stages, and clusters per fracturing stage. As a result, substantial liabilities to third parties or governmental entities may be incurred, the
payment of which could reduce or eliminate the funds available for exploration, development or acquisitions or result in the loss of our
properties and/or force us to expend substantial monies in connection with litigation or settlements. In addition, we will need to quickly
adapt to the evolving technology, which could take time and divert our attention to other business matters. We currently have no insurance
to cover such losses and liabilities, and even if insurance is obtained, it may not be adequate to cover any losses orliabilities. We cannot
predict the availability of insurance or the availability of insurance at premium levels that justify our purchase. The occurrence of a
significant event not fully insured or indemnified against could materially and adversely affectour financial condition and operations. We
may elect to self-insure if management believes that the cost of insurance, although available, is excessive relative to the risks presented. In
addition, pollution and environmental risks generally are not fully insurable. The occurrence of an event not fully covered by insurance
could have a material adverse effect on our financial condition and results of operations.
The market for oil and gas is intensely competitive, and competition pressures could force us to abandon or curtail our business
plan.
The market for oil and gas exploration services is highly competitive, and we only expect competition to intensify in the future. Numerous
well-established companies are focusing significant resources on exploration and are currently competing with us for oil and gas
opportunities. Other oil and gas companies may seek to acquire oil and gas leases and properties that we have targeted. Additionally, other
companies engaged in our line of business may compete with us from time to time in obtaining capital from investors. Competitors include
larger companies which, in particular, may have access to greater resources, may be more successful in the recruitment and retention of
qualified employees and may conduct their own refining and petroleum marketing operations, which may give them a competitive
advantage. Actual or potential competitors may be strengthened through the acquisition of additional assets and interests. Additionally,
there are numerous companies focusing their resources on creating fuels and/or materials which serve the same purpose as oil and gas, but
are manufactured from renewable resources.
As a result, we may not be able to compete successfully and competitive pressures may adversely affect our business, results of operations,
and financial condition. If we are not able to successfully compete in the marketplace, we could be forced to curtail or even abandon our
current business plan, which could cause any investment in us to become worthless.
We may not be able to successfully manage our expected growth, which could lead to our inability to implement our business plan.
Our expected growth may place a significant strain on our managerial, operational and financial resources, especially considering that we
currently only have a small number of executive officers, employees and advisors. Further, as we enter into additional contracts, we will be
required to manage multiple relationships with various consultants, businesses and other third parties. These requirements will be
exacerbated in the event of our further growth or in the event that the number of our drilling and/or extraction operations increases. Our
systems, procedures and/or controls may not be adequate to support our operations or that our management will be able to achieve the rapid
execution necessary to successfully implement our business plan. If we are unable to manage our growth effectively, our business, results
of operations and financial condition will be adversely affected, which could lead to us being forced to abandon or curtail our business plan
and operations.
The due diligence undertaken by us in connection with all of our acquisitions may not have revealed all relevant considerations or
liabilities related to those assets, which could have a material adverse effect on our financial condition or results of operations.
The due diligence undertaken by us in connection with the acquisition of our properties may not have revealed all relevant facts that may
be necessary to evaluate such acquisitions. The information provided to us in connection with our diligence may have been incomplete or
inaccurate. As part of the diligence process, we have also made subjective judgments regarding the results of operations and prospects of
the assets. If the due diligence investigations have failed to correctly identify material issues and liabilities that may be present, such as title
defects or environmental problems, we may incur substantial impairment charges or other losses in the future. In addition, we may be
subject to significant, previously undisclosed liabilities that were not identified during the due diligence processes and which may have a
material adverse effect on our financial condition or results of operations.
Our operations are heavily dependent on current environmental regulation, changes in which we cannot predict.
Oil and natural gas activities that we will engage in, including production, processing, handling and disposal of hazardous materials, such as
hydrocarbons and naturally occurring radioactive materials (if any), are subject to stringent regulation. We could incur significant costs,
including cleanup costs resulting from a release of hazardous material, third-party claims for property damage and personal injuries fines
and sanctions, as a result of any violations or liabilities under environmental or other laws. Changes in or more stringent enforcement of
environmental laws could force us to expend additional operating costs and capital expenditures to stay in compliance.
16
ITEM 1A. RISK FACTORS - continued
Various federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of
the environment, directly impact oil and gas exploration, development and production operations, and consequently may impact our
operations and costs. These regulations include, among others, (i) regulationsby the Environmental Protection Agency and various state
agencies regarding approved methods of disposal for certain hazardous and non-hazardous wastes; (ii) the Comprehensive Environmental
Response, Compensation, and Liability Act, Federal Resource Conservation and Recovery Act and analogous state laws which regulate the
removal or remediation of previously disposed wastes (including wastes disposed of or released by prior owners or operators), property
contamination (including groundwater contamination),and remedial plugging operations to prevent future contamination; (iii) the Clean Air
Act and comparable state and local requirements which may result in the gradual imposition of certain pollution control requirements with
respect to air emissions from our operations; (iv) the Oil Pollution Act of 1990 which contains numerous requirements relating to the
prevention of and response to oil spills into waters of the United States; (v) the Resource Conservation and Recovery Act which is the
principal federal statute governing the treatment, storage and disposal of hazardous wastes; and (vi) state regulations and statutes governing
the handling, treatment, storage and disposal of naturally occurring radioactive material.
We believe that we will be in substantial compliance with applicable environmental laws and regulations. To date, we have not expended
any amounts to comply with such regulations, and we do not currently anticipate that future compliance will have a materially adverse
effect on our consolidated financial position, results of operations or cash flows. However, if we are deemed to not be in compliance with
applicable environmental laws, we could be forced to expend substantial amounts to be in compliance, which would have a materially
adverse effect on our financial condition.
Government regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating
restrictions or delays.
Vast quantities of natural gas, natural gas liquids and oil deposits exist in deep shale and other unconventional formations. It is customary
in our industry to recover these resources through the use of hydraulic fracturing, combined with horizontal drilling. Hydraulic fracturing is
the process of creating or expanding cracks, or fractures, in deep underground formations using water, sand and other additives pumped
under high pressure into the formation. As with the rest of the industry, our third-party operating partners use hydraulic fracturing as a
means to increase the productivity of most of the wells they drill and complete. These formations are generally geologically separated and
isolated from fresh ground water supplies by thousands of feet of impermeable rock layers.
We believe our third-party operating partners follow applicable legal requirements for groundwater protection in their operations that are
subject to supervision by state and federal regulators. Furthermore, we believe our third-party operating partners’ well construction
practices are specifically designed to protect freshwater aquifers by preventing the migration of fracturing fluids into aquifers.
Hydraulic fracturing is typically regulated by state oil and gas commissions. Some states have adopted, and other states are considering
adopting, regulations that could impose more stringent permitting, public disclosure, and/or well construction requirements on hydraulic
fracturing operations.
In addition to state laws, some local municipalities have adopted or are considering adopting land use restrictions, such as city ordinances,
that may restrict or prohibit the performance of well drilling in general and/or hydraulic fracturing in particular. There are also certain
governmental reviews either underway or being proposed that focus on deep shale and other formation completion and production
practices, including hydraulic fracturing. Depending on the outcome of these studies, federal and state legislatures and agencies may seek
to further regulate such activities. Certain environmental and other groups have also suggested that additional federal, state and local laws
and regulations may be needed to more closely regulate the hydraulic fracturing process.
Further, the EPA has asserted federal regulatory authority over hydraulic fracturing involving “diesel fuels” under the Solid Waste
Disposal Act’s Underground Injection Control Program . The EPA is also engaged in a study of the potential impacts of hydraulic
fracturing activities on drinking water resources in the states where the EPA is the permitting authority. These actions, in conjunction with
other analyses by federal and state agencies to assess the impacts of hydraulic fracturing could spur further action toward federal and/or
state legislation and regulation of hydraulic fracturing activities.
We cannot predict whether additional federal, state or local laws or regulations applicable to hydraulic fracturing will be enacted in the
future and, if so, what actions any such laws or regulations would require or prohibit. Restrictions on hydraulic fracturing could make it
prohibitive for our third-party operating partners to conduct operations, and also reduce the amount of oil, natural gas liquids and natural
gas that we are ultimately able to produce in commercial quantities from our properties. If additional levels of regulation or permitting
requirements were imposed on hydraulic fracturing operations, our business and operations could be subject to delays, increased operating
and compliance costs and process prohibitions.
Our estimates of the volume of reserves could have flaws, or such reserves could turn out not to be commercially extractable. As a
result, our future revenues and projections could be incorrect.
17
ITEM 1A. RISK FACTORS - continued
Estimates of reserves and of future net revenues prepared by different petroleum engineers may vary substantially depending, in part, on
the assumptions made and may be subject to adjustment either up or down in the future. Our actual amounts of production, revenue,
taxes, development expenditures, operating expenses, and quantities of recoverable oil and gas reserves may vary substantially from the
estimates. Oiland gas reserve estimates are necessarily inexact and involve matters of subjective engineering judgment. In addition, any
estimates of our future net revenues and the present value thereof are based on assumptions derived in part from historical price and cost
information, which may not reflect current and future values, and/or other assumptions made by us that only represent our best estimates.
If these estimates of quantities, prices and costs prove inaccurate, we may be unsuccessful in expanding our oil and gas reserves base with
our acquisitions. Additionally, if declines in and instability of oil and gas prices occur, then write downs in the capitalized costs associated
with any oil and gas assets we obtain may be required. Because of the nature of the estimates of our reserves and estimates in general,
reductions to our estimated proved oil and gas reserves and estimated future net revenues may not be required in the future, and/or that
our estimated reserves may not present and/or commercially extractable. If our reserve estimates are incorrect, we may be forced to write
down the capitalized costs of our oil and gas properties.
Decommissioning costs are unknown and may be substantial. Unplanned costs could divert resources from other projects.
We may become responsible for costs associated with abandoning and reclaiming wells, facilities and pipelines which we use for
production of oil and natural gas reserves. Abandonment and reclamation of these facilities and the costs associated therewith is often
referred to as “decommissioning.” We accrue a liability for decommissioning costs associated with our wells, but have not established any
cash reserve account for these potential costs in respect of any of our properties. If decommissioning is required before economic
depletion of our properties or if our estimates of the costs of decommissioning exceed the value of the reserves remaining at any
particular time to cover such decommissioning costs, we may have to draw on funds from other sources to satisfy such costs. The use of
other funds to satisfy such decommissioning costs could impair our ability to focus capital investment in other areas of our business.
We may have difficulty distributing production, which could harm our financial condition.
In order to sell the oil and natural gas that we are able to produce, if any, the operators of the wells we obtain interests in may have to
make arrangements for storage and distribution to the market. We will rely on local infrastructure and the availability of transportation for
storage and shipment of our products, but infrastructure development and storage and transportation facilities may be insufficient for our
needs at commercially acceptable terms in the localities in which we operate. This situation could be particularly problematic to the extent
that our operations are conducted in remote areas that are difficult to access, such as areas that are distant from shipping and/or pipeline
facilities. These factors may affect our and potential partners’ ability to explore and develop properties and to store and transport oil and
natural gas production, increasing our expenses.
Furthermore, weather conditions or natural disasters, actions by companies doing business in one or more of the areas in which we will
operate, or labor disputes may impair the distribution of oil and/or natural gas and in turn diminish our financial condition or ability to
maintain our operations.
Our business will suffer if we cannot obtain or maintain necessary licenses.
Our operations will require licenses, permits and in some cases renewals of licenses and permits from various governmental authorities.
Our ability to obtain, sustain or renew such licenses and permits on acceptable terms is subject to change in regulations and policies and
to the discretion of the applicable governments, among other factors. Our inability to obtain, or our loss of or denial of extension of, any
of these licenses or permits could hamper our ability to produce revenues from our operations.
Challenges to our properties may impact our financial condition.
Title to oil and gas interests is often not capable of conclusive determination without incurring substantial expense. While we have made
and intend to make appropriate inquiries into the title of properties and other development rights we have acquired and intend to acquire,
title defects may exist. In addition, we may be unable to obtain adequate insurance for title defects, on a commercially reasonable basis
or at all. If title defects do exist, it is possible that we may lose all or a portion of our right, title and interests in and to the properties to
which the title defects relate. If our property rights are reduced, our ability to conduct our exploration, development and production
activities may be impaired. To mitigate title problems, common industry practice is to obtain a title opinion from a qualified oil and gas
attorney prior to the drilling operations of a well.
We rely on technology to conduct our business, and our technology could become ineffective or obsolete.
We rely on technology, including geographic and seismic analysis techniques and economic models, to develop our reserve estimates
and to guide our exploration, development and production activities. We and our operator partners will be required to continually
enhance and update our technology to maintain its efficacy and to avoid obsolescence. The costs of doing so may be substantial and may
be higher than the costs that we anticipate for technology maintenance and development. If we are unable to maintain the efficacy of our
technology, our ability to manage our business and to compete may be impaired. Further, even if we are able to maintain technical
effectiveness, our technology may not be the most efficient means of reaching our objectives, in which case we may incur higher
operating costs than we would were our technology more efficient.
18
ITEM 1A. RISK FACTORS - continued
The loss of key personnel would directly affect our efficiency and profitability.
Our future success is dependent, in a large part, on retaining the services of our current management team. Our executive officers possess
a unique and comprehensive knowledge of our industry and related matters that are vital to our success within the industry. The
knowledge, leadership and technical expertise of these individuals would be difficult to replace. The loss of one or more of our officers
could have a material adverse effect on our operating and financial performance, including our ability to develop and execute our long-
term business strategy. We do not maintain key-man life insurance with respect to any employees. We do have employment agreements
with each of our executive officers.
We have limited management and staff and are dependent upon partnering arrangements and third-party service providers.
We currently have two full-time employees, including our Chief Executive Officer and Chief Financial Officer. The loss of these
individuals would have an adverse effect on our business, as we have very limited personnel. We leverage the services of other
independent consultants and contractors to perform various professional services, including engineering, oil and gas well planning and
supervision, and land, legal, environmental and tax services. We also pursue alliances with partners in the areas of geological and
geophysical services and prospect generation, evaluation and prospect leasing. Our dependence on third-party consultants and service
providers create a number of risks, including but not limited to:
● the possibility that such third parties may not be available to us as and when needed; and
● the risk that we may not be able to properly control the timing and quality of work conducted with respect to its projects.
If we experience significant delays in obtaining the services of such third parties or they perform poorly, our results of operations and
stock price could be materially adversely affected.
Our officers and directors control a significant percentage of our current outstanding common stock and their interests may
conflict with those of our stockholders.
As of the date of this report, our executive officers and directors collectively and beneficially own approximately 28% of our outstanding
common stock (see Item 12 of this report for an explanation of how this number is computed). This concentration of voting control gives
these affiliates substantial influence over any matters which require a stockholder vote, including without limitation the election of
directors and approval of merger and/or acquisition transactions, even if their interests may conflict with those of other stockholders. It
could have the effect of delaying or preventing a change in control or otherwise discouraging a potential acquirer from attempting to
obtain control of us. This could have a material adverse effect on the market price of our common stock or prevent our stockholders from
realizing a premium over the then prevailing market prices for their shares of common stock.
In the future, we may incur significant increased costs as a result of operating as a public company, and our management may be
required to devote substantial time to new compliance initiatives.
In the future, we may incur significant legal, accounting, and other expenses as a result of operating as a public company. The Sarbanes-
Oxley Act of 2002 (the “Sarbanes-Oxley Act”), as well as new rules subsequently implemented by the SEC, have imposed various
requirements on public companies, including requiring changes in corporate governance practices. Our management and other personnel
will need to devote a substantial amount of time to these new compliance initiatives. Moreover, these rules and regulations will increase
our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, we expect these
new rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we
may be required to incur substantial costs to maintain the same or similar coverage.
In addition, the Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and
disclosure controls and procedures. In particular, we are required to perform system and process evaluation and testing on the
effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. In performing this
evaluation and testing, management concluded that our internal control over financial reporting is effective as of December 31, 2018. Our
continued compliance with Section 404, will require that we incur substantial accounting expense and expend significant management
efforts. We do not have an internal audit group. We have however, engaged independent professional assistance for the evaluation and
testing of internal controls.
19
ITEM 1A. RISK FACTORS - continued
Terrorist attacks or cyber-incidents could result in information theft, data corruption, operational disruption and/or financial loss.
Like most companies, we have become increasingly dependent upon digital technologies, including information systems, infrastructure and
cloud applications and services, to operate our businesses, to process and record financial and operating data, communicate with our
business partners, analyze mine and mining information, estimate quantities of coal reserves, as well as other activities related to our
businesses. Strategic targets, such as energy-related assets, may be at greater risk of future terrorist or cyber-attacks than other targets in
the United States. Deliberate attacks on, or security breaches in, our systems or infrastructure, or the systems or infrastructure of third
parties, or cloud-based applications could lead to corruption or loss of our proprietary data and potentially sensitive data, delays in
production or delivery, difficulty in completing and settling transactions, challenges in maintaining our books and records, environmental
damage, communication interruptions, other operational disruptions and third-party liability. Our insurance may not protect us against such
occurrences. Consequently, it is possible that any of these occurrences, or a combination of them, could have a material adverse effect on
our business, financial condition, results of operations and cash flows. Further, as cyber incidents continue to evolve, we may be required to
expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate any vulnerability to
cyber incidents.
We have adopted an Information Security Policy and Acceptable Use Statement to address precautions with respect to data security and we
have created an Incident Response Plan which outlines appropriate responses in case of a reported breach. These policies and plan have
been executed in coordination with our independent Information Technology Service provider.
Certain Factors Related to Our Common Stock
There presently is a limited market for our common stock, and the price of our common stock may be volatile.
Our common stock is currently quoted on The NASDAQ Stock Market LLC. There could be volatility in the volume and market price of
our common stock moving forward. This volatility may be caused by a variety of factors, including the lack of readily available quotations,
the absence of consistent administrative supervision of “bid” and “ask” quotations, and generally lower trading volume. In addition, factors
such as quarterly variations in our operating results, changes in financial estimates by securities analysts, or our failure to meet our or their
projected financial and operating results, litigation involving us, factors relating to the oil and gas industry, actions by governmental
agencies, national economic and stock market considerations, as well as other events and circumstances beyond our control could have a
significant impact on the future market price of our common stock and the relative volatility of such market price.
Securities analysts may not initiate coverage or continue to cover our shares of common stock and this may have a negative impact
on the market price of our shares of common stock.
The trading market for our shares of common stock will depend, in part, on the research and reports that securities analysts publish about
our business and our shares of common stock. We do not have any control over these analysts. If securities analysts do not cover our shares
of common stock, the lack of research coverage may adversely affect the market price of those shares. If securities analysts do cover our
shares of common stock, they could issue reports or recommendations that are unfavorable to the price of our shares of common stock, and
they could downgrade a previously favorable report or recommendation, and in either case our share prices could decline as a result of the
report. If one or more of these analysts does not initiate coverage, ceases to cover our shares of common stock or fails to publish regular
reports on our business, we could lose visibility in the financial markets, which could cause our share prices or trading volume to decline.
Offers or availability for sale of a substantial number of shares of our common stock may cause the price of our common stock to
decline.
Our stockholders could sell substantial amounts of common stock in the public market, including shares sold upon the filing of a
registration statement that registers such shares and/or upon the expiration of any statutory holding period under Rule 144 of the Securities
Act of 1933 (the “Securities Act”), if available, or upon the expiration of trading limitation periods. Such volume could create a
circumstance commonly referred to as a market “overhang” and in anticipation of which the market price of our common stock could fall.
Additionally, we have a large number of warrants that are presently exercisable. The exercise of a large amount of these securities followed
by the subsequent sale of the underlying stock in the market would likely have a negative effect on our common stock’s market price. The
existence of an overhang, whether or not sales have occurred or are occurring, also could make it more difficult for us to secure additional
financing through the sale of equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate.
20
ITEM 1A. RISK FACTORS - continued
Our directors and officers have rights to indemnification.
Our Bylaws provide, as permitted by governing Nevada law, that we will indemnify our directors, officers, and employees, whether or not
then in service as such, against all reasonable expenses actually and necessarily incurred by him or her in connection with the defense of
any litigation to which the individual may have been made a party because he or she is or was a director, officer, or employee of the
company. The inclusion of these provisions in the Bylaws may have the effect of reducing the likelihood of derivative litigation against
directors and officers, and may discourage or deter stockholders or management from bringing a lawsuit against directors and officers for
breach of their duty of care, even though such an action, if successful, might otherwise have benefited us and our stockholders.
We do not anticipate paying any cash dividends on our common stock.
We do not anticipate paying cash dividends on our common stock for the foreseeable future. The payment of dividends, if any, would be
contingent upon our revenues and earnings, if any, capital requirements, and general financial condition. The payment of any dividends will
be within the discretion of our Board of Directors. We presently intend to retain all earnings, if any, to implement our business strategy;
accordingly, we do not anticipate the declaration of any dividends in the foreseeable future.
NASDAQ may delist our common stock from trading on its exchange, which could limit shareholders’ ability to trade our common
stock.
As a listed company on NASDAQ, we are required to meet certain financial, public float, bid price and liquidity standards on an ongoing
basis in order to continue the listing of our common stock. If we fail to meet these continued listing requirements, our common stock may
be subject to delisting. If our common stock is delisted and we are not able to list our common stock on another national securities
exchange, we expect our securities would be quoted on an over-the-counter market. If this were to occur, our shareholders could face
significant material adverse consequences, including limited availability of market quotations for our common stock and reduced liquidity
for the trading of our securities. In addition, we could experience a decreased ability to issue additional securities and obtain additional
financing in the future.
Issuance of our stock in the future could dilute existing shareholders and adversely affect the market price of our common stock.
We have the authority to issue up to 150,000,000 shares of common stock and 10,000,000 shares of preferred stock, and to issue options
and warrants to purchase shares of our common stock. We are authorized to issue significant amounts of common stock in the future,
subject only to the discretion of our board of directors. These future issuances could be at values substantially below the price paid for our
common stock by investors. In addition, we could issue large blocks of our stock to fend off unwanted tender offers or hostile takeovers
without further shareholder approval. Because the trading volume of our common stock is relatively low, the issuance of our stock may
have a disproportionately large impact on its price compared to larger companies.
The issuance of preferred stock in the future could adversely affect the rights of the holders of our common stock.
An issuance of preferred stock could result in a class of outstanding securities that would have preferences with respect to voting rights and
dividends and in liquidation over the common stock and could, upon conversion or otherwise, have all of the rights of our common stock.
Our board of directors’ authority to issue preferred stock could discourage potential takeover attempts or could delay or prevent a change in
control through merger, tender offer, proxy contest or otherwise by making these attempts more difficult or costly to achieve.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not Applicable.
21
ITEM 2. PROPERTIES
Our principal executive offices are located at 5700 W. Plano Parkway, Suite 3600, Plano, Texas 75093. We currently lease this office
space which totals approximately 3,181 square feet. We believe that the condition and size of our offices are adequate for our current
needs.
Investments in oil and gas properties during the years ended December 31, 2018 and 2017 are detailed as follows:
Property acquisition costs
Development costs
Exploratory costs
Totals
2018
2017
1,072,047
9,191,041
-
10,263,088
$
$
$
$
7,227,362
8,034,962
-
15,262,324
$
$
$
$
Property acquisition costs presented above exclude interest capitalized into the full cost pool of $2,020,019 in 2018 and $1,010,868 in 2017.
Property acquisition cost relates to the Company’s acquisition of additional working interests in the Orogrande Project in west Texas and
the acquisition of the Warwink Project, also in west Texas. The development costs include work in the Orogrande, Hazel, and Warwink
projects in west Texas. No development costs were incurred for Oklahoma properties in 2018.
Oil and Natural Gas Reserves
Reserve Estimates
SEC Case. The following tables sets forth, as of December 31, 2018, our estimated net proved oil and natural gas reserves, the estimated
present value (discounted at an annual rate of 10%) of estimated future net revenues before future income taxes (PV-10) and after future
income taxes (Standardized Measure) of our proved reserves and our estimated net probable oil and natural gas reserves, each prepared
using standard geological and engineering methods generally accepted by the petroleum industry and in accordance with assumptions
prescribed by the Securities and Exchange Commission (“SEC”). All of our reserves are located in the United States.
The PV-10 value is a widely used measure of value of oil and natural gas assets and represents a pre-tax present value of estimated cash
flows discounted at ten percent. PV-10 is considered a non-GAAP financial measure as defined by the SEC. We believe that our PV-10
presentation is relevant and useful to our investors because it presents the estimated discounted future net cash flows attributable to our
proved reserves before taking into account the related future income taxes, as such taxes may differ among various companies. We believe
investors and creditors use PV-10 as a basis for comparison of the relative size and value of our proved reserves to the reserve estimates of
other companies. PV-10 is not a measure of financial or operating performance under GAAP and neither it nor the Standardized Measure is
intended to represent the current market value of our estimated oil and natural gas reserves. PV-10 should not be considered in isolation or
as a substitute for the standardized measure of discounted future net cash flows as defined under GAAP.
The estimates of our proved reserves and the PV-10 set forth herein reflect estimated future gross revenue to be generated from the
production of proved reserves, net of estimated production and future development costs, using prices and costs under existing economic
conditions at December 31, 2018. For purposes of determining prices, we used the average of prices received for each month within the
12-month period ended December 31, 2018, adjusted for quality and location differences, which was $62.04 per barrel of oil and $3.10 per
MCF of gas. This average historical price is not a prediction of future prices. The amounts shown do not give effect to non-property related
expenses, such as corporate general administrative expenses and debt service, future income taxes or to depreciation, depletion and
amortization.
22
ITEM 2. PROPERTIES - continued
December 31, 2018
Reserves
Category
Oil (Bbls)
Gas (Mcf)
Total (BOE)
December 31, 2018
Future Net Revenue (M$)
Present
Value
Discounted
at 10%
Total
Proved Producing
Proved Undeveloped
Total Proved
177,300
797,500
974,800
51,100
105,800
156,900
185,817
815,133
1,000,950
$
$
$
4,027
15,313
19,340
$
$
$
2,029
2,895
4,924
Standardized Measure of Future Net Cash Flows Related to Proved Oil and Gas
Properties
$
5,341
Probable Undeveloped
0
0
0
$
-
$
-
December 31, 2017
Reserves
Category
Oil (Bbls)
Gas (Mcf)
Total (BOE)
December 31, 2017
Future Net Revenue (M$)
Present
Value
Discounted
at 10%
Total
Proved Producing
Proved Nonproducing
Total Proved
2,300
0
2,300
43,800
0
43,800
9,600
0
9,600
$
$
$
132
-
132
$
$
$
96
-
96
Standardized Measure of Future Net Cash Flows Related to Proved Oil and Gas
Properties
$
123
Probable Undeveloped
0
0
0
$
-
$
-
The upward revisions of previous estimates from 2017 to 2018 of proved reserves of 972,500 BBLS and 113,100 MCF results primarily
from 2018 reserve report calculations for the Company’s properties which includes reserves from producing properties in the Hazel and
Warwink Projects for the first time.
Reserve values as of December 31, 2018 are related to a single producing well in Oklahoma, one in the Hazel Project, and one in the
Warwink Project.
BOE equivalents are determined by combining barrels of oil with MCF of gas divided by six.
23
ITEM 2. PROPERTIES - continued
Standardized Measure of Oil & Gas Quantities - Volume Rollforward
Year Ended December 31, 2018
The following table sets forth the Company’s net proved reserves, including the changes therein, and proved developed reserves:
TOTAL PROVED RESERVES:
Beginning of period
Revisions of previous estimates
Extensions, discoveries and other additions
Divestiture of Reserves
Acquisition of Reserves
Production
End of period
Crude Oil
(Bbls)
Natural Gas
(Mcf)
2,300
21,257
974,110
-
-
(22,887)
974,780
43,800
(7,709)
138,670
-
-
(17,821)
156,940
BOE
9,600
19,972
997,222
-
-
(25,857)
1,000,937
Standardized Measure of Oil & Gas Quantities - Volume Rollforward
Year Ended December 31, 2017
The following table sets forth the Company’s net proved reserves, including the changes therein, and proved developed reserves:
TOTAL PROVED RESERVES:
Beginning of period
Revisions of previous estimates
Extensions, discoveries and other additions
Divestiture of Reserves
Acquisition of Reserves
Production
End of period
Crude Oil (Bbls)
Natural Gas (Mcf)
BOE
48,200
(35,509)
-
-
-
(10,391)
2,300
490,900
(437,841)
-
-
-
(9,259)
43,800
130,017
(108,483)
-
-
-
(11,934)
9,600
24
The standardized measure of discounted future net cash flows relating to proved oil and natural gas reserves is as follows :
Standardized Measure of Oil & Gas Quantities
Year Ended December 31, 2018 & 2017
Future cash inflows
Future production costs
Future development costs
Future income tax expense
Future net cash flows
10% annual discount for estimated timing of cash flows
Standardized measure of discounted future net cash flows related to proved reserves
2018
2017
$
$
46,335,070
(15,042,900)
(11,740,000)
-
19,552,170
(14,210,840)
5,341,330
$
$
240,370
(108,000)
-
-
132,370
(9,102)
123,268
A summary of the changes in the standardized measure of discounted future net cash flows applicable to proved oil and natural gas
reserves is as follows :
Balance, beginning of period
Net change in sales and transfer prices and in production (lifting) costs related to future
production
Changes in estimated future development costs
Net change due to revisions in quantity estimates
Accretion of discount
Other
Net change due to extensions and discoveries
Net change due to sales of minerals in place
Sales and transfers of oil and gas produced during the period
Previously estimated development costs incurred during the period
Net change in income taxes
Balance, end of period
2018
2017
$
123,268
$
340,916
40,762
(8,718,999)
289,740
1,036
(385,278)
14,467,005
-
(476,204)
-
-
$
5,341,330
$
207,241
116,934
(129,565)
28,604
(43,372)
-
-
(397,490)
-
-
123,268
Due to the inherent uncertainties and the limited nature of reservoir data, both proved and probable reserves are subject to change as
additional information becomes available. The estimates of reserves, future cash flows, and present value are based on various assumptions,
including those prescribed by the SEC, and are inherently imprecise. Although we believe these estimates are reasonable, actual future
production, cash flows, taxes, development expenditures, operating expenses, and quantities of recoverable oil and natural gas reserves may
vary substantially from these estimates.
In estimating probable reserves, it should be noted that those reserve estimates inherently involve greater risk and uncertainty than
estimates of proved reserves. While analysis of geoscience and engineering data provides reasonable certainty that proved reserves can be
economically producible from known formations under existing conditions and within a reasonable time, probable reserves involve less
certainty than reserves with a higher classification due to less data to support their ultimate recovery. Probable reserves have not been
discounted for the additional risk associated with future recovery. Prospective investors should be aware that as the categories of reserves
decrease with certainty, the risk of recovering reserves at the PV-10 calculation increases. The reserves and net present worth discounted at
10% relating to the different categories of proved and probable have not been adjusted for risk due to their uncertainty of recovery and thus
are not comparable and should not be summed into total amounts.
Reserve Estimation Process, Controls and Technologies
The reserve estimates, including PV-10 estimates, set forth above were prepared by PeTech Enterprises, Inc. for the Company’s properties
in Oklahoma and Texas. A copy of their full reports with regard to our reserves is attached as Exhibit 99.1 to this annual report on Form 10-
K. These calculations were prepared using standard geological and engineering methods generally accepted by the petroleum industry and
in accordance with SEC financial accounting and reporting standards.
25
ITEM 2. PROPERTIES - continued
We do not have any employees with specific reservoir engineering qualifications in the company. Our Chairman and Chief Executive
Officer worked closely with PeTech Enterprises Inc. in connection with their preparation of our reserve estimates, including assessing the
integrity, accuracy, and timeliness of the methods and assumptions used in this process.
PeTech Enterprises, Inc. (“PeTech”), who provided 2018 reserve estimates for our properties, is a Texas based family owned oil and gas
production and investment company that provides reservoir engineering, economics and valuation support to energy banks, energy
companies and law firms as an expert witness. PeTech has been in business since 1982. Amiel David is the President of PeTech and the
primary technical person in charge of the estimates of reserves and associated cash flow and economics on behalf of the company for the
results presented in its reserves report to us. He has a PhD in Petroleum Engineering from Stanford University. He is a registered
Professional Engineer in the state of Texas (PE #50970), granted in 1982, a member of the Society of Petroleum Engineers and a member of
the Society of Petroleum Evaluation Engineers.
Proved Nonproducing Reserves
As of December 31, 2018, our proved non producing reserves totaled 815,133 barrels of oil equivalents (BOE) compared to -0- as of
December 31, 2017, an increase of 815,133 BOE. The net reserves change associated with nonproducing reserves is an increase of
approximately 797,500 bbls of oil and an increase of approximately 105,800 Mcf of gas (calculated with a gas-oil equivalency factor of
six).
We made investments and development progress during 2018 to further develop proved producing reserves in the Orogrande, Hazel, and
Warwink Projects in the Permian Basin in West Texas. As of December 31, 2018 four test wells have been developed in the Orogrande
Project and six test wells have been developed in the Hazel Project including the Flying B #3 which has been in continuous production
since September, 2017. The Warwink Project which was initiated in 2018 has continuing production from the Warwink # 47H well
beginning in October, 2018.
Our current drilling plans, subject to sufficient capital resources and the periodic evaluation of interim drilling results and other potential
investment opportunities, include drilling additional evaluation wells in the Orogrande and Hazel AMI’s to continue to derisk the prospects
and obtain initial production from the development efforts. The next scheduled wells in the Hazel Project are scheduled to spud near the
end of May, 2019.
Production, Price, and Production Cost History
During the year ended December 31, 2018, we produced and sold 22,887 barrels of oil net to our interest at an average sale price of $54.93
per bbl. We produced and sold 17,821 MCF of gas net to our interest at an average sales price of $1.41 per MCF. Our average production
cost including lease operating expenses and direct production taxes was $31.17 per BOE. Our depreciation, depletion, and amortization
expense was $45.39 per BOE.
During the year ended December 31, 2017, we produced and sold 10,391 barrels of oil net to our interest at an average sale price of $52.37
per bbl. We produced and sold 9,259 MCF of gas net to our interest at an average sales price of $2.84 per MCF. Our average production
cost including lease operating expenses and direct production taxes was $14.51 per BOE. Our depreciation, depletion, and amortization
expense was $43.67 per BOE.
The changes in production, revenue, and operating costs were impacted by the production from the Flying B #3 well in the Hazel Project
which began in late September, 2017 and production from the Warwink 47 H beginning in October, 2018.
Our 2018 production was from properties located in central Oklahoma and in west Texas. Reserves at the beginning of 2018 from central
Oklahoma comprised more than 15% of total reserves. For 2018, approximately 1,849 BOE was produced in Oklahoma and 24,008 BOE
produced in Texas, or 7% from Oklahoma and 93% from wells in west Texas.
26
ITEM 2. PROPERTIES - continued
Quarterly Revenue and Production by State for 2018 and 2017 are detailed as follows:
Property
Oklahoma
Hazel (TX)
Total Q1-
2018
Oklahoma
Hazel (TX)
Meco (TX)
Total Q2-
2018
Oklahoma
Hazel (TX)
Meco (TX)
Total Q3-
2018
Oklahoma
Hazel (TX)
Meco (TX)
Total Q4-
2018
2018 Year To
Date
Oklahoma
Hazel (TX)
Total Q1-
2017
Oklahoma
Hazel (TX)
Total Q2-
2017
Oklahoma
Hazel (TX)
Total Q3-
2017
Oklahoma
Hazel (TX)
Total Q4-
2017
Year Ended
12/31/17
Quarter
Q1 - 2018
Q1 - 2018
Q2 - 2018
Q2 - 2018
Q2 - 2018
Q3 - 2018
Q3 - 2018
Q3 - 2018
Q4 - 2018
Q4 - 2018
Q4 - 2018
Q1 - 2017
Q1 - 2017
Q2 - 2017
Q2 - 2017
Q3 - 2017
Q3 - 2017
Q4 - 2017
Q4 - 2017
Oil
Production
{BBLS}
Gas
Production
{MCF}
Oil
Gas
Revenue
Revenue
Total
Revenue
72
7,786
7,858
446
4,368
51
4,865
41
2,283
0
2,324
94
3,779
3,967
7,840
2,008
0
4,463
471,498
5,202
-
$
$
9,665
471,498
2,008
$
475,961
$
5,202
$
481,163
1,857
0
0
10,912
266,506
3,155
2,690
-
-
$
$
$
13,602
266,506
3,155
1,857
$
280,573
$
2,690
$
283,263
2,324
0
0
$
$
$
1,264
123,566
-
$
$
$
3,845
-
-
$
$
$
5,109
123,566
-
2,324
$
124,830
$
3,845
$
128,675
986
0
10,646
$
$
$
4,878
178,015
192,916
$
$
$
1,104
-
12,348
$
$
$
5,982
178,015
205,264
11,632
$
375,809
$
13,452
$
389,261
22,887
17,821
$ 1,257,173
$
25,189
$ 1,282,362
101
0
101
140
0
140
132
204
336
84
9,730
9,814
$
2,303
0
$
5,346
-
$
7,604
-
12,950
-
2,303
$
5,346
$
7,604
$
12,950
2,332
0
6,594
-
6,709
-
13,303
-
2,332
$
6,594
$
6,709
$
13,303
2,041
0
5,733
8,836
3,727
-
9,460
8,836
2,041
$
14,569
$
3,727
$
18,296
2,583
4,739
8,227
12,966
0
512,984
-
512,984
2,583
$
517,723
$
8,227
$
525,950
10,391
9,259
$
544,232
$
26,267
$
570,499
27
ITEM 2. PROPERTIES - continued
Drilling Activity and Productive Wells
Combined Well Status
The following table summarizes drilling activity and Well Status as of December 31, 2018:
Drilling Activity/Well Status
Development Wells:
Productive -Texas (Hazel)
Productive -Texas (Warwink)
Productive - Okla
Test Wells (Dry) - Orogrande
Test Wells (Dry) - Hazel
Exploration
Wells:
Productive
Dry
Total Drilled
Wells:
Productive -Texas
Productive - Okla
Test Wells (Dry)
Acquired
Wells:
Productive -Texas
Productive - Okla
Total
Wells:
Productive -Texas
Productive - Okla
Test Wells (Dry)
Total
Well
Type:
Oil
Gas
Combination -Oil and Gas
Test Wells (Dry)
Total
Cumulative Well Status
at 12/31/2018
Wells Drilled
2018
Cumulative Well Status
at 12/31/2017
Gross
Net
Gross
Net
Gross
Net
-
1.00
-
4.00
2.00
-
-
1.00
-
6.00
-
-
1.00
-
6.00
7.00
-
-
1.00
6.00
7.00
-
0.13
-
2.71
1.60
-
-
0.13
-
4.31
-
-
0.13
-
4.31
4.44
-
-
0.13
4.31
4.44
1.00
-
2.00
2.00
2.00
-
-
1.00
2.00
4.00
-
-
1.00
2.00
4.00
7.00
-
-
3.00
4.00
7.00
0.80
-
0.40
0.95
1.60
-
-
0.80
0.40
2.55
-
-
0.80
0.40
2.55
3.75
-
-
1.20
2.55
3.75
1.00
1.00
2.00
6.00
4.00
-
-
2.00
2.00
10.00
-
-
2.00
2.00
10.00
14.00
-
-
4.00
10.00
14.00
0.80
0.13
0.40
3.66
3.20
-
-
0.93
0.40
6.86
-
-
0.93
0.40
6.86
8.19
-
-
1.33
6.86
8.19
28
ITEM 2. PROPERTIES - continued
Our acreage positions at December 31, 2018 are summarized as follows:
Leasehold Interests - 12/31/2018
Gross
Net
Gross
Net
Total Acres
TRCH Interest
Developed Acres
TRCH Interest
Undeveloped Acres
Net
Gross
Texas -
Orogrande
Hazel Project
Warwink Properties
Oklahoma -
Viking
Total
Current Projects
133,000
12,000
1,400
90,108
9,600
175
-
320
1,400
-
256
175
133,000
11,680
-
90,108
9,344
-
640
192
640
192
-
-
147,040
100,075
2,360
623
144,680
99,452
As of December 31, 2018, we had interests in four oil and gas projects: the Orogrande Project in Hudspeth County, Texas, the Hazel Project
in Sterling, Tom Green, and Irion Counties, Texas, the Winkler Project in Winkler County, Texas, and the Hunton wells in partnership with
Husky Ventures in central Oklahoma.
See the description under “Current Projects” above under “Item 1. Business” for information and disclosure regarding these projects which
description is incorporated herein by reference.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable.
29
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
Our common stock is quoted on The NASDAQ Stock Market LLC under the symbol, “TRCH.” Trading in our common stock has
historically been limited and occasionally sporadic and the quotations set forth below are not necessarily indicative of actual market
conditions.
Record Holders
As of March 8, 2019, there were approximately 225 stockholders of record of our common stock, and we estimate that there were
approximately 3,800 additional beneficial stockholders who hold their shares in “street name” through a brokerage firm or other institution.
As of March 15, 2019, we have a total of 71,695,865 shares of common stock issued and outstanding.
The holders of the common stock are entitled to one vote for each share held of record on all matters submitted to a vote of stockholders.
Holders of the common stock have no preemptive rights and no right to convert their common stock into any other securities. There are no
redemption or sinking fund provisions applicable to the common stock.
Equity Compensation Plan Information
The following table sets forth all equity compensation plans as of December 31, 2018:
Number of
securities to
be issued
upon
exercise of
outstanding
options,
warrants
and rights
Weighted-
average
exercise
price of
outstanding
options,
warrants
and rights
Number of
securities
remaining
available
for future
issuance
under
equity
compensation
plans
(excluding
securities
reflected in
column (a))
8,014,931
$
1.48
1,985,069
Plan Category
Equity compensation plans
approved by security holders
Sales of Unregistered Securities
Other than the sales below, all equity securities that we have sold during the period covered by this report that were not registered under the
Securities Act have previously been included in a Quarterly Report on Form 10-Q or in a Current Report on Form 8-K.
All of the above sales of securities described in this Item 2 were sold under the exemption from registration provided by Section 4(a)(2) of
the Securities Act of 1933 and the rules and regulations promulgated thereunder. The issuances of securities did not involve a “public
offering” based upon the following factors: (i) the issuances of securities were isolated private transactions; (ii) a limited number of
securities were issued to a limited number of purchasers; (iii) there were no public solicitations; (iv) the investment intent of the purchasers;
and (v) the restriction on transferability of the securities issued.
ITEM 6. SELECTED FINANCIAL DATA
Not Applicable.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Information set forth and discussed in this Management’s Discussion and Analysis and Results of Operations is derived from our historical
financial statements and the related notes thereto which are included in this Form 10-K. The following information and discussion should
be read in conjunction with such financial statements and notes. Additionally, this Management’s Discussion and Analysis and Plan of
Operations contain certain statements that are not strictly historical and are “forward-looking” statements within the meaning of the Private
Securities Litigation Reform Act of 1995 and involve a high degree of risk and uncertainty. Actual results may differ materially from those
projected in the forward-looking statements due to other risks and uncertainties that exist in our operations, development efforts, and
business environment, and due to other risks and uncertainties relating to our ability to obtain additional capital in the future to fund our
planned expansion, the demand for oil and natural gas, and other general economic factors.
30
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - continued
All forward-looking statements included herein are based on information available to us as of the date hereof, and we assume no obligation
to update any such forward-looking statements.
Summary of Key Results
Overview
We are engaged in the acquisition, exploration, exploitation, and/or development of oil and natural gas properties in the United States.
During the year ended December 31, 2016 the Board of Directors initiated a review of Company operations in view of the divestiture of its
Oklahoma properties, which included the previous sale of the Chisholm Trail and Cimarron properties. During 2016 development had
continued on the Orogrande Project in West Texas and in April, 2016, the Company acquired the Hazel Project in the Midland Basin also in
West Texas. These West Texas properties demonstrate significant potential and future production capabilities based upon the analysis of
scientific data being gathered in the day by day development activity. Therefore, the Board has determined to focus its efforts and capital on
these projects to maximize shareholder value for the long run.
During 2017 the Company increased its commitment to the Orogrande and Hazel Projects. Additional working interests were acquired and
test wells were drilled on the properties which is detailed in the Properties section of this filing. Near the end of 2017 the Warwink Project,
also in West Texas, was acquired.
During 2018 the Company continued development in the Orogrande and Hazel Projects. Additional test wells were drilled to capture
additional science data to support lease value. Production from the Hazel Flying B #3 continued through 2018. The carried well provision
of the Warwink acquisition in 2017 was fulfilled with the drilling of the Warwink #47-H. That well began production in October, 2018.
The strategy in divesting of projects other than the Orogrande Project was to refocus on the greatest potential future value for the Company
while systematically eliminating debt as noncore assets are sold and operations are streamlined.
The following discussion of our financial condition and results of operations should be read in conjunction with our audited financial
statements for the years ended December 31, 2018 and 2017 included herewith. This discussion should not be construed to imply that the
results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of
actual operating results in the future. Such discussion represents only the best present assessment by our management.
Historical Results for the Years Ended December 31, 2018 and 2017
For the year ended December 31, 2018, we had a net loss of $5,806,612 compared to a net loss of $919,910 for the year ended December
31, 2017. The difference is primarily due to increased general and administrative and depletion and depreciation expense and the impact of
a nonrecurring income item of $2,781,500 received in 2017.
Revenues and Cost of Revenues
For the year ended December 31, 2018, we had production revenue of $1,282,362 compared to $570,499 of production revenue for the year
ended December 31, 2017. Refer to the table of production and revenue for 2018 and 2017 included below. Our cost of revenue, consisting
of lease operating expenses and production taxes, was $806,158, and $173,187 for the years ended December 31, 2018 and 2017,
respectively.
The change in revenue was impacted by the new production from the Flying B #3 well in the Hazel Project that began in late September,
2017 and production from the Warwink #47H which began production in October, 2018.
31
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - continued
Production and Revenue are detailed as follows:
Property
Oklahoma
Hazel (TX)
Total Q1-
2018
Oklahoma
Hazel (TX)
Meco (TX)
Total Q2-
2018
Oklahoma
Hazel (TX)
Meco (TX)
Total Q3-
2018
Oklahoma
Hazel (TX)
Meco (TX)
Total Q4-
2018
2018 Year To
Date
Oklahoma
Hazel (TX)
Total Q1-
2017
Oklahoma
Hazel (TX)
Total Q2-
2017
Oklahoma
Hazel (TX)
Total Q3-
2017
Oklahoma
Hazel (TX)
Total Q4-
2017
Year Ended
12/31/17
Quarter
Q1 - 2018
Q1 - 2018
Q2 - 2018
Q2 - 2018
Q2 - 2018
Q3 - 2018
Q3 - 2018
Q3 - 2018
Q4 - 2018
Q4 - 2018
Q4 - 2018
Q1 - 2017
Q1 - 2017
Q2 - 2017
Q2 - 2017
Q3 - 2017
Q3 - 2017
Q4 - 2017
Q4 - 2017
Oil
Production
{BBLS}
Gas
Production
{MCF}
Oil
Gas
Revenue
Revenue
Total
Revenue
72
7,786
7,858
446
4,368
51
4,865
41
2,283
0
2,324
94
3,779
3,967
7,840
2,008
0
4,463
471,498
5,202
-
$
$
9,665
471,498
2,008
$
475,961
$
5,202
$
481,163
1,857
0
0
10,912
266,506
3,155
2,690
-
-
$
$
$
13,602
266,506
3,155
1,857
$
280,573
$
2,690
$
283,263
2,324
0
0
$
$
$
1,264
123,566
-
$
$
$
3,845
-
-
$
$
$
5,109
123,566
-
2,324
$
124,830
$
3,845
$
128,675
986
0
10,646
$
$
$
4,878
178,015
192,916
$
$
$
1,104
-
12,348
$
$
$
5,982
178,015
205,264
11,632
$
375,809
$
13,452
$
389,261
22,887
17,821
$ 1,257,173
$
25,189
$ 1,282,362
101
0
101
140
0
140
132
204
336
84
9,730
9,814
$
2,303
0
$
5,346
-
$
7,604
-
12,950
-
2,303
$
5,346
$
7,604
$
12,950
2,332
0
6,594
-
6,709
-
13,303
-
2,332
$
6,594
$
6,709
$
13,303
2,041
0
5,733
8,836
3,727
-
9,460
8,836
2,041
$
14,569
$
3,727
$
18,296
2,583
0
4,739
512,984
8,227
-
12,966
512,984
2,583
$
517,723
$
8,227
$
525,950
10,391
9,259
$
544,232
$
26,267
$
570,499
32
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- continued
We recorded depreciation, depletion and amortization expense of $1,173,752 for the year ended December 31, 2018 compared to $100,156
for 2017. Impairment expense recognized was $139,891 in 2018 compared to $-0- for 2017. Although we had no recognized impairment
expense in 2017, the Company has adjusted the separation of evaluated versus unevaluated costs within its full cost pool to recognize the
value impairment related to the expiration of unevaluated leases in 2017 in the amount of $2,300,626. The impact of this change will be to
increase the basis for calculation of future period’s depletion, depreciation and amortization to include $2,300,626 of cost which will
effectively recognize the impairment on the Statement of Operations over future periods. The $2,300,626 will also become an evaluated
cost for purposes of future period’s Ceiling Tests and which may further recognize the impairment expense recognized in future periods.
General and Administrative Expenses
Our general and administrative expenses for the years ended December 31, 2018 and 2017 were $4,053,062 and $3,652,970, respectively,
an increase of $400,092. Our general and administrative expenses consisted of consulting and compensation expense, substantially all of
which were non-cash or deferred, accounting and administrative costs, professional consulting fees, and other general corporate expenses.
The increase in general and administrative expenses for the year ended December 31, 2018 compared to 2017 is detailed as follows:
Increase(decrease) in non cash stock and warrant compensation
Increase(decrease) in consulting expense
Increase(decrease) in investor relations
Increase(decrease) in travel expense
Increase(decrease) in salaries and compensation
Increase(decrease) in legal fees
Increase(decrease) in filing and compliance fees
Increase(decrease) in insurance
Increase(decrease) in general corporate expenses
Increase(decrease) in audit fees
Total Increase in General and Administrative Expenses
$
$
$
$
$
$
$
$
$
$
$
189,263
292,488
140,043
(13,019)
(20,676)
(347,848)
33,186
55,279
(11,513)
82,889
400,092
The increase in noncash stock and warrant compensation arises from the combination of a decrease in vested employee stock options
expense, an increase in expense related to warrants issued by the company, and an increase in the value of common stock issued for
services. Consulting expense and investor relations expense increased due to fees related to capital raise activity in 2018. Legal fees were
reduced from prior years due to a reduction in transaction activity. Increased audit fees arose from the expanded compliance requirements
under SOX 404.
Liquidity and Capital Resources
For the year ended December 31, 2018, we had a net loss of $5,806,612 compared to a net loss of $919,910 for the year ended December
31, 2017.
At December 31, 2018, we had current assets of $1,521,982 and total assets of $38,097,881. As of December 31, 2018, we had current
liabilities of $2,198,672. Stockholders’ equity was $18,022,776 at December 31, 2018.
Cash from operating activities for the year ended December 31, 2018, was $(1,168,524) compared to $465,592 for the year ended
December 31, 2016, a decrease of $1,634,116. Cash from operating activities during 2018 can be attributed principally to net loss from
operations of $5,806,212 adjusted for noncash stock based compensation of $1,340,324 and for $1,173,752 in depletion, depreciation, and
amortization expense.
Cash used in operating activities during 2017 can be attributed principally to net losses from operations of $919,910 adjusted for noncash
stock based compensation of $1,151,061.
Cash used in investing activities for year ended December 31, 2018 was $12,149,916 compared to $9,458,648 for the year ended December
31, 2017. Cash used in investing activities consisted of investment in oil and gas properties during the year ended December 31, 2018 and
2017.
Cash from financing activities for the year ended December 31, 2018 was $13,106,883 as compared to $8,275,275 for the year ended
December 31, 2017. Cash from financing activities in 2018 consisted primarily of proceeds from common stock issuances and debt
financing. 2017 activity consisted principally of debt financing transactions. We expect to continue to have cash provided by financing
activities as we seek new rounds of financing and continue to develop our oil and gas investments. Reference Note 11 to the Financial
Statements regarding additional funding closed subsequent to December 31, 2018.
33
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - continued
Our current assets are insufficient to satisfy our cash needs over the next twelve months and as such we will require additional debt or
equity financing to meet our plans and needs. We face obstacles in continuing to attract new financing due to our history and current record
of net losses and past working capital deficits. Despite our efforts, we can provide no assurance that we will be able to obtain the financing
required to meet our stated objectives or even to continue as a going concern.
We do not expect to pay cash dividends on our common stock in the foreseeable future.
Critical Accounting Policies and Estimates
Oil and gas properties – The Company uses the full cost method of accounting for exploration and development activities as defined by
the Securities and Exchange Commission (“SEC”). Under this method of accounting, the costs of unsuccessful, as well as successful,
exploration and development activities are capitalized as properties and equipment. This includes any internal costs that are directly related
to property acquisition, exploration and development activities but does not include any costs related to production, general corporate
overhead or similar activities. Gain or loss on the sale or other disposition of oil and gas properties is not recognized, unless the gain or loss
would significantly alter the relationship between capitalized costs and proved reserves.
Oil and gas properties include costs that are excluded from costs being depleted or amortized. Oil and natural gas property costs excluded
represent investments in unevaluated properties and include non-producing leasehold, geological, and geophysical costs associated with
leasehold or drilling interests and exploration drilling costs. The Company allocates a portion of its acquisition costs to unevaluated
properties based on relative value. Costs are transferred to the full cost pool as the properties are evaluated over the life of the reservoir.
Unevaluated properties are reviewed for impairment at least quarterly and are determined through an evaluation considering, among other
factors, seismic data, requirements to relinquish acreage, drilling results, remaining time in the commitment period, remaining capital plan,
and political, economic, and market conditions.
Gains and losses on the sale of oil and gas properties are not generally reflected in income unless the gain or loss would significantly alter
the relationship between capitalized costs and proved reserves. Sales of less than 100% of the Company’s interest in the oil and gas
property are treated as a reduction of the capital cost of the field, with no gain or loss recognized, as long as doing so does not significantly
affect the unit-of-production depletion rate. Costs of retired equipment, net of salvage value, are usually charged to accumulated
depreciation.
Depreciation, depletion, and amortization – The depreciable base for oil and natural gas properties includes the sum of all capitalized costs
net of accumulated depreciation, depletion, and amortization (“DD&A”), estimated future development costs and asset retirement costs not
included in oil and natural gas properties, less costs excluded from amortization. The depreciable base of oil and natural gas properties is
amortized on a unit-of-production method.
Ceiling test – Future production volumes from oil and gas properties are a significant factor in determining the full cost ceiling limitation
of capitalized costs. Under the full cost method of accounting, the Company is required to periodically perform a “ceiling test” that
determines a limit on the book value of oil and gas properties. If the net capitalized cost of proved oil and gas properties, net of related
deferred income taxes, plus the cost of unproved oil and gas properties, exceeds the present value of estimated future net cash flows
discounted at 10 percent, net of related tax affects, plus the cost of unproved oil and gas properties, the excess is charged to expense and
reflected as additional accumulated DD&A. The ceiling test calculation uses a commodity price assumption which is based on the
unweighted arithmetic average of the price on the first day of each month for each month within the prior 12 month period and excludes
future cash outflows related to estimated abandonment costs.
The determination of oil and gas reserves is a subjective process, and the accuracy of any reserve estimate depends on the quality of
available data and the application of engineering and geological interpretation and judgment. Estimates of economically recoverable
reserves and future net cash flows depend on a number of variable factors and assumptions that are difficult to predict and may vary
considerably from actual results. In particular, reserve estimates for wells with limited or no production history are less reliable than those
based on actual production. Subsequent re-evaluation of reserves and cost estimates related to future development of proved oil and gas
reserves could result in significant revisions to proved reserves. Other issues, such as changes in regulatory requirements, technological
advances, and other factors which are difficult to predict could also affect estimates of proved reserves in the future.
Asset retirement obligations – The fair value of a liability for an asset’s retirement obligation (“ARO”) is recognized in the period in which
it is incurred if a reasonable estimate of fair value can be made, with the corresponding charge capitalized as part of the carrying amount of
the related long-lived asset. The liability is accreted to its then-present value each subsequent period, and the capitalized cost is depleted
over the useful life of the related asset. Abandonment costs incurred are recorded as a reduction of the ARO liability.
Inherent in the fair value calculation of an ARO are numerous assumptions and judgments including the ultimate settlement amounts,
inflation factors, credit adjusted discount rates, timing of settlement, and changes in the legal, regulatory, environmental, and political
environments. To the extent future revisions to these assumptions impact the fair value of the existing ARO liability, a corresponding
adjustment is made to the oil and gas property balance. Settlements greater than or less than amounts accrued as ARO are recorded as a
gain or loss upon settlement.
34
Share-based compensation – Compensation cost for equity awards is based on the fair value of the equity instrument on the date of grant
and is recognized over the period during which an employee is required to provide service in exchange for the award.
The Company accounts for stock option awards using the calculated value method. The expected term was derived using the simplified
method provided in Securities and Exchange Commission release Staff Accounting Bulletin No. 110, which averages an awards weighted
average vesting period and contractual term for “plain vanilla” share options.
The Company accounts for any forfeitures of options when they occur. Previously recognized compensation cost for an award is reversed
in the period that the award is forfeited.
The Company also issues equity awards to non-employees. The fair value of these option awards is estimated when the award recipient
completes the contracted professional services. The Company recognizes expense for the estimated total value of the awards during the
period from their issuance until performance completion.
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-
Based Payment Accounting, which simplifies the accounting for share-based payments granted to nonemployees for goods and services.
Under this ASU, the guidance on such payments to nonemployees is aligned with the requirements for share-based payments granted to
employees. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018, however the Company has opted for early
adoption effective July 1, 2018. The amendments in this ASU are to be applied through a cumulative-effect adjustment to retained earnings
as of the first reporting period in which the ASU is effective. In evaluating early adoption the Company has determined that the change
does not have a material impact on its consolidated financial statements.
The Company values warrant and option awards using the Black-Scholes option pricing model.
Commitments and Contingencies
Leases
The Company has a noncancelable lease for its office premises that expires on November 30, 2019 and which requires the payment of base
lease amounts and executory costs such as taxes, maintenance and insurance. Rental expense for lease was $82,075 and $84,197 for the
years ended December 31, 2018 and 2017, respectively.
Approximate future minimum rental commitments under the office premises lease are:
Year Ending December 31,
Rent
To 2019 Expiration
Total
$
88,605
88,605
As of December 31, 2018, the Company had interests in four oil and gas projects: the Orogrande Project in Hudspeth County, Texas, the
Hazel Project in Sterling, Tom Green, and Irion Counties, Texas, the Warwink Project in Winkler County, Texas, and Hunton wells in
Central Oklahoma, ..
See the description under “Current Projects” above under “Item 1. Business” for more information and disclosure regarding commitments
and contingencies relating to these projects which description is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
35
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of Torchlight Energy Resources, Inc.
Plano, Texas
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Torchlight Energy Resources, Inc. (the Company) as of December 31,
2018 and 2017, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the two-
year period ended December 31, 2018, and the related notes (collectively referred to as the financial statements). We also have audited the
Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control—Integrated
Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of
December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the two-year period ended
December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the
Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria
established in Internal Control—Integrated Framework (2013) issued by COSO.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As
discussed in Note 2 to the consolidated financial statements, the Company has incurred recurring losses from its operations and has a net
capital deficiency which raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these
matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Basis for Opinion
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial
reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Item 9A,
“Management’s Annual Report on Internal Control Over Financial Reporting.” Our responsibility is to express an opinion on the
Company’s financial statements and an opinion on the Company’s internal control over financial reporting 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, and
whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements 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.
Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based
on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We
believe that our audits provide a reasonable basis for our opinions.
36
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Briggs & Veselka Co.
We have served as the Company’s auditor since 2016.
Houston, Texas
March 18, 2019
37
TORCHLIGHT ENERGY RESOURCES, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
Current assets:
Cash
Accounts receivable
Production revenue receivable
Prepayments - development costs
Prepaid expenses
Total current assets
Oil and gas properties, net
Office equipment, net
Other assets
TOTAL ASSETS
December 31,
2018
December 31,
2017
$
$
840,163
179,702
294,715
146,422
60,980
1,521,982
1,051,720
596,141
142,932
1,335,652
39,506
3,165,951
36,565,461
4,076
6,362
25,579,279
15,716
6,362
$
38,097,881
$
28,767,308
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Funds received pending settlement
Accrued payroll
Related party payables
Due to working interest owners
Accrued interest payable
Total current liabilities
$
$
729,806
-
816,176
45,000
54,320
553,370
2,198,672
Unsecured promissory notes, net of discount and financing costs of $702,217 at December 31,
2018 and $795,017 at December 31, 2017
Notes payable
Asset retirement obligations
11,862,080
6,000,000
14,353
762,502
520,400
695,176
45,000
54,320
202,050
2,279,448
7,269,281
3,250,000
9,274
Total liabilities
Commitments and contingencies
Stockholders’ equity:
20,075,105
12,808,003
Preferred stock, par value $0.001, 10,000,000 shares authorized; -0- issued and outstanding at
December 30, 2018 and December 31, 2017
Common stock, par value $0.001 per share; 150,000,000 shares authorized;
70,112,376 issued and outstanding at December 30, 2018
63,340,034 issued and outstanding at December 31, 2017
Additional paid-in capital
Accumulated deficit
Total stockholders’ equity
-
-
70,116
63,344
107,266,965
(89,314,305)
99,403,654
(83,507,693)
18,022,776
15,959,305
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
38,097,881
$
28,767,308
The accompanying notes are an integral part of these consolidated financial statements.
38
TORCHLIGHT ENERGY RESOURCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Revenues
Oil and gas sales
Cost of revenues
Gross profit
Operating expenses:
General and administrative expense
Depreciation, depletion and amortization
Loss on settlement
Impairment loss
Total operating expenses
Other income (expense)
Interest expense and accretion of note discounts
Interest income
Consulting income
Total income (expense)
Loss before income taxes
Provision for income taxes
Net loss
Loss per common share:
Basic and Diluted
Weighted average number of common shares outstanding:
Basic and Diluted
Year
Ended
December 31,
2018
Year
Ended
December 31,
2017
$
1,282,362
$
570,499
(806,158)
(173,187)
476,204
397,312
(4,053,062)
(1,173,752)
(369,439)
(139,891)
(5,736,144)
(3,652,970)
(100,156)
-
-
(3,753,126)
(547,710)
1,038
-
(546,672)
(346,050)
454
2,781,500
2,435,904
(5,806,612)
(919,910)
-
-
$
(5,806,612)
$
(919,910)
$
(0.09)
$
(0.02)
68,134,745
59,623,105
The accompanying notes are an integral part of these consolidated financial statements.
39
TORCHLIGHT ENERGY RESOURCES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEAR ENDED DECEMBER 31, 2018 AND 2017
Common
stock
shares
Common
stock
amount
Additional
paid-in
capital
Accumulated
deficit
Total
Balance, December 31, 2016
55,096,506
$
55,100
$ 89,675,488
$(82,587,783) $ 7,142,805
Issuance of common stock for services
Issuance of common stock for lease
interests
Issuance of common stock for Note
conversion
Issuance of stock for warrant exercise
Warrants issued for services
Stock options issued for services
Net loss
507,894
508
579,246
579,754
6,420,395
6,421
6,805,941
6,812,362
1,007,890
307,349
1,008
307
1,006,882
242,993
161,560
931,544
1,007,890
243,300
161,560
931,544
(919,910)
(919,910)
Balance, December 31, 2017
63,340,034
$
63,344
$ 99,403,654
$(83,507,693) $ 15,959,305
Issuance of common stock for services
Issuance of common stock for cash
less Underwriting/Offering Costs
Issuance of common stock for note
payment in kind
Warrant exercise into common stock
Warrants issued for services
Stock options issued for services
Net loss
450,000
5,750,000
172,342
400,000
450
5,750
544,550
6,043,984
172
400
220,852
199,600
510,575
343,750
545,000
6,049,734
221,024
200,000
510,575
343,750
(5,806,612) (5,806,612)
Balance, December 31, 2018
70,112,376
$
70,116
$107,266,965
$(89,314,305) $ 18,022,776
The accompanying notes are an integral part of these consolidated financial statements.
40
TORCHLIGHT ENERGY RESOURCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows From Operating Activities
Net loss
Adjustments to reconcile net loss to net cash from
operations:
Stock based compensation
Accrued interest payable in stock
Amortization of debt issuance costs
Accretion of note discounts
Depreciation, depletion and amortization
Net settlement offset
Impairment loss
Change in:
Accounts receivable
Production revenue receivable
Prepayments - development costs
Prepaid expenses
Other assets
Accounts payable and accrued expenses
Accrued interest payable
Net cash from operating activities
Cash Flows From Investing Activities
Investment in oil and gas properties
Acquisition of office equipment
Net cash from investing activities
Cash Flows From Financing Activities
Issuance of common stock, net of offering costs
Proceeds from promissory notes, net of offering costs
Repayment of promissory notes
Proceeds from notes payable
Proceeds from warrant exercise
Net cash from financing activities
Net decrease in cash
Cash - beginning of period
Cash - end of period
Supplemental disclosure of cash flow information: (Non Cash Items)
Increase in accounts payable for property development costs
Common stock issued for financing costs
Common stock issued for mineral interests
Accounts payable increase-investment in oil and gas properties
Common stock issued for partial payment of unpaid compensation
Common stock issued in conversion of promissory note
Common stock issued for payment in kind on notes payable
Cash paid for interest
Cash paid for income tax
Year
Ended
December 31,
2018
Year
Ended
December 31,
2017
$
(5,806,612)
$
(919,910)
1,340,324
228,057
268,917
216,732
1,173,752
(100,561)
139,891
(3,400)
(151,783)
1,189,230
(21,474)
-
14,116
344,287
(1,168,524)
1,151,061
-
188,342
103,044
100,156
-
-
7,305
(135,607)
(752,305)
(12,676)
12,000
519,818
204,364
465,592
(12,149,916)
-
(9,460,830)
2,182
(12,149,916)
(9,458,648)
6,049,734
4,107,149
(3,250,000)
6,000,000
200,000
13,106,883
-
10,541,475
(2,509,500)
-
243,300
8,275,275
(211,557)
(717,781)
1,051,720
1,769,501
$
840,163
$
1,051,720
$
$
$
$
$
$
$
$
$
133,189
-
-
-
59,000
-
221,024
1,519,573
-
$
$
$
$
$
$
$
$
$
375,000
279,754
6,812,362
375,000
-
1,007,890
-
813,652
-
The accompanying notes are an integral part of these consolidated financial statements.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
Torchlight Energy Resources, Inc. (“Company”) was incorporated in October 2007 under the laws of the State of Nevada as Pole Perfect
Studios, Inc. (“PPS”). From its incorporation to November 2010, the company was primarily engaged in business start-up activities.
On November 23, 2010, we entered into and closed a Share Exchange Agreement (the “Exchange Agreement”) between the major
shareholders of PPS and the shareholders of Torchlight Energy, Inc. (“TEI”). As a result of the transactions effected by the Exchange
Agreement, at closing TEI became our wholly-owned subsidiary, and the business of TEI became our sole business. TEI was incorporated
under the laws of the State of Nevada in June 2010. We are engaged in the acquisition, exploitation and/or development of oil and natural
gas properties in the United States. We operate our business through our subsidiaries Torchlight Energy Inc., Torchlight Energy Operating,
LLC, and Hudspeth Oil Corporation, Torchlight Hazel LLC, and Winkler Properties LLC.
2. GOING CONCERN
At December 31, 2018, the Company had not yet achieved profitable operations. We had a net loss of $5,806,612 for the year ended
December 31, 2018 and had accumulated losses of $89,314,305 since our inception. We expect to incur further losses in the development
of our business. The Company had a working capital deficit as of December 31, 2018 of $676,690. These conditions raise substantial doubt
about the Company’s ability to continue as a going concern.
The Company’s ability to continue as a going concern is dependent on its ability to generate future profitable operations and/or to obtain
the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due.
Management’s plan to address the Company’s ability to continue as a going concern includes: (1) obtaining debt or equity funding from
private placement or institutional sources; (2) obtain loans from financial institutions, where possible, or (3) participating in joint venture
transactions with third parties. Although management believes that it will be able to obtain the necessary funding to allow the Company to
remain a going concern through the methods discussed above, there can be no assurances that such methods will prove successful.
These consolidated financial statements have been prepared assuming that the Company will continue as a going concern and therefore, the
financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or
the amount and classifications of liabilities that may result from the outcome of this uncertainty.
3.
SIGNIFICANT ACCOUNTING POLICIES
The Company maintains its accounts on the accrual method of accounting in accordance with accounting principles generally accepted in
the United States of America. Accounting principles followed and the methods of applying those principles, which materially affect the
determination of financial position, results of operations and cash flows are summarized below:
Use of estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and certain assumptions that affect the amounts reported in these consolidated financial
statements and accompanying notes. Actual results could differ from these estimates.
Basis of presentation—The financial statements are presented on a consolidated basis and include all of the accounts of Torchlight Energy
Resources Inc. and its wholly owned subsidiaries, Torchlight Energy, Inc., Torchlight Energy Operating, LLC, Hudspeth Oil Corporation,
Torchlight Hazel LLC, and Warwink Properties LLC. All significant intercompany balances and transactions have been eliminated.
Certain reclassifications have been made to the 2017 consolidated financial statements to make them consistent with the 2018 presentation.
Total stockholders’ equity and net loss are unchanged due to these reclassifications made in cash flow statement.
Risks and uncertainties – The Company’s operations are subject to significant risks and uncertainties, including financial, operational,
technological, and other risks associated with operating an emerging business, including the potential risk of business failure.
Concentration of risks – At times the Company’s cash balances are in excess of amounts guaranteed by the Federal Deposit Insurance
Corporation. The Company’s cash is placed with a highly rated financial institution, and the Company regularly monitors the credit
worthiness of the financial institutions with which it does business.
Fair value of financial instruments – Financial instruments consist of cash, receivables, payables and promissory notes, if any. The
estimated fair values of cash, receivables, and payables approximate the carrying amount due to the relatively short maturity of these
instruments. The carrying amounts of any promissory notes approximate their fair value giving affect for the term of the note and the
effective interest rates.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3.
SIGNIFICANT ACCOUNTING POLICIES - continued
For assets and liabilities that require re-measurement to fair value the Company categorizes them in a three-level fair value hierarchy as
follows:
●
●
●
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or
liability, either directly or indirectly through market corroboration.
Level 3 inputs are unobservable inputs based on management’s own assumptions used to measure assets and liabilities at fair value.
A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair
value measurement.
Cash and cash equivalents - Cash and cash equivalents include certain investments in highly liquid instruments with original maturities of
three months or less.
Accounts receivable – Accounts receivable consist of uncollateralized oil and natural gas revenues due under normal trade terms, as well as
amounts due from working interest owners of oil and gas properties for their share of expenses paid on their behalf by the Company.
Management reviews receivables periodically and reduces the carrying amount by a valuation allowance that reflects management’s best
estimate of the amount that may not be collectible. As of December 31, 2018 and December 31, 2017, no valuation allowance was
considered necessary.
As of December 31, 2017 accounts receivable included $419,839 the Company computed as being due from Husky Ventures with respect to
the sale of Chisholm Trail properties in 2015 and in dispute as part of the Husky legal action in process at that dates. Additionally, a
payment of $520,400 made by Husky Ventures which is also disputed by the Company had been included in current liabilities captioned
“Funds received pending settlement”. The Company settled the matter with Husky during the quarter ended June 30, 2018.
Oil and gas properties – The Company uses the full cost method of accounting for exploration and development activities as defined by
the Securities and Exchange Commission (“SEC”). Under this method of accounting, the costs of unsuccessful, as well as successful,
exploration and development activities are capitalized as properties and equipment. This includes any internal costs that are directly related
to property acquisition, exploration and development activities but does not include any costs related to production, general corporate
overhead or similar activities. Gain or loss on the sale or other disposition of oil and gas properties is not recognized, unless the gain or loss
would significantly alter the relationship between capitalized costs and proved reserves.
Oil and gas properties include costs that are excluded from costs being depleted or amortized. Oil and natural gas property costs excluded
represent investments in unevaluated properties and include non-producing leasehold, geological, and geophysical costs associated with
leasehold or drilling interests and exploration drilling costs. The Company allocates a portion of its acquisition costs to unevaluated
properties based on relative value. Costs are transferred to the full cost pool as the properties are evaluated over the life of the reservoir.
Unevaluated properties are reviewed for impairment at least quarterly and are determined through an evaluation considering, among other
factors, seismic data, requirements to relinquish acreage, drilling results, remaining time in the commitment period, remaining capital plan,
and political, economic, and market conditions.
Gains and losses on the sale of oil and gas properties are not generally reflected in income unless the gain or loss would significantly alter
the relationship between capitalized costs and proved reserves. Sales of less than 100% of the Company’s interest in the oil and gas
property are treated as a reduction of the capital cost of the field, with no gain or loss recognized, as long as doing so does not significantly
affect the unit-of-production depletion rate. Costs of retired equipment, net of salvage value, are usually charged to accumulated
depreciation.
Capitalized interest – The Company capitalizes interest on unevaluated properties during the periods in which they are excluded from costs
being depleted or amortized. During the years ended December 31, 2018 and 2017, the Company capitalized $2,020,019 and $1,010,868,
respectively, of interest on unevaluated properties.
Depreciation, depletion, and amortization – The depreciable base for oil and natural gas properties includes the sum of all capitalized costs
net of accumulated depreciation, depletion, and amortization (“DD&A”), estimated future development costs and asset retirement costs not
included in oil and natural gas properties, less costs excluded from amortization. The depreciable base of oil and natural gas properties is
amortized on a unit-of-production method.
Ceiling test – Future production volumes from oil and gas properties are a significant factor in determining the full cost ceiling limitation
of capitalized costs. Under the full cost method of accounting, the Company is required to periodically perform a “ceiling test” that
determines a limit on the book value of oil and gas properties. If the net capitalized cost of proved oil and gas properties, net of related
deferred income taxes, plus the cost of unproved oil and gas properties, exceeds the present value of estimated future net cash flows
discounted at 10 percent, net of related tax affects, plus the cost of unproved oil and gas properties, the excess is charged to expense and
reflected as additional accumulated DD&A. The ceiling test calculation uses a commodity price assumption which is based on the
unweighted arithmetic average of the price on the first day of each month for each month within the prior 12 month period and excludes
future cash outflows related to estimated abandonment costs.
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3.
SIGNIFICANT ACCOUNTING POLICIES - continued
The determination of oil and gas reserves is a subjective process, and the accuracy of any reserve estimate depends on the quality of
available data and the application of engineering and geological interpretation and judgment. Estimates of economically recoverable
reserves and future net cash flows depend on a number of variable factors and assumptions that are difficult to predict and may vary
considerably from actual results. In particular, reserve estimates for wells with limited or no production history are less reliable than those
based on actual production. Subsequent re-evaluation of reserves and cost estimates related to future development of proved oil and gas
reserves could result in significant revisions to proved reserves. Other issues, such as changes in regulatory requirements, technological
advances, and other factors which are difficult to predict could also affect estimates of proved reserves in the future.
Asset retirement obligations –The fair value of a liability for an asset’s retirement obligation (“ARO”) is recognized in the period in which
it is incurred if a reasonable estimate of fair value can be made, with the corresponding charge capitalized as part of the carrying amount of
the related long-lived asset. The liability is accreted to its then-present value each subsequent period, and the capitalized cost is depleted
over the useful life of the related asset. Abandonment costs incurred are recorded as a reduction of the ARO liability.
Inherent in the fair value calculation of an ARO are numerous assumptions and judgments including the ultimate settlement amounts,
inflation factors, credit adjusted discount rates, timing of settlement, and changes in the legal, regulatory, environmental, and political
environments. To the extent future revisions to these assumptions impact the fair value of the existing ARO liability, a corresponding
adjustment is made to the oil and gas property balance. Settlements greater than or less than amounts accrued as ARO are recorded as a
gain or loss upon settlement.
Income taxes - Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities
and their respective tax bases and operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years 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 income in the period that includes the enactment date. A valuation
allowance is established to reduce deferred tax assets if it is more likely than not that the related tax benefits will not be realized.
Authoritative guidance for uncertainty in income taxes requires that the Company recognize the financial statement benefit of a tax position
only after determining that the relevant tax authority would more likely than not sustain the position following an examination.
Management has reviewed the Company’s tax positions and determined there were no uncertain tax positions requiring recognition in the
consolidated financial statements. Company tax returns remain subject to Federal and State tax examinations. Generally, the applicable
statutes of limitation are three to four years from their respective filings.
Estimated interest and penalties related to potential underpayment on any unrecognized tax benefits are classified as a component of tax
expense in the statement of operation. The Company has not recorded any interest or penalties associated with unrecognized tax benefits
for any periods covered by these financial statements.
Share-based compensation – Compensation cost for equity awards is based on the fair value of the equity instrument on the date of grant
and is recognized over the period during which an employee is required to provide service in exchange for the award.
The Company accounts for stock option awards using the calculated value method. The expected term was derived using the simplified
method provided in Securities and Exchange Commission release Staff Accounting Bulletin No. 110, which averages an awards weighted
average vesting period and contractual term for “plain vanilla” share options.
The Company accounts for any forfeitures of options when they occur. Previously recognized compensation cost for an award is reversed
in the period that the award is forfeited.
The Company also issues equity awards to non-employees. The fair value of these option awards is estimated when the award recipient
completes the contracted professional services. The Company recognizes expense for the estimated total value of the awards during the
period from their issuance until performance completion.
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-
Based Payment Accounting, which simplifies the accounting for share-based payments granted to nonemployees for goods and services.
Under this ASU, the guidance on such payments to nonemployees is aligned with the requirements for share-based payments granted to
employees. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018, however the Company has opted for early
adoption effective July 1, 2018. The amendments in this ASU are to be applied through a cumulative-effect adjustment to retained earnings
as of the first reporting period in which the ASU is effective. In evaluating early adoption the Company has determined that the change
does not have a material impact on its consolidated financial statements.
The Company values warrant and option awards using the Black-Scholes option pricing model.
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3.
SIGNIFICANT ACCOUNTING POLICIES - continued
Revenue recognition – On January 1, 2018, the Company adopted ASC 606, Revenue from Contracts with Customers, and the related
guidance in ASC 340-40 (the new revenue standard), and related guidance on gains and losses on derecognition of nonfinancial assets ASC
610-20, using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Under the
modified retrospective method, the Company recognizes the cumulative effect of initially applying the new revenue standard as an
adjustment to the opening balance of retained earnings; however, no significant adjustment was required as a result of adopting the new
revenue standard. Results for reporting periods beginning after January 1, 2018 are presented under the new revenue standard. The
comparative information has not been restated and continues to be reported under the historic accounting standards in effect for those
periods. The impact of the adoption of the new revenue standard was immaterial to the Company’s net income.
The Company’s revenue is typically generated from contracts to sell natural gas, crude oil or NGLs produced from interests in oil and gas
properties owned by the Company. Contracts for the sale of natural gas and crude oil are evidenced by (1) base contracts for the sale and
purchase of natural gas or crude oil, which document the general terms and conditions for the sale, and (2) transaction confirmations, which
document the terms of each specific sale. The transaction confirmations specify a delivery point which represents the point at which
control of the product is transferred to the customer. These contracts frequently meet the definition of a derivative under ASC 815, and are
accounted for as derivatives unless the Company elects to treat them as normal sales as permitted under that guidance. The Company elects
to treat contracts to sell oil and gas production as normal sales, which are then accounted for as contracts with customers. The Company has
determined that these contracts represent multiple performance obligations which are satisfied when control of the commodity transfers to
the customer, typically through the delivery of the specified commodity to a designated delivery point.
Revenue is measured based on consideration specified in the contract with the customer, and excludes any amounts collected on behalf of
third parties. The Company recognizes revenue in the amount that reflects the consideration it expects to be entitled to in exchange for
transferring control of those goods to the customer. Amounts allocated in the Company’s price contracts are based on the standalone selling
price of those products in the context of long-term contracts. Payment is generally received one or two months after the sale has occurred.
Gain or loss on derivative instruments is outside the scope of ASC 606 and is not considered revenue from contracts with customers subject
to ASC 606. The Company may in the future use financial or physical contracts accounted for as derivatives as economic hedges to manage
price risk associated with normal sales, or in limited cases may use them for contracts the Company intends to physically settle but do not
meet all of the criteria to be treated as normal sales.
Producer Gas Imbalances. The Company applies the sales method of accounting for natural gas revenue. Under this method, revenues are
recognized based on the actual volume of natural gas sold to purchasers.
Basic and diluted earnings (loss) per share – Basic earnings (loss) per common share is computed by dividing net income (loss) available
to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per
common share is computed in the same way as basic earnings (loss) per common share except that the denominator is increased to include
the number of additional common shares that would be outstanding if all potential common shares had been issued and if the additional
common shares were dilutive. The calculation of diluted earnings per share excludes 14,814,586 shares issuable upon the exercise of
outstanding warrants and options because their effect would be anti-dilutive.
Environmental laws and regulations – The Company is subject to extensive federal, state, and local environmental laws and regulations.
Environmental expenditures are expensed or capitalized depending on their future economic benefit. The Company believes that it is in
compliance with existing laws and regulations.
Recent accounting pronouncements – In February 2016 the FASB, issued ASU, 2016-02, Leases. The ASU requires companies to
recognize on the balance sheet the assets and liabilities for the rights and obligations created by leased assets. ASU 2016-02 will be
effective for the Company in the first quarter of 2019, with early adoption permitted. The Company is currently evaluating the impact that
the adoption of ASU 2016-02 will have on the Company’s consolidated financial statements and related disclosures.
Other recently issued or adopted accounting pronouncements are not expected to have, or did not have, a material impact on the Company’s
financial position or results from operations.
Subsequent events – The Company evaluated subsequent events through March 18, 2019, the date of issuance of these financial
statements. Subsequent events are disclosed in Note 11.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. OIL & GAS PROPERTIES
The following table presents the capitalized costs for oil & gas properties of the Company as of December 31, 2018 and 2017:
Evaluated costs subject to amortization
Unevaluated costs
Total capitalized costs
Less accumulated depreciation, depletion and amortization
Total oil and gas properties
2018
2017
$
$
11,664,586
31,746,477
43,411,063
(6,845,602)
36,565,461
$
$
5,022,129
26,100,749
31,122,878
(5,543,599)
25,579,279
Unevaluated costs as of December 31, 2018 include cumulative costs on developing projects including the Orogrande, Hazel, and Winkler
projects in West Texas.
The Company identified impairment of $2,300,626 in 2017 related to its unevaluated properties. Although we had no recognized
impairment expense in 2017, the Company has adjusted the separation of evaluated versus unevaluated costs within its full cost pool to
recognize the value impairment related to the expiration of unevaluated leases in 2017 in the amount of $2,300,626. The impact of this
change will be to increase the basis for calculation of future period’s depletion, depreciation and amortization to include $2,300,626 of cost
which will effectively recognize the impairment on the Consolidated Statement of Operations over future periods. The $2,300,626 has also
become an evaluated cost for purposes of future period’s Ceiling Tests and which may further recognize the impairment expense
recognized in future periods. The impact of this cost reclassification at March 31, 2018 was a recognized impairment expense of $139,891.
No additional impairment adjustment was required through December 31, 2018.
Due to the volatility of commodity prices, should oil and natural gas prices decline in the future, it is possible that a further write-down
could occur. Proved reserves are estimated quantities of crude oil, natural gas, and natural gas liquids, which geological and engineering
data demonstrate with reasonable certainty to be recoverable from known reservoirs under existing economic and operating conditions. The
independent engineering estimates include only those amounts considered to be proved reserves and do not include additional amounts
which may result from new discoveries in the future, or from application of secondary and tertiary recovery processes where facilities are
not in place or for which transportation and/or marketing contracts are not in place. Estimated reserves to be developed through secondary
or tertiary recovery processes are classified as unevaluated properties.
Orogrande Project, West Texas
On August 7, 2014, we entered into a Purchase Agreement with Hudspeth Oil Corporation (“Hudspeth”), McCabe Petroleum Corporation
(“MPC”), and Gregory McCabe, our Chairman. Mr. McCabe was the sole owner of both Hudspeth and MPC. Under the terms and
conditions of the Purchase Agreement, at closing, we purchased 100% of the capital stock of Hudspeth which holds certain oil and gas
assets, including a 100% working interest in approximately 172,000 mostly contiguous acres in the Orogrande Basin in West Texas. As of
December 31, 2017, leases covering approximately 133,000 acres remain in effect. This acreage is in the primary term under five-year
leases that carry additional five-year extension provisions. As consideration, at closing we issued 868,750 restricted shares of our common
stock to Mr. McCabe and paid a total of $100,000 in geologic origination fees to third parties. Additionally, Mr. McCabe has, at his option,
a 10% working interest back-in after payout and a reversionary interest if drilling obligations are not met, all under the terms and conditions
of a participation and development agreement among Hudspeth, MPC and Mr. McCabe. We believe all drilling obligations through
December 31, 2018 have been met.
On September 23, 2015, Hudspeth entered into a Farmout Agreement with Pandora Energy, LP (“Pandora”), Founders Oil & Gas, LLC
(“Founders”), and for the limited purposes set forth therein, MPC and Mr. McCabe, for the entire Orogrande Project in Hudspeth County,
Texas. The Farmout Agreement provided that Hudspeth and Pandora (collectively referred to as “Farmor”) would assign to Founders an
undivided 50% of the leasehold interest and a 37.5% net revenue interest in the oil and gas leases and mineral interests in the Orogrande
Project, which interests, except for any interests retained by Founders, would be reassigned to Farmor by Founders if Founders did not
spend a minimum of $45.0 million on actual drilling operations on the Orogrande Project by September 23, 2017. Under a joint operating
agreement also entered into on September 23, 2015, Founders was designated as operator of the leases.
On March 22, 2017, Founders, Founders Oil & Gas Operating, LLC, Founders’ operating partner, Hudspeth and Pandora signed a Drilling
and Development Unit Agreement (the “DDU Agreement”), with the Commissioner of the General Land Office, on behalf of the State of
Texas, and as approved by the Board for Lease of University Lands, or University Lands, on the Orogrande Project. The DDU Agreement
has an effective date of January 1, 2017 and required a payment from Founders, Hudspeth and Pandora, collectively, of $335,323 as the
initial consideration fee. The initial consideration fee was paid by Founders in April 2017 and was to be deducted from the required spud
fee payable to us at commencement of the next well drilled.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. OIL & GAS PROPERTIES - continued
The DDU Agreement allows for all 192 existing leases covering approximately 133,000 net acres leased from University Lands to be
combined into one drilling and development unit for development purposes. The term of the DDU Agreement expires on December 31,
2023, and the time to drill on the drilling and development unit continues through December 2023. The DDU Agreement also grants the
right to extend the DDU Agreement through December 2028 if compliance with the DDU Agreement is met and the extension fee
associated with the additional time is paid. Our drilling obligations began with one well to be spudded and drilled on or before September 1,
2017, and increased to two wells in year 2018, three wells in year 2019, four wells in year 2020 and five wells per year in years 2021, 2022
and 2023. The drilling obligations are minimum yearly requirements and may be exceeded if acceleration is desired. The DDU Agreement
replaces all prior agreements, and will govern future drilling obligations on the drilling and development unit if the DDU Agreement is
extended. The Company drilled three wells during fourth quarter, 2018.
There are two vertical tests wells in the Orogrande Project, the Orogrande Rich A-11 test well and the University Founders B-19 #1 test
well. The Orogrande Rich A-11 test well was spudded on March 31, 2015, drilled in the second quarter of 2015 and was evaluated and
numerous scientific tests were performed to provide key data for the field development thesis. We believe that future utility of this well
may be conversion to a salt water disposal well in the course of further development of the Orogrande acreage. The University Founders B-
19 #1 was spudded on April 24, 2016 and drilled in the second quarter of 2016. The well successfully pumped down completion fluid in
the third quarter of 2016 and indications of hydrocarbons were seen at the surface on this second Orogrande Project test well. We believe
that future utility of this well may be conversion to a salt water disposal well in the course of further development of the Orogrande
acreage.
During the fourth quarter of 2017, we took back operational control from Founders on the Orogrande Project. We were joined by Wolfbone
Investments, LLC, (“Wolfbone”), a company owned by Mr. McCabe. We, along with Hudspeth, Wolfbone and, for the limited purposes
set forth therein, Pandora, entered into an Assignment of Farmout Agreement with Founders, (the “Assignment of Farmout Agreement”),
pursuant to which we and Wolfbone will share the remaining commitments under the Farmout Agreement. All original provisions of our
carried interest were to remain in place including reimbursement to us on each wellbore. Founders was to remain a 9.5% working interest
owner in the Orogrande Project for the $9.5 million it had spent as of the date of the Assignment of Farmout Agreement, and such interests
were to be carried until $40.5 million is spent by Wolfbone and us, with each contributing 50% of such capital spend, under the existing
agreement. Our working interest in the Orogrande Project thereby increased by 20.25% to a total of 67.75% and Wolfbone then owned
20.25%.
Founders was to operate a newly drilled horizontal well called the University Founders #A25 (at 5,540’ depth in a 1,000’ lateral) with
supervision from us and our partners. The University Founders #A25 was spudded on November 28, 2017. During the month of April,
2018, we, MPC and Mr. McCabe were to assume full operational control including managing drilling plans and timing for all future wells
drilled in the project.
On July 25, 2018, we and Hudspeth entered into a Settlement & Purchase Agreement (the “Settlement Agreement”) with Founders (and
Founders Oil & Gas Operating, LLC), Wolfbone and MPC, which agreement provides for Hudspeth and Wolfbone to each immediately pay
$625,000 and for Hudspeth or the Company and Wolfbone or MPC to each pay another $625,000 on July 20, 2019, as consideration for
Founders assigning all of its working interest in the oil and gas leases of the Orogrande Project to Hudspeth and Wolfbone equally. The
assignments to Hudspeth and Wolfbone were made in July when the first payments were made. The payments to Founders in 2019 are not
securitized. Future well capital spending obligations will require the same 50% contribution from Hudspeth and 50% from Wolfbone until
such time as the $40.5 million to be spent on the project (as per our Assignment of Farmout Agreement with Founders) is completed. The
Company estimates that there is still approximately $23 million remaining to be spent on the project until such time as the capital
expenditures revert back to the percentages of the working interest owners.
After the assignment by Founders (for which Hudspeth’s total consideration is $1,250,000), Hudspeth’s working interest increased to
72.5%. Additionally, the Settlement Agreement provides that the Founders parties will assign to the Company, Hudspeth, Wolfbone and
MPC their claims against certain vendors for damages, if any, against such vendors for negligent services or defective equipment. Further,
the Settlement Agreement has a mutual release and waivers among the parties.
Rich Masterson, our consulting geologist, is credited with originating the Orogrande Project in Hudspeth County in the Orogrande Basin.
With Mr. Masterson’s assistance, we have identified target payzone depths between 4,100’ and 6,100’ with primary pay, described as the
WolfPenn formation, located at depths of 5,300 to 5,900’. Based on our geologic analysis to date, the Wolfpenn formation is prospective
for oil and high British thermal unit (Btu) gas, with a 70/30 mix expected, respectively.
Recently, the Company drilled three additional test wells in the Orogrande in order to stay in compliance with University Lands D&D Unit
Agreement, as well as, to test for potential shallow pay zones and deeper pay zones that may be present on structural plays. At the time of
this writing, the results have not been published.
Hazel Project in the Midland Basin in West Texas
Effective April 4, 2016, TEI acquired from MPC a 66.66% working interest in approximately 12,000 acres in the Midland Basin in
exchange for 1,500,000 warrants to purchase shares of our common stock with an exercise price of $1.00 for five years and a back-in after
payout of a 25% working interest to MPC.
Initial development of the first well on the property, the Flying B Ranch #1, began July 9, 2016 and development continued through
September 30, 2016. This well is classified as a test well in the development pursuit of the Hazel Project. We believe that this wellbore will
be utilized as a salt water disposal well in support of future development.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. OIL & GAS PROPERTIES - continued
In October 2016, the holders of all of our then-outstanding shares of Series C Preferred Stock (which were issued in July 2016) elected to
convert into a total 33.33% working interest in our Hazel Project, reducing our ownership from 66.66% to a 33.33% working interest. As of
December 31, 2018, no shares of our Series C Preferred Stock were outstanding.
On December 27, 2016, drilling activities commenced on the second Hazel Project well, the Flying B Ranch #2. The well is a vertical test
similar to our first Hazel Project well, the Flying B Ranch #1. Recompletion in an alternative geological formation for this well was
performed during the three months ended September 30, 2017; however, we believe that the results were uneconomic for continuing
production. We believe that this wellbore will be utilized as a salt water disposal well in support of future development.
We commenced planning to drill the Flying B Ranch #3 horizontal well in the Hazel Project in June 2017 in compliance with the
continuous drilling obligation. The well was spudded on June 10, 2017. The well was completed and began production in late September
2017.
Acquisition of Additional Interests in Hazel Project
On January 30, 2017, we and our then wholly-owned subsidiary, Torchlight Acquisition Corporation, a Texas corporation (“TAC”), entered
into and closed an Agreement and Plan of Reorganization and a Plan of Merger with Line Drive Energy, LLC, a Texas limited liability
company (“Line Drive”), and Mr. McCabe, under which agreements TAC merged with and into Line Drive and the separate existence of
TAC ceased, with Line Drive being the surviving entity and becoming our wholly-owned subsidiary. Line Drive, which was wholly-owned
by Mr. McCabe, owned certain assets and securities, including approximately 40.66% of 12,000 gross acres, 9,600 net acres, in the Hazel
Project and 521,739 warrants to purchase shares of our common stock (which warrants had been assigned by Mr. McCabe to Line Drive).
Upon the closing of the merger, all of the issued and outstanding shares of common stock of TAC automatically converted into a
membership interest in Line Drive, constituting all of the issued and outstanding membership interests in Line Drive immediately following
the closing of the merger, the membership interest in Line Drive held by Mr. McCabe and outstanding immediately prior to the closing of
the merger ceased to exist, and we issued Mr. McCabe 3,301,739 restricted shares of our common stock as consideration therefor.
Immediately after closing, the 521,739 warrants held by Line Drive were cancelled, which warrants had an exercise price of $1.40 per share
and an expiration date of June 9, 2020. A Certificate of Merger for the merger transaction was filed with the Secretary of State of Texas on
January 31, 2017. Subsequent to the closing the name of Line Drive Energy, LLC was changed to Torchlight Hazel, LLC. We are required
to drill one well every six months to hold the entire 12,000 acre block for eighteen months, and thereafter two wells every six months
starting June 2018.
Also on January 30, 2017, TEI entered into and closed a Purchase and Sale Agreement with Wolfbone. Under the agreement, TEI acquired
certain of Wolfbone’s Hazel Project assets, including its interest in the Flying B Ranch #1 well and the 40 acre unit surrounding the well,
for consideration of $415,000, and additionally, Wolfbone caused to be cancelled a total of 2,780,000 warrants to purchase shares of our
common stock, including 1,500,000 warrants held by MPC, and 1,280,000 warrants held by Green Hill Minerals, an entity owned by Mr.
McCabe’s son, which warrant cancellations were effected through certain Warrant Cancellation Agreements. The 1,500,000 warrants held
by MPC that were cancelled had an exercise price of $1.00 per share and an expiration date of April 4, 2021. The warrants held by Green
Hill Minerals that were cancelled included 100,000 warrants with an exercise price of $1.73 and an expiration date of September 30, 2018
and 1,180,000 warrants with an exercise price of $0.70 and an expiration date of February 15, 2020.
Since Mr. McCabe held the controlling interest in both Line Drive and Wolfbone, the transactions were combined for accounting purposes.
The working interest in the Hazel Project was the only asset held by Line Drive. The warrant cancellation was treated in the aggregate as
an exercise of the warrants with the transfer of the working interests as the consideration. We recorded the transactions as an increase in its
investment in the Hazel Project working interests of $3,644,431, which is equal to the exercise price of the warrants plus the cash paid to
Wolfbone.
Upon the closing of the transactions, our working interest in the Hazel Project increased by 40.66% to a total ownership of 74%.
Effective June 1, 2017, we acquired an additional 6% working interest from unrelated working interest owners in exchange for 268,656
shares of common stock valued at $373,430, increasing our working interest in the Hazel project to 80%, and an overall net revenue interest
of 74-75%.
Mr. Masterson is credited with originating the Hazel Project in the Midland Basin. With Mr. Masterson’s assistance, we are targeting
prospects in the Midland Basin that have 150 to 130 feet of thickness, are likely to require six to eight laterals per bench, have the potential
for twelve to sixteen horizontal wells per section, and 200 long lateral locations, assuming only two benches.
In April 2018, we announced that we have commenced a process that could result in the monetization of the Hazel Project. We believe the
development activity at the Hazel Project, coupled with nearby activities of other oil and gas operators, suggests that this project has
achieved a level of value worth monetizing. We anticipate that the liquidity that would be provided from selling the Hazel Project could be
redeployed into the Orogrande Project. While this process is underway, we will take all necessary steps to maintain the leasehold as
required. In May, the working interest partners in the Hazel Project drilled a shallow well to test a zone at 2500’. As of this filing, we
continue to maintain the leases in good standing and continue to market the acreage in an effort to focus on the Orogrande Project.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. OIL & GAS PROPERTIES - continued
Winkler Project, Winkler County, Texas
On December 1, 2017, the Agreement and Plan of Reorganization that we and our then wholly-owned subsidiary, Torchlight Wolfbone
Properties, Inc., a Texas corporation (“TWP”), entered into with MPC and Warwink Properties, LLC (Warwink Properties) on November
14, 2017 closed. Under the agreement, TWP merged with and into Warwink Properties and the separate existence of TWP ceased, with
Warwink Properties being the surviving entity and becoming our wholly-owned subsidiary. Warwink Properties was wholly owned by
MPC. Warwink Properties owns certain assets, including a 10.71875% working interest in approximately 640 acres in Winkler County,
Texas. Upon the closing of the merger, all of the issued and outstanding shares of common stock of TWP converted into a membership
interest in Warwink Properties, constituting all of the issued and outstanding membership interests in Warwink Properties immediately
following the closing of the merger, the membership interest in Warwink Properties held by MPC and outstanding immediately prior to the
closing of the merger ceased to exist, and we issued MPC 2,500,000 restricted shares of our common stock as consideration. Also on
December 1, 2017, MPC closed its transaction with MECO IV, LLC (” MECO”), for the purchase and sale of certain assets as
contemplated by the Purchase and Sale Agreement dated November 9, 2017 among MPC, MECO and additional parties thereto (the
“MECO PSA”), to which we are not a party. Under the MECO PSA, Warwink Properties received a carry from MECO (through the tanks)
of up to $1,179,076 in the next well drilled on the Winkler County leases. A Certificate of Merger for the merger transaction was filed with
the Secretary of State of Texas on December 5, 2017.
Also on December 1, 2017, the transactions contemplated by the Purchase Agreement that TEI entered into with MPC closed. Under the
Purchase Agreement, which was entered into on November 14, 2017, TEI acquired beneficial ownership of certain of MPC’s assets,
including acreage and wellbores located in Ward County, Texas (the “Ward County Assets”). As consideration under the Purchase
Agreement, at closing TEI issued to MPC an unsecured promissory note in the principal amount of $3,250,000, payable in monthly
installments of interest only beginning on January 1, 2018, at the rate of 5% per annum, with the entire principal amount together with all
accrued interest due and payable on January 1, 2021. In connection with TEI’s acquisition of beneficial ownership in the Ward County
Assets, MPC sold those same assets, on behalf of TEI, to MECO at closing of the MECO PSA, and accordingly, TEI received $3,250,000
in cash for its beneficial interest in the Ward County Assets. Additionally, at closing of the MECO PSA, MPC paid TEI a performance fee
of $2,781,500 in cash as compensation for TEI’s marketing and selling the Winkler County assets of MPC and the Ward County Assets as a
package to MECO.
Addition to the Winkler Project
As of May 7, 2018 our Winkler project in the Delaware Basin had begun the drilling phase of the first Winkler Project well, the UL 21
War-Wink 47 #2H. Our operating partner, MECO had begun the pilot hole on the project. The plan is to evaluate the various potential
zones for a lateral leg to be drilled once logging is completed. We expect the most likely target to be the Wolfcamp A interval. The well is
on 320 newly acquired acres offsetting the original leasehold we entered into in December, 2017. The additional acreage was leased by our
operating partner under the Area of Mutual Interest Agreement (AMI) and we exercised its right to participate for its 12.5% in the
additional 1,080 gross acres at a cash cost of $447,847 in July, 2018. Our carried interest in the first well, as outlined in the agreement, was
originally planned to be on the first acreage acquired. That carried interest is being applied to this new well and will allow MECO to drill
and produce potential revenues sooner than originally planned. The primary leasehold is a 320-acre block directly west of the current
position and will allow for 5,000-foot lateral wells to be drilled. The well was completed and began production in October, 2018.
Two additional wells are planned for development by MECO in 2019.
In December, 2018, the Company began to take measures on its own to market the Warwink Project in an effort to focus on the Orogrande.
5. RELATED PARTY PAYABLES
As of December 31, 2018 and 2017, related party payables consisted of accrued and unpaid compensation to one of our executive officers
totaling $45,000.
6. COMMITMENTS AND CONTINGENCIES
Leases
The Company has a noncancelable lease for its office premises that expires on November 30, 2019 and which requires the payment of base
lease amounts and executory costs such as taxes, maintenance and insurance. Rental expense for lease was $82,075 and $84,197 for the
years ended December 31, 2018 and 2017, respectively.
Approximate future minimum rental commitments under the office premises lease are:
Year Ending December 31,
Rent
To 2019 Expiration
Total
88,605
88,605
$
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7.
STOCKHOLDERS’ EQUITY
Environmental matters
The Company is subject to contingencies as a result of environmental laws and regulations. Present and future environmental laws and
regulations applicable to the Company’s operations could require substantial capital expenditures or could adversely affect its operations
in other ways that cannot be predicted at this time. As of December 31, 2018 and 2017, no amounts had been recorded because no specific
liability has been identified that is reasonably probable of requiring the Company to fund any future material amounts.
Common Stock
During the years ended December 31, 2018 and 2017, the Company issued 5,750,000 and -0- shares of common stock, respectively, for
cash of $6,049,734 and $-0-.
During the years ended December 31, 2018 and 2017, the Company issued 450,000 and 507,897 shares of common stock, respectively,
with total fair values of $545,000 and $579,754 as compensation for services.
During the years ended December 31, 2018 and 2017, the Company issued -0- and 6,420,395 shares of common stock respectively, for
lease interests with total fair values of $-0- and $6,812,362.
During the year ended December 31, 2017 the Company issued 1,007,890 shares of common stock, in conversions of notes payable valued
at $1,007,890.
During the year ended December 31, 2018 the Company issued 172,342 shares of common stock, in payment in kind on notes payable
valued at $221,024.
During the year ended December 31, 2018 and 2017, the Company issued 400,000 and 307,349 shares of common stock, respectively,
resulting from warrant exercises for consideration totaling $200,000 and $243,300.
Warrants and Options
During the years ended December 31, 2018 and 2017, the Company issued/vested 1,820,000 and 1,808,026 warrants and options with total
fair values of $854,325 and $1,093,104, respectively, as compensation for services.
A summary of warrants outstanding as of December 31, 2018 and 2017 by exercise price and year of expiration is presented below:
Exercise
Price
2019
2020
Expiration Date in
2021
2022
2023
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
0.70
0.77
1.00
1.03
1.08
1.14
1.21
1.40
1.50
1.64
1.80
2.00
2.23
2.50
3.50
4.50
6.00
7.00
-
100,000
25,116
-
37,500
-
-
-
-
-
-
-
-
35,211
15,000
700,000
22,580
700,000
1,635,407
420,000
-
-
-
-
-
-
1,121,736
-
1,250,000
-
832,512
-
-
-
-
-
3,624,248
-
-
-
120,000
-
-
-
100,000
200,000
-
400,000
-
-
-
-
-
820,000
50
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
600,000
120,000
-
-
-
-
-
-
-
-
-
-
-
720,000
2018
Total
420,000
100,000
25,116
120,000
37,500
600,000
120,000
1,121,736
100,000
200,000
1,250,000
400,000
832,512
35,211
15,000
700,000
22,580
700,000
6,799,655
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7.
STOCKHOLDERS’ EQUITY - continued
Exercise
Price
2018
2019
2020
2021
Expiration Date in
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
0.50
0.70
0.77
1.00
1.03
1.08
1.40
1.64
1.73
1.80
2.00
2.03
2.09
2.23
2.29
2.50
2.82
3.50
4.50
6.00
7.00
400,000
-
-
-
-
-
-
-
100,000
-
1,906,249
2,000,000
2,800,000
-
120,000
-
38,174
-
-
523,123
-
7,887,546
-
-
100,000
25,116
-
37,500
-
-
-
-
-
-
-
-
-
35,211
-
15,000
700,000
22,580
700,000
1,635,407
-
420,000
-
-
-
-
1,121,736
-
-
1,250,000
-
-
-
832,512
-
-
-
-
-
-
-
3,624,248
-
-
-
-
120,000
-
200,000
-
-
-
-
-
-
-
-
-
-
-
-
-
320,000
2017
Total
400,000
420,000
100,000
25,116
120,000
37,500
1,121,736
200,000
100,000
1,250,000
1,906,249
2,000,000
2,800,000
832,512
120,000
35,211
38,174
15,000
700,000
545,703
700,000
13,467,201
A summary of stock options outstanding as of December 31, 2018 and 2017 by exercise price and year of expiration is presented below:
Exercise
Price
2019
2020
Expiration Date in
2021
2022
2023
$
$
$
$
$
$
0.97
1.10
1.19
1.57
1.63
1.79
-
-
-
1,497,163
-
-
1,497,163
-
-
-
4,500,000
-
300,000
4,800,000
-
800,000
-
-
58,026
-
858,026
-
-
600,000
-
-
-
600,000
259,742
-
-
-
-
-
259,742
51
2018
Total
259,742
800,000
600,000
5,997,163
58,026
300,000
8,014,931
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7.
STOCKHOLDERS’ EQUITY - continued
Exercise
Price
2018
2019
Expiration Date in
2020
2021
2022
$
$
$
$
$
0.97
1.10
1.57
1.63
1.79
-
-
-
-
-
-
-
-
-
-
-
-
-
-
5,997,163
-
300,000
6,297,163
259,742
-
-
58,026
-
317,768
-
800,000
-
-
-
800,000
2017
Total
259,742
800,000
5,997,163
58,026
300,000
7,414,931
At December 31, 2018, the Company 2018 and 2017 had reserved 14,814,586 and 20,882,132 common shares, respectively, for future
exercise of warrants and options.
Warrants and options granted were valued using the Black-Scholes Option Pricing Model. The assumptions used in calculating the fair
value of the warrants and options issued were as follows:
2018
Risk-free interest rate
Expected volatility of common stock
Dividend yield
Discount due to lack of marketability
Expected life of option/warrant
2017
Risk-free interest rate
Expected volatility of common stock
Dividend yield
Discount due to lack of marketability
Expected life of option/warrant
8.
INCOME TAXES
2.15% - 2.83%
97% - 119%
0.00%
20%
2.75 to 5 Years
1.47% - 2.06%
106% - 122%
0.00%
20%
2.75 to 5 Years
The Company recorded no income tax provision for 2018 and 2017 because of losses incurred. The Company has placed a full valuation
allowance against net deferred tax assets because future realization of these assets is not assured.
The following is a reconciliation between the federal income tax benefit computed at statutory federal income tax rates and actual income
tax provision for the years ended December 31, 2018 and 2017:
Federal income tax benefit at statutory rate
Permanent Differences
Annual reconciling adjustment
Change in valuation allowance
Change in federal tax rate
Provision for income taxes
52
Year ended
December 31,
2018
(1,221,483)
505
1,449,429
(228,451)
-
-
$
Year ended
December 31,
2017
$
$
(312,769)
1,640
719,197
(9,186,334)
8,778,266
-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8.
INCOME TAXES – continued
The tax effects of temporary differences that gave rise to significant portions of deferred tax assets and liabilities at December 31, 2018 and
December 31, 2017 are as follows:
Deferred tax assets:
Net operating loss carryforward
Stock based compensation
Other
Deferred tax liabilities:
Investment in oil and gas properties
Net deferred tax assets and liabilities
Less valuation allowance
Total deferred tax assets and liabilities
December 31,
2018
December 31,
2017
$
11,968,500
4,490,775
371,636
11,116,332
4,209,307
302,042
(2,879,086)
13,951,825
(13,951,825)
-
$
(1,447,405)
14,180,276
(14,180,276)
-
$
The Company had a net deferred tax asset related to federal net operating loss carryforwards of $56,992,857 and $52.934.915 at December
31, 2018 and December 31, 2017, respectively. The federal net operating loss carryforward will begin to expire in 2033. Realization of the
deferred tax asset is dependent, in part, on generating sufficient taxable income prior to expiration of the loss carryforwards. The Company
has placed a 100% valuation allowance against the net deferred tax asset because future realization of these assets is not assured.
On December 22, 2017, the U.S. government enacted comprehensive legislation titled the Tax Cuts and Jobs Act. Generally, effective for
years 2018 and beyond, it makes broad and complex changes to the Internal Revenue Code, including, but not limited to, reducing the
federal corporate income tax rate from 35% to 21%. As of December 31, 2017 we made a reasonable estimate of the effects on our deferred
tax assets and liabilities of the change in the corporate tax rate to be effective in 2018. The estimated amount is included our computation of
net deferred tax assets and liabilities and the related valuation allowance.
9.
PROMISSORY NOTES
On April 10, 2017, we sold to investors in a private transaction two 12% unsecured promissory notes with a total of $8,000,000 in principal
amount. Interest only is due and payable on the notes each month at the rate of 12% per annum, with a balloon payment of the outstanding
principal due and payable at maturity on April 10, 2020. The holders of the notes will also receive annual payments of common stock at the
rate of 2.5% of principal amount outstanding, based on a volume-weighted average price. Both notes were sold at an original issue discount
of 94.25% and accordingly, we received total proceeds of $7,540,000 from the investors. We used the proceeds for working capital and
general corporate purposes, which includes, without limitation, drilling capital, lease acquisition capital and repayment of prior debt.
These 12% promissory notes allow for early redemption. The notes also contain certain covenants under which we have agreed that, except
for financing arrangements with established commercial banking or financial institutions and other debts and liabilities incurred in the
normal course of business, we will not issue any other notes or debt offerings which have a maturity date prior to the payment in full of the
12% notes, unless consented to by the holders.
The effective interest rate is 16.15%.
On April 24, 2017, we used $2,509,500 of the proceeds from this financing to redeem and repay a portion of the outstanding 12% Series B
Convertible Unsecured Promissory Notes. Separately, $1,000,000 of the principal amount of the Series B Notes plus accrued interest was
converted into 1,007,890 shares of common stock and $64,297 was rolled into the new debt financing.
On February 6, 2018, we sold to an investor in a private transaction a 12% unsecured promissory note with a principal amount of
$4,500,000. Interest only is due and payable on the note each month at the rate of 12% per annum, with a balloon payment of the
outstanding principal due and payable at maturity on April 10, 2020. The holder of the note will also receive annual payments of common
stock at the rate of 2.5% of principal amount outstanding, based on a volume-weighted average price. We sold the note at an original issue
discount of 96.27% and accordingly, we received total proceeds of $4,332,150 from the investor. We used the proceeds for working capital
and general corporate purposes, which includes, without limitation, drilling capital, lease acquisition capital and repayment of prior debt.
This 12% promissory note allows for early redemption, provided that if we redeem before February 6, 2019, we must pay the holder all
unpaid interest and common stock payments on the portion of the note redeemed that would have been earned through February 6, 2019.
The note also contains certain covenants under which we have agreed that, except for financing arrangements with established commercial
banking or financial institutions and other debts and liabilities incurred in the normal course of business, we will not issue any other notes
or debt offerings which have a maturity date prior to the payment in full of the 12% note, unless consented to by the holder.
The effective interest rate is 15.88%.
53
TORCHLIGHT ENERGY RESOURCES, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
9.
PROMISSORY NOTES (CONTINUED)
On April 12, 2018, the holders of the notes described above received 172,342 shares of common stock as a payment in kind representing
the annual payments of common stock due at the rate of 2.5% of principal amount outstanding as of April 10, 2018 based on a volume-
weighted average price calculation.
Promissory note transactions for the year ended December 31, 2018 and 2017 are summarized as follows:
Unsecured promissory note balance - December 31, 2016
$
-
New borrowing
Original issue discount
Proceeds from borrowing
New note debt issuance costs
Accretion of discount and amortization of debt issuance costs
8,000,000
(460,000)
7,540,000
(279,754)
9,035
Unsecured promissory note balance - December 31, 2017
$ 7,269,281
New borrowing
Original issue discount
Proceeds from borrowing
New note debt issuance costs
Accretion of discount and amortization of debt issuance costs
4,500,000
(167,850)
4,332,150
(225,000)
485,649
Unsecured promissory note balance - December 31, 2018
$ 11,862,080
In connection with the transaction for the acquisition of Warwink Properties effective December 5, 2017, the Company borrowed $3.25
million from its Chairman, Greg McCabe on a three-year interest only promissory note bearing interest at 5% per annum. The Company
paid $250,000 as a principal payment on June 20, 2018 and paid the remaining principal balance of $3,000,000 on October 19, 2018.
On October 17, 2018, we sold to certain investors in a private transaction 16% Series C Unsecured Convertible Promissory Notes with a
total principal amount of $6,000,000. Interest and principal are due and payable on the notes in one balloon payment at maturity on April
17, 2020. The notes are convertible, at the election of the holders, into an aggregate 6% working interest in certain oil and gas leases in
Hudspeth County, Texas, known as our “Orogrande Project.” After an analysis of the transaction and a review of applicable accounting
pronouncements, management concluded that the notes issued on October 17, 2018 which contain a conversion right for holders to convert
into a working interest in the Orogrande Project of the Company, meet a specific scope exception to the provisions requiring derivative
accounting.
The notes allow us to redeem them early only upon the event of a fundamental transaction, such as a merger or sale of substantially all our
assets. The notes provide that the noteholders may accelerate and declare any and all of the obligations under the notes to be immediately
due and payable in the event of default, such as nonpayment, failure to perform required conversions, failure to perform any covenant or
agreement under the notes, an insolvency event, or certain defaults or judgments. As part of the sale of the of the notes, the noteholders
required that McCabe Petroleum Corporation, a Texas corporation owned by our Chairman Gregory McCabe (“MPC”), provide them a put
option whereby they have the right to have MPC purchase from them any unpaid principal amount due on the notes. Additionally, if there
is a fundamental transaction, Mr. McCabe will be required to pay a fee to each noteholder that elects not to convert or require MPC to
purchase the principal amount under the note, which fee will be equal to such noteholder’s pro-rata share of a total fee amount of
$1,500,000.
We received total proceeds of $6,000,000 from the sale of the notes, of which $3,000,000 was used to pay back the promissory note issued
to MPC on December 1, 2017, which note was due on December 31, 2020. We used the remaining proceeds for working capital and
general corporate purposes, which includes, without limitation, drilling and lease acquisition capital.
Prior to entering into the above transactions, our Board of Directors formed a special committee composed of independent directors to
analyze and authorize the transactions on behalf of Torchlight Energy Resources, Inc. and determine whether the transactions are fair to the
company. In this role, the special committee engaged an independent financial consulting firm which rendered a fairness opinion deeming
that the transactions were fair to the company, from a financial point of view, and contained terms no less favorable to the company than
those that could be obtained in arm’s length transactions.
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. ASSET RETIREMENT OBLIGATIONS
The following is a reconciliation of the asset retirement obligation liability for the year ended December 31, 2018 and 2017:
Asset retirement obligation – December 31, 2016
$
7,051
Accretion expense
Estimated liabilities recorded
216
2,007
Asset retirement obligation – December 31, 2017
$
9,274
Accretion expense
Estimated liabilities recorded
390
4,689
Asset retirement obligation – December 31, 2018
$
14,353
11. SUBSEQUENT EVENTS
In February and March, 2019 the Company raised a total of $2,000,000 from investors through the sale of 14% Series D Unsecured
Convertible Promissory Notes. Principal is payable in a lump sum at maturity on May 11, 2020 with payments of interest payable monthly
at the rate of 14% per annum. Holders of the notes have the right to convert principal and interest at any time into common stock at a
conversion price of $1.08 per share. The Company has the right to redeem the notes at any time, provided that the redemption amount must
include all interest that would have been earned through maturity.
Additionally, the Company received $1,214,078 from the sale of common stock at $.80 per share during February and March, 2019. The
offering included provisions for the cancellation of warrants to purchase common stock issued to the participants in the agreements in prior
periods.
55
TORCHLIGHT ENERGY RESOURCES, INC.
SUPPLEMENTAL INFORMATION ON OIL AND GAS EXPLORATION
AND PRODUCTION ACTIVITIES
(Unaudited)
The unaudited supplemental information on oil and gas exploration and production activities has been presented in accordance with
Financial Accounting Standards Board Accounting Standards Codification Topic 932, Extractive Activities—Oil and Gas and the SEC’s
final rule, Modernization of Oil and Gas Reporting.
Investment in oil and gas properties during the years ended December 31, 2018 and 2017 is detailed as follows:
Property acquisition costs
Development costs
Exploratory costs
Totals
2018
2017
1,072,047
9,191,041
-
10,263,088
$
$
$
$
7,227,362
8,034,962
-
15,262,324
$
$
$
$
Property acquisition costs presented above exclude interest capitalized into the full cost pool of $2,020,019 in 2018 and $1,010,868 in 2017.
Property acquisition cost relates to the Company’s acquisition of additional working interests in the Orogrande Project in west Texas and
the acquisition of the Warwink Project, also in west Texas. The development costs include work in the Orogrande, Hazel, and Warwink
projects in west Texas. No development costs were incurred for Oklahoma properties in 2018.
Oil and Natural Gas Reserves
Reserve Estimates
SEC Case. The following tables sets forth, as of December 31, 2018, our estimated net proved oil and natural gas reserves, the estimated
present value (discounted at an annual rate of 10%) of estimated future net revenues before future income taxes (PV-10) and after future
income taxes (Standardized Measure) of our proved reserves and our estimated net probable oil and natural gas reserves, each prepared
using standard geological and engineering methods generally accepted by the petroleum industry and in accordance with assumptions
prescribed by the Securities and Exchange Commission (“SEC”). All of our reserves are located in the United States.
The PV-10 value is a widely used measure of value of oil and natural gas assets and represents a pre-tax present value of estimated cash
flows discounted at ten percent. PV-10 is considered a non-GAAP financial measure as defined by the SEC. We believe that our PV-10
presentation is relevant and useful to our investors because it presents the estimated discounted future net cash flows attributable to our
proved reserves before taking into account the related future income taxes, as such taxes may differ among various companies. We believe
investors and creditors use PV-10 as a basis for comparison of the relative size and value of our proved reserves to the reserve estimates of
other companies. PV-10 is not a measure of financial or operating performance under GAAP and neither it nor the Standardized Measure is
intended to represent the current market value of our estimated oil and natural gas reserves. PV-10 should not be considered in isolation or
as a substitute for the standardized measure of discounted future net cash flows as defined under GAAP.
The estimates of our proved reserves and the PV-10 set forth herein reflect estimated future gross revenue to be generated from the
production of proved reserves, net of estimated production and future development costs, using prices and costs under existing economic
conditions at December 31, 2018. For purposes of determining prices, we used the average of prices received for each month within the
12-month period ended December 31, 2018, adjusted for quality and location differences, which was $62.04 per barrel of oil and $3.10 per
MCF of gas. This average historical price is not a prediction of future prices. The amounts shown do not give effect to non-property related
expenses, such as corporate general administrative expenses and debt service, future income taxes or to depreciation, depletion and
amortization.
56
December 31, 2018
Reserves
Category
Oil (Bbls)
Gas (Mcf)
Total (BOE)
December 31, 2018
Future Net Revenue (M$)
Present
Value
Discounted
at 10%
Total
Proved Producing
Proved Undeveloped
Total Proved
177,300
797,500
974,800
51,100
105,800
156,900
185,817
815,133
1,000,950
$
$
$
4,027
15,313
19,340
$
$
$
2,029
2,895
4,924
Standardized Measure of Future Net Cash Flows Related to Proved Oil and Gas
Properties
$
5,341
Probable Undeveloped
0
0
0
$
-
$
-
December 31, 2017
Reserves
Category
Oil (Bbls)
Gas (Mcf)
Total (BOE)
December 31, 2017
Future Net Revenue (M$)
Present
Value
Discounted
at 10%
Total
Proved Producing
Proved Nonproducing
Total Proved
2,300
0
2,300
43,800
0
43,800
9,600
0
9,600
$
$
$
132
-
132
$
$
$
96
-
96
Standardized Measure of Future Net Cash Flows Related to Proved Oil and Gas
Properties
$
123
Probable Undeveloped
0
0
0
$
-
$
-
The upward revisions of previous estimates from 2017 to 2018 of proved reserves of 972,500 BBLS and 113,100 MCF results primarily
from 2018 reserve report calculations for the Company’s properties which includes reserves from producing properties in the Hazel and
Warwink Projects for the first time.
Reserve values as of December 31, 2018 are related to a single producing well in Oklahoma, one in the Hazel Project, and one in the
Warwink Project.
BOE equivalents are determined by combining barrels of oil with MCF of gas divided by six.
57
Standardized Measure of Oil & Gas Quantities - Volume Rollforward
Year Ended December 31, 2018
The following table sets forth the Company’s net proved reserves, including the changes therein, and proved developed reserves:
TOTAL PROVED RESERVES:
Beginning of period
Revisions of previous estimates
Extensions, discoveries and other additions
Divestiture of Reserves
Acquisition of Reserves
Production
End of period
Crude Oil
(Bbls)
Natural Gas
(Mcf)
2,300
21,257
974,110
-
-
(22,887)
974,780
43,800
(7,709)
138,670
-
-
(17,821)
156,940
BOE
9,600
19,972
997,222
-
-
(25,857)
1,000,937
Standardized Measure of Oil & Gas Quantities - Volume Rollforward
Year Ended December 31, 2017
The following table sets forth the Company’s net proved reserves, including the changes therein, and proved developed reserves:
TOTAL PROVED RESERVES:
Beginning of period
Revisions of previous estimates
Extensions, discoveries and other additions
Divestiture of Reserves
Acquisition of Reserves
Production
End of period
Crude Oil
(Bbls)
Natural Gas
(Mcf)
BOE
48,200
(35,509)
-
-
-
(10,391)
2,300
490,900
(437,841)
-
-
-
(9,259)
43,800
130,017
(108,483)
-
-
-
(11,934)
9,600
58
The standardized measure of discounted future net cash flows relating to proved oil and natural gas reserves is as follows :
Standardized Measure of Oil & Gas Quantities
Year Ended December 31, 2018 & 2017
Future cash inflows
Future production costs
Future development costs
Future income tax expense
Future net cash flows
10% annual discount for estimated timing of cash flows
Standardized measure of discounted future net cash flows related to proved reserves
2018
2017
$
$
46,335,070
(15,042,900)
(11,740,000)
-
19,552,170
(14,210,840)
5,341,330
$
$
240,370
(108,000)
-
-
132,370
(9,102)
123,268
A summary of the changes in the standardized measure of discounted future net cash flows applicable to proved oil and natural gas
reserves is as follows :
Balance, beginning of period
Net change in sales and transfer prices and in production (lifting) costs related to future
production
Changes in estimated future development costs
Net change due to revisions in quantity estimates
Accretion of discount
Other
Net change due to extensions and discoveries
Net change due to sales of minerals in place
Sales and transfers of oil and gas produced during the period
Previously estimated development costs incurred during the period
Net change in income taxes
Balance, end of period
2018
2017
$
123,268
$
340,916
40,762
(8,718,999)
289,740
1,036
(385,278)
14,467,005
-
(476,204)
-
-
207,241
116,934
(129,565)
28,604
(43,372)
-
-
(397,490)
-
-
$
5,341,330
$
123,268
Due to the inherent uncertainties and the limited nature of reservoir data, both proved and probable reserves are subject to change as
additional information becomes available. The estimates of reserves, future cash flows, and present value are based on various assumptions,
including those prescribed by the SEC, and are inherently imprecise. Although we believe these estimates are reasonable, actual future
production, cash flows, taxes, development expenditures, operating expenses, and quantities of recoverable oil and natural gas reserves may
vary substantially from these estimates.
In estimating probable reserves, it should be noted that those reserve estimates inherently involve greater risk and uncertainty than
estimates of proved reserves. While analysis of geoscience and engineering data provides reasonable certainty that proved reserves can be
economically producible from known formations under existing conditions and within a reasonable time, probable reserves involve less
certainty than reserves with a higher classification due to less data to support their ultimate recovery. Probable reserves have not been
discounted for the additional risk associated with future recovery. Prospective investors should be aware that as the categories of reserves
decrease with certainty, the risk of recovering reserves at the PV-10 calculation increases. The reserves and net present worth discounted at
10% relating to the different categories of proved and probable have not been adjusted for risk due to their uncertainty of recovery and thus
are not comparable and should not be summed into total amounts.
59
Reserve Estimation Process, Controls and Technologies
The reserve estimates, including PV-10 estimates, set forth above were prepared by PeTech Enterprises, Inc. for the Company’s Properties
in Oklahoma. A copy of their full reports with regard to our reserves is attached as Exhibit 99.1 to this annual report on Form 10-K. These
calculations were prepared using standard geological and engineering methods generally accepted by the petroleum industry and in
accordance with SEC financial accounting and reporting standards.
Results of Operations for Oil and Gas Producing Activities
For the Year Ended December 31, 2018
Oil and Gas revenue
Production costs
Depreciation, depletion, and amortization
Exploration expenses
Income tax expense
Results of Operations (excluding corporate overhead and interest costs)
Total
Texas
Oklahoma
$
$
$
$
$
$
1,282,362
806,158
1,173,752
-
1,979,910
-
(697,548)
$
$
$
$
$
$
$
1,248,004
787,681
464,318
-
1,251,999
-
(3,995)
$
$
$
$
$
$
$
34,358
18,477
709,434
-
727,911
-
(693,553)
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Management’s Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2018. Based
on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2018, our disclosure
controls and procedures were effective, in that they ensure that information required to be disclosed by us in the reports that we file or
submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules
and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control Over Financial Reporting
Management acknowledges its responsibility for establishing and maintaining adequate internal control over financial reporting in
accordance with Rule 13a-15(f) promulgated under the Exchange Act. The company’s internal control over financial reporting includes
those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures
of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial statements.
Management has also evaluated the effectiveness of its internal control over financial reporting in accordance with generally accepted
accounting principles within the guidelines of the Committee of Sponsoring Organizations of the Treadway Commission framework
(2013). Based on the results of this evaluation, management has determined that the Company’s internal control over financial reporting
was effective as of December 31, 2018. The independent registered public accounting firm of Briggs & Veselka Co, the auditors of the
Company’s financial statements included in the Annual Report, has issued an attestation report on the Company’s internal control over
financial reporting.
Changes in Internal Controls
There were no changes in our Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange
Act of 1934) during the year ended December 31, 2018, that have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
60
ITEM 9A. CONTROLS AND PROCEDURES - continued
Limitations on Effectiveness of Controls and Procedures
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that disclosure controls or internal
controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. In addition, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in
all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a
company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management’s
override of the control. The design of any systems of controls is based in part upon certain assumptions about the likelihood of future
events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over
time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of these inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not
be detected. Individual persons may perform multiple tasks which normally would be allocated to separate persons and therefore extra
diligence must be exercised during the period these tasks are combined.
ITEM 9B. OTHER INFORMATION
Not applicable.
61
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Our executive officers and directors are as follows:
Name
John A. Brda
Roger N. Wurtele
Greg McCabe, Sr.
Robert Lance Cook
Michael Graves
Alexandre Zyngier
Age
54
72
58
62
51
49
Position(s) and Office(s)
Chief Executive Officer, Secretary and Director
Chief Financial Officer
Director (Chairman)
Director
Director
Director
Below is certain biographical information of our executive officers and directors:
John A. Brda – Mr. Brda has been our Chief Executive Officer since December 2014 and our Secretary and a member of the Board of
Director since January 2012. He has been the Managing Member of Brda & Company, LLC since 2002, which provided consulting
services to public companies—with a focus in the oil and gas sector—on investor relations, equity and debt financings, strategic business
development and securities regulation matters, prior to him becoming President of the company.
We believe Mr. Brda is an excellent fit to our Board of Directors and management team based on his extensive experience in transaction
negotiation and business development, particularly in the oil and gas sector as well as other non-related industries. He has consulted with
many public companies in the last ten years, and we believe that his extensive network of industry professionals and finance firms will
contribute to our success.
Roger N. Wurtele – Mr. Wurtele has served as our Chief Financial Officer since September 2013. He is a versatile, experienced finance
executive that has served as Chief Financial Officer for several public and private companies. He has a broad range of experience in public
accounting, corporate finance and executive management. Mr. Wurtele previously served as CFO of Xtreme Oil & Gas, Inc. from February
2010 to September 2013. From May 2013 to September 2013 he worked as a financial consultant for us. From November 2007 to January
2010, Mr. Wurtele served as CFO of Lang and Company LLC, a developer of commercial real estate projects. He graduated from the
University of Nebraska and has been a Certified Public Accountant for 40 years.
Gregory McCabe – Mr. McCabe has been a member of our Board of Directors since July 2016 and was appointed Chairman of the Board
in October 2016. He is an experienced geologist who brings over 32 years of oil and gas experience to our company. He is a principal of
numerous oil and gas focused entities including McCabe Petroleum Corporation, Manix Royalty, Masterson Royalty Fund and GMc
Exploration. He has been the President of McCabe Petroleum Corporation from 1986 to the present. Mr. McCabe has been involved in
numerous oil and gas ventures throughout his career and has a vast experience in technical evaluation, operations and acquisitions and
divestitures. Mr. McCabe is also our largest stockholder and provided entry for us into our two largest assets, the Hazel Project in the
Midland Basin and the Orogrande Project in Hudspeth County, Texas.
We believe that Mr. McCabe’s background in geology and his many years in the oil and gas industry compliments the Board of Directors.
Robert Lance Cook – Mr. Cook has been a member of our Board of Directors since February 2019. He is currently the Vice President of
Production Operations of WellsX Corp., a position he has held since July 2018. WellsX provides hydraulic fracturing and related oilfield
services. Additionally, he has been the Managing Partner of Metis Energy LLC since January 2017, which owns and operates oil and gas
wells in Texas as well as holds proprietary intellectual properties. Prior to that, Mr. Cook worked for Shell Oil Company and its
subsidiaries for over 36 years, retiring from the company in September 2016. He held numerous management and engineering positions for
Shell, including most recently Chief Scientist for Wells and Production Technology and Chief Operations Officer for SWMS JV with Great
Wall Drilling Company from January 2012 until his retirement. He holds a Bachelor of Science in Petroleum Engineering from the
University of Texas.
We believe Mr. Cook’s wide-ranging experience in operating exploration and production companies makes him an excellent fit to the
Board of Directors.
Michael J. Graves – Mr. Graves has served on the Board of Directors since August 17, 2017. He is a Certified Public Accountant, and
since 2005 he has been a managing shareholder of Fitch & Graves in Sioux City, Iowa, which provides accounting and tax, financial
planning, consulting and investment services. Since 2008, he has also been a registered representative with Western Equity Group where he
has worked in investment sales. He is also presently a shareholder in several businesses involved in residential construction and property
rentals. Previously, he worked at Bill Markve & Associates, Gateway 2000 and Deloitte & Touche. He graduated Summa Cum Laude from
the University of South Dakota with a B.S. in Accounting.
62
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE - continued
With Mr. Graves’ extensive background in accounting and investment businesses, we believe his understanding of financial statements,
business valuations, and general business performance are a valuable asset to the Board.
Alexandre Zyngier - Mr. Zyngier has served on our Board of Directors since June 2016. He has been the Managing Director of Batuta
Advisors since founding it in August 2013. The firm pursues high return investment and advisory opportunities in the distressed and
turnaround sectors. Mr. Zyngier has over 20 years of investment, strategy, and operating experience. He is currently a director of Atari SA,
AudioEye Inc. and GT Advanced Technologies, Inc. Before starting Batuta Advisors, Mr. Zyngier was a portfolio manager at Alden Global
Capital from February 2009 until August 2013, investing in public and private opportunities. He has also worked as a portfolio manager at
Goldman Sachs & Co. and Deutsche Bank Co. Additionally, he was a strategy consultant at McKinsey & Company and a technical brand
manager at Procter & Gamble. Mr. Zyngier holds an MBA in Finance and Accounting from the University of Chicago and a BS in
Chemical Engineering from UNICAMP in Brazil.
We believe that Mr. Zyngier’s investment experience and his experience in overseeing a broad range of companies will greatly benefit the
Board of Directors.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our directors and executive officers, and persons who own beneficially more
than ten percent of our common stock, to file reports of ownership and changes of ownership with the Securities and Exchange
Commission. Based solely upon a review of Forms 3, 4 and 5 furnished to us during the fiscal year ended December 31, 2018, we believe
that the directors, executive officers, and greater than ten percent beneficial owners have complied with all applicable filing requirements
during the fiscal year ended December 31, 2018.
Code of Ethics
We have adopted a code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions. The Code of Ethics is available at our website at torchlightenergy.com. Further, we
undertake to provide by mail to any person without charge, upon request, a copy of such code of ethics if we receive the request in writing
by mail to: Torchlight Energy Resources, Inc., 5700 W. Plano Parkway, Suite 3600, Plano, Texas 75093.
Procedures for Stockholders to Recommend Nominees to the Board
There have been no material changes to the procedures by which stockholders may recommend nominees to our Board of Directors since
we last provided disclosure regarding this process.
Audit Committee
We maintain a separately-designated standing audit committee. The Audit Committee currently consists of our three independent directors,
Alexandre Zyngier, Michael Graves, and Robert Lance Cook. Mr. Zyngier is the Chairman of the Audit Committee, and the Board of
Directors has determined that he is an audit committee financial expert as defined in Item 5(d)(5) of Regulation S-K. The primary purpose
of the Audit Committee is to oversee our accounting and financial reporting processes and audits of our financial statements on behalf of
the Board of Directors. The Audit Committee meets privately with our management and with our independent registered public accounting
firm and evaluates the responses by our management both to the facts presented and to the judgments made by our outside independent
registered public accounting firm.
63
ITEM 11. EXECUTIVE COMPENSATION
The following table provides summary information for the years of 2018 and 2017 concerning cash and non-cash compensation paid or
accrued to or on behalf of certain executive officers.
Summary Executive Compensation Table
($)
($)
Year Salary Bonus Stock Option Non-Equity Change in
Pension
Awards Awards
Value
and
Nonqualified
Deferred
Compensation
($)
Incentive
Plan
Compensation
($)
($)
(A)
(1)
($)
All Other
Compensation
($)
Total
($)
Name and
Principal
Position
John A. Brda
2018 $ 375,000
CEO/Secretary/Director 2017 $ 375,000
Roger Wurtele
CFO
2018 $ 225,000
2017 $ 225,000
-
-
-
-
- $
- $
- $
- $
-
-
-
-
-
-
-
-
-
-
-
-
- $375,000
- $375,000
- $225,000
- $225,000
(A) Stock/Option Value as applicable is determined using the Black Scholes Method.
Setting Executive Compensation
We fix executive base compensation at a level we believe enables us to hire and retain individuals in a competitive environment and to
reward satisfactory individual performance and a satisfactory level of contribution to our overall business goals. We also take into account
the compensation that is paid by companies that we believe to be our competitors and by other companies with which we believe we
generally compete for executives.
In establishing compensation packages for executive officers, numerous factors are considered, including the particular executive’s
experience, expertise, and performance, our company’s overall performance, and compensation packages available in the marketplace for
similar positions. In arriving at amounts for each component of compensation, our Compensation Committee strives to strike an appropriate
balance between base compensation and incentive compensation. The Compensation Committee also endeavors to properly allocate
between cash and non-cash compensation (including without limitation stock and stock option awards) and between annual and long-term
compensation.
Employment Agreements
On June 16, 2015, we entered into new five-year employment agreements with each of John Brda, our President and Chief Executive
Officer, and Roger Wurtele, our Chief Financial Officer. Under the new agreements, which replace and supersede their prior employment
agreements, each individual’s salary was increased by 25%, so that the salaries of Messrs. Brda and Wurtele were $375,000, and $225,000,
respectively, provided these salary increases will accrue unpaid until such time as management believes there is adequate cash for such
increases. Also under the new agreements, each individual was eligible for a bonus, at the Compensation Committee’s discretion, of up to
two times his salary and was eligible for any additional stock options, as deemed appropriate by the Compensation Committee. Each
agreement also provided that if we (or our successor) terminate the employee upon the occurrence of a change in control, the employee will
be paid in one lump sum his salary and any bonus or other amounts due through the end of the term of the agreement. Each employment
agreement also has a covenant not to compete.
64
ITEM 11. EXECUTIVE COMPENSATION - continued
Outstanding Equity Awards at Fiscal Year End
The following table details all outstanding equity awards held by our named executive officers at December 31, 2018:
Option
Awards
Number of
Number of
Securities
Underlying
Unexercised
Options
(#)
Exercisable
Securities
Underlying
Unexercised
Options
(#)
Unexercisable
Equity
Incentive
Plan Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
(#)
Option
Exercise
Price
($)
Option
Expiration
Date
3,000,000
(1)
1,500,000
(1)
-
-
-
-
$
$
1.57
1.57
6/11/2020
6/11/2020
Name
John A. Brda
Roger Wurtele
(1) The options were awarded on June 11, 2015. The options were granted under our 2015 Stock Option Plan which plan was approved
by stockholders on September 9, 2015. Presently, the options are all fully vested.
Compensation of Directors
We have no standard arrangement pursuant to which directors are compensated for any services they provide or for committee
participation or special assignments. We anticipate, however, implementing more standardized director compensation arrangements in the
near future.
Summary Director Compensation Table
Compensation to directors during the year ended December 31, 2018 was as follows:
Option Awards
Fees Earned
Paid
in
Cash
($)
Stock
Awards
($)
Option
Awards
($)(A)
Nonqualified
Deferred
Non-Equity
Incentive Plan Compensation
Compensation
($)
Earnings
($)
All
Other
Compensation Total
($)
($)
Name
Alexandre Zyngier
R. David Newton (2)
Michael Graves
-
-
-
- $
- $
- $
100,000 (1)
100,000 (1)
100,000 (1)
-
-
-
-
-
-
- $ 100,000
- $ 100,000
- $ 100,000
(A) Stock Value as applicable is determined using the Black Scholes Method.
65
ITEM 11. EXECUTIVE COMPENSATION - continued
(1) On August 16, 2018, this director was granted 200,000 stock options under the 2015 Stock Option Plan as director compensation.
100,000 of the stock options vested immediately, and the remaining 100,000 stock options vest on August 16, 2019.
(2) Mr. Newton resigned from the Board of Directors on February 4, 2019.
Compensation Policies and Practices as they Relate to Risk Management
We attempt to make our compensation programs discretionary, balanced and focused on the long term. We believe goals and objectives of
our compensation programs reflect a balanced mix of quantitative and qualitative performance measures to avoid excessive weight on a
single performance measure. Our approach to compensation practices and policies applicable to employees and consultants is consistent
with that followed for its executives. Based on these factors, we believe that our compensation policies and practices do not create risks
that are reasonably likely to have a material adverse effect on us.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information, as of March 18, 2019, concerning, except as indicated by the footnotes below, (i) each person
whom we know beneficially owns more than 5% of our common stock, (ii) each of our directors, (iii) each of our named executive officers,
and (iv) all of our directors and executive officers as a group. The table includes these persons’ beneficial ownership of common stock.
Unless otherwise noted below, the address of each beneficial owner listed in the table is c/o Torchlight Energy Resources, Inc., 5700 W.
Plano Parkway, Suite 3600, Plano, Texas 75093. We have determined beneficial ownership in accordance with the rules of the SEC. Except
as indicated by the footnotes below, we believe, based on the information furnished to us, that the persons and entities named in the table
below have sole voting and investment power with respect to all shares of common stock that they beneficially own, subject to applicable
community property laws. Applicable percentage ownership is based on 71,433,864 shares of common stock outstanding at March 18,
2019 (which amount excludes the 262,001 restricted shares of common stock held by our director Alexandre Zyngier). In computing the
number of shares of common stock beneficially owned by a person and the percentage ownership of that person, we deemed outstanding
shares of common stock subject to stock options or warrants held by that person that are currently exercisable or exercisable within 60 days
after March 18, 2019 and shares of common stock issuable upon conversion of other securities held by that person that are currently
convertible or convertible within 60 days after March 18, 2019. We did not deem these shares outstanding, however, for the purpose of
computing the percentage ownership of any other person. Unless otherwise noted, stock options and warrants referenced in the footnotes
below are currently fully vested and exercisable. Beneficial ownership representing less than 1% is denoted with an asterisk (*).
66
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT – continued
Shares Beneficially Owned
Name of beneficial owner
John A. Brda
President, CEO, Secretary and Director
Gregory McCabe
Director (Chairman of the Board)
Roger N. Wurtele
Chief Financial Officer
Robert Lance Cook
Director
Michael J. Graves
Director
Alexandre Zyngier
Director
All directors and executive officers as a group (6 persons)
Robert Kenneth Dulin (7)
David Moradi (8)
Common Stock
Shares
% of Class
5,318,322(1)
7.15
13,648,390(2)
19.08
1,510,000(3)
2.07
100,000(4)
445,000(5)
300,000(6)
21,321,712
4,351,381(7)
4,176,891(8)
*
*
*
27.79
5.94
5.85
(1)Includes 2,318,322 shares of common stock held by the John A. Brda Trust (the “Trust”). Mr. Brda is the settlor of the Trust and
reserves the right to revoke the Trust without the consent of another person. Further, he is the trustee of the Trust and exercises
investment control over the securities held by the Trust. Also includes stock options that are exercisable into 3,000,000 shares of
common stock, held individually by Mr. Brda.
(2)Includes (a) 10,264,335 shares of common stock held individually by Mr. McCabe; (b) securities held by G Mc Exploration, LLC
(“GME”), including (i) 797,099 shares of common stock and (ii) 86,956 shares issuable upon exercise of warrants; and (c) 2,500,000
shares of common stock beneficially owned by McCabe Petroleum Corporation (“MPC”). Mr. McCabe may be deemed to hold
beneficial ownership of securities held by GME as a result of his ownership of 50% of the outstanding membership interests of GME.
Mr. McCabe may be deemed to hold beneficial ownership of securities held by MPC as a result of his ownership of 100% of the
outstanding shares of capital stock of MPC.
(3)Includes 10,000 shares of common stock and stock options that are exercisable into 1,500,000 shares of common stock held by Mr.
Wurtele.
(4)Includes stock options that are exercisable into 100,000 shares of common stock held by Mr. Cook.
(5)Includes 145,000 shares of common stock and stock options that are exercisable into 300,000 shares of common stock held by Mr.
Graves. Excludes stock options that are exercisable into 100,000 shares of common stock held by Mr. Graves that are not scheduled to
vest within 60 days after March 18, 2019.
(6)Includes stock options that are exercisable into 300,000 shares of common stock held by Mr. Zyngier. Excludes stock options that are
exercisable into 100,000 shares of common stock held by Mr. Zyngier that are not scheduled to vest within 60 days after March 18,
2019.
67
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - continued
(7)Includes (a) securities held individually by Robert Kenneth Dulin, including (i) 27,000 shares of common stock and (ii) warrants that
are exercisable into 150,000 shares of common stock; (b) 243,360 shares of common stock held in trust for the benefit of immediate
family members of Mr. Dulin; (c) securities held by Sawtooth Properties, LLLP (“Sawtooth”), including (i) 892,258 shares of common
stock and (ii) warrants that are exercisable into 234,745 shares of common stock; (d) securities held by Black Hills Properties, LLLP
(“Black Hills”), including (i) 612,099 shares of common stock, and (ii) warrants that are exercisable into 189,956 shares of common
stock; (e) securities held by Pine River Ranch, LLC (“Pine River”), including (i) 801,939 shares of common stock and (ii) warrants that
are exercisable into 450,024 shares of common stock; and (f) securities held by Pandora Energy, LP (“Pandora”), including warrants
that are exercisable into 750,000 shares of common stock. Mr. Dulin is trustee/custodian of each of the trusts and/or accounts
referenced in “(b)” above and has voting and investment authority over the shares held by them. Mr. Dulin is the Managing Partner of
Sawtooth Properties, LLLP, the Managing Partner of Black Hills, the Managing Member of Pine River, and the General Partner of
Pandora, and he has voting and investment authority over the shares held by each entity. Mr. Dulin’s address is 8449 Greenwood
Drive, Niwot, Colorado, 80503. The information herein is based in part on information provided to us by Mr. Dulin, and accordingly,
we are unable to verify the accuracy this information.
(8)Based on a Schedule 13G/A filed on February 5, 2019, by Anthion Management, LLC, a Delaware limited liability company (“Anthion
Management”), which reports beneficial ownership of our common stock held by Anthion Management, Anthion Partners II LLC, a
Delaware limited liability company (“Anthion Partners”), and David Moradi, an individual. The filing lists the address of all three
reporting persons as 119 Washington Avenue, Suite 406, Miami Beach, Florida 33139, and indicates that Anthion Management and
Antion Partners each has sole voting power and sole dispositive power with respect to 2,034,513 shares of common stock and David
Moradi has sole voting power and sole dispositive power with respect to 4,176,891 shares of common stock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On January 30, 2017, we and our wholly-owned subsidiary, Torchlight Acquisition Corporation, a Texas corporation (“TAC”), entered into
and closed an Agreement and Plan of Reorganization and Plan of Merger with Line Drive Energy, LLC, a Texas limited liability company
(“Line Drive”), under which agreements TAC merged with and into Line Drive and the separate existence of TAC ceased, with Line Drive
being the surviving organization and becoming our wholly-owned subsidiary. Line Drive, which was wholly-owned by Gregory McCabe,
owned certain assets and securities, including approximately 40.66% of 12,000 gross acres in the Hazel Project and 521,739 warrants to
purchase our common stock (which warrants had been assigned by Mr. McCabe to Line Drive). Under the merger transaction, our shares of
common stock of TAC converted into a membership interest of Line Drive, the membership interest in Line Drive held by Mr. McCabe
immediately prior to the transaction ceased to exist, and we issued Mr. McCabe 3,301,739 restricted shares of common stock as
consideration therefor. Immediately after closing, the 521,739 warrants held by Line Drive were cancelled, which warrants had an exercise
price of $1.40 per share and an expiration date of June 9, 2020. A Certificate of Merger for the merger transaction was filed with the
Secretary of State of Texas on January 31, 2017.
Also on January 30, 2017, our wholly-owned subsidiary, Torchlight Energy, Inc., a Nevada corporation (“TEI”), entered into and closed a
Purchase and Sale Agreement with Wolfbone Investments, LLC, a Texas limited liability company (“Wolfbone”) which is wholly-owned
by Gregory McCabe. Under the agreement, TEI acquired certain of Wolfbone’s Hazel Project assets, including its interest in the Flying B
Ranch #1 well and the 40 acre unit surrounding the well, for consideration of $415,000, and additionally, Wolfbone caused to be cancelled
a total of 2,780,000 warrants to purchase our common stock, including 1,500,000 warrants held by McCabe Petroleum Corporation, an
entity owned by Mr. McCabe, and 1,280,000 warrants held by Green Hill Minerals, an entity owned by Mr. McCabe’s son, which warrant
cancellations were effected through certain Warrant Cancellation Agreements. The 1,500,000 warrants held by McCabe Petroleum
Corporation had an exercise price of $1.00 per share and an expiration date of April 4, 2021. The warrants held by Green Hill Minerals
included 100,000 warrants with an exercise price of $1.73 and an expiration date of September 30, 2018 and 1,180,000 warrants with an
exercise price of $0.70 and an expiration date of February 15, 2020.
On November 15, 2017, we and our wholly-owned subsidiary, Hudspeth Oil Corporation, a Texas corporation (“HOC”), entered into an
Assignment of Farmout Agreement with Founders Oil & Gas, LLC (“Founders”) and Wolfbone Investments, LLC (“Wolfbone”), along
with Pandora Energy, LP as a party to the agreement for limited purposes. Wolfbone is owned by our Chairman, Gregory McCabe. Under
the agreement, Founders will assign to HOC and Wolfbone all its right, title and interest in the remaining leases under the original
Farmout Agreement that Founders entered into with us on September 23, 2015; provided, however, that Founders will retain an undivided
9.5% of 8/8ths working interest and 9.5% of 75% of 8/8ths net revenue interest to the remaining leases, which retained interest will be
carried by HOC and Wolfbone through the next $40,500,000 in total costs. Accordingly, HOC and Wolfbone will each gain a 20.25%
working interest in the remaining leases, bringing HOC’s total working interest to 67.75%. On behalf of HOC and Wolfbone, Founders
(through its operating affiliate) will take such action necessary to spud the University Founders A 25 Well on or before December 1,
2017. After spudding of the well, Founders’ operating affiliate will remain operator of that well under the direction of us and Gregory
McCabe.
68
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS- continued
On December 1, 2017, the transactions contemplated by the Agreement and Plan of Reorganization that we and our newly formed wholly-
owned subsidiary, Torchlight Wolfbone Properties, Inc., a Texas corporation (“TWP”), entered into with McCabe Petroleum Corporation, a
Texas corporation (“MPC”), and Warwink Properties, LLC, a Texas limited liability company (“Warwink Properties”) closed. Under the
agreement, which was entered into on November 14, 2017, TWP merged with and into Warwink Properties and the separate existence of
TWP ceased, with Warwink Properties becoming the surviving organization and our wholly-owned subsidiary. Warwink Properties was
wholly owned by MPC which is wholly owned by Gregory McCabe, our Chairman. Warwink Properties owns certain assets, including a
10.71875% working interest in 640 acres in Winkler County, Texas. At closing of the merger transaction, our shares of common stock of
TWP converted into a membership interest of Warwink Properties, the membership interest in Warwink Properties held by MPC ceased to
exist, and we issued MPC 2,500,000 restricted shares of common stock as consideration. Also on December 1, 2017, MPC closed its
transaction with MECO IV, LLC (“MECO”) for the purchase and sale of certain assets as contemplated by the Purchase and Sale
Agreement dated November 9, 2017 (the “MECO PSA”), to which we are not a party. Under the MECO PSA, Warwink Properties
received a carry from MECO (through the tanks) of up to $1,475,000 in the next well drilled on the Winkler County leases. A Certificate of
Merger for the merger transaction was filed with the Secretary of State of Texas on December 5, 2017.
Also on December 1, 2017, the transactions contemplated by the Purchase Agreement that our wholly-owned subsidiary, Torchlight
Energy, Inc., a Nevada corporation (“TEI”), entered into with MPC closed. Under the Purchase Agreement, which was entered into on
November 14, 2017, TEI acquired beneficial ownership of certain of MPC’s assets, including acreage and wellbores located in Ward
County, Texas (the “Ward County Assets”). As consideration under the Purchase Agreement, at closing TEI issued to MPC an unsecured
promissory note in the principal amount of $3,250,000, payable in monthly installments of interest only beginning on January 1, 2018, at
the rate of 5% per annum, with the entire principal amount together with all accrued interest due and payable on December 31, 2020. In
connection with TEI’s acquisition of beneficial ownership in the Ward County Assets, MPC sold those same assets, on behalf of TEI, to
MECO at closing of the MECO PSA, and accordingly, TEI received $3,250,000 in cash for its beneficial interest in the Ward County
Assets. Additionally, at closing of the MECO PSA, MPC paid TEI a performance fee of $2,781,500 in cash as compensation for TEI’s
marketing and selling the Winkler County assets of MPC and the Ward County Assets as a package to MECO.
On July 25, 2018, Torchlight Energy Resources, Inc. and our wholly-owned subsidiary, Hudspeth Oil Corporation, entered into a
Settlement & Purchase Agreement (the “Settlement Agreement”) with Founders Oil & Gas, LLC, Founders Oil & Gas Operating, LLC,
Wolfbone Investments, LLC (a wholly-owned company of Gregory McCabe, our Chairman) and McCabe Petroleum Corporation (also a
wholly-owned company of Mr. McCabe), which agreement provides for Hudspeth Oil and Wolfbone Investments to each immediately pay
$625,000 and for Hudspeth Oil or the Company and Wolfbone Investments or McCabe Petroleum to each pay another $625,000 on July 20,
2019, as consideration for Founders Oil & Gas assigning all of its working interest in the oil and gas leases of the Orogrande Project to
Hudspeth Oil and Wolfbone Investments equally. The assignments to Hudspeth Oil and Wolfbone Investments will be made when the first
payments are made, and the payments to Founders Oil & Gas due in 2019 are not securitized. After this assignment (for which Hudspeth
Oil’s total consideration is $1,250,000), Hudspeth Oil’s working interest will increase to 72.5%. Additionally, the Settlement Agreement
provides that the Founders parties will assign to the Company, Hudspeth Oil, Wolfbone Investments and McCabe Petroleum their claims
against certain vendors for damages, if any, against such vendors for negligent services or defective equipment. Further, the Settlement
Agreement has a mutual release and waivers among the parties.
On October 17, 2018, we sold to certain investors in a private transaction 16% Series C Unsecured Convertible Promissory Notes with a
total principal amount of $6,000,000. Interest and principal are due and payable on the notes in one balloon payment at maturity on April
17, 2020. The notes are convertible, at the election of the holders, into an aggregate 6% working interest in certain oil and gas leases in
Hudspeth County, Texas, known as our “Orogrande Project.” The notes allow us to redeem them early only upon the event of a
fundamental transaction, such as a merger or sale of substantially all our assets. The notes provide that the noteholders may accelerate and
declare any and all of the obligations under the notes to be immediately due and payable in the event of default, such as nonpayment, failure
to perform required conversions, failure to perform any covenant or agreement under the notes, an insolvency event, or certain defaults or
judgments. As part of the sale of the of the notes, the noteholders required that McCabe Petroleum Corporation, a Texas corporation owned
by our Chairman Gregory McCabe (“MPC”), provide them a put option whereby they have the right to have MPC purchase from them any
unpaid principal amount due on the notes. Additionally, if there is a fundamental transaction, Mr. McCabe will be required to pay a fee to
each noteholder that elects not to convert or require MPC to purchase the principal amount under the note, which fee will be equal to such
noteholder’s pro-rata share of a total fee amount of $1,500,000. We received total proceeds of $6,000,000 from the sale of the notes, of
which $3,000,000 was used to pay back the promissory note issued to MPC on December 1, 2017, which note was due on December 31,
2020. We intend to use the remaining proceeds for working capital and general corporate purposes, which includes, without limitation,
drilling and lease acquisition capital. Prior to entering into the above transactions, our Board of Directors formed a special committee
composed of independent directors to analyze and authorize the transactions on behalf of Torchlight Energy Resources, Inc. and determine
whether the transactions are fair to the company. In this role, the special committee engaged an independent financial consulting firm
which rendered a fairness opinion deeming that the transactions were fair to the company, from a financial point of view, and contained
terms no less favorable to the company than those that could be obtained in arm’s length transactions.
69
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS- continued
In December 2018, we paid WellsX Corp. a total of $173,000 for performing hydraulic fracturing services on a well at our Orogrande
Project in Hudspeth County, Texas. Robert Lance Cook, a member of our Board of Directors, holds a 19% beneficial ownership in WellsX
Corp. and is its Vice President of Production Operations.
Director Independence
We currently have three independent directors on our Board, Alexandre Zyngier, Michael Graves, and Robert Lance Cook. The definition
of “independent” used herein is based on the independence standards of The NASDAQ Stock Market LLC. The Board performed a review
to determine the independence of these Directors and made a subjective determination as to each of these directors that no transactions,
relationships, or arrangements exist that, in the opinion of the Board, would interfere with the exercise of independent judgment in carrying
out the responsibilities of a director of Torchlight Energy Resources, Inc. In making these determinations, the Board reviewed information
provided by these directors with regard to each Director’s business and personal activities as they may relate to us and our management.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the fees paid or accrued by us for the audit and other services provided by our auditor, Briggs & Veselka Co.
and our independent consultant during the years ended December 31, 2018 and 2017.
Audit Fees(1)
Audit Related Fees(2)
Tax Fees(3)
All Other Fees
$
$
2018
159,253
107,186
20,400
41,959
2017
196,666
-
65,888
-
Total Fees
$
328,798
$
262,554
(1) Audit Fees: This category represents the aggregate fees billed for professional services rendered by the principal independent
accountant for the audit of our annual financial statements and review of financial statements included in our Form 10-K and
services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for the
fiscal years.
(2) Audit Related Fees: This category consists of the aggregate fees billed for SOX 404 Internal Control compliance services and
assurance and related services by our independent consultant that are reasonably related to the performance of the audit or review of
our financial statements and are not reported under “Audit Fees.”
(3) Tax Fees: This category consists of the aggregate fees billed for professional services rendered by the principal independent
consultant for tax compliance, tax advice, and tax planning.
70
ITEM 15. EXHIBITS
Exhibit
No.
Description
PART IV
2.1
3.1
3.2
3.3
3.4
Share Exchange Agreement dated November 23, 2010. (Incorporated by reference from Form 8-K filed with the SEC on
November 24, 2010.) *
Articles of Incorporation
Certificate of Amendment to Articles of Incorporation dated December 10, 2014. (Incorporated by reference from Form 10-Q
filed with the SEC on May 15, 2015.) *
Certificate of Amendment to Articles of Incorporation dated September 15, 2015. (Incorporated by reference from Form 10-
Q filed with the SEC on November 12, 2015.) *
Certificate of Amendment to Articles of Incorporation dated August 18, 2017. (Incorporated by reference from Form 10-Q
filed with the SEC on November 9, 2018.) *
3.5
Amended and Restated Bylaws (Incorporated by reference from Form 8-K filed with the SEC on October 26, 2016.) *
10.1
Employment Agreement (with John A. Brda) (Incorporated by reference from Form 8-K filed with the SEC on June 16,
2015.) *
10.2
Employment Agreement (with Roger Wurtele) (Incorporated by reference from Form 8-K filed with the SEC on June 16,
2015.) *
10.3
Farmout Agreement between Hudspeth Oil Corporation, Founders Oil & Gas, LLC and certain other parties (Incorporated by
reference from Form 8-K filed with the SEC on September 29, 2015) *
10.4
Purchase and Sale Agreement with Husky Ventures, Inc. (Incorporated by reference from Form 8-K filed with the SEC on
November 12, 2015) *
10.5
Purchase Agreement with McCabe Petroleum Corporation for acquisition of “Hazel Project” (Incorporated by reference from
Form 10-Q filed with the SEC on August 15, 2016) *
10.6
Agreement and Plan of Reorganization and Plan of Merger with Line Drive Energy, LLC (Incorporated by reference from
Form 10-K filed with the SEC on March 31, 2017) *
10.7
Purchase and Sale Agreement with Wolfbone Investments, LLC (Incorporated by reference from Form 10-K filed with the
SEC on March 31, 2017) *
10.8
12% 2020 Senior Unsecured Promissory Note (form of) (Incorporated by reference from Form 10-Q filed with the SEC on
May 12, 2017) *
10.9
Agreement and Plan of Reorganization and Plan of Merger with McCabe Petroleum Corporation and Warwink Properties,
LLC (Incorporated by reference from Form 10-K filed with the SEC on March 16, 2018) *
71
ITEM 15. EXHIBITS - continued
10.10
Purchase Agreement with Torchlight Energy, Inc. and McCabe Petroleum Corporation (Incorporated by reference from Form
10-K filed with the SEC on March 16, 2018) *
10.11
Promissory Note for $3,250,000 by Torchlight Energy, Inc. to McCabe Petroleum Corporation (Incorporated by reference
from Form 10-K filed with the SEC on March 16, 2018) *
10.12
Assignment of Farmout Agreement between Hudspeth Oil Corporation, Founders Oil & Gas, LLC and Wolfbone
Investments, LLC (Incorporated by reference from Form 10-K filed with the SEC on March 16, 2018) *
10.13
12% 2020 Senior Unsecured Promissory Note for $4,500,000 with David A. Straz, Jr Revocable Trust of 1986 (Incorporated
by reference from Form 10-K filed with the SEC on March 16, 2018) *
10.14
Underwriting Agreement, dated April 19, 2018, between Torchlight Energy Resources, Inc. and Roth Capital Partners, LLC
(Incorporated by reference from Form 8-K filed with the SEC on April 19, 2018) *
10.15
Purchase & Settlement Agreement, dated July 24, 2018, between Torchlight Energy Resources, Inc., Hudspeth Oil
Corporation, Founders Oil & Gas, LLC, Founders Oil & Gas Operating, LLC, Wolfbone Investments, LLC and McCabe
Petroleum. Corporation (Incorporated by reference from Form 10-Q filed with the SEC on August 9, 2018) *
10.16
16% Series C Unsecured Convertible Promissory Note (form of) dated October 17, 2018 (Incorporated by reference from
Form 8-K filed with the SEC on October 18, 2018)*
14.1
Code of Ethics (Incorporated by reference from Form S-1 filed with the SEC on May 2, 2008.) *
16.01
Letter from Calvetti Ferguson to the Securities and Exchange Commission (Incorporated by reference from Form 8-K filed
21.1
23.1
23.2
31.1
with the SEC on December 19, 2016) *
Subsidiaries
Consent of Briggs & Veselka Co.
Consent of PeTech Enterprises, Inc.
Certification of principal executive officer required by Rule 13a 14(1) or Rule 15d 14(a) of the Securities Exchange Act of
1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of principal financial officer required by Rule 13a 14(1) or Rule 15d 14(a) of the Securities Exchange Act of
1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of principal executive officer and principal financial officer pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 and Section 1350 of 18 U.S.C. 63.
99.1
Report of PeTech Enterprises, Inc.
101.INS
XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema
101.CAL XBRL Taxonomy Extension Calculation Linkbase
101.DEF XBRL Taxonomy Extension Definitions Linkbase
101.LAB XBRL Taxonomy Extension Label Linkbase
101.PRE XBRL Taxonomy Extension Presentation Linkbase
*
Incorporated by reference from our previous filings with the SEC
72
Pursuant to the requirements of Section 13 or 15(d) 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.
SIGNATURES
Torchlight Energy Resources, Inc.
/s/ John A. Brda
By: John A. Brda
Chief Executive Officer
Date: March 18, 2019
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf
of the registrant and in the capacities and on the dates indicated:
Signature
/s/ John A. Brda
John A. Brda
/s/ Gregory McCabe
Gregory McCabe
/s/ Roger N. Wurtele
Roger N. Wurtele
/s/ Robert Lance Cook
Robert Lance Cook
/s/ Alexandre Zyngier
Alexandre Zyngier
/s/ Michael J. Graves
Michael J. Graves
Title
Date
Director, Chief Executive Officer, President and
Secretary
March 18, 2019
Director (Chairman of the Board)
March 18, 2019
Chief Financial Officer and Principal Accounting
Officer
Director
Director
Director
73
March 18, 2019
March 18, 2019
March 18, 2019
March 18, 2019
EXHIBIT 3.1
Subsidiaries of the Registrant
Name
Torchlight Energy, Inc.
Torchlight Energy Operating, LLC
Hudspeth Oil Corporation
Torchlight Hazel, LLC
Warwink Properties LLC
EXHIBIT 21.1
State of Organization
Nevada
Texas
Texas
Texas
Texas
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statements on Form S-1 (File Nos. 333-215586, 333-213732 and
333-208467), on Form S-8 (File No. 333-210812) and on Form S-3 (File No. 333-220181) of Torchlight Energy Resources, Inc. of our
report dated March 18, 2019 relating to the financial statements and the effectiveness of internal control over financial reporting, which
appear in this Form 10-K for the year ended December 31, 2018.
EXHIBIT 23.1
/s/ Briggs & Veselka Co.
Houston, Texas
March 18, 2019
CONSENT OF PETECH ENTERPRISES, INC.
EXHIBIT 23.2
We hereby consent to the references to our firm in the form and context in which they appear in the Annual Report on Form 10-K of
Torchlight Energy Resources, Inc. for the year ended December 31, 2018 (the “Annual Report”). We hereby further consent to the
inclusion in the Annual Report of estimated oil and gas reserves as of December 31, 2018, contained in our report dated March 4, 2019, and
to the inclusion of such report as an exhibit to the Annual Report. We further consent to the incorporation by reference thereof into
Torchlight Energy Resources, Inc.’s Registration Statements on Form S-1 (File Nos. 333-215586, 333-213732 and 333-208467), on Form
S-8 (File No. 333-210812) and on Form S-3 (File No. 333-220181).
PETECH ENTERPRISES, INC.
By: /s/ Amiel David, PE
Amiel David, PE #5097
Houston, Texas
March 14, 2019
EXHIBIT 31.1
CERTIFICATION PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
I, John A. Brda, certify that:
1. I have reviewed this annual report on Form 10-K of Torchlight Energy Resources, Inc. for the year ended December 31, 2018;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15 (e) and 15d- 15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiary, is made known
to us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures, and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's
fourth quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over the financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's
internal control over financial reporting.
/s/ John A. Brda
John A. Brda
Chief Executive Officer
(Principal Executive Officer)
Date: March 18, 2019
EXHIBIT 31.2
CERTIFICATION PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
I, Roger Wurtele, certify that:
1. I have reviewed this annual report on Form 10-K of Torchlight Energy Resources, Inc. for the year ended Decembe 31, 2018;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15 (e) and 15d- 15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiary, is made known
to us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures, and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's
fourth quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over the financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's
internal control over financial reporting.
/s/ Roger Wurtele
Roger Wurtele,
Chief Financial Officer
(Principal Financial Officer)
Date: March 18, 2019
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
EXHIBIT 32.1
I, John A. Brda, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the
annual report on Form 10-K of Torchlight Energy Resources, Inc. for the year ended December 31, 2018, fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such annual report on
Form 10-K fairly presents, in all material respects, the financial condition and results of operations of Torchlight Energy Resources, Inc.
/s/ John A. Brda
John A. Brda,
Chief Executive Officer (Principal Executive Officer)
Date: March 18, 2019
I, Roger Wurtele, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that
the annual report on Form 10-K of Torchlight Energy Resources, Inc. for the year ended December 31, 2018, fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such annual report on
Form 10-K fairly presents, in all material respects, the financial condition and results of operations of Torchlight Energy Resources, Inc.
/s/ Roger Wurtele
Roger Wurtele,
Chief Financial Officer (Principal Financial Officer)
Date: March 18, 2019
The foregoing certification is not deemed filed with the Securities and Exchange Commission for purposes of Section 18 of the Securities
Exchange Act of 1934, as amended (“Exchange Act”), and is not to be incorporated by reference into any filing of Torchlight Energy
Resources, Inc. under the Securities Act of 1933, as amended, or the Exchange Act, whether made before or after the date hereof,
regardless of any general incorporation language in such filing.
EXHIBIT 99.1