Exhibit 99.1

 

 

 

 

 

 

 

 

 

 

 

Equus Energy, LLC and Subsidiary

 

Consolidated Financial Statements

As of December 31, 2019 and 2018 and for the three years ended December 31, 2019

 

 

 

 

 

 

 

 

 

 

 

 

Equus Energy, LLC and Subsidiary

 

Contents

 

 

 

Independent Auditor’s Report		3
Consolidated Financial Statements
Consolidated Balance Sheets		4
Consolidated Statements of Operations		5
Consolidated Statements of Changes in Member’s Capital		6
Consolidated Statements of Cash Flows		7
Notes to Consolidated Financial Statements		8

 

 

 

 

 

Independent Auditor’s Report

 

 

Board of Managers

Equus Energy, LLC

Houston, Texas

 

We have audited the accompanying consolidated financial statements of Equus Energy, LLC and its subsidiary, which comprise the consolidated balance sheets as of December 31, 2019 and 2018, and the related consolidated statements of operations, changes in member’s capital, and cash flows for the three years ended December 31, 2019, and the related notes to the consolidated financial statements.

 

Management’s Responsibility for the Financial Statements

 

Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

 

Auditor’s Responsibility

 

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

 

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

 

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

 

Opinion

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Equus Energy, LLC and its subsidiary as of December 31, 2019 and 2018, and the results of their operations and their cash flows for the three years ended December 31, 2019 in accordance with accounting principles generally accepted in the United States of America.

 

Emphasis of a Matter - COVID-19

 

As more fully described in Note 9 to the consolidated financial statements, the Company may be materially impacted by the outbreak of a novel coronavirus (“COVID-19”), which was declared a global pandemic by the World Health Organization in March 2020 and the failure of OPEC to agree on oil production levels which has led to a substantial decline in oil prices and an increasingly volatile market.

 

 

 

 

/s/ BDO USA, LLP

Houston, Texas

March 30, 2020

 

 

Equus Energy, LLC and Subsidiary

 

 

December 31,			2019				2018
Assets
Current Assets
Cash and cash equivalents		$	553,111			$	965,648
Accounts receivable			65,374				126,718
Prepaid expenses and other current assets			34,119				34,119
Total Current Assets			652,384				1,126,485
Oil and Gas Properties, net, using full cost method			241,558				236,422
Total Assets		$	894,162			$	1,362,907
Liabilities and Member's Equity
Current Liabilities
Accounts payable and other current liabilities		$	82,461			$	130,879
Due to Parent			561,047				561,047
Total Current Liabilities			643,508				691,926
Asset Retirement Obligations			201,059				194,522
Total Liabilities			844,567				886,448
Commitments and Contingencies (See Note 7)
Member's Equity			49,595				476,459
Total Member's Equity			49,595				476,459
Total Liabilities and Member's Equity		$	894,162			$	1,362,907

 

 

See accompanying notes to the consolidated financial statements.

 

 

 

Equus Energy, LLC and Subsidiary

 

 

 

Year Ended December 31,		2019				2018				2017
Operating Revenue
Oil revenues		$	339,507			$	478,041			$	407,772
NGL revenues			233,743				346,777				171,047
Natural gas revenues			130,645				259,953				281,761
Total Operating Revenue			703,895				1,084,771				860,580
Operating Expenses
Direct operating expenses			856,362				786,737				553,230
Gain on sale of oil and gas properties			—				(619,293	)			—
Depletion, depreciation, amortization and accretion			23,479				343,666				295,391
General and administrative			251,138				284,448				278,193
Total Operating Expenses			1,130,979				795,558				1,126,814
(Loss) Income Before Income Taxes			(427,084	)			289,213				(266,234	)
Income Tax (Benefit) Expense, net			(220	)			1,185				—
Net (Loss) Income		$	(426,864	)		$	288,028			$	(266,234	)

 

 

 

 

See accompanying notes to the consolidated financial statements.

 

 

Equus Energy, LLC and Subsidiary

 

Consolidated Statements of Changes in Member’s Capital

 

		Total
		Member's
		Equity
Balance, January 1, 2017		$	454,665
Net loss			(266,234	)
Balance, December 31, 2017			188,431
Net income			288,028
Balance, December 31, 2018			476,459
Net loss			(426,864	)
Balance, December 31, 2019		$	49,155

 

 

See accompanying notes to the consolidated financial statements.

 

Equus Energy, LLC and Subsidiary

 

Consolidated Statements of Cash Flows

 

Year Ended December 31,		2019				2018				2017
Cash Flows from Operating Activities
Net income (loss)		$	(426,864	)		$	288,028			$	(266,234	)
Adjustments to reconcile net income (loss) to net
cash (used in) provided by operating activities:
Depletion, depreciation and amortization			16,942				337,710				289,340
Gain on sale of oil and gas properties			—				(619,293	)			—
Accretion expense			6,537				5,956				6,051
Changes in operating assets and liabilities:
Accounts receivable			61,344				(25,935	)			(9,809	)
Prepaid expenses and other current assets			—				(1,459	)			(843	)
Accounts payable and accrued liabilities			(48,418	)			24,540				31,844
Due to Parent			—				(24,999	)			(25,000	)
Net Cash (Used in) Provided by Operating Activities			(390,459	)			(15,452	)			25,349
Cash Flows from Investing Activities
Sales of oil and gas properties			—				846,975				—
Investment in oil and gas properties			(22,078	)			(172,884	)			(9,625	)
Net Cash (Used in) Provided by Investing Activities			(22,078	)			674,091				(9,625	)
Net (Decrease) Increase in Cash and
Cash Equivalents			(412,537	)			658,639				15,724
Cash and Cash Equivalents, beginning of year			965,648				307,009				291,285
Cash and Cash Equivalents, end of year		$	553,111			$	965,648			$	307,009

 

See accompanying notes to the consolidated financial statements.

 

Equus Energy, LLC and Subsidiary

Notes to Consolidated Financial Statements

 

1.       Nature of Operations

 

Equus Energy, LLC (“Equus Energy”) was formed in November 2011 as a wholly-owned subsidiary of the Equus Total Return, Inc. (the “Fund”) to make investments in properties in the energy sector, with a particular emphasis on income-producing oil & gas properties. In December 2011, the Fund made an initial contribution of $250,000 to Equus Energy. On December 27, 2012, the Fund invested an additional $6,800,000 in Equus Energy for the purpose of additional working capital and to fund the purchase of various working interests, presently consisting of 144 producing and non-producing oil and gas wells. The interests were acquired by EQS Energy Holdings, Inc., a taxable wholly-owned subsidiary of Equus Energy (Equus Energy and EQS Energy Holdings, Inc. are collectively referred to herein as the “Company”).

 

Currently owned working interests include associated development rights of approximately 21,520 acres situated on 11 separate properties in Texas and Oklahoma. The working interests range from a de minimus amount to 50% of the leasehold that includes these wells.

 

The wells are operated by a number of experienced operators, including Chevron USA, Inc., which has operating responsibility for all of the Company’s 40 producing well interests located in the Conger Field, an oil and gas field on the edge of the Permian Basin, a 50% working interest in each of the leases on which the wells are located, and working interests of 7.5% and 2.5% in the Burnell and North Pettus Units, respectively, which collectively comprise approximately 13,000 acres located in the area known as the “Eagle Ford Shale” play.

 

On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus originating in Wuhan, China (the “COVID-19 outbreak”) and the risks to the international community as the virus spreads globally beyond its point of origin. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally.

 

The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. As such, it is uncertain as to the full magnitude that the pandemic will have on the Company’s financial condition, liquidity, and future results of operations. Management is actively monitoring the global situation on its financial condition, liquidity, operations, suppliers, industry, and workforce. Given the daily evolution of the COVID-19 outbreak and the global responses to curb its spread, the Company is not able to estimate the effects of the COVID-19 outbreak on its results of operations, financial condition, or liquidity for fiscal year 2020.

 

2.       Summary of Significant Accounting Policies

 

Basis of Presentation and Consolidation

 

The accompanying consolidated financial statements are prepared on the accrual basis of accounting as codified in the Financial Standards Accounting Board’s (“FASB”) Accounting Standards Codification (“ASC”) and include the accounts of the Company. All significant intercompany balances and transactions have been eliminated.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management believes that these estimates and assumptions provide a reasonable basis for the fair presentation of the consolidated financial statements.

 

Significant estimates include volumes of oil and natural gas reserves used in calculating depreciation and depletion of oil and gas properties, future net revenues, abandonment obligations, impairment of undeveloped properties, the collectability of outstanding accounts receivable, contingencies, and the results of current and future litigation. Oil and natural gas reserve estimates, which are the basis for unit-of-production depreciation and depletion, and impairment have numerous inherent uncertainties. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Subsequent drilling results, testing, and production may justify revision of such estimates. Accordingly, reserve estimates are often different from the quantities of oil and natural gas that are ultimately recovered. In addition, reserve estimates are sensitive to changes in wellhead prices of crude oil and natural gas. Such prices have been volatile in the past and can be expected to be volatile in the future.

 

The significant estimates are based on current assumptions that may be materially affected by changes to future economic conditions such as the market prices received for sales of volumes of oil and natural gas. Future changes in these assumptions may affect these significant estimates materially in the near term.

 

Equus Energy, LLC and Subsidiary

Notes to Consolidated Financial Statements

 

Cash and Cash Equivalents

 

The Company considers cash and cash equivalents to include all cash, time deposits, certificates of deposit, and all highly liquid instruments with original maturities of three months or less.

 

Receivables

 

Accounts receivable primarily consists of accrued revenues from oil and gas sales. The Company routinely assesses the recoverability of all material receivables to determine their collectability. The Company recognizes a reserve on a receivable when, based on the judgment of management, it is likely that a receivable will not be collected and the amount of any reserve may be reasonably estimated. No allowance for doubtful accounts was considered necessary as of December 31, 2019 and 2018.

 

Oil and Gas Properties

 

The Company follows the full cost method of accounting for oil and gas properties. Under this method of accounting, all costs incurred for both successful and unsuccessful exploration and development activities, including salaries, benefits and other internal costs directly identified with these activities, and oil and gas property acquisitions are capitalized. All costs related to production, general corporate overhead or similar activities are expensed as incurred. Proved properties are amortized using the units of production method (“UOP”). The UOP calculation, in its simplest terms, multiplies the percentage of estimated proved reserves produced by the cost of those reserves. The amortization base in the UOP calculation includes the sum of proved property, net of accumulated depreciation, depletion and amortization (“DD&A”), estimated future development costs (future costs to access and develop reserves) and asset retirement costs that are not already included in oil and gas property, less related salvage value. In arriving at rates under the UOP method, the quantities of recoverable oil and natural gas reserves are established based on estimates made by the third-party geologists and engineers using end-of-period costs and an unweighted arithmetic average of commodity prices in effect on the first day of each of the previous twelve months, held flat for the life of the production, except where prices are defined by contractual arrangements. Prices are adjusted for “basis” or location differentials which require significant judgment, as does the projection of future production volumes and levels of future costs, including future development costs. In addition, considerable judgment is necessary in determining when unproved properties become impaired and in determining the existence of proved reserves once a well has been drilled. All of these judgments may have significant impact on the calculation of depletion expense.

 

Under the full-cost method of accounting, the net book value of oil and gas properties may not exceed a calculated “ceiling.” The ceiling limitation is the estimated future net cash flows from proved oil and gas reserves, discounted at ten percent per annum. Estimated future cash flows exclude future cash outflows associated with settling accrued asset retirement obligations. The estimated future net cash flows are calculated using end-of-period costs and an unweighted arithmetic average of commodity prices in effect on the first day of each of the previous twelve months, held flat for the life of the production, except where prices are defined by contractual arrangements. Prices are adjusted for “basis” or location differentials. Any excess of the net book value of proved oil and gas properties over the ceiling is charged to expense and reflected as additional impairment in the accompanying statements of operations. Equus Energy did not record any impairment during the year ended December 31, 2019, 2018 and 2017. Based on calculated reserves at December 31, 2019, the unamortized costs of the Company’s oil and natural gas properties exceeded the ceiling test limit.

 

Proceeds from the sales or disposition of oil and gas of proved and unproved properties are accounted for as a reduction of capitalized costs with no gain or loss recognized, unless such reduction would significantly alter the relationship between capitalized costs and proved reserves, in which case the gain or loss is recognized in the statement of operations. In general, a significant alteration occurs when the deferral of gains or losses will result in an amortization rate materially different from the amortization rate calculated upon recognition of gains or losses. Abandonments of properties are accounted for as adjustments of capitalized costs with no loss recognized.

 

During the year ended December 31, 2019 and 2017, the Company had no sales of properties. During the year ended December 31, 2018, the Company has two sales of certain properties within the Permian Basin.  The Company evaluated both sales and demonstrated that the first sale did not constitute a material difference in amortization rates; therefore, the proceeds were taken against the full cost pool and reduced the basis by $200,000.  The Company evaluated the second sale and determined a material difference in amortization rates would occur if no gain was recognized on the sale and therefore recorded a gain of $619,293 on the sale. The corresponding reduction in the carrying amount of its oil and gas full cost pool related to the second sale was $15,707.

Equus Energy, LLC and Subsidiary

Notes to Consolidated Financial Statements

Accounting Standards Recently Adopted

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 supersedes the revenue recognition requirements under ASC 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the ASC. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. Under the new guidance, an entity is required to perform the following five steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new guidance will significantly enhance comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. Additionally, the guidance requires improved disclosures as to the nature, amount, timing and uncertainty of revenue that is recognized.

 

Revenue Recognition

 

The Company recognizes revenue at the point in time when control of the promised goods is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company adopted ASU No. 2014-09, Accounting Standards Codification ("ASC") 606, "Revenue from Contracts with Customers" ("ASC 606"), which supersedes the revenue recognition requirements in ASC 605, "Revenue Recognition" ("ASC 605"), on January 1, 2019 using the modified retrospective transition method. The Company did not record a change to its opening retained earnings as of January 1, 2019 as there was no material change to the timing or pattern of revenue recognition due to the adoption of ASC 606.

 

The Company’s revenue is generated primarily from the sale of oil, gas and natural gas liquids (“NGL”) produced from working interests and to a lesser extent from royalty interests in oil and gas properties owned by the Company. As a working interest owner, the Company is responsible for the incurred production expenses proportionate to the interest stipulated in the operating agreement. As a non-operator, the Company does not manage the daily well operations, which are borne by the well operator. Sales of oil, gas and NGLs are recognized at the time control of the product is transferred to the customer.

 

Various arrangements amongst the eleven different oil and gas properties all differ in some respects, although they do share the commonality that, as a non-operating working interest holder, the Company does not engage in the selling process, but instead relies on the operator, as their selling agent, for negotiating and determining pricing, volume, and delivery terms. Such pricing terms are often a function of a specified discount from the daily/monthly NYMEX or Henry Hub average. The discount is usually based on differentials such as distance of the field/wells from the distribution node or the buyer’s storage facility, as well as the quality of the product itself (i.e., in the case of oil, its gravity).

 

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. The contract consideration is typically allocated to specific performance obligations in the contract according to the terms of the contract. Each unit of oil or gas is considered a separate performance obligation under the contract. Wells are spot measured once a month to determine production and the composition of each of the products (i.e. oil, gas, NGLs) from the well. Each month the consideration obtained by the operator is allocated to the related performance obligations.

 

Performance Obligations

 

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Revenue is recognized when performance obligations are satisfied in accordance with contractual terms, in an amount that reflects the consideration the Company expects to be entitled to in exchange for services rendered.

 

Depending on the contract and commodity, there are various means by which upstream entities can transfer control (i.e., at the wellhead, inlet, tailgate of the processing plant, or a location where the product is delivered to a third party). The Operator has control of the commodity before it is extracted, therefore consideration must be given to whether the transfer of control of the commodity is to the operator or to the end customer at the point of sale.

 

Unless special arrangements are entered into, the Company’s performance obligations are generally considered performed when control of the extracted commodity transfers when it is delivered to the end customer at the agreed-upon market or index price. At the end of each month, when the performance obligation is satisfied, the variable consideration can be reasonably estimated. Variances between the Company’s estimated revenue and actual payments are recorded in the month the payment is received.

Equus Energy, LLC and Subsidiary

Notes to Consolidated Financial Statements

 

Contract Balances

 

Receivables from contracts with customers are recorded when the right to consideration becomes unconditional, generally when control of the product has been transferred to the customer. Under the terms of the Company’s contract with the operator, the operator processes invoices to the liable parties and payments to the interest owners. Other than trade receivables, the Company’s contracts do not give rise to contract assets or liabilities under ASC 606.

 

Principal vs. Agent

 

While the guidance on principal versus agent considerations is similar to legacy GAAP, the key difference is that ASC 606 focuses on control of the specified goods and services as the overarching principle for entities to consider when determining whether they are acting as a principal or an agent. This could result in entities reaching different conclusions than they did under legacy GAAP.

 

An entity acting as a principal records revenue on a gross basis if it controls a promised good or service before transferring that good or service to the customer. An entity is an agent if it does not control the promised good or service before transfer to the customer. If the entity is an agent, it records as revenue the net amount it retains for its agency services. However, due to the uncertainty of the variable pricing component and the separation of expenses billed to the Company from the consideration processed and paid by the operator, the revenue is recorded at net.

 

Under the Company’s normal operating activity arrangements, the operator is responsible for negotiating, fulfilling and collecting the agreed-upon amount from the sale with the end customer and is, therefore, determined to be acting as agent on behalf of the Company. The principal versus agent consideration will continue to be assessed for new contracts, both within and outside the company’s normal operating activities.

 

Major Customers and Concentration of Credit Risk

 

In the exploration, development and production business, production is normally sold to relatively few customers. Substantially all of the Company’s customers are concentrated in the oil and natural gas industry and revenue can be materially affected by current economic conditions, the price of certain commodities such as crude oil and natural gas and the availability of alternate purchasers. The Company believes the loss of any of its major purchasers would not have a long-term material adverse effect on its operations.

 

Environmental Expenditures

 

The Company is subject to extensive federal, state and local environmental laws and regulations. These laws regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed.

 

Liabilities for expenditures of a non-capital nature are recorded when environmental assessment and/or remediation is probable, and the costs can be reasonably estimated. Such liabilities are generally undiscounted unless the timing of cash payments for the liability or component is fixed or reliably determinable. No such liabilities existed or were recorded at December 31, 2019 and 2018.

 

Asset Retirement Obligations

 

The initial estimated asset retirement obligation related to property and equipment is recorded as a liability at its fair value, with an offsetting asset retirement cost recorded as an increase to the associated property and equipment on the consolidated balance sheet. If any of the assumptions used in determining the fair value of the recorded asset retirement obligation change, a revision is recorded to both the asset retirement obligation and the asset retirement cost. Revisions in estimated liabilities can result from changes in estimated inflation rates, changes in service and equipment costs and changes in the estimated timing of an asset’s retirement. Asset retirement costs are depreciated using a systematic and rational method similar to that used for the associated property and equipment. Accretion on the liability is recognized over the estimated productive life of the related assets. Accretion expense for the years ended December 31, 2019, 2018 and 2017 was $6,537, $5,956 and $6,051, respectively.

 

Income Taxes

 

These financial statements are presented on a consolidated basis. For state tax purposes, EQS Energy Holdings files a combined Texas franchise filing with its direct parent Equus Energy, LLC along with its ultimate parent Equus Total Return, Inc. However, Equus Energy, LLC is disregarded as an entity separate from its owner for U.S. federal income tax purposes, and its activity is reported by Equus Total Return, Inc.

Equus Energy, LLC and Subsidiary

Notes to Consolidated Financial Statements

 

EQS Energy Holdings, conversely, is a taxable C-corporation that is not included in either the tax returns for Equus Energy, LLC or Equus Total Return, Inc. under U.S. federal income tax principles, and accordingly files a separate corporate income tax return.

 

The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of the events that have been included in the consolidated financial statements.

 

Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

 

The Company records deferred tax assets to the extent the Company believes these assets will more-likely-than-not be realized. In making such determinations, the Company considers all available positive and negative evidence, including future reversals of existing temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In the event the Company were to determine that it would be able to realize deferred income tax assets in the future in excess of their net recorded amount, an adjustment to the valuation allowance would be made which would reduce the provision for income taxes.

 

ASC Topic 740-10, “Income Taxes” provides that a tax benefit from an uncertain position may be recognized in the financial statements when it is more-likely-than-not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on technical merits. This guidance also addresses measurement, derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition. The Company has no material uncertain tax positions in its prior or current filings.

 

3.       Oil and Gas Properties

 

Oil and gas properties as of December 31, 2019 and 2018 consist of the following:

 

		2019				2018
Oil and gas properties being depleted		$	8,030,506			$	8,008,428
Less: accumulated depreciation, depletion and impairment			7,788,948				7,772,006
Oil and gas properties, net		$	241,558			$	236,422

 

4.       Asset Retirement Obligations

 

The fair value of a liability for ARO is recorded in the period in which it is incurred if a reasonable estimate of fair value can be made, and the corresponding cost is capitalized as part of the carrying amount of the related long-lived asset. The liability is accreted to its then present value each period, and the capitalized cost is depreciated over the useful life of the related asset. If the liability is settled for an amount other than the recorded amount, an adjustment is made to the full cost pool, with no gain or loss recognized, unless the adjustment would significantly alter the relationship between capitalized costs and proved reserves. The Company has estimated its future ARO with respect to its operations. The ARO assets, which are carried on the balance sheet as part of the full cost pool, have been included in the Company’s amortization base for the purposes of calculating depreciation, depletion and amortization expense.

 

The Company estimates the initial fair value of its ARO based on discounted cash flow projections using numerous estimates, assumptions and judgments regarding such factors as the existence of a legal obligation for an ARO, amounts and timing of settlements; the credit-adjusted risk-free rate to be used; and inflation rates. The Company’s initial recording of AROs are Level 3 fair value measurements.

 

The following summarizes the changes in the asset retirement obligation during the years ended December 31, 2019 and 2018:

 

		2019				2018
Balance, beginning of year		$	194,522			$	189,756
Accretion, net of settlements			6,537				4,766
Balance, end of year		$	201,059			$	194,522

Equus Energy, LLC and Subsidiary

Notes to Consolidated Financial Statements

 

5.       Fair Value Measurements

 

Equus Energy uses various inputs in determining the fair value of certain assets and liabilities. FASB ASC 820, Fair Value Measurements and Disclosures “ASC 820”, establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. The asset or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. The three levels of the fair value hierarchy under ASC 820, including the types of Company assets or liabilities that fall under each category and the valuation methodologies used to measure fair value, are described below:

 

Level 1 - Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets.

 

Level 2 - Inputs to the methodology are other than quoted market prices in active markets that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices that are in inactive markets; inputs other than quoted prices that are observable for the assets or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

Level 3 - Inputs to the valuation methodology are unobservable inputs (i.e. projections, estimates, interpretations, etc.) that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

The inputs and methodology used for valuing the Company’s assets and liabilities are not indicators of the risks associated with those assets and liabilities.

 

The following is a description of the valuation methodology used for assets and liabilities measured at fair value:

 

Asset retirement obligation (“ARO”) at initial recognition: the Company’s ARO is based on the present value of future estimated cash flows, using a credit-adjusted risk free discount rate and has been categorized under ASC 820 as a Level 3 fair value assessment.

 

6.       Concentrations of Credit Risk

 

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and receivables. The Company maintains its cash with a financial institution it believes has high credit quality. The Company at times maintains bank deposits in excess of insured limits. The possibility of a loss exists if the bank holding excess deposits were to fail. Trade receivables result from oil and gas sales to a small number of purchasers. To mitigate this credit risk, the Company closely monitors the payment history and credit worthiness of each customer.

 

Equus Energy, LLC and Subsidiary

Notes to Consolidated Financial Statements

 

7.       Legal Matters and Contingencies

 

Litigation and Other Legal Matters

 

In the normal course of business, the Company may be party to various pending or threatened claims, lawsuits and administrative proceedings seeking damages or other remedies concerning its commercial operations, employees and other matters. Although the outcome of any pending legal proceedings is unknown, the Company believes that any liability resulting from the outcome of such proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on the Company’s consolidated financial positions, results of operations or liquidity.

 

Certain conditions may exist as of the date the financial statements are issued, which may result in a loss to the Company, but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims, as well as the perceived merits of the amount of relief sought or expected to be sought therein.

 

If the assessment of a loss contingency indicates that it is probable that a loss has been incurred and the amount of the liability can be reasonably estimated, then the estimated liability is accrued in the Company’s financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss, if determinable and material, would be disclosed. Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the nature of the guarantee would be disclosed. The Company expenses legal costs associated with contingencies as incurred. (See Footnote 7- Legal Matters and Contingencies)

 

Environmental Contingencies

 

The Company’s activities are subject to local, state and federal laws and regulations governing environmental quality and pollution control in the United States. The exploration, drilling and production from wells, natural gas facilities, including the operation and construction of pipelines, plants and other facilities for transporting, processing, treating or storing natural gas and other products, are subject to stringent environmental regulation by state and federal authorities, including the Environmental Protection Agency (“EPA”). Such regulation can increase our cost of planning, designing, installing and operating such facilities.

 

Significant fines and penalties may be imposed for the failure to comply with environmental laws and regulations. Some environmental laws provide for joint and several strict liabilities for remediation of releases of hazardous substances, rendering a person liable for environmental damage without regard to negligence or fault on the part of such person. In addition, we may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances, such as oil and natural gas related products.

 

At the present time, the Company believes that none of the environmental laws materially hinder nor adversely affect the Company business. The Company believes it has abided by and is currently in compliance with all applicable environmental laws.

 

 

 

Equus Energy, LLC and Subsidiary

Notes to Consolidated Financial Statements

 

8.       Income Taxes

 

The provision for income taxes for the years ended December 31, 2019, 2018 and 2017 consisted of the following:

 

Years Ended December 31,		2019				2018				2017
Current (expense) benefit:
Federal		$	63,854			$	(92,972	)		$	—
State			(1,414	)			27,651				—
Total current (expense) benefit			62,440				(65,321	)			—
Deferred (expense) benefit:
Federal			(63,510	)			86,916				—
State			1,290				(22,780	)			—
Total deferred (expense) benefit			(62,220	)			64,136				—
Total benefit (expense):
Federal			344				(6,056	)			—
State			(124	)			4,871				—
Total benefit (expense)		$	220			$	(1,185	)		$	—

 

 

The components of the net deferred tax assets (liabilities) in the Company’s balance sheets were as follows:

 

As of December 31,			2019				2018
Deferred tax assets:
Properties		$	761,652			$	807,396
Asset retirement obligation			42,222				40,849
State taxes			27,202				28,836
Net operating loss carryforwards			355,240				247,359
Deferred tax liabilities:
State tax deduction			(5,712	)			(6,056	)
Total net deferred tax assets (liabilities)			1,180,604				1,181,384
Valuation allowance			(1,180,604	)			(1,118,384	)
Net deferred tax liabilities		$	—			$	—

 

 

Equus Energy, LLC and Subsidiary

Notes to Consolidated Financial Statements

 

The provision for income taxes varies from the maximum federal statutory rate of 21%, 21% and 35% for the years ended December 31, 2019, 2018, and 2017, respectively as follows:

 

Years Ended December 31,		2019				2018				2017
Income tax expense (benefit) at federal statutory rate		$	(89,688	)		$	60,485			$	(93,182	)
Effect of state income taxes			1,070				(21,595	)			—
Effect of tax reform			—				—				788,347
Other non-deductible expenses			26,178				26,431				58,755
Change in valuation allowance			62,220				(64,136	)			(753,920	)
Total income tax (benefit) expense		$	(220	)		$	1,185			$	—

 

At December 31, 2019, 2018 and 2017, the tax effected amount of net operating loss carryforwards (“NOLs”) totaled $355,240, $247,359 and $282,034 respectively.

 

The Company has determined, after weighing both positive and negative evidence, that the net deferred tax asset (DTA) for the Company is not more-likely-than-not to be realizable. Therefore, valuation allowances of $1,180,604 and $1,118,384 were established at December 31, 2019, and December 31, 2018, respectively, to completely offset the net DTA in existence at each year end.

 

Deferred income tax assets and liabilities are based on enacted tax rates applicable to the future period when those temporary differences are expected to be recovered or settled. The 2017 Tax Reform lowered the U.S. federal corporate tax rate from 35% to 21%, which caused the Company to remeasure its deferred income tax assets and liabilities at the new rate. For the tax years ended December 31, 2019, 2018, and 2017, the Company’s statutory tax rate was 21%, 21%, and 35%, respectively. As a result of the change in the statutory tax rate on our deferred tax assets and liabilities, the Company recorded a $788,347 (after-tax) reduction in its net deferred tax assets with a corresponding reduction in the valuation allowance for the period ended December 31, 2017. There were no amounts recorded in 2018 or 2019 related to 2017 Tax Reform.

 

9.       Subsequent Events

 

The Company evaluates events and transactions occurring after the balance sheet date but before the financial statements are available to be issued. The Company evaluated such events and transactions through March 30, 2020, the date the consolidated financial statements were available for issuance.

 

On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus originating in Wuhan, China (the “COVID-19 outbreak”) and the risks to the international community as the virus spreads globally beyond its point of origin. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally.

 

The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. As such, it is uncertain as to the full magnitude that the pandemic will have on the Company’s financial condition, liquidity, and future results of operations. Management is actively monitoring the global situation on its financial condition, liquidity, operations, suppliers, industry, and workforce. Given the daily evolution of the COVID-19 outbreak and the global responses to curb its spread, the Company is not able to estimate the effects of the COVID-19 outbreak on its results of operations, financial condition, or liquidity for fiscal year 2020.

 

In addition, in March 2020, members of OPEC failed to agree on oil production levels, which is expected to result in an increased supply of oil and has led to a substantial decline in oil prices and an increasingly volatile market. However, if the depressed pricing environment continues for an extended period, it may lead to i) a reduction in the borrowing base needed in order to obtain a credit facility or additional funding, which could negatively impact our liquidity, ii) a reduction in reserves, and iii) the potential impairment of proved and unproved oil & gas properties. Consumer demand for our products may also be negatively impacted.

 

Management is actively monitoring its financial condition, liquidity, operations, suppliers, industry, and workforce. Although the Company cannot estimate the length or gravity of the impacts of these events at this time, if the pandemic and/or decline in oil prices continue, they may have a material adverse effect on the Company’s results of future operations, financial position, and liquidity in fiscal year 2020.