UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

☒  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2014

 

☐  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______to______.

 

001-35330
(Commission File No.)

 

LILIS ENERGY, INC.

(Exact name of registrant as specified in charter)

 

NEVADA   74-3231613

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

216 16th Street, Suite #1350

Denver, CO 80202

(Address of Principal Executive Offices)

 

(303) 951-7920

(Registrant’s telephone number, including area code)

 

 

1900 Grant Street, Suite #720

Denver, CO 80203

 
  (Former name, former address and former fiscal year, if changed since last report)  

 

Indicate by check mark if 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 past 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).  Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act):

 

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

 

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

 

As of February 24, 2015, 28,918,475 shares of the registrant’s common stock were issued and outstanding.

 

 

 

 
 

 

Lilis Energy, Inc.

 

INDEX

 

PART I– FINANCIAL INFORMATION
       
Item 1.   Financial Statements (Unaudited) 4
    Condensed Balance Sheets as of September 30, 2014 and December 31, 2013 (Audited) 4-5
    Condensed Statements of Operations for the Three and Nine Months Ended September 30, 2014 and 2013 6
    Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013 7
    Notes to Condensed Financial Statements 8
       
Item 2.   Management’s Discussion and Analysis of Financial Condition 26
       
Item 3.   Quantitative and Qualitative Disclosures About Market Risk 40
       
Item 4.   Control and Procedures 40
       
PART II– OTHER INFORMATION
       
Item 1.   Legal Proceedings 41
Item 1A.   Risk Factors 42
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds 42
Item 3.   Defaults Upon Senior Securities 42
Item 4.   Mine Safety Disclosures 43
Item 5.   Other Information 43
Item 6.   Exhibits 43
       
SIGNATURES 44
   
EXHIBIT INDEX 45

 

2
 

 

FORWARD-LOOKING STATEMENTS

 

This quarterly report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws, including, but not limited to, any projections of earnings, revenue or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements concerning future production, reserves or other resource development opportunities or financing opportunities; any projected well performance or economics, or potential joint ventures or strategic partnerships; any statements regarding future economic conditions or performance; any statements regarding future capital-raising activities; any statements of belief; and any statements of assumptions underlying any of the foregoing.

 

Forward-looking statements may include the words “may,” “should,” “could,” “estimate,” “intend,” “plan,” “project,” “continue,” “believe,” “expect” or “anticipate” or other similar words. These forward-looking statements present our estimates and assumptions only as of the date of this presentation. Except as required by law, we do not intend, and undertake no obligation, to update any forward-looking statement.

 

Although we believe that the expectations reflected in any of our forward-looking statements are reasonable, actual results could differ materially from those projected or assumed in any of our forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and inherent risks and uncertainties. The factors impacting these risks and uncertainties include, but are not limited to:

 

the risk factors discussed in Part I, Item 1A of our 2013 Annual Report on Form 10-K for the year ended December 31, 2013;
availability of capital on an economic basis, or at all, to fund our capital or operating needs;
failure to meet requirements or covenants under our debt instruments, which could lead to foreclosure of significant core assets;
failure to fund our authorization for expenditures from other operators for key projects which will reduce/ or eliminate our interest in the wells/asset
inability to address our negative working capital position in a timely manner;
the inability of management to effectively implement our strategies and business plans;
potential default under our secured obligations or material debt agreements;
estimated  quantities and quality of oil and natural gas reserves;
exploration, exploitation and development results;
fluctuations in the price of oil and natural gas, including further reductions in prices that would adversely affect our revenue, cash flow, liquidity and access to capital;
availability of, or delays related to, drilling, completion and production, personnel, supplies and equipment;
the timing and amount of future production of oil and natural gas;
the timing and success of our drilling and completion activity;
lower oil and natural gas prices negatively affecting our ability to borrow or raise capital, or enter into joint venture arrangements;
declines in the values of our natural gas and oil properties resulting in write-down or impairments;
inability to hire or retain sufficient qualified operating field personnel;
our ability to successfully identify and consummate acquisition transactions;
our ability to successfully integrate acquired assets or dispose of non-core assets;
Availability of funds under our credit facility;
increases in interest rates or our cost of borrowing;
deterioration in general or regional (especially Rocky Mountain) economic conditions;
the strength and financial resources of our competitors;
the occurrence of natural disasters, unforeseen weather conditions, or other events or circumstances that could impact our operations or could impact the operations of companies or contractors we depend upon in our operations;
inability to acquire or maintain mineral leases at a favorable economic value that will allow us to expand our development efforts;
inability to successfully develop the acreage we currently hold on a timely basis;
transportation capacity constraints or interruptions, curtailment of production, natural disasters, adverse weather conditions, or other issues affecting the Denver-Julesburg Basin;
technique risks inherent in drilling in existing or emerging unconventional shale plays using horizontal drilling and complex completion techniques;
delays, denials or other problems relating to our receipt of operational consents and approvals from governmental entities and other parties;
unanticipated recovery or production problems, including cratering, explosions, blow-outs, fires and uncontrollable flows of oil, natural gas or well fluids;
environmental liabilities;
operating hazards and uninsured risks;
loss of senior management or technical personnel;
adverse state or federal legislation or regulation that increases the costs of compliance, or adverse findings by a regulator with respect to existing operations, including those related to climate change and hydraulic fracturing;
changes in U.S. GAAP or in the legal, regulatory and legislative environments in the markets in which we operate; and
other factors, many of which are beyond our control.

 

Many of these factors are beyond our ability to control or predict. These factors are not intended to represent a complete list of the general or specific factors that may affect us.

 

For a detailed description of these and other factors that could cause actual results to differ materially from those expressed in any forward-looking statement, we urge you to carefully review and consider the disclosures made in the “Risk Factors” sections of our Annual Report on Form 10-K for the year ended December 31, 2013 and other SEC filings, available free of charge at the SEC’s website (www.sec.gov).

3
 

 

Part 1. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

LILIS ENERGY, INC.

CONDENSED BALANCE SHEETS

 

   September 30,   December 31, 
   2014   2013 
   (Unaudited)   (Audited) 
         
Assets        
Current assets:        
Cash  $1,472,996   $165,365 
Restricted cash   221,774    504,623 
Accounts receivable (net of allowance of $76,016 at September 30, 2014 and $50,000 at December 31, 2013, respectively)   705,332    467,337 
Prepaid assets   134,091    195,716 
Commodity price derivative receivable   -    6,679 
Total current assets   2,534,193    1,339,720 
           
Oil and natural gas properties (full cost method), at cost:          
Evaluated properties   37,298,201    68,213,467 
Unevaluated acreage, excluded from amortization   12,931,701    18,663,569 
Wells in progress, excluded from amortization   6,041,743    1,145,794 
Total oil and natural gas properties, at cost   56,271,645    88,022,830 
           
Less accumulated depreciation, depletion, and amortization   (25,525,672)   (45,457,637)
Total oil and natural gas properties, net   30,745,973    42,565,193 
           
Other assets:          
Office equipment, net   81,304    91,161 
Deferred financing costs, net   15,949    294,699 
Restricted cash and deposits   215,541    215,541 
Total other assets   312,794    601,401 
Total assets  $33,592,960   $44,506,314 

 

The accompanying notes are an integral part of these condensed financial statements.

 

4
 

 

LILIS ENERGY, INC.

CONDENSED BALANCE SHEETS

 

   September 30,   December 31, 
   2014   2013 
   (Unaudited)   (Audited) 
Liabilities and Shareholders' Equity        
Current liabilities:        
Dividends accrued on preferred stock  $121,167   $- 
Accrued expenses for drilling activity   5,698,193    - 
Accounts payable   282,421    1,932,618 
Accrued expenses   3,055,462    1,439,956 
Short term loans payable   -    10,662,904 
Total current liabilities   9,157,243    14,035,478 
           
Long term liabilities:          
Asset retirement obligation   196,248    1,104,952 
Term loans payable   -    8,111,436 
Convertible debentures payable, net of discount   6,683,299    14,724,366 
Convertible debentures conversion derivative liability   1,540,481    605,315 
Total long-term liabilities   8,420,028    24,546,069 
Total liabilities   17,577,271    38,581,547 
           
Commitments and contingencies          
           
Conditionally redeemable 6% preferred stock, $0.0001 par value: 7,000 shares issued and authorized, 2,000 shares, outstanding at September 30, 2014, liquidation preferences of $2,000,000 as of September 30, 2014. No shares were outstanding as of December 31, 2013   2,000,000    - 
           
Shareholders’ equity:          
Series A Preferred Stock, $.0001 par value; stated rate $1,000:10,000,000 authorized, 7,500 and issued and outstanding as of September 30, 2014 and, liquidation preferences of $7,621,167 as of September 30, 2014. No shares were issued as of December 31, 2013.   6,794,000    - 
Common stock, $0.0001 par value:100,000,000 shares authorized; 27,655,631 and 19,671,901 shares issued and outstanding as of September 30, 2014 and December 31, 2013, respectively   2,765    1,967 
Additional paid in capital   154,224,704    121,451,232 
Accumulated deficit   (147,005,780)   (115,528,432)
Total shareholders' equity   14,015,689    5,924,767 
Total liabilities and shareholders’ equity  $33,592,960   $44,506,314 

 

The accompanying notes are an integral part of these condensed financial statements.

 

5
 

 

LILIS ENERGY, INC.

CONDENSED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

   Three months ended
September 30,
   Nine months ended
September 30,
 
   2014   2013   2014   2013 
Revenues:                
Oil sales  $735,386   $1,003,745   $2,414,995   $3,320,083 
Natural gas sales   118,639    82,651    308,629    227,853 
Operating fees   (39,015)   28,331    37,866    118,853 
Realized gain (loss) on commodity price derivatives   -    (43,551)   11,143    (23,661)
Change in fair value on  commodity price derivatives   -    (20,000)   -    (20,000)
Total revenues   815,010    1,051,176    2,772,633    3,623,128 
                     
Costs and expenses:                    
Production costs   101,593    318,322    739,176    877,623 
Production taxes   71,864    102,919    266,774    380,958 
General and administrative   2,935,404    1,214,029    8,536,882    3,566,264 
Depreciation, depletion and amortization   252,548    532,173    1,211,587    1,873,002 
Total costs and expenses   3,361,409    2,167,443    10,754,419    6,697,847 
                     
Loss from operations before loss on conveyance of property   (2,546,399)   (1,116,267)   (7,981,786)   (3,074,719)
Loss on conveyance of property   (2,694,466)   -    (2,694,466)   - 
Loss from operations   (5,240,865)   (1,116,267)   (10,676,252)   (3,074,719)
                     
Other Income (expenses):                    
Other income   32,338    145    32,435    536 
Inducement expense   -    -    (6,661,275)   - 
Change in fair value of convertible debentures conversion derivative   (572,427)   (207,251)   (5,966,236)   93,851 
Interest expense   (1,130,727)   (1,582,881)   (4,477,277)   (4,723,624)
Total other expenses   (1,670,816)   (1,789,987)   (17,072,353)   (4,629,238)
                     
Net loss   (6,911,681)   (2,906,254)   (27,748,605)  $(7,703,956)
Dividends on preferred stock   (121,167)   -    (161,848)   - 
Deemed dividend Series A Convertible Preferred Stock   -    -    (3,566,895)   - 
Net loss attributable to common shareholders  $(7,032,848)  $(2,906,254)  $(31,477,348)  $(7,703,956)
Loss per common share:                    
Net loss per common share (basic and diluted)  $(0.25)  $(0.15)  $(1.17)  $(0.41)
Weighted average common shares outstanding (basic and diluted)   27,631,220    19,254,329    26,794,437    18,786,598 

 

The accompanying notes are an integral part of these condensed financial statements.

 

6
 

 

LILIS ENERGY, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

   Nine months ended 
   September 30, 
   2014   2013 
Cash flows from operating activities:        
Net loss  $(27,748,605)   (7,703,956)
Adjustments to reconcile net loss to net cash used in operating activities:          
Inducement expenses   6,661,275    - 
Common stock issued to investment bank for fees related to conversion of convertible debentures   686,251    - 
Common stock issued for services and compensation   2,667,213    1,293,315 
Reserve on bad debt expense   26,016    - 
Loss on conveyance of property   2,694,466    - 
Change in fair value of commodity price derivative     6,679    20,000 
Change in fair value of executive incentive bonus     (35,000)   - 
Amortization of deferred financing costs   278,750    531,739 
Change in fair value of convertible debentures conversion derivative   5,966,236    (93,851)
Accretion of debt discount   810,804    1,742,099 
Depreciation, depletion, amortization and accretion of asset retirement obligation   1,211,587    1,873,002 
Changes in operating assets and liabilities:          
Accounts receivable   (264,011)   452,476 
Restricted cash   282,849    86,636 
Other assets   (104,510)   77,486 
Accounts payable and other accrued expenses   566,855    162,748 
Net cash used in operating activities   (6,293,145)   (1,558,306)
Cash flows from investing activities:          
Acquisition of undeveloped acreage   (305,000)   (303,814)
Drilling capital expenditures   (92,708)   (429,678)
Sale of oil and natural gas properties   -    640,000 
Additions to office furniture and fixtures   (10,815)   (25,081)
Net cash used in investing activities   (408,523)   (118,573)
Cash flows from financing activities:          
Proceeds from issuance of common stock   5,327,700    - 
Proceeds from issuance of debt   1,000,000    1,429,902 
Proceeds from issuance of Series A Convertible Preferred Stock   6,794,000      
Dividend payments on preferred stock   (40,681)   - 
Repayment of debt   (5,071,720)   (369,123)
Net cash provided by financing activities   8,009,299    1,060,779 
Change in cash   1,307,631    (616,101)
Cash at beginning of period   165,365    970,035 
           
Cash at end of period  $1,472,996   $353,934 
           
Supplementary Cash Flow Information:          
Cash paid during the period for:          
Interest  $1,170,300   $1,614,243 
Income taxes   -    - 
           
Non-cash investing and financing activities:          
Common stock issued for accrued convertible debenture interest  $148,129    830,660 
Acquisition of oil and natural gas assets for accounts payable and other accrued expenses  $5,410,467    - 
Transfer from derivative liability to equity classification  $5,031,070    - 
Issuance of common stock for payment of convertible debentures  $8,851,871    - 
Issuance of redeemable preferred stock for payment of term note  $2,000,000    - 
Conveyance of property for payment of term note  $14,833,311    - 
Disposition of asset retirement obligation (liability) through the conveyance of property for payment of term loan  $973,135    - 

 

The accompanying notes are an integral part of these condensed financial statements

 

7
 

 

LILIS ENERGY, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

 

NOTE 1 – ORGANIZATION

 

Lilis Energy, Inc. (“Lilis”, “Lilis Energy”, and the “Company) is an independent oil and natural gas exploration and production company focused on the Denver-Julesburg Basin (“DJ Basin”), where it holds approximately 84,000 net acres. Lilis drills, operates and produces oil and natural gas wells through the Company’s land holdings located in Colorado, Wyoming, and Nebraska.

 

All references to production, sales volumes and reserves quantities are net to the Company’s interest unless otherwise indicated.

 

NOTE 2 – LIQUIDITY AND MANAGEMENT PLANS

 

As of September 30, 2014, the Company had a negative working capital balance and a cash balance of approximately $6.62 million and $1.47 million, respectively. Also as of September 30, 2014, the Company had $6.68 million, net, outstanding under its 8% Senior Secured Convertible Debentures (the “Debentures”). The Debentures were originally to mature on January 15, 2015; however, in connection with the Company’s entry into the Credit Agreement (discussed below) in January 2015. As of the date of the report, the Company has entered into an extension agreement with the holders of the Debentures which extends the maturity date until January 8, 2018. The maturity date now coincides with the maturity date of the Credit Agreement.

 

On January 8, 2015, the Company entered into a credit agreement with Heartland Bank (the “Credit Agreement”) which provides for a three-year senior secured term loan in an initial aggregate principal amount of $3,000,000, which principal amount may be increased to a maximum principal amount of $50,000,000 at the request of the Company, subject to certain conditions, and pursuant to an accordion advance provision in the Credit Agreement (the “Term Loan”). The availability of additional funds is generally based on the value of the Company’s proved developed producing (“PDP”) and proved undeveloped (“PUD”) reserves. The Company intends to use proceeds borrowed under the Credit Agreement to fund producing property acquisitions in North America, drill wells in the core of the Company’s lease positions and to fund working capital (See Note 13-Subsequent Events.)

 

As of February 23, 2015, the Company has $2.40 million in cash on hand and is currently producing approximately 70 barrels of oil equivalent (“BOE”) a day from eight economically producing wells.

 

On June 6, 2014, T.R. Winston executed a commitment to purchase or affect the purchase by third parties of an additional $15 million in Series A 8% Convertible Preferred Stock, to be consummated within ninety (90) days thereof. The agreement was subsequently extended and expired on February 22, 2015. On February 25, 2015, the Company and TRW agreed in principal to a replacement commitment, pursuant to which TRW has agreed to purchase or affect the purchase by third parties of an additional $7.5 million in Series A 8% Convertible Preferred Stock, to be consummated no later than February 23, 2016, with all other terms substantially the same as those of the original commitment.

The Company will require additional capital to satisfy its obligations, to fund its current drilling commitments, as well as its acquisition and capital budget plans; to help fund its ongoing overhead; and to provide additional capital to generally improve its negative working capital position. The Company anticipates that such additional funding will be provided by a combination of capital raising activities, including borrowing transactions, the sale of additional debt and/or equity securities, and the sale of certain assets and by the development of certain of the Company’s undeveloped properties via arrangements with joint venture partners. If the Company is not successful in obtaining sufficient cash to fund the aforementioned capital requirements, the Company would be required to curtail its expenditures, and may be required to restructure its operations, sell assets on terms which may not be deemed favorable and/or curtail other aspects of its operations, including deferring all or portions of the Company’s capital budget. There is no assurance that any such funding will be available to the Company on acceptable terms, if at all.

 

8
 

 

NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation and Restatement

 

The condensed financial statements and accompanying footnotes are prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”).

 

The unaudited condensed financial information furnished herein reflects all adjustments, consisting solely of normal recurring items, which in the opinion of management are necessary to fairly state the financial position of the Company and the results of its operations for the periods presented.

 

This report should be read in conjunction with the Company’s financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission (the “SEC”) on June 11, 2014. The results of operations for the interim periods presented are not necessarily indicative of results for the entire year ending December 31, 2014. The financial statements in this Quarterly Report on Form 10-Q include the restated figures for the comparative periods in 2013, as provided in Amendment No. 1 to Form 10-Q/A to the Quarterly Report on Form 10-Q of Lilis Energy for the quarterly period ended September 30, 2013 (the “Amended Q3 2013 Report”).

 

In February 2015, the Company discovered an error in the valuation of the conversion derivative liability of the Company’s 8% Senior Secured Convertible Debentures (the “Debentures”) for the periods ended December 31, 2011, December 31, 2012, December 31, 2013, as well as the quarterly periods ended September 30, 2013, March 31, 2014 and June 30, 2014 (together, the “Relevant Periods”). Specifically, the calculation of the derivative liability included in the Company’s financial statements for the Relevant Periods only included the value of the price protection (anti-dilution) feature, when it should have included both the conversion option and the price protection feature embedded in the Debentures. The changes in the fair value of the derivative resulted in additional non-cash charges to the previously filed financial statements.

 

The Company has evaluated the effect of the error on all Relevant Periods in accordance with Staff Accounting Bulletin (“SAB”) 99 and SAB 108 and determined that the impact of the error on its previously filed annual financial statements for the fiscal years ended December 31, 2011, December 31, 2012, and December 31, 2013 was not material. However, the Company has concluded that the impact of these non-cash items in its previously filed quarterly financial statements for the fiscal quarters ended September 30, 2013, March 31, 2014 and June 30, 2014 was sufficiently material to warrant restatement of the Company’s previously filed Quarterly Reports on Form 10-Q for those periods. In addition, the Company will restate the immaterial amounts for the fiscal years ended December 31, 2011, December 31, 2012, and December 31, 2013 in its Annual Report on Form 10-K for the fiscal year ended December 31, 2014. The opening balance as of January 1, 2013 will be adjusted in the annual report on Form 10K for the fiscal year ended December 31, 2014 to reflect the restatement of the immaterial amounts for the fiscal year ended December 31, 2011 and 2012. The Company filed amended quarterly reports on Form 10-Q/A for the fiscal quarters ended September 30, 2013, March 31, 2014 and June 30, 2014 on February 23, 2015. This Quarterly Report should be read in conjunction with those amended quarterly reports on Form 10-Q/A, which resulted in retroactive changes to financial statements for those periods, including changes to net loss and net loss per common share.

 

Use of Estimates

 

The preparation of condensed financial statements in conformity with U.S. GAAP requires the Company to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Management evaluates estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic and commodity price environment.

 

The most significant financial estimates are associated with the Company’s estimated volumes of proved oil and natural gas reserves, asset retirement obligations, assessments of impairment imbedded in the carrying value of undeveloped acreage and undeveloped properties, fair value of financial instruments, estimated convertible debentures derivative liabilities, depreciation and accretion, income taxes and contingencies.

 

Oil and Natural Gas Properties

 

The Company follows the full cost method of accounting for oil and natural gas operations whereby all costs related to the exploration, non-production-related development and acquisition of oil and natural gas reserves are capitalized.  Such costs include land acquisition costs, geological and geophysical expenses, carrying charges on non-producing properties, costs of drilling, developing and completing productive wells and/or plugging and abandoning non-productive wells, and any other costs directly related to acquisition and exploration activities.  Proceeds from property sales are generally applied as a credit against capitalized exploration and development costs, with no gain or loss recognized, unless such a sale/conveyance would significantly alter the relationship between capitalized costs and the proved reserves attributable to these costs.  A significant alteration would typically involve a sale of 25% or more of proved reserves.

 

The Company accounts for its unproven long-lived assets in accordance with Accounting Standards Codification (“ASC”) Topic 360-10-05, Accounting for the Impairment or Disposal of Long-Lived Assets. ASC Topic 360-10-05 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the historical cost carrying value of an asset may no longer be appropriate.

 

9
 

 

Depletion of exploration and development costs and depreciation of wells and tangible production assets is computed using the units-of-production method based upon estimated proved oil and natural gas reserves.  Costs included in the depletion base to be amortized include (a) all proved capitalized costs including capitalized asset retirement costs net of estimated salvage values, less accumulated depletion, (b) estimated future development costs to be incurred in developing proved reserves, and (c) estimated decommissioning and abandonment/restoration costs, net of estimated salvage values, that are not otherwise included in capitalized costs.

 

The costs of undeveloped acreage are withheld from the depletion base until it is determined whether or not proved reserves can be assigned to the properties. When proved reserves are assigned to such properties or one or more specific properties are deemed to be impaired, the cost of such properties or the amount of the impairment is added to the full cost pool which is subject to depletion calculations.

 

Under the full cost method of accounting, capitalized oil and natural gas property costs less accumulated depletion and net of deferred income taxes may not exceed an amount equal to sum of: i.) The present value, discounted at 10%, of estimated future net revenues from proved oil and natural gas reserves, plus ii.) 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 not subject to amortization.  Should capitalized costs exceed this ceiling, an impairment expense is recognized. As of September 30, 2014, the Company tested its oil and natural gas assets under the ceiling test which yielded no impairment.

 

The present value of estimated future net cash flows was computed by applying a flat oil and natural gas price to forecast revenues from estimated future production of proved oil and natural gas reserves as of period-end, less estimated future expenditures to be incurred in developing and producing the proved reserves (assuming the continuation of existing economic conditions), less any applicable future taxes.

 

Wells in Progress

 

Wells in progress denotes wells that are currently in the process of being drilled or completed or otherwise under evaluation as to their potential to produce oil and natural gas reserves in commercial quantities.  Such wells continue to be classified as capitalized wells in progress and withheld from the depletion calculation and the ceiling test until such time as either proved reserves can be assigned, or the wells are otherwise abandoned.  Upon either the assignment of proved reserves or abandonment, the costs for these wells are then transferred to the full cost pool and become subject to both depletion and the ceiling test calculations in accordance with full cost accounting under S-X Rule 4-10.

 

Asset Retirement Obligation

 

The Company incurs asset retirement obligations for certain oil and natural gas assets at the time they are placed in service.  The fair values of these obligations are recorded as liabilities on a discounted basis. The costs associated with these liabilities are capitalized as part of the related assets and accretion.  Over time, the liabilities are accreted for the change in their present value.

 

For purposes of depletion calculations, the Company also includes estimated dismantlement and abandonment costs, net of salvage values, associated with future development activities that have not yet been capitalized as asset retirement obligations.

 

Oil and Natural Gas Revenue

 

Sales of oil and natural gas, net of any royalties, are recognized when oil and natural gas have been delivered to a custody transfer point, persuasive evidence of a sales arrangement exists, the rights and responsibility of ownership pass to the purchaser upon delivery, collection of revenue from the sale is reasonably assured, and the sales price is fixed or determinable. Virtually all of the Company’s contracts’ oil and natural gas pricing provisions are tied to a NYMEX market index, with certain local differential adjustments based on, among other factors, whether a well delivers oil or natural gas to a gathering, refinery, marketing company, or transmission line and prevailing local supply and demand conditions. The price of the oil and natural gas fluctuates to remain competitive with other local oil suppliers.

 

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Net Loss per Common Share

 

Earnings (losses) per common share are computed based on the weighted average number of common shares outstanding during the period presented. Diluted earnings (losses) per share are computed using the weighted-average number of common shares outstanding plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive common shares. Potentially dilutive securities, such as shares issuable upon the conversion of debt or preferred stock, and exercise of stock purchase warrants and options, are excluded from the calculation when their effect would be anti-dilutive. As of September 30, 2014 and 2013 shares underlying options, warrants, preferred stock and convertible debentures have been excluded from the diluted share calculations as they were anti-dilutive as a result of net losses incurred.

 

The Company had the following common stock equivalents at September 30, 2014 and 2013:

 

As of  September 30, 2014   September 30, 2013 
Stock Options   3,600,000    3,800,000 
Series A Preferred Stock   3,112,033    - 
Stock Purchase Warrants   17,749,281    6,773,913 
Convertible debentures   3,364,016    3,665,859 
    27,825,330    14,239,772 

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09), which creates Topic 606, Revenue from Contracts with Customers, and supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. In addition, ASU 2014-09 supersedes the cost guidance in Subtopic 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts, and creates new Subtopic 340-40, Other Assets and Deferred Costs— Contracts with Customers. In summary, the core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, ASU 2014-09 requires enhanced financial statement disclosures over revenue recognition as part of the new accounting guidance. The amendments in ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and early application is not permitted. The Company is currently evaluating the provisions of ASU 2014-09 and assessing the impact, if any, it may have on its condensed financial position and results of operations.

 

In June 2014, FASB issued Accounting Standards Update 2014–12, Compensation – Stock Compensation (Topic 718), which clarifies accounting for share–based payments for which the terms of an award provide that a performance target could be achieved after the requisite service period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of the period in which a performance target could be achieved and still be eligible to vest in the award if and when the performance target is achieved. The updated guidance clarifies that such a term should be treated as a performance condition that affects vesting. As such, the performance target should not be reflected in estimating the grant–date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which the requisite service has already been rendered. The guidance will be effective for the annual periods (and interim periods therein) ending after December 15, 2015. Early application is permitted. The Company is currently evaluating the effects of ASU 2014–12 on the condensed financial statements.

 

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In August 2014, the Financial Accounting Standards Board issued Accounting Standards Update 2014–15, Presentation of Financial Statements – Going Concern.  The Update provides U.S. GAAP guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued.  This Accounting Standards Update is the final version of Proposed Accounting Standards Update 2013–300—Presentation of Financial Statements (Topic 205): Disclosure of Uncertainties about an Entity’s Going Concern Presumption, which has been deleted. The Company is currently evaluating the effects of ASU 2014–15 on the condensed financial statements.

 

Management does not believe that these or any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying condensed financial statements.

 

Subsequent Events

 

The Company evaluates subsequent events through the date the condensed financial statements are issued.

  

NOTE 4 – OIL AND NATURAL GAS PROPERTIES

 

On September 2, 2014, the Company entered into an agreement to convey its interest in 31,725 evaluated and unevaluated net acres located in the Denver Julesburg Basin and the associated oil and natural gas production (the “Hexagon Collateral”) to its primary lender, Hexagon, LLC (“Hexagon”) in exchange for extinguishment of all outstanding debt and accrued interest obligations owed to Hexagon aggregating to $14,833,311. The conveyance assigned all assets and liabilities associated with the property, which includes PDP and PUD reserves, plugging and abandonment, and other assets and liabilities associated with the property. Pursuant to the agreement, the Company also issued to Hexagon $2.0 million in Conditionally Redeemable 6% Preferred Stock, which is recognized as temporary equity.

 

Under the full cost method, sales or abandonments of oil and natural gas properties, whether or not being amortized, are accounted for as adjustments of capitalized costs, with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and natural gas attributable to the cost center. The conveyance to Hexagon represented greater than 25 percent of the Company’s proved reserves of oil and natural gas attributable to the full cost pool, as a result, there was a significant alteration in the relationship between capitalized costs and proved reserves of oil and natural gas attributable to the full cost pool. Total capitalized costs within the full cost pool are allocated on the basis of the relative fair values of the properties sold and those retained due to substantial economic differences between the properties sold and those retained.

 

The following table represents an allocation of the transaction:

 

Conveyance of oil and natural gas property to extinguish the obligation of debt and accrued interest payable  $14,833,311 
Add: disposition of asset retirement obligations   973,135 
Net value of liabilities satisfied upon conveyance  $15,806,446 
      
Oil and natural gas properties (full cost method), at cost     
Evaluated oil and natural gas properties  $31,022,171 
Wells in progress, transferred to evaluated oil and natural gas properties   510,895 
Unevaluated oil and natural gas properties, transferred to evaluated oil and natural gas properties   6,026,297 
Total evaluated oil and natural gas properties   37,559,363 
Accumulated depletion   (21,058,451)
Net oil and natural gas properties conveyed, at cost   16,500,912 
Conditionally 6% Redeemable Preferred Stock   2,000,000 
Loss on conveyance of evaluated oil and natural gas properties   (2,694,466)
Net value of transaction  $15,806,446 

 

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NOTE 5 – WELLS IN PROGRESS

 

As of September 30, 2014 and December 31, 2013, the Company had $6.04 million and $1.15 million of wells in progress, respectively. Wells in progress are related to certain wells in the Company’s core development program within the Northern Wattenberg field. The Company has capitalized and accrued approximately $5.70 million of costs through September 30, 2014 associated with these wells, which are currently in dispute.

 

The dispute relates to the Company ownership in certain wells being reduced and or eliminated from a possible farm-out.  The operator of the producing wells claims the Company entered into a farm-out which will reduce the Company’s ownership in the wells. As of February 23, 2015, the Company is currently attempting to negotiate a settlement to this dispute or will pursue litigation to resolve the dispute. The Company will continue analyzing the ownership of the wells on a periodic basis to determine if any impairment is deemed necessary. If the dispute is resolved in favor of the Company, the value of the assets will be transferred to the full cost pool and the accrual of $5.20 million will be relieved from accrued expenses.

 

During 2014, the Company transferred $0.47 million from wells-in progress to developed oil and natural gas properties for one of its other wells in Northern Wattenberg, when it became producing and economic. The amount transferred to producing properties represents 12.5% of the total 25% interest owned by the Company. The remaining 12.5% ownership in the well is currently being accrued at $0.50 million for the authorization for expenditure to drill the wells, since the remaining ownership is being disputed by the mineral owners. The Company purchased the rights from both royalty owners which claimed ownership of the mineral rights. The Company has secured its 12.5% ownership by paying both owners $0.10 million (total $0.20 million). The payment was recorded as an asset to obtain the right to the minerals. By securing the interest with both interest owners, the Company’s interest will remain at 25%.

 

The mineral owners are disputing the validity of an overriding royalty interest, and as a result, the operator of the well is currently holding revenues from the Company until the dispute is resolved. The Company believes the well is near payout and this should be resolved in the near future. The Company is currently accruing the remaining 12.5% authorization of expenditure and deferring the revenue in a suspense receivable account. As of February 23, 2015, the Company received notification that the settlement between both royalty owners has been settled. As a result, the Company is working with the operator to receive payment of its interest.

 

NOTE 6 - DERIVATIVES

 

Oil Price Hedging

 

The Company is exposed to fluctuations in crude oil prices for all of its production. In order to mitigate the effect of commodity price volatility and enhance the predictability of cash flows relating to the marketing of the Company’s crude oil, from time to time, the Company enters into crude oil price hedging arrangements with respect to a portion of its expected production. Realized gains and losses are recorded as income or expenses in the periods during which applicable contracts mature and settle. As of December 31, 2013, such hedges were not material and as of September 30, 2014, the Company did not maintain any commodity derivatives.

 

NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The Company measures the fair value of its financial assets on a three-tier value hierarchy, which prioritizes the inputs, used in the valuation methodologies in measuring fair value:

 

Level 1 – Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
   
Level 2 – Other inputs that are directly or indirectly observable in the market place.
   
Level 3 – Unobservable inputs which are supported by little or no market activity.

 

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

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The Company’s accounts receivable, accounts payable, accrued expenses and interest payable approximate fair value due to the short-term nature or maturity of the instruments.

 

Convertible Debentures Conversion Derivative Liability

 

As of September 30, 2014, the Company had $6.68 million, net, in remaining Debentures which are convertible at any time at the holders’ option into shares of Common Stock at $2.00 per share, or 3,364,016 underlying conversion shares. The debentures have elements of a derivative from the ability for certain adjustments, including both the conversion option and the price protection embedded in the Debentures. The conversion option allows the Debenture holders to convert their Debentures to the underlying common stock at $2.00. When the price of the common stock exceeds $2.00, it is more attractive for the Debenture holders to convert. Adversely, the price protection protects the holder of the Debenture for any capital raises with a strike price lower than $2.00 per share. The Company values this conversion liability at each reporting period using a Monte Carlo pricing model.

 

Common stock incentive options

 

The Executive Stock Incentive Options Bonus was issued on September 16, 2013 as a part of the employment agreement with the current Chief Executive Officer. The incentive bonus contains a target provision, whereby the bonus amount to be earned by the executive may vary between 0% and 300%, depending on the Company achieving certain operating milestones. The change in fair value for the common stock incentive option bonus is recorded in general and administrative expenses.

 

The following table provides a summary of the fair values of assets and liabilities measured at fair value (in thousands):

 

September 30, 2014:

 

   Level 1   Level 2   Level 3   Total 
Liabilities                
Convertible debentures conversion derivative liability  $-   $-   $(1,540)  $(1,540)
Common stock incentive options for executive employment agreements compensation with both market and performance factors.   -    -    (110)   (110)
Total liability, at fair value  $-   $-   $(1,650)  $(1,650)

 

December 31, 2013:

 

   Level 1   Level 2   Level 3   Total 
Liabilities                
Common stock  incentive options for executive employment agreements compensation with both market and performance factors  $-   $-   $(145)  $(145)
Convertible debentures conversion derivative liability  $-   $-   $(605)  $(605)
Total liability, at fair value  $-   $-   $(750)  $(750)

 

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The following table provides a summary of changes in fair value of the Company’s Level 3 financial assets and liabilities:

 

For the nine months ended September 30, 2014 (in thousands)  Executive
compensation
liability
   Convertible
 debentures derivative
 liability
   Total 
Beginning balance, January 1, 2014  $(145)  $(605)  $(750)
Change in fair value of the common stock executive employment agreement   35    -    35 
Change in fair value of the convertible debentures conversion derivative liability        (5,966)   (5,966)
Reclassification of convertible debenture conversion derivative liability to additional paid in capital upon conversion of debenture   -    5,031   5,031
Ending balance, September 30, 2014  $(110)   (1,540)   (1,650)

 

For the three months ended September 30, 2014 (in thousands)  Executive
compensation
liability
   Convertible
debentures
derivative
 liability
   Total 
Beginning balance, June 1, 2014  $(325)  $(968)  $(1,293)
Change in fair value of the common stock executive employment agreement   215    -    215 
Change in fair value of the convertible conversion debentures derivative liability   -    (572)   (572)
Ending balance, September 30, 2014  $(110)   (1,540)   (1,650)

 

For the nine months ended September 30, 2013 (in thousands)  Convertible
notes derivative
 liability
 
Beginning balance, January 1, 2013  $(694)
Change in fair value of the convertible debentures conversion derivative liability   48
Ending balance, September 30, 2013   (646)

 

For the three months ended September 30, 2013 (in thousands)  Convertible
 debentures derivative
 liability
 
Beginning balance, June 30, 2013  $(427)
Change in fair value of the convertible debentures derivative   (218)
Ending balance, September 30, 2013   (646)

 

The Company did not have any transfers of assets or liabilities between Level 1, Level 2 or Level 3 of the fair value measurement hierarchy during the three and nine months ended September 30, 2014 or 2013.

 

NOTE 8 – LOAN AGREEMENTS

 

The Company’s term loan and Debenture for the period ended September 30, 2014 and December 31, 2014, consists of the following:

 

(thousands, except percentages)  As of September 30,
2014
   As of December 31,
2013
 
10% Hexagon term loans  $-   $18,774 
8% Convertible Debentures   6,728    15,580 
Total   6,728    34,354 
Unamortized debenture discount   (45)   (993)
Total debt, net of discount   6,683    33,361 
Less: amount due within one year   -    (10,663)
Long-term debt due after one year  $6,683  $22,698 

 

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10% Term Loans

 

Prior to September 2, 2014, the Company had three term loans with Hexagon, its senior lender, with an aggregate outstanding principal amount of approximately $19.83 million. The loans required the Company to make monthly payments of $0.23 million consisting of interest and principal. On May 19, 2014, the Company received an extension from Hexagon of the maturity date under its term loans, from May 16, 2014 to August 15, 2014. In connection with the extension, the Company paid a forbearance fee of $0.25 million which was recorded as deferred financing cost and amortized over the extension period of the term loans.

 

On May 30, 2014, the Company entered into the First Settlement Agreement with Hexagon, which provided for the settlement of all amounts outstanding under the term loans. In connection with the execution of the First Settlement Agreement, the Company made an initial cash payment of $5.0 million reducing the total principal and interest due under the term loan from $19.83 million to $14.83 million. The First Settlement Agreement required the Company to make an additional cash payment of $5.0 million (the “Second Cash Payment”) by August 15, 2014, and at that time issue to Hexagon (i) a two-year $6.0 million unsecured note (the “Replacement Note”), bearing interest at an annual rate of 8%, requiring principal and interest payments of $90,000 per month, and (ii) 943,208 shares of unregistered Common Stock (the “Shares”). The parties also agreed that if the Second Cash Payment was not made by June 30, 2014, an additional $1.0 million in principal would be added to the Replacement Note, and if the Replacement Note was not retired by December 31, 2014, the Company would issue an additional 1.0 million shares of Common Stock to Hexagon. The first settlement agreement was superseded by the final settlement agreement which is discussed below.

  

On September 2, 2014, the Company entered into the Final Settlement Agreement with Hexagon which replaced the First Settlement Agreement, pursuant to which, in exchange for full extinguishment of all amounts outstanding under the term loans (approximately $14.83 million in principal and interest as of the settlement date), the Company assigned Hexagon the Hexagon Collateral, which consisted of approximately 32,000 net acres including 17 producing wells that consisted of several economic wells which secured properties with PDP reserves and PUD reserves with a carrying value of approximately $16.5 million. The Company also conveyed $0.97 million in asset retirement obligations (“ARO”) for the 17 active and several non-producing wells. In addition to the conveyance of oil and natural gas property, the Company issued to Hexagon $2,000,000 in 6% Conditionally Redeemable Preferred Stock with a par value of $0.0001, stated value of $1,000 and dividends paid on a quarterly basis. As a result of this conveyance, the Company recorded a loss on conveyance of property during the three and nine months ended September 30, 2014 of approximately $2.7 million.

 

8% Convertible Debentures

 

In numerous separate private placement transactions between February 2011 and October 2013, the Company issued an aggregate of approximately $15.6 million of Debentures, secured by mortgages on several of its properties. The Debentures are currently convertible at the holders' option into shares of Common Stock at $2.00 per share, subject to certain adjustments which include a convertible option and price protection, and bear interest at an annualized rate of 8%, payable quarterly on each May 15, August 15, November 15 and February 15 in cash or, at the Company's option subject to certain conditions, in shares of Common Stock. The interest option price is calculated using a 10 day VWAP discounted by 10% and applied to the outstanding interest.

 

On January 31, 2014, the Company entered into a "Conversion Agreement" with all of the holders of the Debentures. Pursuant to the terms of the Conversion Agreement, $9.00 million in Debentures (approximately $8.85 million of principal and $0.15 million in interest) was converted by the holders to shares of common stock at a conversion price of $2.00 per share of Common Stock. In addition, the Company issued warrants to the Debenture holders to purchase one share of Common Stock for each share issued in connection with conversion of the Debentures, at an exercise price equal to $2.50 per share (see Inducement Expense, discussed below).  As of September 30, 2014, the Company had $6.68 million, net, remaining Debentures which are convertible at any time at the holders’ option into shares of Common Stock at $2.00 per share, subject to certain adjustments, including the requirement to reset the conversion price based upon any subsequent equity offering at a lower price per share amount.

 

During September 30, 2014 and December 31, 2013, the Company valued the conversion feature associated with the Debentures at $1.54 million and $0.61 million, respectively. The Company used the following inputs to calculate the valuation of the derivative as of September 30, 2014: volatility 70%; conversion price $2.00; stock price $2.25; and present value of conversion feature $0.47 per convertible share. For the year ended December 31, 2013, the Company valued the derivative using the following inputs: volatility 70%, stock price $2.32, conversion price $4.25, risk free rate 0.38%, and present value of conversion feature of $0.17 per convertible share. The Company utilized a Monte Carlo model to value both conversion features.

 

The Company’s failure to meet its obligations under the First Settlement Agreement with Hexagon constituted a default under the term loans, which in turn triggered an event of default under the Debentures. However, the holders of the Debentures waived their right to declare a default in respect of that matter.

 

The Debentures were to mature on January 15, 2015; however, as of the date of this filing, the Company has received waivers from each Debenture holders extending the maturity date thereunder to match the maturity date of the Credit Agreement to January 8, 2018.

 

Convertible Debenture Interest

 

During the nine months ended September 30, 2014, the Company elected to fund their interest payment for their convertible debentures with stock and issued 70,000 shares valued at $0.15 million which is an add back to accrued expense in the cash flow and further disclosed in the supplemental disclosure. The interest was accrued for past interest from November 15, 2013 to January 2014.

 

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Debenture Conversion Agreement

 

As of September 30, 2014, the Company has $6.68 million, net, outstanding convertible debentures.

 

   Convertible
Debentures
   Convertible Debentures Debt Discount   Total 
Balance at 12/31/2013  $(15,579,902)  $855,536   $(14,724,366)
Accretion of debt discount   -    (433,725)   (433,725)
Less: conversion of convertible debenture   8,851,871    (377,079)   8,474,792 
Balance at 9/30/2014   (6,728,031)   44,732    (6,683,299)

 

Inducement Expense

 

On January 31, 2014, the Company entered into a Debenture Conversion Agreement (the “Conversion Agreement”) with all of the holders of the Debentures.  Under the terms of the Conversion Agreement, $9.0 million of the approximately $15.6 million in Debentures outstanding as of January 30, 2014 immediately converted to shares of common stock at a price of $2.00 per common share.  As additional inducement for the conversions, the Company issued warrants to the converting Debenture holders to purchase one share of Common Stock, at an exercise price equal to $2.50 per share (the “Warrants”), for each share of Common Stock issued upon conversion of the Debentures. Utilizing Black Scholes option price model, with a 3 year life and 65% volatility, risk free rate of 0.2%, and the market price of $3.05. The Company recorded an inducement expense of $6.61 million, during the nine months ended September 30, 2014 for the warrants issued to induce the convertible debentures to convert their debt to Common Stock. T.R. Winston acted as the investment banker for the Conversion Agreement and was compensated by issuing 225,000 shares of the Company’s common stock and valued at a market price of $3.05 per share. During the nine months ended September 30, 2014, the Company valued the investment banker compensation at $0.69 million, which was expensed immediately.

 

Under the terms of the Conversion Agreement, the balance of the Debentures may be converted to common stock on the terms provided in the Conversion Agreement (including the terms related to the warrants) at the holder’s option, subject to receipt of shareholder approval as required by NASDAQ continued listing requirements. The Company intends to present proposals to approve the conversion of the remaining outstanding Debentures at its 2015 annual meeting of shareholders.

 

NOTE 9 - COMMITMENTS and CONTINGENCIES

 

Environmental and Governmental Regulation

 

At September 30, 2014, there were no known environmental or regulatory matters which are reasonably expected to result in a material liability to the Company. Many aspects of the oil and gas industry are extensively regulated by federal, state, and local governments in all areas in which the Company has operations. Regulations govern such things as drilling permits, environmental protection and air emissions/pollution control, spacing of wells, the unitization and pooling of properties, reports concerning operations, land use, royalty rates and various other matters including taxation. Oil and natural gas industry legislation and administrative regulations are periodically changed for a variety of political, economic, and other reasons. As of September 30, 2014 the Company had not been fined or cited for any violations of governmental regulations that would have a material adverse effect upon the financial condition of the Company.

 

Legal Proceedings

 

The Company may from time to time be involved in various legal actions arising in the normal course of business. In the opinion of management, the Company’s liability, if any, in these pending actions would not have a material adverse effect on the financial position of the Company. The Company’s general and administrative expenses would include amounts incurred to resolve claims made against the Company.

 

Parker v. Tracinda Corporation, Denver District Court, Case No. 2011CV561. In November 2012, the Company filed a motion to intervene in garnishment proceedings involving Roger Parker, the Company’s former Chief Executive Officer and Chairman. The Defendant, Tracinda, served various writs of garnishment on the Company to enforce a judgment against Mr. Parker seeking, among other things, shares of unvested restricted stock. The Company asserted rights to lawful set-offs and deductions in connection with certain tax consequences, which may be material to the Company. The underlying judgment against Mr. Parker was appealed to the Colorado Court of Appeals and, by Order dated October 17, 2013, that Court reversed the trial court with respect to Mr. Parker’s claims of waiver, estoppel and mitigation of damages and remanded with instruction to enter judgment for Mr. Parker. The Court of Appeals also ordered the trial court to conduct further proceedings to determine the amount of damages to award Mr. Parker on his breach of contract claim. The trial court conducted a later hearing and found in its Findings of Fact, Conclusions of Law and Order dated January 9, 2015, in favor of Mr. Parker on his claim for breach of contract, awarding him $6,981,302.60. Tracinda’s Motion for Amendment of the Court’s January 9 Findings and Conclusions is pending.

In re Roger A. Parker: Tracinda Corp. v. Recovery Energy, Inc. and Roger A. Parker, United States Bankruptcy Court for the District of Colorado, Case No. 13-10897-EEB. On June 10, 2013, Tracinda Corp. (“Tracinda”) filed a complaint (Adversary No. 13-01301 EEB) against the Company and Roger Parker in connection with the personal bankruptcy proceedings of Roger Parker, alleging that the Company improperly failed to remit to Tracinda certain property in connection with a writs of garnishment issued by the Denver District Court (discussed above). The Company filed an answer to this complaint on July 10, 2013. A trial date has not been set and, by Order dated February 2, 2015, the Bankruptcy Court ordered that the Adversary Proceeding be held in abeyance pending final resolution of the state-court action (2011CV561). The Company is unable to predict the timing and outcome of this matter.

 

From time to time the Company is involved in legal proceedings arising in the ordinary course of business. The Company believes there is no other litigation pending that could have, individually or in the aggregate, a material adverse effect on its results of operations or financial condition.

 

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NOTE 10 - SHAREHOLDERS’ EQUITY

 

January 2014 Private Placement

 

In January 2014, the Company entered into and closed a series of subscription agreements with accredited investors, pursuant to which the Company issued an aggregate of 2,959,125 units, with each unit consisting of (i) one share of the Common Stock and (ii) one three-year warrant to purchase one share of Common Stock, at an exercise price equal to $2.50 per share (together, the “Units”), for a purchase price of $2.00 per Unit, for aggregate gross proceeds of $5,918,250 (the “January Private Placement”).  The warrants are not exercisable for six months following the closing of the January Private Placement. As of February 23, 2015, the underlying common shares have not been registered. The warrants still can be exercised without an effective registration statement on file. The Company will be filing a registration statement during the year 2015. The Company valued the warrants within the Unit, utilizing a Black Scholes Option Pricing Model using a volatility calculation of 65%, and 3 year term, the relative fair value allocated to warrants were approximately $1.69 million. The Company paid $1.06 million in financing fees to T.R. Winston.

 

Series A 8% Convertible Preferred Stock

 

On May 30, 2014, the Company consummated a private placement of 7,500 shares of Series A Preferred, along with detachable warrants to purchase up to 1,556,016 shares of Common Stock at an exercise price of $2.89 per share, for aggregate proceeds of $7.50 million. The Series A Preferred has a par value of $0.0001 per share, a stated value of $1,000 per share, a conversion price of $2.41 per share, and a liquidation preference to any junior securities. Except as otherwise required by law, holders of Series A Preferred shall not be entitled to voting rights, except with respect to proposals to alter or change adversely the powers, preferences or rights given to the Series A Preferred, authorize or create any class of stock ranking senior to the Series A Preferred as to dividends, redemption or distribution of assets upon liquidation, amend its certificate of incorporation or other charter documents in any manner that adversely affects any rights of the Preferred Stock holder, or increase the number of authorized Series A Preferred Stock. The holders of the Series A Preferred are entitled to receive a dividend payable, at the election of the Company (subject to certain conditions as set forth in the Certificate of Designations), in cash or shares of Common Stock, at a rate of 8% per annum payable a day after the end of each quarter. The Series A Preferred is convertible at any time at the option of the holders, or at the Company’s discretion when Common Stock trades above $7.50 for ten consecutive days with a daily dollar trading volume above $300,000. In addition, the Company has the right to redeem the shares of Series A Preferred, along with any accrued and unpaid dividends, at any time, subject to certain conditions as set forth in the Certificate of Designations. In addition, holders of the Series A Preferred can require the Company to redeem the Series A Preferred upon the occurrence of certain triggering events, including (i) failure to timely deliver shares of Common Stock after valid delivery of a notice of conversion by the holder; (ii) failure to have available a sufficient number of authorized and unreserved shares of Common Stock to issue upon conversion; (iii) the occurrence of certain change of control transactions; (iv) the occurrence of certain events of insolvency; and (v) the ineligibility of the Company to electronically transfer its shares via the Depository Trust Company or another established clearing corporation.

 

The Series A Preferred is classified as equity based on the following criteria: i) the redemption of the instrument at the control of the Company; ii) the instrument is convertible into a fixed amount of shares at a conversion price of $2.41; iii) the instrument is closely related to the underlying Company’s common stock; iv) the conversion option is indexed to the Company’s stock; v) the conversion option cannot be settled in cash and only can be redeemed at the discretion of the Company; vi) and the Series A Preferred is not considered convertible debt.

 

In connection with the issuance of the Series A Preferred, the Company also issued a warrant for 50% of the amount of shares of Common Stock into which the Series A Preferred is convertible.

 

In connection with issuance of the Series A Preferred, the beneficial conversion feature (“BCF”) was valued at $2.25 million and the fair value of the warrant were valued at $1.35 million. The BCF was valued at $3.6 million was considered a deemed dividend and the full amount was expensed immediately.

 

The Company determined the transaction created a beneficial conversion feature which is calculated by taking the net proceeds of $6.79 million and valuing the warrants as of May 2014, utilizing a Black Scholes option pricing model. The inputs for the pricing model are: $2.48 market price per share; exercise price of $2.89 per share; expected life of 3 years; volatility of 70%; and risk free rate of 0.20 %. The Company calculated the total consideration given to be $8.40 million comprised of $5.50 million for the Series A Preferred and $1.30 million for the warrants. The Company deemed the value of the beneficial conversion feature to be $2.21 million and immediately accreted that amount as a deemed dividend. As of September 30, 2014, the Company has accrued a cumulative dividend for $0.11 million, which was paid fully on October 1, 2014. 

 

Conditionally Redeemable 6% Preferred Stock

 

In August 2014, the Company designated 2,000 shares of its authorized preferred stock as “Conditionally Redeemable 6% Preferred Stock” (“Redeemable Preferred”). The Redeemable Preferred has the same par value and stated value characteristics and liquidation preferences of the Series A preferred stock, yet the 6% Conditionally Redeemable Preferred is not convertible into common stock or any other securities of the Company. Except as otherwise required by law, holders of the Redeemable Preferred shall not be entitled to voting rights.

 

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The Redeemable Preferred Stock bears a 6% dividend per annum, payable quarterly, and is redeemable at face value (plus any accrued and unpaid dividends) at any time at the Company’s option, or at the Holders option upon the Company’s achievement of certain production and reserves thresholds. As of September 30, 2014, the Company accrued $0.01 million of accrued dividends during the period. In September 2014, the 2,000 shares of Redeemable Preferred Stock were issued pursuant to the Settlement Agreement with Hexagon at a value of $2.0 million.

 

Consulting Agreement with Market Development Consulting Group, Inc. (“MDC”)

 

In January 2014, the Company entered into a consulting agreement with MDC, a public relations company. The agreement provided for the issuance by the Company of 90,000 shares of Common Stock, 350,000 warrants to purchase common shares, and cash of $0.1 million a month.

 

The 90,000 shares of Common Stock were issued on February 7, 2014 with an original market price of $3.35 for a total value of $0.30 million. The fair value of the shares amortized over the life of the contract, or until December 31, 2014 which were revalued at each reporting period. As of September 30, 2014, the Company had 25,322 shares remaining to vest at a value of $0.06 million. During the three and nine months ended September 30, 2014, the Company amortized the non-cash consulting expense for the Common Stock issued of $0.06 million and $0.20 million, respectively.

 

The 350,000 warrants were valued using the Black Scholes option pricing model with the following inputs: (i) 350,000 warrants to purchase common stock; (ii) assumed stock price $2.33; (iii) strike price $4.25 for 100,000 and $2.33 for 250,000 warrants; volatility 45%; risk free rate of 0.20%; and expected life of 5 years. The valuation yielded a value of $0.40 million. The warrant value vested immediately and was recognized as stock based non-employee compensation.

 

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Investment Banking Agreement

 

During the year ended December 31, 2013, the Company was party to a one-year, non-exclusive investment banking agreement with T.R. Winston, pursuant to which the Company issued to T.R. Winston 100,000 common shares, and 900,000 common stock purchase warrants. All warrants have a term of three years and a strike price of $4.25 per share, risk free rate of 0.20%, common stock price $1.880, volatility 63% valued at $0.26 million and amortized over the life of the contract. As of September 30, 2014, the full $0.26 million has been expensed through general and administrative expenses.

 

Consulting Agreement with Bristol Capital

 

On September 2, 2014, the Company entered into a Consulting Agreement (the “Consulting Agreement”) with Bristol Capital, LLC (“Bristol”). Pursuant to the Consulting Agreement, Bristol agreed to assist the Company in general corporate activities including but not limited to strategic planning; management and business operations; introductions to further its business goals; advice and services related to the Company’s growth initiatives; and any other consulting or advisory services the Company reasonably requests that Bristol provide to the Company. The Consulting Agreement has a term of three years. In connection with the Consulting Agreement and as compensation for the services to be provided by Bristol thereunder, the Company issued to Bristol a warrant to purchase up to 1,000,000 shares of Common Stock at an exercise price of $2.00 per share (the “Bristol Warrant”). In addition, the Company issued to Bristol an option to purchase up to 1,000,000 shares with no forfeitures provisions. The Bristol Option is intended as an alternative to the Bristol Warrant, and will automatically terminate upon and to the extent the Bristol Warrant is exercised. Likewise, if and to the extent the Bristol Option is exercised, the Bristol Warrant will terminate. If the Company has not registered the Common Shares underlying the Bristol Warrants within six months following the execution of the Consulting Agreement, Bristol may elect to terminate the Bristol Warrant and retain the Bristol Option, or to terminate the Bristol Option and retain the Bristol Warrant, but in either case may only retain either the Warrant or the Option. In no event will Bristol have the right to exercise, in whole or in part, the Bristol Warrant and/or Bristol Option for a number of shares in excess of 1,000,000. Each of the Bristol Warrant and the Bristol Option (whichever ultimately remains outstanding) has a term of five years. The Consulting Agreement does not include any cash payment. The Company used a Black Scholes option pricing model to value the warrants/options using the following variables: (i) warrants/options issued 1,000,000 total (as stated above, the Company will only issue a total of 1,000,000 shares of Common Stock under the option or the warrant, but no more than 1,000,000 shares in the aggregate); (ii) stock price $1.47; (iii) exercise price $ 2.00; expected life of 5 years; volatility of 60%; risk free rate of 0.20% for a total value of $0.62 million, which was expensed immediately. The warrants/options did not have any cancellation or forfeiture provisions in the contract and as a result, the amounts were fully recognized at the date of issuance.

 

Warrants

 

A summary of warrant activity for the nine months ended September 30, 2014 is presented below:

 

   Warrants   Weighted-
Average
Exercise
Price
 
Outstanding at December 31, 2013   6,773,913   $5.24 
Granted – January 2014 private placement   3,326,340    2.50 
Granted – May 2014 preferred private placement   1,556,017    2.89 
Granted-debenture conversion agreement   4,743,011    2.5 
Granted-issued to service consulting firms   350,000    2.88 
Granted – Consulting Agreement with Bristol Capital   1,000,000    2.00 
Exercised, forfeited, or expired   -    - 
Outstanding at September 30, 2014   17,749,281   $3.25 

 

The weighted average remaining contract life of the warrants, as of September 30, 2014, was 1.09 years. These warrants are valued at $63.17 million. These warrants are cash warrants and the holders must pay the Company the full exercise price in cash. The intrinsic value of the warrants as of September 30, 2014 is $0.25 million.

 

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NOTE 11 - SHARE BASED AND OTHER COMPENSATION

 

Share-Based Compensation

 

In September 2012, the Company adopted the 2012 Equity Incentive Plan (the “EIP”). The EIP was amended by the stockholders on June 27, 2013 to increase the number of shares of Common Stock available for grant under the EIP from 900,000 shares to 1,800,000 shares and again on November 13, 2013 to increase the number of shares of Common Stock available for grant under the EIP from 1,800,000 shares to 6,800,000 shares and to increase the number of shares of Common Stock eligible for grant under the EIP in a single year to a single participant from 1,000,000 shares to 3,000,000 shares. Each member of the board of directors and the management team has been periodically awarded restricted stock grants, and in the future may be awarded such grants under the terms of the EIP.

 

The value of employee services received in exchange for an award of equity instruments are based on the grant-date fair value of the award, recognized over the period during which an employee is required to provide services in exchange for such award.

 

During the nine months ended September 30, 2014, the Company granted 324,428 shares of restricted common stock and 1,500,000 stock options, to employees, directors and consultants, which 2,212,084 shares of restricted common stock and stock options that had previously been granted under the EIP were forfeited in connection with the termination of certain employees, directors and consultants. The 1,500,000 options to purchase common stock were subsequently forfeited upon the resignation of Robert A. Bell, ex-COO/ President. As a result, the Company currently has 1,852,928 restricted shares and 3,600,000 options to purchase common shares outstanding to employees and directors. The restricted shares are included in the outstanding share count in the balance sheet and at the front of this document, yet they are currently on a vesting schedule based on service. Some of the options vest based on time and other options to purchase common stock are vested based certain operating thresholds.

 

The Company recognized a restricted stock share based compensation expense of approximately $2.67 million, net of a credit of $0.31 million for cancelled Plan shares and options for the nine months ended September 30, 2014. The elements of share based compensation are as follows:

 

Restricted Stock

 

A summary of restricted stock grant activity for the nine months ended September 30, 2014 is presented below:

 

   Shares 
Balance outstanding at December 31, 2013   2,024,375 
Granted restricted shares   12,750 
Granted restricted shares   45,011 
Granted restricted shares   216,667 
Granted restricted shares   50,000 
Vested   (183,791)
Expired/ cancelled   (312,084)
Balance outstanding at September 30, 2014   1,852,928 

 

As of September 30, 2014, total unrecognized compensation cost related to unvested stock grants was approximately $0.18 million, which is expected to be recognized over a weighted-average remaining service period of 1years. 

 

Employment and Separation Agreements

 

W. Phillip Marcum

 

In April 2014, the Company entered into a separation agreement (the “Marcum Agreement”) with W. Phillip Marcum, its Former Chief Executive Officer, in connection with his resignation from his positions with the Company. The Marcum Agreement provides, among other things, that, consistent with his resignation for good reason under his Employment Agreement, the Company would pay him 12 months of severance through payroll continuation, in the gross amount of $220,000, less all applicable withholdings and taxes, that all stock options held by Mr. Marcum as of the time of his termination would immediately vest, and that Mr. Marcum would remain eligible to receive any performance bonus granted by the Company to its senior executives with respect to Company and/or executive performance in 2013. In addition, the Marcum Agreement provides that the Company would pay Mr. Marcum $150,000 in accrued base salary for his service in 2013, less all applicable withholdings and taxes, in exchange for Mr. Marcum’s forfeiture of the 93,750 shares of unvested restricted common stock of the Company that was issued to Marcum in June 2013 in lieu of such base salary. Mr. Marcum may elect to apply amounts payable under the Marcum Agreement against his commitment to invest $125,000 in the Company’s previously disclosed private offering, upon shareholder approval of the participation of the Company’s officers and directors in that offering. The Marcum Agreement also contains certain mutual non-disparagement covenants, as well as certain mutual confidentiality, non-solicitation and non-compete covenants. In addition, Mr. Marcum and the Company each mutually released and discharged all known and unknown claims against the other and their respective representatives that they had or presently may have, including claims relating to Mr. Marcum’s employment. The Marcum Agreement effectively terminated the previously disclosed Employment Agreement entered into between Mr. Marcum and the Company, dated as of June 25, 2013 and all items were immediately accrued.

 

In connection with the Marcum Agreement, the Company reversed the 200,000 unvested options previously issued to Mr. Marcum valued at $0.07 million, and reissued fully vested options, which it valued utilizing the Black Scholes option pricing model at $0.41 million. The Company used a Black Scholes option pricing model to value the 200,000 options which Mr. Marcum retained using the following variables: i) 200,000 options; ii) stock price $ 3.50; iii) strike price $1.60; volatility 65%; and a total value of $0.41 million which is expensed immediately since under the terms of his separation agreement, the Company is not to be provided any additional services.

 

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Robert A. Bell

 

On August 1, 2014, the Company entered into a separation agreement with Robert A. Bell, its former president and chief operating officer (the “Separation Agreement”). The Separation Agreement provides, among other things, that the Company would pay to Mr. Bell an aggregate of $100,000 in cash and issue to Mr. Bell 66,667 shares of Common Stock, in addition to satisfying the Company’s outstanding obligation to pay Mr. Bell $100,000 in cash and issue to Mr. Bell 33,333 shares of Common Stock. The Separation Agreement also contains certain mutual covenants, and reaffirms the survival of certain confidentiality provisions contained in the Employment Agreement dated as of May 1, 2014 between the Company and Mr. Bell. In addition, Mr. Bell and the Company each mutually released and discharged all known and unknown claims against the other and their respective representatives that they had or presently may have, including claims relating to Mr. Bell’s employment. The total amount was fully expensed as of September 30, 2014 for $0.26 million.

 

In connection with the termination of his employment, Mr. Bell forfeited the 1,500,000 stock options that were unvested at the time of his termination and the Company reversed $0.30 million.

 

A .Bradley Gabbard

 

In May 2014, in connection with his resignation as CFO of the Company, A. Bradley Gabbard forfeited the 200,000 options that were unvested at the time of his termination. At the date of his resignation, the Company recorded a credit of $0.07 million into the shareholder employee compensation expense account. Additionally, Mr. Gabbard forfeited his respective 52,084 shares of unvested restricted stock, for which the Company recorded a reversal of $0.07 million.

 

Board of Directors

 

In October 2013, the Company granted each of its independent directors 200,000 non-statutory options to purchase Common Stock at an exercise price of $2.05, equal to the closing price at October 24, 2013. The options vest one-third for the next three years on the anniversary grant date. The value of the 600,000 options at grant date was $0.64 million and will be amortized over the vesting period.

 

In connection with execution of an amended independent agreement, each director also agreed to receive 31,250 shares of restricted common stock in lieu of a portion of their cash salaries, to vest on April 15, 2014. During the three and nine months ended September 30, 2104, the Company recognized $0.05 million and $0.20 million, respectively.

 

Stock Options

 

A summary of stock options activity for the nine months ended September 30, 2014 is presented below:

 

   Stock   Weighted Average
Exercise
 
   Options   Price 
Outstanding at December 31, 2013   3,800,000    2.25 
Granted   1,700,000    2.45 
Exercised, forfeited, or expired   (1,900,000)   (2.36)
Outstanding at September 30, 2014   3,600,000    2.28 

 

The average life of the options is 3 years and has no intrinsic value as of September 30, 2014.

 

As of September 30, 2014, the Company has 3,600,000 options outstanding which have an unrecognized expense to be expensed over the next 25 months of $0.50 million.

 

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NOTE 12- RELATED PARTY TRANSACTIONS

 

Abraham Mirman

Transactions between the Company and Abraham Mirman

 

The Company’s Chief Executive Officer (“CEO”) is an indirect owner of a group which converted approximately $0.22 million of Debentures in connection with the $9.00 million of Debentures converted in January 2014,and was paid $0.01 million in interest at the time of the Debenture conversion.

 

During the January 2014 private placement, Mr. Mirman entered into a subscription agreement with the Company to invest $0.50 million, for which Mr. Mirman will receive 250,000 shares of stock and 250,000 warrants. The subscription agreement will not be consummated until a shareholder meeting is conducted to allow executives and board directors the ability to participate in the offering.

 

During the May Private Placement, Mr. Mirman invested $0.25 million, for which Mr. Mirman received 250 shares of Series A Preferred and 51,867 warrants.

 

In September 2013, the Company appointed Abraham Mirman as its President and in April 2014 he was appointed to serve as the Company’s Chief Executive Officer. Prior to joining the Company, Mr. Mirman was employed by TRW as its Managing Director of Investment Banking and until September 2014 continued to devote a portion of his time to serving in that role. In connection with the appointment of Mr. Mirman, the Company and TRW amended the investment banking agreement in place between the Company and TRW at that time to provide that, upon the receipt by the Company of gross cash proceeds or drawing availability of at least $30,000,000, measured on a cumulative basis and including certain restructuring transactions, subject to the Company’s continued employment of Mr. Mirman, TRW would receive from the Company a lump sum payment of $1.00 million. Mr. Mirman’s compensation arrangements with TRW provided that upon TRW’s receipt from the Company of the lump sum payment, TRW would make a payment of $1.00 million to Mr. Mirman. The Board determined in September 2014 that the criteria for the lump sum payment had been met. Mr. Mirman also received, as part of his compensation arrangement with TRW, the 100,000 common shares of the Company that were issued to TRW in conjunction with the investment banking agreement.

 

G. Tyler Runnells

Transactions between the Company and G. Tyler Runnels

 

The Company has participated in several transactions with TRW, of which G. Tyler Runnels, currently a member of the Company’s directors, is the majority owner of TRW. Mr. Runnels also beneficially holds more than 5% of the Company’s common stock, including the holdings of TRW and his personal holdings, and has personally participated in certain transactions with the Company.

 

On January 22, 2014, the Company paid TRW a commission equal to $486,000 (equal to 8% of gross proceeds at the closing of the January Private Placement). Of this $486,000 commission, $313,750 was paid in cash and $172,250 was paid in 86,125 Units. In addition, the Company paid TRW a non-accountable expense allowance of $182,250 (equal to 3% of gross proceeds at the closing of the January Private Placement) in cash. If the participation of certain of the Company’s current and former officers and directors is approved by the Company’s shareholders, the Company will pay TRW an additional commission equal to $0.06 million (equal to 8% of gross proceeds from the sale of Units of the Company’s officers and directors agreed to purchase in the January Private Placement), and the Company will pay TRW a non-accountable expense allowance of $0.02 million (equal to 3% of gross proceeds of the Units members of the Company’s officers and board of directors agreed to purchase in the January Private Placement). The Units issued to TRW were the same Units sold in the January Private Placement and were invested in the January Private Placement.

 

On January 31, 2014, the Company entered into a Debenture Conversion Agreement (the “Conversion Agreement”) with all of the holders of the Debentures.  Under the terms of the Conversion Agreement, $9.0 million of the approximately $15.6 million in Debentures outstanding as of January 30, 2014 immediately converted to shares of common stock at a price of $2.00 per common share.  As additional inducement for the conversions, the Company issued warrants to the converting Debenture holders to purchase one share of Common Stock, at an exercise price equal to $2.50 per share (the “Warrants”), for each share of Common Stock issued upon conversion of the Debentures. T.R. Winston acted as the investment banker for the Conversion Agreement and was compensated by issuing 225,000 shares of the Company’s common stock and valued at a market price of $3.05 per share. During the nine months ended September 30, 2014, the Company valued the investment banker compensation at $0.69 million, which was expensed immediately.

 

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On May 19, 2014, the Company and the holders of the Debentures agreed to extend the maturity date under the Debentures until August 15, 2014, and on June 6, 2014, they agreed to further extend the maturity date under the Debentures from August 15, 2014 to January 15, 2015. In January 2015, the Company has entered into an extension agreement which extends the maturity date until January 8, 2018. The maturity date now coincides with the maturity date of the Credit Agreement.

 

On March 28, 2014, the Company and TRW entered into a Transaction Fee Agreement in connection the May Private Placement. Pursuant to the Transaction Fee Agreement, the Company agreed to compensate TRW 5% of the gross proceeds of the May Private Placement, plus a $25,000 expense reimbursement. On April 29, 2014, the Company and TRW amended the Transaction Fee Agreement to increase TRW’s compensation to 8% of the gross proceeds, plus an additional 1% of the gross proceeds as a non-accountable expense reimbursement in addition to the $25,000 originally contemplated.

 

On October 6, 2014, the Company entered into a letter agreement (the “Waiver”) with the holders of its Debentures. Pursuant to the Waiver, the holders of the Debentures agreed to waive any Event of Default (as that term is defined in the Debentures) that may have occurred prior to the date of the Waiver, including any default in connection with the Hexagon term loan, and to rescind and annul any acceleration or right to acceleration that may have been triggered thereby. In exchange for the Waiver, the Company agreed that TRW, as representative for the holders of the Debentures, would have the right to nominate two qualified individuals to serve on the Company’s Board. Mr. Runnells is one of the qualified nomination designees which TRW has elected to place on the board.

 

On May 30, 2014, the Company paid TRW a commission equal to $600,000 (equal to 8% of gross proceeds at the closing of the May Private Placement). Of this $600,000 commission, $51,850 was paid in cash to TRW, $94,150 was paid in cash to other brokers designated by TRW, and $454,000 was paid in shares of Preferred Stock. In addition, the Company paid TRW a non-accountable expense allowance of $75,000 (equal to 1% of gross proceeds at the closing of the May Private Placement) in cash.

 

From May 2013 until March 2014, the Company was party to a one-year, non-exclusive investment banking agreement with T.R. Winston, pursuant to which the Company issued to T.R. Winston 100,000 common shares, and 900,000 common stock purchase warrants. All warrants have a term of three years and a strike price of $4.25 per share, risk free rate of 0.20%, common stock price $1.880, volatility 63% valued at $0.26 million and amortized over the life of the contract. As of September 30, 2014, the full $0.26 million has been expensed through general and administrative expenses.

 

On June 6, 2014, T.R. Winston executed a commitment to purchase or affect the purchase by third parties of an additional $15 million in Series A 8% Convertible Preferred Stock, to be consummated within ninety (90) days thereof. The agreement was subsequently extended and expired on February 22, 2015. On February 25, 2015, the Company and TRW agreed in principal to a replacement commitment, pursuant to which TRW has agreed to purchase or affect the purchase by third parties of an additional $7.5 million in Series A 8% Convertible Preferred Stock, to be consummated no later than February 23, 2016, with all other terms substantially the same as those of the original commitment.

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NOTE 13- SUBSEQUENT EVENTS

 

Waiver of Default under Debentures

 

On October 6, 2014, the Debenture holders agreed to waive any event of default under the Debentures that may have occurred prior to the date of the waiver (including, without limitation, any default relating to the Company’s indebtedness to Hexagon), and to rescind and annul any acceleration or right to acceleration that may have been triggered thereby.

 

Heartland Bank

On January 8, 2015, Lilis Energy, Inc. (the “Company”) entered into a credit agreement (the “Credit Agreement”) with Heartland Bank, as administrative agent, and the financial institutions from time to time signatory thereto (individually a “Lender,” and any and all such financial institutions collectively the “Lenders”).

 

The Credit Agreement provides for a three-year senior secured term loan in an initial aggregate principal amount of $3,000,000, which principal amount may be increased to a maximum principal amount of $50,000,000 at the request of the Company pursuant to an accordion advance provision in the Credit Agreements subject to certain conditions, including the discretion of the lender (the “Term Loan”). Funds borrowed under the Credit Agreement may be used by the Company to (i) purchase oil and gas assets, (ii) fund certain Lender-approved development projects, (iii) fund a debt service reserve account, (iv) pay all costs and expenses arising in connection with the negotiation and execution of the Credit Agreement, and (v) fund the Company’s general working capital needs.

 

The Term Loan bears interest at a rate calculated based upon the Company’s leverage ratio and the “prime rate” then in effect. In connection with its entry into the Credit Agreement, the Company also paid a nonrefundable commitment fee in the amount of $75,000, and agreed to issue to the Lenders 75,000, 5-year warrants for every $1 million funded. An initial warrant to purchase up to 225,000 shares of the Company’s common stock at $2.50 per share was issued in connection with closing.

  

The Company has the right to prepay the Term Loan, in whole or in part, subject to certain conditions. If the Company exercises its right to prepay under the Credit Agreement prior to January 8, 2016, it will be assessed a prepayment premium in an amount equal to 3% of the amount of such prepayment. If the Company exercises its right to prepay under the Credit Agreement after January 8, 2016, such prepayment shall be without premium or penalty.

 

The Credit Agreement contains certain customary representations and warranties and affirmative and negative covenants. The Credit Agreement also contains financial covenants with respect to the Company’s (i) debt to EBITDAX ratio and (ii) debt coverage ratio. In addition, in certain situations, the Credit Agreement requires mandatory prepayments of the Term Loans, including in the event of certain non-ordinary course asset sales, the incurrence of certain debt, and the Company’s receipt of proceeds in connection with insurance claims.

 

Debenture extension

As of September 30, 2014, the Company had $6.68 million, net, outstanding under the Debentures. The Debentures were originally to mature on January 15, 2015; however, as of the date of this Form 10Q, the Company has entered into an extension agreement with each of the Debenture holders which extends the maturity date until January 8, 2018. As of the date of this filing, the maturity date now coincides with the maturity date of the Credit Agreement (discussed above).

 

Convertible Debenture Interest Payment

On December 29, 2014, the Company issued 1,262,844 shares to fund $0.94 million Debenture interest obligation.

 

T.R. Winston

On June 6, 2014, T.R. Winston executed a commitment to purchase or affect the purchase by third parties of an additional $15 million in Series A 8% Convertible Preferred Stock, to be consummated within ninety (90) days thereof. The agreement was subsequently extended and expired on February 22, 2015. On February 25, 2015, the Company and TRW agreed in principal to a replacement commitment, pursuant to which TRW has agreed to purchase or affect the purchase by third parties of an additional $7.5 million in Series A 8% Convertible Preferred Stock, to be consummated no later than February 23, 2016, with all other terms substantially the same as those of the original commitment.

 

Executive Employment Agreement

On February 19, 2015, the Company entered into an Employment Agreement with Eric Ulwelling, its Chief Financial Officer. The Employment Agreement provides for a base salary of $175,000, a discretionary bonus equal to up to 50% of base salary, and 400,000 stock options with an exercise price equal to the greater of fair market value of the Company’s common stock on the date of execution of the Employment Agreement or $2.50 per share. One quarter of the stock options vested immediately upon grant, and the other three quarters will vest in three annual installments on the anniversary of the execution of the Employment Agreement. The Employment Agreement provides for severance and accelerated vesting of any outstanding equity award upon termination of Mr. Ulwelling’s employment by the Company without cause or by Mr. Ulwelling for good reason or in connection with a change in control, as each is defined in the Employment Agreement.

 

The foregoing description of the Employment Agreement is not complete and is qualified in its entirety by reference to the text of the full Employment Agreement, which is attached as Exhibit 10.14 hereto and is incorporated herein by reference.

 

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ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2013, as well as the unaudited condensed financial statements and notes thereto included in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors including those set forth under Item “1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2013.

 

General

 

Lilis Energy, Inc. is an independent oil and gas company engaged in the acquisition, drilling and production of oil and natural gas properties and prospects within the Denver-Julesburg Basin (“DJ Basin”). Our business strategy is designed to create shareholder value by developing our undeveloped acreage and leveraging the knowledge, expertise and experience of our management team.

 

We principally target low to medium risk projects that have the potential for multiple producing horizons, and offer repeatable success allowing for meaningful production and reserve growth. Our acquisition and exploration pursuits of oil and natural gas properties are principally in Colorado, Nebraska, and Wyoming within the DJ Basin.  

 

Financial Condition and Liquidity

 

As of September 30, 2014, the Company had a negative working capital balance and a cash balance of approximately $6.62 million and $1.47 million, respectively. Also as of September 30, 2014, the Company had $6.68 million, net, outstanding under its 8% Senior Secured Convertible Debentures (the “Debentures”). The Debentures were originally to mature on January 15, 2015; however, in connection with the Company’s entry into the Credit Agreement (discussed below) in January 2015, as of the date of this filing, the Company has entered into an extension agreement with each of the Debenture holders which extends the maturity date until January 8, 2018. The maturity date now coincides with the maturity date of the Credit Agreement.

 

26
 

 

On January 8, 2015, the Company entered into a credit agreement with Heartland Bank (the “Credit Agreement”) which provides for a three-year senior secured term loan in an initial aggregate principal amount of $3,000,000, which principal amount may be increased to a maximum principal amount of $50,000,000 at the request of the Company, subject to certain conditions, and pursuant to an accordion advance provision in the Credit Agreement (the “Term Loan”). The availability of additional funds is generally based on the value of the Company’s proved developed producing (“PDP”) and proved undeveloped (“PUD”) reserves. The Company intends to use proceeds borrowed under the Credit Agreement to fund producing property acquisitions throughout North America, to drill wells in the core of the Company’s lease positions and to fund working capital.

 

On June 6, 2014, T.R. Winston executed a commitment to purchase or affect the purchase by third parties of an additional $15 million in Series A 8% Convertible Preferred Stock, to be consummated within ninety (90) days thereof. The agreement was subsequently extended and expired on February 22, 2015. On February 25, 2015, the Company and TRW agreed in principal to a replacement commitment, pursuant to which TRW has agreed to purchase or affect the purchase by third parties of an additional $7.5 million in Series A 8% Convertible Preferred Stock, to be consummated no later than February 23, 2016, with all other terms substantially the same as those of the original commitment. As of February 23, 2015, the Company has $2.40 million in cash on hand and is currently producing approximately 70 barrels of oil equivalent (“BOE”) a day from eight economically producing wells.

 

The Company will require additional capital to satisfy its obligations, to fund its current drilling commitments, as well as its acquisition and capital budget plans; to help fund its ongoing overhead; and to provide additional capital to generally improve its negative working capital position. The Company anticipates that such additional funding will be provided by a combination of capital raising activities, including borrowing transactions, the sale of additional debt and/or equity securities, and the sale of certain assets and by the development of certain of the Company’s undeveloped properties via arrangements with joint venture partners. If the Company is not successful in obtaining sufficient cash to fund the aforementioned capital requirements, the Company would be required to curtail its expenditures, and may be required to restructure its operations, sell assets on terms which may not be deemed favorable and/or curtail other aspects of its operations, including deferring all or portions of the Company’s capital budget. There is no assurance that any such funding will be available to the Company on acceptable terms, if at all.

 

Restatement

 

This report should be read in conjunction with the Company’s financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission (the “SEC”) on June 11, 2014. The results of operations for the interim periods presented are not necessarily indicative of results for the entire year ending December 31, 2014. The financial statements in this Quarterly Report on Form 10-Q include the restated figures for the comparative periods in 2013, as provided in Amendment No. 1 to Form 10-Q/A to the Quarterly Report on Form 10-Q of Lilis Energy for the quarterly period ended September 30, 2013 (the “Amended Q3 2013 Report”).

 

In February 2015, the Company discovered an error in the valuation of the conversion derivative liability of the Company’s 8% Senior Secured Convertible Debentures (the “Debentures”) for the periods ended December 31, 2011, December 31, 2012, December 31, 2013, as well as the quarterly periods ended September 30, 2013, March 31, 2014 and June 30, 2014 (together, the “Relevant Periods”). Specifically, the calculation of the derivative liability included in the Company’s financial statements for the Relevant Periods only included the value of the price protection (anti-dilution) feature, when it should have included both the conversion option and the price protection feature embedded in the Debentures. The changes in the fair value of the derivative resulted in additional non-cash charges to the previously filed financial statements.

 

27
 

 

The Company has evaluated the effect of the error on all Relevant Periods in accordance with Staff Accounting Bulletin (“SAB”) 99 and SAB 108 and determined that the impact of the error on its previously filed annual financial statements for the fiscal years ended December 31, 2011, December 31, 2012, and December 31, 2013 was not material. However, the Company has concluded that the impact of these non-cash items in its previously filed quarterly financial statements for the fiscal quarters ended September 30, 2013, March 31, 2014 and June 30, 2014 was sufficiently material to warrant restatement of the Company’s previously filed Quarterly Reports on Form 10-Q for those periods. In addition, the Company will restate the immaterial amounts for the fiscal years ended December 31, 2011, December 31, 2012, and December 31, 2013 in its Annual Report on Form 10-K for the fiscal year ended December 31, 2014. The opening balance as of January 1, 2013 will be adjusted. In the annual report on Form 10K for the fiscal year ended December 31, 2011 and 2012. The Company filed amended quarterly reports on Form 10-Q/A for the fiscal quarters ended September 30, 2013, March 31, 2014 and June 30, 2014 on February 23, 2015. This Quarterly Report should be read in conjunction with those amended quarterly reports on Form 10-Q/A, which resulted in retroactive changes to financial statements for those periods, including changes to net loss and net loss per common share.

 

Cash Flows

 

Cash used in operating activities during the nine months ended September 30, 2014 was $6.29 million. Cash used in operating activities and cash used in investing activities was offset by cash provided in financing activities of $8.00 million, and resulted in a corresponding increase in cash.  

 

The following table compares cash flow items during the nine months ended September 30, 2014 and 2013 (in thousands):

 

   Nine months ended
September 30,
 
   2014   2013 
Cash provided by (used in):        
Operating activities  $(6,293)  $(1,558)
Investing activities   (409)   (119)
Financing activities   8,009    1,061 
Net change in cash  $1,307   $(616)

 

During the nine months ended September 30, 2014, net cash used in operating activities was $6.29 million, compared to cash used in operating activities of $1.56 million during the nine months ended September 30, 2013, cash used in operating activities increased by $4.73 million. The changes to operating cash was predominately the increase in net loss during the nine months ended September 30, 2014 of $27.75 million compared to $7.70 million in September 30, 2013, respectively. The increase in cash used for operating activities was a direct result of the Company paying $1.00 million to TRW for financing fees in connection with closing of $30.0 million of financing and debt restructuring. Additionally, the decrease in operating cash flow was from the due diligence efforts in January 2014 related to a potential acquisition, which the Company expended $0.35 million. In addition, general and administrative went up from legal, accounting, and other professional services from the possible due diligence and several opportunities being analyzed. During the nine months ended September 30, 2014, the Company did not have these types of events. In connection with non-cash expenses, in 2014, the Company had additional non-cash charges for an inducement expense of $6.61 million $ 2.69 million for conveyance of property, and $0.68 million in fees paid to an investment bank related to conversion of convertible debt. These charges were not present in 2013.

 

During the nine months ended September 30, 2014, net cash used in investing activities was $0.41 million, compared to net cash used in investing activities of $0.12 million during the nine months ended September 30, 2013, an increase of cash used in investing activities of $0.29 million. The primary change between nine months ended September 30, 2014 and 2013 is that in 2014 the Company expended $0.40 million to acquire oil and gas assets while in 2013, the Company expended $0.76 million, respectively. The $0.76 million, for the nine months ended September 30, 2013, was offset by a sale of property of $0.64 million.

 

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During the nine months ended September 30, 2014, net cash provided by financing activities was $8.01 million, compared $1.06 million during the nine months ended September 30, 2013, an increase of $6.96 million. The changes in financing cash during the nine months ended September 30, 2014 were primarily due to proceeds from a private placement of 3,750,000 units in January 2014 for net proceeds of $5.33 million. Investment activities were additionally increased by the proceeds from a private placement of the Series A Preferred for $7.50 million. The proceeds of the May Private Placement were offset by transaction fees paid in cash and preferred shares for $0.70 million. The proceeds from the January 2014 Private Placement were partially offset by net repayments of debt of $4.07 million.

 

Capital Resources and Budget

 

Capital Resources 

 

The Company will require substantial additional capital to fund its long-term convertible debenture obligations of $6.68 million, net, due in 2018, current capital obligations, capital budget plans, to help fund its ongoing G&A, to execute acquisitions of other oil and gas companies, and to provide an additional capital and to generally improve its working capital position.  We anticipate that such additional funding will be provided by a combination of new capital raising activities, including the selling of additional debt and/or equity securities in common stock and preferred stock, the receipt of additional advances under the Credit Agreement with Heartland Bank, the selling of working interests in certain un-evaluated and evaluated properties and by the development of certain undeveloped properties via arrangements with joint venture partners which may reduce our working interest in the minerals.  If we are not successful in obtaining sufficient cash resources to fund the aforementioned capital requirements, we may be required to curtail our expenditures, restructure our operations, sell assets on terms which may not be deemed favorable and/or curtail other aspects of our operations, decrease our working interest in planned drilling areas, including deferring certain capital expenditures in key development areas.  There is no assurance that any such funding will be available to the Company.

 

The Company is party to a dispute relating to the ownership in certain wells in the Company’s Wattenberg acreage being reduced and or eliminated from a possible farm-out.  The operator of the producing wells claims the Company entered into a farm-out which would reduce the Company’s ownership in the wells. As of February 23, 2015, the Company is currently attempting to negotiate a settlement to this dispute or will pursue litigation to resolve the dispute. The Company will continue analyzing the ownership of the wells on a periodic basis to determine if any impairment is deemed necessary. If the dispute is resolved in favor of the Company, the value of the assets will be transferred to the full cost pool and the accrual of $5.20 million will be relieved from accrued expenses.

 

Capital Budget

 

We anticipate a capital budget of up to $50.0 million for 2015. The budget is allocated toward the acquisition of properties and companies in North America and to develop two wells focused on unconventional reservoirs located in the Wattenberg field within the DJ Basin that will apply horizontal drilling in the Niobrara shale and Codell formations.

 

The entire capital budget is subject the securing additional capital through equity placement, utilizing the term loan from Heartland Bank and additional debt instruments and funds contemplated by the agreement with Heartland Bank to acquire production in North America. Some of the proceeds from the initial borrowing under the Heartland Bank loan were applied to the payment and servicing of our term debt and working capital and participating in working interests in the Wattenberg area.

 

In addition to the need to secure adequate capital to fund our capital budget, the execution of, and results from, our capital budget are contingent on various factors, including, but not limited to, the sourcing of capital, market conditions, oilfield services and equipment availability, commodity prices and drilling/ production results.  Results from the wells identified in the capital budget may lead to additional adjustments to the capital budget. Other factors that could impact our level of activity and capital expenditure budget include, but are not limited to, a reduction or increase in service and material costs, the formation of joint ventures with other exploration and production companies, and the divestiture of non-strategic assets. We do not anticipate any significant expansion of our current DJ Basin acreage position in the near term; however, we are targeting attractive Wattenberg acquisitions.

 

29
 

 

Results of Operations

 

Three months ended September 30, 2014 compared to three months ended September 30, 2013

 

The following table compares operating data for the three months ended September 30, 2014 to September 30, 2013: 

 

   Three months ended
September 30,
 
   2014   2013 
Revenues:        
Oil sales  $735,386   $1,003,745 
Gas sales   118,639    82,651 
Operating fees   (39,015)   28,331 
Realized gain (loss) on commodity price derivatives   -    (43,551)
Unrealized gain (loss) on commodity price derivatives   -    (20,000)
           
Total revenues   815,010    1,051,176 
           
Costs and expenses:          
Production costs   101,593    318,322 
Production taxes   71,864    102,919 
General and administrative   2,935,404    1,214,029 
Depreciation, depletion and amortization   252,548    532,173 
Total costs and expenses   3,361,409    2,167,443 
Loss from operations before loss of conveyance of property   (2,546,399)   (1,116,267)
Loss on conveyance of oil and gas properties   (2,694,466)   - 
Loss from operations   (2,546,399)   (1,116,267)
           
Other Income (expenses):          
Other income   32,338    145 
Convertible debentures conversion derivative gain (loss)   (572,427)   (207,251)
Interest expense   (1,130,727)   (1,582,881)
Total other expenses   (1,670,816)   (1,789,987)
           
Net loss  $(6,911,681)  $(2,906,254)

 

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Total revenues

 

Total revenues were $0.82 million for the three months ended September 30, 2014, compared to $1.05 million for the three months ended September 30, 2013, decrease of $0.23 million, or 22%. The decrease in revenues was primarily due to a decrease in production volumes from the conveyance of 17 producing wells and approximately 32,000 net acres. During the three months ended September 30, 2014 and 2013, production amounts were 13,285 and 13,822 BOE, respectively, a decrease of 537 BOE, or 4%. Declines in production are primarily attributable to natural production declines related to mature producing properties and wells which need work overs to continue production. During the three months ended September 30, 2014, the differential between the price per BOE received by the Company and the NYMEX crude price ranged from $11.50-$15.15 from the excess supply of oil in the area; compared to $7.64 from the same period in 2013.

 

During the three months September 2014, the work over down time can range from a few days to a months based on the availability of the work over rigs in the immediate area. Furthermore, the decrease in production is from the Company analyzing the economics of the wells and cycling producing days instead of continuous production. These decreases were offset by the Company’s participation in and production from one non-operated horizontal Wattenberg well. The revenue effect of the production decrease was worsened by an overall average effective price decrease per BOE to $64.28 in 2014 from $78.60 in 2013, decrease of $14.32 or 18%. 

 

The following table shows a comparison of production volumes and average prices:

 

   For the 
   Three Months Ended 
   September 30, 
   2014   2013 
Product          
Oil (Bbl.)   9,633    11,389 
Oil (Bbls)-average price  $76.34   $88.13 
           
Natural Gas (MCF)-volume   21,909    14,595 
Natural Gas  (MCF)-average price (1)  $5.41   $5.66 
           
Barrels of oil equivalent (BOE)   13,285    13,822 
Average daily net production (BOE)   144    150 
Average Price per BOE (1)  $64.28   $78.60 
           
(1) Includes proceeds from the sale of Natural Gas Liquids (“NGL”)          
           
Oil and gas production costs, production taxes, depreciation, depletion, and amortization          
           
Average Price per BOE  $64.28   $78.60 
           
Production costs per BOE   12.72    23.03 
Production taxes per BOE   5.41    7.45 
Depreciation, depletion, and amortization per BOE   19.01    39.00 
           
Total operating costs per BOE   37.14    69.48 

 

Commodity Price Derivative Activities

 

Changes in the market price of oil can significantly affect our profitability and cash flow.  In the past we have entered into various commodity derivative instruments to mitigate the risk associated with downward fluctuations in oil prices.  These derivative instruments consisted exclusively of swaps.  The duration and size of our various derivative instruments varies, and depends on our view of market conditions, available contract prices and our operating strategy.

 

As of September 30, 2014, the Company did not maintain any active commodity derivatives.

 

Production costs

 

Production costs were $0.10 million during the three months ended September 30, 2014, compared to $0.32 million for the three months ended September 30, 2013, a decrease of $0.22 million, or 69%. Decrease in production costs in 2014 resulted from the Company’s in-depth analysis of our wells and determining the economics of the wells and changing well mechanics to reduce work overs and strain on the pumping units and downhole mechanics. Additionally, as discussed above, in September 2014, the Company conveyed 32,000 acres and 17 operated wells to their senior lender, Hexagon, LLC. Within the 17 wells, there were numerous wells which were uneconomic and which required several work overs in a period. As a result of the conveyance of these older wells, the Company now receives revenue from newer wells which have a lower lease operating cost and production tax burden. Production costs per BOE decreased to $12.72 for the three months ended September 30, 2014 from $23.03 in 2013, a decrease of $10.31 per BOE, or 45%.

 

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Production taxes

 

Production taxes were $0.07 million for the three months ended September 30, 2014, compared to $0.10 million for the three months ended September 30, 2013, a decrease of $0.03 million, or 30%.  Decrease in production taxes was due primarily to a change in production and product mix per state.  Currently, ad valorem, severance and conservation taxes range from 1% to 13% based on the state and county from which production is derived.  Additionally, as discussed above, in September 2014, the Company conveyed 32,000 acres and 17 operated wells to their senior lender, Hexagon, LLC. As a result of the conveyance, the Company now receives revenue from newer wells which have a lower lease operating cost and production tax. Production taxes per BOE decreased to $5.41 during the three months ended September 30, 2014 from $7.45 in 2013, a decrease of $2.04 or 27%. Decline in production tax is a result of the change in product mix by state. The Company produced more oil and natural gas from lower taxed states and counties in 2014 compared to 2013.

 

General and administrative

 

General and administrative expenses were $2.94 million during the three months ended September 30, 2014, compared to $1.21 million during the three months ended September 30, 2013, an increase of $1.73 million, or 143%.  Non-cash general and administrative items for the three months ended September 30, 2014 were $2.16 million compared to $0.72 million during the three months ending September 30, 2013, an increase of $1.44 million, or 200%. The increase in non-cash general and administrative expenses was the change in non-cash stock compensation for employees and consultants due to the issuance of $1.49 million of stock and options for services for both employee, board of directors and consultants; Cash general and administrative expense was $0.78 million during the three months ended September 30, 2014, compared to $0.49 million during the three months ended September 30, 2013, an increase of $0.29 million, or 59%. The increase in cash general and administrative expense for the three months ended September 30, 2014 was due to the lump sum payment of $1.00 million paid by the Company to TRW. Mr. Mirman’s compensation arrangements with TRW provided that upon TRW’s receipt from the Company of the lump sum payment, TRW would make a payment of $1.00 million to Mr. Mirman. This was offset by a reduction other general and administrative expenses which include a reduction in employee compensation due to the reduction of staff from 9 to 3 employees.

 

Depreciation, depletion, and amortization

 

Depreciation, depletion, and amortization were $0.25 million during the three months ended September 30, 2014, compared to $0.53 million during the three months ended September 30, 2013, a decrease of $0.28 million, or 53%.  Decrease in depreciation, depletion, and amortization was from (i) a decrease in production amounts in 2014 from 2013, (ii) a decrease in the depletion base for the depletion calculation due to the conveyance of assets, and (iii) a decrease in the depletion rate.  Production amounts decreased to 13,285 BOE from 13,822 BOE for the three months ended September 30, 2014 and 2013, respectively, a decrease of 537, or 4%. The decrease in depletion was based on a lower depletion base. Depreciation, depletion, and amortization per BOE decreased to $16.50 from $39.00, respectively, for the three months ended September 30, 2014 and 2013, a decrease of $22.50, or 58%.  Declines in production are primarily attributable to the conveyance of property and natural production declines related to mature producing properties.

 

Loss on conveyance of oil and gas properties

 

On September 2, 2014, the Company entered into an agreement to convey its interest in 31,725 evaluated and unevaluated net acres located in the Denver Julesburg Basin and the associated oil and natural gas production (the “Hexagon Collateral”) to its primary lender, Hexagon, LLC (“Hexagon”) in exchange for extinguishment of all outstanding debt and accrued interest obligations owed to Hexagon aggregating to $14,833,311. The conveyance assigned all assets and liabilities associated with the property, which includes PDP and PUD reserves, plugging and abandonment, and other assets and liabilities associated with the property. Pursuant to the agreement, the Company also issued to Hexagon $2.0 million in 6% Conditionally Redeemable Preferred Stock, which is recognized as temporary equity.

 

Under the full cost method, sales or abandonments of oil and natural gas properties, whether or not being amortized, are accounted for as adjustments of capitalized costs, with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and natural gas attributable to the cost center. The conveyance to Hexagon represented greater than 25 percent of the Company’s proved reserves of oil and natural gas attributable to the full cost pool, as a result, there was a significant alteration in the relationship between capitalized costs and proved reserves of oil and natural gas attributable to the full cost pool. Total capitalized costs within the full cost pool are allocated on the basis of the relative fair values of the properties sold and those retained due to substantial economic differences between the properties sold and those retained.

 

The following table represents an allocation of the transaction:

 

Conveyance of oil and natural gas property to extinguish the obligation of debt and accrued interest payable  $14,833,311 
Add: disposition of asset retirement obligations   973,135 
Net value of liabilities satisfied upon conveyance  $15,806,446 
      
Oil and natural gas properties (full cost method), at cost     
Evaluated oil and natural gas properties  $31,022,171 
Wells in progress, transferred to evaluated oil and natural gas properties   510,895 
Unevaluated oil and natural gas properties, transferred to evaluated oil and natural gas properties   6,026,297 
Total evaluated oil and natural gas properties   37,559,363 
Accumulated depletion   (21,058,451)
Net oil and natural gas properties conveyed, at cost   16,500,912 
Conditionally 6% Redeemable Preferred Stock   2,000,000 
Loss on conveyance of evaluated oil and natural gas properties   (2,694,466)
Net value of transaction  $15,806,446 

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Interest Expense

 

For the three months ended September 30, 2014 and 2013, the Company incurred interest expense of approximately $1.13 million and $1.58 million, respectively, of which approximately $0.86 million and $1.68 million is classified as non-cash interest expense, respectively. The details of the non-cash interest expense are as follows: (i) amortization of the deferred financing costs of $0.01 million, (ii) accretion of the convertible debentures payable discount of $0.04 million, (iii) common stock issued for interest of $0.59 million, (iv) accrued interest for term note loan fees of $0.04 million and (v) amortization of forbearance fees of $0.13 million. Cash interest is comprised of term loan cash expenses of payment. In comparative, during the three months ended September 30, 2013, non-cash interest consisted of: (i) amortization of the deferred financing costs of $0.18 million, and (ii) accretion of the convertible debentures payable discount of $0.61 million.

 

Change in derivative liability of convertible debentures

 

For the three months ended September 30, 2014 and 2013, the Company incurred a loss on change in the fair value of the derivative liability related to the convertible debentures of approximately $0.57 million and $0.21 million, respectively.

 

Results of Operations

 

Nine months ended September 30, 2014 compared to nine ended September 30, 2013

 

The following table compares operating data for the nine months ended September 30, 2014 to September 30, 2013:

 

    Nine months ended  
    September 30,  
    2014     2013  
Revenues:            
Oil sales   $ 2,414,995     $ 3,320,083  
Gas sales     308,629       227,853  
Operating fees     37,866       118,853  
Realized gain on commodity price derivatives     11,143       (23,661 )
Unrealized gain (loss) on commodity price derivatives     -       (20,000 )
Total revenues     2,772,633       3,623,128  
                 
Costs and expenses:                
Production costs     739,176       877,623  
Production taxes     266,774       380,958  
General and administrative     8,536,882       3,566,264  
Depreciation, depletion and amortization     1,211,587      

1,873,002

 
                 
Total costs and expenses     10,754,419       6,697,847  
                 
Loss from operations before loss on conveyance of oil and natural gas properties     (7,981,786 )     (3,074,719 )
Loss on conveyance of oil and natural gas properties     (2,694,466 )     -  
Loss from operations     (10,676,252 )     (3,074,719 )
                 
Other Income (expenses):                
Other income     32,435       536  
Inducement expense     (6,661,275 )     -  
Convertible debentures conversion derivative gain (loss)     (5,966,236 )     93,851  
Interest expense     (4,477,277 )     (4,723,624 )
Total other expenses     (17,072,353 )     (4,629,237 )
                 
Net loss   $ (27,748,605 )   $ (7,703,956 )

 

Total revenues

 

Total revenues were $2.77 million for the nine months ended September 30, 2014, compared to $3.62 million for the nine months ended September 30, 2013, a decrease of $0.85 million, or 23%. The decrease in revenues was due primarily to a decrease in production volumes including decreases attributable to the Company’s conveyance of properties. As discussed, in September 2014, the Company conveyed 32,000 acres and 17 operated wells its senior lender, Hexagon, LLC. During the nine months ended September 30, 2014 and 2013, production amounts were 38,191 and 46,904 BOE, respectively, a decrease of 8,713 BOE, or 19%. The 2014 period declines in production were primarily attributable to few properties owned and natural production declines related to mature producing properties but were also affected by the temporary reduction in production from five of the Company’s properties that experienced production difficulties. During the nine months ended September 30, 2014, the differential between the price per BOE received by the Company and the NYMEX crude price ranged from $11.50-$15.15 due to the excess supply of oil in the area; compared to a $7.64 basis differential from the same period in 2013.

 

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During the nine months ended September 30, 2014, work-over rigs had limited availability due to high industry activity within the Company’s operating area, and the Company performed an in-depth analysis of production and started to reduce the amount of on-time that the wells pumped.  As a result, idled wells for routine well maintenance or other repairs were off-line more often and longer than anticipated, which substantially decreased our production.

 

The following table shows a comparison of production volumes and average prices:

 

   For the 
   Nine Months Ended 
   September 30, 
   2014   2013 
Product          
Oil (Bbl.)   29,353    38,464 
Oil (Bbls)-average price  $82.27   $86.32 
           
Natural Gas (MCF)-volume   53,028    50,642 
Natural Gas (MCF)-average price (1)  $5.82   $4.49 
           
Barrels of oil equivalent (BOE)   38,191    46,904 
Average daily net production (BOE)   140    172 
Average Price per BOE  $71.32   $75.64 
           
(1) Includes proceeds from the sale of NGL's          
           
Oil and gas production costs, production taxes, depreciation, depletion, and amortization          
           
Average Price per BOE  $70.60   $75.64 
           
Production costs per BOE   19.35    18.71 
Production taxes per BOE   6.99    8.12 
Depreciation, depletion, and amortization per BOE   31.72    40.08 
Total operating costs per BOE   58.06    66.91 

 

Commodity Price Derivative Activities

 

Changes in the market price of oil and natural gas can significantly affect our profitability and cash flow.  In the past we have entered into various commodity derivative instruments to mitigate the risk associated with downward fluctuations in oil and natural gas prices.  These derivative instruments consisted exclusively of swaps.  The duration and size of our various derivative instruments varies, and depends on our view of market conditions, available contract prices and our operating strategy.

 

As of September 30, 2014, the Company did not maintain any active commodity swaps. The Company held one commodity swap during the nine months ended September 30, 2014, which matured in January 31, 2014.

 

Commodity price derivative realized gains were $0.01 million for the nine months ended September 30, 2014, compared to a realized loss of $0.02 million during the nine months ended September 30, 2013, an increase in realized gains/losses of $0.01 million or 50%.

 

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Production costs

 

Production costs were $0.74 million during the nine months ended September 30, 2014, compared to $0.88 million for the nine months ended September 30, 2013, a decrease of $0.14 million, or 16%. Decrease in production costs in 2014 was from a decrease operated wells from the conveyance of property discussed below. The decrease in production costs was due primarily to a decrease in well count including decreases attributable to the Company’s conveyance of properties. As discussed above, in September 2014, the Company conveyed 32,000 acres and 17 operated wells to its senior lender, Hexagon, LLC. Production costs per BOE increased to $19.35 for the nine months ended September 30, 2014 from $18.71 in 2013, an increase of $0.64 per BOE, or 3%, primarily as a result of reduced volumes of BOE in 2014 and high well work frequency. During the nine months ended September 30, 2014, work-over rigs had limited availability due to high industry activity within the operating area of the Company and the company performed an in-depth analysis of production and started to reduce the amount of on-time that the wells pumped.  As a result, the Company has idled wells for regular scheduled well maintenance or other repairs. A substantial amount of the wells needed continuous replacement of rod strings and holes in the tubing. An addition, as a result of the conveyance of properties to Hexagon, the Company now receives revenue from newer wells which have a lower lease operating cost and production tax.

 

Production taxes

 

Production taxes were $0.27 million for the nine months ended September 30, 2014, compared to $0.38 million for the nine months ended September 30, 2013, a decrease of $0.11 million, or 30%.  Decrease in production taxes was due to a decrease in production and product mix per state and the decrease in well count including decreases attributable to the Company’s conveyance of properties to Hexagon. Currently, ad valorem, severance and conservation taxes range from 1% to 13% based on the state and county from which production is derived.  Production taxes per BOE decreased to $6.99 during the three months ended September 30, 2014 from $8.12 in 2013, a decrease of $1.13 or 14%. Decline in production tax is a result of the change in product mix by state. The Company produced more oil and natural gas from lower taxed states and counties in 2014 compared to 2013. 

 

General and administrative

 

General and administrative expenses were $8.57 million during the nine months ended September 30, 2014, compared to $3.57 million during the nine months ended September 30, 2013, an increase of $5.00 million, or 140%.  Non-cash general and administrative items for the nine months ended September 30, 2014 were $4.05 million compared to $1.73 million during the nine months ended September 30, 2013, an increase of $2.32 million, or 134%.  The increase in non-cash general and administrative expenses was due to an increase of $0.69 million fees associated with completing the January 2014 Private Placement; and $0.70 million for non-cash payment of the financing fees for the May Private Placement, increase in stock based compensation of $1.37 million, increase in reserve for bad debt of $0.03 million. Cash general and administrative expenses were $4.49 million during the nine months ended September 30, 2014, compared to $1.83 million during the nine months ended September 30, 2013, an increase of $4.09 million, or 223%.  The increase in cash general and administrative expenses was largely due to a $1.00 million in placement fees paid to T.R. Winston which was ultimately paid to Mr. Mirman. In connection with the appointment of Mr. Mirman, Chief Executive Officer, the Company and TRW amended the investment banking agreement in place between the Company an TRW at that time to provide that, upon the receipt by the Company of gross cash proceeds or drawing availability of at least $30,000,000, measured on a cumulative basis and including certain restructuring transactions, subject to the Company’s continued employment of Mr. Mirman, TRW would receive from the Company a lump sum payment of $1.00 million. Mr. Mirman’s compensation arrangements with TRW provided that upon TRW’s receipt from the Company of the lump sum payment, TRW would make a payment of $1.00 million to Mr. Mirman. The Board determined in September 2014 that the criteria for the lump sum payment had been met.  Furthermore, the Company paid $0.33 million for the due diligence of a potential acquisition which dissolved in Q1 2014, $0.25 million for additional investment banking firms, additional legal fees and other professional fees for acquisitions and additional support during the year of $0.65 million.

 

Depreciation, depletion, and amortization

 

Depreciation, depletion, and amortization were $1.21 million during the nine months ended September 30, 2014, compared to $1.88 million during the nine months ended September 30, 2013, a decrease of $0.67 million, or 36%.  Decrease in depreciation, depletion, and amortization was from (i) a decrease in production amounts in 2014 from 2013, (ii) an decrease in the depletion base for the depletion calculation due to the conveyance of property, and (iii) a decrease in the depletion rate.  During the nine months ended September 30, 2014 and 2013, production amounts were 38,191 and 46,904 BOE, respectively, a decrease of 8,713 BOE, or 19%. The decrease in depletion was based on a lower depletion base. Depreciation, depletion, and amortization per BOE decreased to $31.72 from $40.08, respectively, for the nine months ended September 30, 2014 and 2013, a decrease of $8.36, or 21%.

 

Inducement expense

 

Inducement expenses were $6.66 million during the nine months ended September 30, 2014, compared to $0 during the nine months ended September 30, 2013. In January 2014, the Company entered into the Conversion Agreement between the Company and all of the holders of the Debentures.  Under the terms of the Conversion Agreement, $9.0 million of the approximately $15.6 million in Debentures then outstanding converted to Common Stock at a price of $2.00 per common share.  As inducement, for the Company issued warrants to the converting Debenture holders to purchase one share of Common Stock, at an exercise price equal to $2.50 per share (the “Warrants”), for each share of Common Stock issued upon conversion of the Debentures. The Company used the Lattice model to value the warrants, utilizing a volatility of 65%, and a life of 3 years, which arrived at a fair value of $6.61 million for the Warrants.

 

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Loss on conveyance of oil and gas properties

 

On September 2, 2014, the Company entered into an agreement to convey its interest in 31,725 evaluated and unevaluated net acres located in the Denver Julesburg Basin and the associated oil and natural gas production (the “Hexagon Collateral”) to its primary lender, Hexagon, LLC (“Hexagon”) in exchange for extinguishment of all outstanding debt and accrued interest obligations owed to Hexagon aggregating to $14,833,311. The conveyance assigned all assets and liabilities associated with the property, which includes PDP and PUD reserves, plugging and abandonment, and other assets and liabilities associated with the property. Pursuant to the agreement, the Company also issued to Hexagon $2.0 million in 6% Conditionally Redeemable Preferred Stock, which is recognized as temporary equity.

 

Under the full cost method, sales or abandonments of oil and natural gas properties, whether or not being amortized, are accounted for as adjustments of capitalized costs, with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and natural gas attributable to the cost center. The conveyance to Hexagon represented greater than 25 percent of the Company’s proved reserves of oil and natural gas attributable to the full cost pool, as a result, there was a significant alteration in the relationship between capitalized costs and proved reserves of oil and natural gas attributable to the full cost pool. Total capitalized costs within the full cost pool are allocated on the basis of the relative fair values of the properties sold and those retained due to substantial economic differences between the properties sold and those retained.

 

The following table represents an allocation of the transaction:

 

Conveyance of oil and natural gas property to extinguish the obligation of debt and accrued interest payable  $14,833,311 
Add: disposition of asset retirement obligations   973,135 
Net value of liabilities satisfied upon conveyance  $15,806,446 
      
Oil and natural gas properties (full cost method), at cost     
Evaluated oil and natural gas properties  $31,022,171 
Wells in progress, transferred to evaluated oil and natural gas properties   510,895 
Unevaluated oil and natural gas properties, transferred to evaluated oil and natural gas properties   6,026,297 
Total evaluated oil and natural gas properties   37,559,363 
Accumulated depletion   (21,058,451)
Net oil and natural gas properties conveyed, at cost   16,500,912 
Conditionally 6% Redeemable Preferred Stock   2,000,000 
Loss on conveyance of evaluated oil and natural gas properties   (2,694,466)
Net value of transaction  $15,806,446 

 

Interest Expense

 

For the nine months ended September 30, 2014 and 2013, the Company incurred interest expense of approximately $4.48 million and $4.72 million, respectively, of which approximately $2.30 million and $1.68 million is classified as non-cash interest expense, respectively. The details of the non-cash interest expense for the nine months ended September 30, 2014 are as follows: (i) amortization of the deferred financing costs of $0.28 million, (ii) accretion of the convertible debentures payable discount of $0.81 million, (iii) common stock issued for interest of $0.46 million, and (iv) accrued interest for term note loan fees of $0.25 million and (v) accrued interest to convertible debenture of $0.50 million (vi) amortization of forbearance fees of $0.25 million. Cash interest is comprised of term loan cash expenses of payment. In comparative, during the nine months ended September 30, 2013, non-cash interest consisted of: (i) amortization of the deferred financing costs of $0.53 million, and (ii) accretion of the convertible debentures payable discount of $1.74 million.

 

Change in derivative liability of convertible debentures

 

For the nine months ended September 30, 2014 and 2013, the Company incurred a change in the fair value of the derivative liability related to the convertible debentures of approximately $5.97 million and <$0.09> million respectively. During the nine months ended September 30, 2014, the Company’s conversion price of the convertible debentures was priced at $2.00 compared to $4.25 in 2013. During the nine months ended September 30, 2014, the Company reduced the conversion price from $4.25 to $2.00, as a result the Debenture converted $9.0 million of the outstanding Debentures. The conversion resulted in a reduction of the convertible debenture liability by $5.03 million and an increase in additional paid in capital.

 

Off-Balance Sheet Arrangements

 

We do not have any material off-balance sheet arrangements.

 

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Overview of Our Business, Strategy, and Plan of Operations

 

We have acquired and developed a producing base of oil and natural gas proved reserves, as well as a portfolio of exploration and other undeveloped assets with conventional and non-conventional reservoir opportunities, with an emphasis on those with multiple producing horizons, in particular the Muddy “J” conventional reservoirs and the Niobrara shale and Codell resource plays. We believe these assets offer the possibility of repeatable year-over-year success and significant and cost-effective production and reserve growth. Our acquisition, development and exploration pursuits are principally directed at oil and natural gas properties in North America. Since early 2010, we have acquired and/or developed 25 producing wells. As of September 30, 2014 we owned interests in approximately 8 economically producing wells and 93,000 gross (84,000 net) leasehold acres, of which 81,000 gross (58,000 net) acres are classified as undeveloped acreage and all of which are located in Colorado, Wyoming and Nebraska within the DJ Basin.   We are primarily focused on acquiring companies and production throughout North America and developing our North and South Wattenberg Field, assets which include attractive unconventional reservoir drilling opportunities in mature development areas that low risk Niobrara and Codell formation productive potential. 

 

Our intermediate goal is to create significant value via the investment of up to $50.0 million in our inventory of low and controlled-risk conventional and unconventional properties, while maintaining a low cost structure, and to acquire companies and production throughout North America. To achieve this, our business strategy includes the following elements:

 

Acquiring additional assets and companies throughout North America. We are targeting acquisitions in North America which meet certain current and future production thresholds to increase shareholder value. We anticipate the acquisitions will be funded by Heartland Bank $50.0 million facility and also utilizing either a preferred stock or a common stock offering.

 

Pursuing the initial development of our Greater Wattenberg Field unconventional assetsWe currently have two key unconventional reservoir properties located in the Greater Wattenberg field.  We participated in the drilling of one non-operated horizontal well in our North Wattenberg asset during the fourth quarter of 2013, which was completed in the first quarter of 2014 and is now producing. We also plan to operate the drilling of several horizontal wells on our South Wattenberg property during the third quarter of 2015 in which we have a 50% working interest and a 25% working interest for a net of two wells.  Drilling activities on both properties will target the prolific and well established Niobrara and Codell formations.  Subject to the securing of additional capital, we expect to participate in up to 18 wells in these two assets, with an expected investment of up to $26.0 million. As of February 23, 2015, the Company has participated in one horizontal well that is currently on-line.

 

Extending the development of certain conventional prospects within our inventory of other DJ Basin properties.  Subject to the securing of additional capital, we anticipate the expenditure of up to an additional $50.0 million in drilling and development costs on three of our DJ Basin assets where initial exploitation has yielded positive results. Additional drilling activities will be conducted on each property in an effort to fully assess each property and define field productivity and economic limits.  

 

Engaging in certain exploration activities, including geologic and geophysics projects, to define additional prospects within our inventory of DJ Basin properties that may have significant development upside.   Subject to the securing of additional capital, we anticipate an expenditure of $5.0 million in second quarter 2015 to acquire seismic data on at least three key DJ Basin target areas to identify both conventional and unconventional drilling opportunities.

 

Controlling Costs. We seek to maximize our returns on capital employed by minimizing our production costs via prudent engineering and field management, and by closely monitoring general and administrative expenses. We also minimize initial capital expenditures on geological and geophysical overhead, seismic data, hardware and software by partnering with cost efficient operators that have already invested capital in such. We also outsource some of our technical functions in order to help reduce general and administrative and capital requirements.

 

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From time to time, we use commodity price hedging instruments to reduce our exposure to oil and natural gas price fluctuations and to help ensure that we have adequate cash flow to fund our debt service costs and capital programs. From time to time, we will enter into futures contracts, collars and basis swap agreements, as well as fixed price physical delivery contracts. We intend to use hedging primarily to manage price risks and returns on certain acquisitions and drilling programs. Our policy is to consider hedging an appropriate portion of our production at commodity prices we deem attractive. In the future we may also be required by our lenders to hedge a portion of production as part of any financing.

 

Currently, our inventory of developed and undeveloped acreage includes approximately 11,000 net acres that are held by production, approximately, 61,000, 4,000, 5,000 and 2,000 net acres that expire in the years 2015, 2016, 2017, and thereafter, respectively. Approximately 82% of our inventory of undeveloped acreage provides for extension of lease terms from two to five years, at the option of the Company, via payment of varying, but typically nominal, extension amounts. We will use our Credit Agreement with Heartland bank to acquire additional bolt-on properties, acquire other properties throughout North America, or drill wells on the core properties to hold the property by production.

 

The business of oil and natural gas property acquisition, exploration and development is highly capital intensive and the level of operations attainable by oil and natural gas company is directly linked to and limited by the amount of available capital. Therefore, a principal part of our plan of operations is to raise the additional capital required to finance the exploration and development of our current oil and natural gas prospects and the acquisition of additional properties to balance our existing organic cash flow. We will need to raise additional capital to fund our exploration and development budget. We will seek additional capital through the sale of our securities, through debt and project financing, joint venture agreements with industry partners, and through sale of assets. Our ability to obtain additional capital through new debt instruments, project financing and sale of assets may be subject to the repayment of our existing obligations.

 

We intend to use the services of independent consultants and contractors to provide various professional services, including land, legal, environmental, technical, investor relations and tax services.  We believe that by limiting our management and employee costs, we may be able to better control lifting costs and retain G&A flexibility. 

 

Marketing and Pricing

 

We derive revenue principally from the sale of oil and natural gas.  As a result, our revenues are determined, to a large degree, by prevailing prices for crude oil and natural gas.  We sell our oil and natural gas on the open market at prevailing market prices or through forward delivery contracts.  The market price for oil and natural gas is dictated by supply and demand, and we cannot accurately predict or control the price we may receive for our oil and natural gas.

 

Our revenues, cash flows, profitability and future rate of growth will depend substantially upon prevailing prices for oil and natural gas.  Prices may also affect the amount of cash flow available for capital expenditures and our ability to borrow money or raise additional capital.  Lower prices may also adversely affect the value of our reserves and make it uneconomical for us to commence or continue production levels of oil and natural gas.  Historically, the prices received for oil and natural gas have fluctuated widely.  Among the factors that can cause these fluctuations are:

 

  changes in global supply and demand for oil and natural gas;
  the actions of the Organization of Petroleum Exporting Countries, or OPEC;
  the price and quantity of imports of foreign oil and natural gas;
  acts of war or terrorism;
  political conditions and events, including embargoes, affecting oil-producing activity;
  the level of global oil and natural gas exploration and production activity;
  the level of global oil and natural gas inventories;
  weather conditions;
  technological advances affecting energy consumption; and
  transportation options from trucking, rail, and pipeline
  the price and availability of alternative fuels.

 

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From time to time, we will enter into hedging arrangements to reduce our exposure to decreases in the prices of oil and natural gas.  Hedging arrangements may expose us to risk of significant financial loss in some circumstances including circumstances where:

 

  our production and/or sales of natural gas are less than expected;
  payments owed under derivative hedging contracts come due prior to receipt of the hedged month’s production revenue; or
  the counter party to the hedging contract defaults on its contract obligations.

 

In addition, hedging arrangements may limit the benefit we would receive from increases in the prices for oil and natural gas.  We cannot assure you that any hedging transactions we may enter into will adequately protect us from declines in the prices of oil and natural gas.  On the other hand, where we choose not to engage in hedging transactions in the future, we may be more adversely affected by changes in oil and natural gas prices than our competitors who engage in hedging transactions.

 

Critical Accounting Policies and Estimates

 

The preparation of our financial statements in conformity with generally accepted accounting principles in the United States, or GAAP, requires our management to make assumptions and estimates that affect the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities at the date of our financial statements and the reported amounts of revenues and expenses during the reporting period.  The following is a summary of the significant accounting policies and related estimates that affect our financial disclosures. See our 2013 Annual Report on Form 10-K for the year ended December 31, 2013 for the remaining Critical Accounting Policies and Estimates.

 

Critical accounting policies are defined as those significant accounting policies that are most critical to an understanding of a company’s financial condition and results of operation. We consider an accounting estimate or judgment to be critical if (i) it requires assumptions to be made that were uncertain at the time the estimate was made, and (ii) changes in the estimate or different estimates that could have been selected could have a material impact on our results of operations or financial condition.

 

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Use of Estimates

 

The preparation of financial statements in conformity with US GAAP requires us to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates. Management evaluates estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic and commodity price environment.

 

Our most significant financial estimates are associated with our estimated proved oil and natural gas reserves, assessments of impairment imbedded in the carrying value of undeveloped acreage and undeveloped properties, as well as valuation of common stock used in various issuances, options and warrants, and estimated derivative liabilities.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk.

 

Not Applicable

 

Item 4.  Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) under the Securities Exchange Act of 1934, as amended, the Exchange Act) as of September 30, 2014. Disclosure controls and procedures are controls and other procedures designed to ensure that information required to be disclosed by the Company in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and include, without limitation, controls and procedures designed to ensure that information that the Company is required to disclose in such reports is accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of September 30, 2014, the Company’s disclosure controls and procedures were not effective, due to the material weaknesses in internal controls over financial reporting described below.

 

Internal Controls over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. 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 in accordance with GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods is 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.

 

Based on the evaluation and the identification of the material weakness in internal control over financial reporting described below, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of September 30, 2014, the Company’s disclosure controls and procedures, which we previously reported as being effective, were actually  not effective.

 

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. In connection with management’s assessment of our internal control over financial reporting, we identified the following material weaknesses in our internal control over financial reporting as of September 30, 2014:

 

As a result of the resignation of our Chief Financial Officer as previously disclosed by way of current reports on Form 8-K, we did not maintain effective monitoring controls and related segregation of duties over automated and manual journal entry transaction processes.
   
As disclosed in our Form 8-K filed on November 7, 2014, the Company determined that during the fourth quarter of 2013 and the first three quarters of 2014, there existed a material weakness with respect to the operation of the Company’s internal controls relating to the documentation and authorization procedures of certain travel and entertaining expenses incurred by certain past and present officers in those periods.

 

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Restatement of Previously Issued Financial Statements

 

As discussed above in the Note 3-Summary of Significant Accounting Policies-Basis of Presentation and Restatement, in February 2015, the Company discovered an error in the valuation of the conversion derivative liability of the Company’s Debentures for the Relevant Periods. Specifically, the calculation of the conversion liability included in the Company’s financial statements for the Relevant Periods only included the value of the price protection (anti-dilution) feature, when it should have included both the conversion option and the price protection embedded in the Debentures. The changes in the value of the derivative resulted in changes to the Company’s financial statements, which warranted restatement of the Company’s Quarterly Reports on Form 10-Q for the fiscal quarters ended September 30, 2013, March 31, 2014 and June 30, 2014.

As a result of the restatement described in this quarterly report, the Company’s Chief Executive Officer and Chief Financial Officer, with the assistance of other members of management and expert internal control consultants, re-evaluated the effectiveness of the Company’s internal controls over financial reporting as of September 30, 2014 in accordance with the assessment and testing procedures described above. Based on this re-evaluation, and because the impact of the errors on the Company’s quarterly financial statements for the fiscal quarters ended September 30, 2013, March 31, 2014 and June 30, 2014, described in Note 3-Summary of Significant Accounting Policies-Basis of Presentation and Restatement, was sufficiently material to warrant restatement of the Company’s Quarterly Reports on Form 10-Q for those periods, we have determined that the following additional material weakness in internal controls over financial reporting existed as of September 30, 2014:

 

We did not maintain effective controls to provide reasonable assurance that our convertible debenture conversion derivative liability was being valued correctly during the fiscal years ended December 31, 2011, December 31, 2012 and December 31, 2013 and the quarters ended March 31, 2014 and June 30, 2014. This material weakness resulted in errors in our financial statements and related disclosures, including inaccuracies in previously reported fair value of convertible debentures debenture derivative liability, convertible  debenture discount, net gain/loss and total shareholders’ equity.

 

Because of the material weaknesses described above, management has concluded that we did not maintain effective internal control over financial reporting as of September 30, 2014, based on the Internal Control—Integrated Framework issued by COSO (1992).

  

Remediation Efforts

 

We plan to make necessary changes and improvements to the overall design of our control environment to address the material weaknesses in internal control over financial reporting described above. In particular, we expect to hire additional staff to assist with journal entry processing and complex accounting issues such as convertible debentures. Additionally, we will perform an analysis of all automated and manual procedures to strengthen the effectiveness of our segregation of duties.

 

In the fourth quarter of 2014, we implemented a new extensive Travel and Entertainment policy which all employees and directors are required to review and sign. Furthermore, the Company has required all employees and directors to review and sign all of the Company’s corporate documents which include, but are not limited to, the Code of Ethics, By-laws, and Corporate Governance Policy. The Company is planning to test the remediation in second quarter of 2015 and fully remediate the weakness by that time.

 

Management believes through the implementation of the foregoing policies, we will significantly improve our control environment, the completeness and accuracy of underlying accounting data and the timeliness with which we are able to close our books. Management is committed to continuing efforts aimed at fully achieving an operationally effective control environment and timely filing of regulatory required financial information. The remediation efforts noted above are subject to our internal control assessment, testing, and evaluation processes. While these efforts continue, we will rely on additional substantive procedures and other measures as needed to assist us with meeting the objectives otherwise fulfilled by an effective control environment.

 

Changes in Internal Control over Financial Reporting

 

Other than those described above, management has determined that there were no changes in the Company’s internal controls over financial reporting during the fiscal quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. 

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

The Company may from time to time be involved in various legal actions arising in the normal course of business.  In the opinion of management, the Company’s liability, if any, in these pending actions would not have a material adverse effect on the financial position of the Company.  The Company’s general and administrative expenses would include amounts incurred to resolve claims made against the Company.

 

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Parker v. Tracinda Corporation, Denver District Court, Case No. 2011CV561. In November 2012, the Company filed a motion to intervene in garnishment proceedings involving Roger Parker, the Company’s former Chief Executive Officer and Chairman. The Defendant, Tracinda, served various writs of garnishment on the Company to enforce a judgment against Mr. Parker seeking, among other things, shares of unvested restricted stock. The Company asserted rights to lawful set-offs and deductions in connection with certain tax consequences, which may be material to the Company. The underlying judgment against Mr. Parker was appealed to the Colorado Court of Appeals and, by Order dated October 17, 2013, that Court reversed the trial court with respect to Mr. Parker’s claims of waiver, estoppel and mitigation of damages and remanded with instruction to enter judgment for Mr. Parker. The Court of Appeals also ordered the trial court to conduct further proceedings to determine the amount of damages to award Mr. Parker on his breach of contract claim. The trial court conducted a later hearing and found in its Findings of Fact, Conclusions of Law and Order dated January 9, 2015, in favor of Mr. Parker on his claim for breach of contract, awarding him $6,981,302.60. Tracinda’s Motion for Amendment of the Court’s January 9 Findings and Conclusions is pending.

In re Roger A. Parker: Tracinda Corp. v. Recovery Energy, Inc. and Roger A. Parker, United States Bankruptcy Court for the District of Colorado, Case No. 13-10897-EEB. On June 10, 2013, Tracinda Corp. (“Tracinda”) filed a complaint (Adversary No. 13-01301 EEB) against the Company and Roger Parker in connection with the personal bankruptcy proceedings of Roger Parker, alleging that the Company improperly failed to remit to Tracinda certain property in connection with a writs of garnishment issued by the Denver District Court (discussed above). The Company filed an answer to this complaint on July 10, 2013. A trial date has not been set and, by Order dated February 2, 2015, the Bankruptcy Court ordered that the Adversary Proceeding be held in abeyance pending final resolution of the state-court action (2011CV561). The Company is unable to predict the timing and outcome of this matter.

 

There are no other material pending legal proceedings to which we or our properties are subject.

 

Item 1A. Risk Factors.

 

Not applicable.

 

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

 

We have previously disclosed by way of current reports on Form 8-K filed with the SEC all sales by us of our unregistered securities during the first nine months of 2014.

 

Limitations upon the Payment of Dividends

 

The Company filed a Certificate of Designation of Preferences, Rights and Limitations of Series A 8% Convertible Preferred Stock (the “Certificate of Designation”) on May 30, 2014 with the Secretary of State of the State of Nevada, which was effective upon filing. The Certificate of Designation provides that the holders of the Series A Preferred are entitled to receive a dividend payable at the election of the Company at a rate of 8% per annum. (See Note 12 – Preferred Stock). In addition, the Certificate of Designation provides that so long as the Series A Preferred remains outstanding, neither the Company nor any subsidiary of the Company may directly or indirectly pay or declare any dividend or make any distribution upon or in respect of any Junior Securities (as that term is defined in the Certificate of Designation) as long as any dividends due on the Series A Preferred remain unpaid. Moreover, no money may be set aside for or applied to the purchase of or redemption (through a sinking fund or otherwise) of any Junior Securities or shares pari passu with the Series A Preferred.

 

Restrictions under Credit Agreement

 

As discussed above, on January 8, 2015 the Company entered into the Credit Agreement with Heartland Bank. Pursuant to the Credit Agreement, the Company is subject to certain customary working capital restrictions and limitations upon the payment of dividends. For example, the Company is prohibited from taking any of the following actions without the prior written consent of Heartland: incurring any debt, other than certain permitted debt as specified in the Credit Agreement; declaring or paying any distributions, including dividends, other than certain permitted distributions specified in the Credit Agreement; making any acquisitions of the stock or equity interests of another person, other than certain permitted equity acquisitions as specified in the Credit Agreement; or making any direct or indirect purchase or other acquisition of stock or other securities of any other person or any other item which would be classified as an “investment” on a balance sheet of such other person, other than certain permitted investments as specified in the Credit Agreement. The foregoing description does not purport to be complete and is qualified in its entirety by reference to the full text of the Credit Agreement, a copy of which is filed herewith as [Exhibit 10.13].

 

Item 3. Defaults upon Senior Securities.

 

None other than what has previously been disclosed.

 

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Item 4. Mine Safety Disclosures.

 

Not Applicable

 

Item 5. Other Information.

 

In December 2014, the Company established a Nominating and Corporate Governance Committee (the “Committee”). Pursuant to the Charter of the Committee (the “Charter”), the Committee is responsible for considering any director candidate recommended by the Company’s stockholders. Stockholders who wish to recommend individuals for consideration by the Committee to become nominees for election to our Board may do so by delivering a written recommendation to the Nominating and Corporate Governance Committee at the following address: 216 16th Street, Suite #1350, Denver CO 80202 at least 120 days prior to the anniversary date of the mailing of our proxy statement for the last annual meeting of stockholders.

 

On February 19, 2015, the Company entered into an Employment Agreement with Eric Ulwelling, its Chief Financial Officer. The Employment Agreement provides for a base salary of $175,000, a discretionary bonus equal to up to 50% of base salary, and 400,000 stock options with an exercise price equal to the greater of fair market value of the Company’s common stock on the date of execution of the Employment Agreement or $2.50 per share. One quarter of the stock options vested immediately upon grant, and the other three quarters will vest in three annual installments on the anniversary of the execution of the Employment Agreement. The Employment Agreement provides for severance and accelerated vesting of any outstanding equity award upon termination of Mr. Ulwelling’s employment by the Company without cause or by Mr. Ulwelling for good reason or in connection with a change in control, as each is defined in the Employment Agreement.

The foregoing description of the Employment Agreement is not complete and is qualified in its entirety by reference to the text of the full Employment Agreement, which is attached as Exhibit 10.14 hereto and is incorporated herein by reference.

Item 6. Exhibits.

 

Exhibit

Number

  Exhibit Description
     
4.1   Form of Bristol Capital Warrant (incorporated herein by reference to Exhibit 4.3 from our quarterly report on Form 10-Q filed on November 26, 2014).
4.2   Certificate of Designation of 6% Redeemable Preferred Stock, dated August 29, 2014 (incorporated herein by reference to Exhibit 3.3 from our quarterly report on Form 10-Q filed on November 26, 2014).
4.3   Form of Heartland Bank Warrant.
10.1   Letter Agreement with T.R. Winston dated as of June 6, 2014 (incorporated herein by reference to Exhibit 10.9 from our quarterly report filed on Form 10-Q filed on June 17, 2014).
10.2   Separation Agreement with Robert A. Bell dated August 1, 2014 (incorporated herein by reference to Exhibit 10.9 from our quarterly report on Form 10-Q filed on November 26, 2014).
10.3   Consulting Agreement with Bristol Capital dated September 2, 2014 (incorporated herein by reference to Exhibit 10.11 from our quarterly report on Form 10-Q filed on November 26, 2014).
10.4   Settlement Agreement with Hexagon dated September 2, 2014 (incorporated herein by reference to Exhibit 10.10 from our quarterly report on Form 10-Q filed on November 26, 2014).
10.5   Option Award Agreement between the Company and Nuno Brandolini, dated as of October 1, 2014 (fully-vested).
10.6   Option Award Agreement between the Company and Nuno Brandolini, dated as of October 1, 2014 (subject to vesting).
10.7   Amendment to Abraham Mirman Employment Agreement, dated as of October 1, 2014.
10.8   Letter Agreement with holders of the Company’s 8% Senior Secured Convertible Debentures, dated as of October 6, 2014 (incorporated herein by reference to Exhibit 99.1 from our current report filed on Form 8-K filed on October 7, 2014).
10.9   Lilis Energy, Inc. Director agreement with G. Tyler Runnels (incorporated herein by reference to Exhibit 10.1 from our current report filed on Form 8-K filed on December 2, 2014).
10.10   Separation Agreement with Bruce B. White, dated as of December 11, 2014.
10.11   Separation Agreement with Timothy N. Poster, dated as of December 11, 2014.
10.12   Credit Agreement, dated as of January 8, 2015, among Lilis Energy, Inc., Heartland Bank, as administrative agent, and the other lender parties thereto (incorporated herein by reference to Exhibit 10.1 from our current report filed on Form 8-K filed on January 13, 2015).
10.12(a)   Security Agreement, dated as of January 8, 2015, by and between Lilis Energy, Inc. and Heartland Bank, as collateral agent.
10.12(b)   Form of Promissory Note from Lilis Energy, Inc. as Borrower to Heartland Bank as Payee, dated as of January 8, 2015.
10.12(c)   Subordination Agreement, dated as of January 8, 2015.
10.12(d)   Form of Mortgage from Lilis Energy, Inc. as Mortgagor to Heartland Bank as Mortgagee (Colorado Oil and Gas Properties).
10.12(e)   Form of Mortgage from Lilis Energy, Inc. as Mortgagor to Heartland Bank as Mortgagee (Nebraska Oil and Gas Properties).
10.12(f)   Form of Mortgage from Lilis Energy, Inc. as Mortgagor to Heartland Bank as Mortgagee (Wyoming Oil and Gas Properties).
10.13   Letter Agreement with holders of the Company’s 8% Senior Secured Convertible Debentures dated as
10.14   Employment Agreement with Eric Ulwelling.
10.15   Market Development Termination letter (dated August 1, 2014).
31.1   Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002
31.2   Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002
32.1   Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002
32.2   Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002

 

43
 

 

SIGNATURES

 

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

 

Signature   Title   Date
         
/s/ Abraham Mirman   Chief Executive Officer   February 25, 2015
Abraham Mirman   (Principal Executive Officer)    
         
/s/ Eric Ulwelling   Chief Financial Officer and Chief Accounting Officer   February 25, 2015
Eric Ulwelling   (Principal Financial Officer)    

 

44
 

 

EXHIBIT INDEX

 

 

Exhibit

Number

  Exhibit Description
     
4.1   Form of Bristol Capital Warrant (incorporated herein by reference to Exhibit 4.3 from our quarterly report on Form 10-Q filed on November 26, 2014).
4.2   Certificate of Designation of 6% Redeemable Preferred Stock, dated August 29, 2014 (incorporated herein by reference to Exhibit 3.3 from our quarterly report on Form 10-Q filed on November 26, 2014).
4.3   Form of Heartland Bank Warrant.
10.1   Letter Agreement with T.R. Winston dated as of June 6, 2014 (incorporated herein by reference to Exhibit 10.9 from our quarterly report filed on Form 10-Q filed on June 17, 2014).
10.2   Separation Agreement with Robert A. Bell dated August 1, 2014 (incorporated herein by reference to Exhibit 10.9 from our quarterly report on Form 10-Q filed on November 26, 2014).
10.3   Consulting Agreement with Bristol Capital dated September 2, 2014 (incorporated herein by reference to Exhibit 10.11 from our quarterly report on Form 10-Q filed on November 26, 2014).
10.4   Settlement Agreement with Hexagon dated September 2, 2014 (incorporated herein by reference to Exhibit 10.10 from our quarterly report on Form 10-Q filed on November 26, 2014).
10.5   Option Award Agreement between the Company and Nuno Brandolini, dated as of October 1, 2014 (fully-vested).
10.6   Option Award Agreement between the Company and Nuno Brandolini, dated as of October 1, 2014 (subject to vesting).
10.7   Amendment to Abraham Mirman Employment Agreement, dated as of October 1, 2014.
10.8   Letter Agreement with holders of the Company’s 8% Senior Secured Convertible Debentures, dated as of October 6, 2014 (incorporated herein by reference to Exhibit 99.1 from our current report filed on Form 8-K filed on October 7, 2014).
10.9   Lilis Energy, Inc. Director agreement with G. Tyler Runnels (incorporated herein by reference to Exhibit 10.1 from our current report filed on Form 8-K filed on December 2, 2014).
10.10   Separation Agreement with Bruce B. White, dated as of December 11, 2014.
10.11   Separation Agreement with Timothy N. Poster, dated as of December 11, 2014.
10.12   Credit Agreement, dated as of January 8, 2015, among Lilis Energy, Inc., Heartland Bank, as administrative agent, and the other lender parties thereto (incorporated herein by reference to Exhibit 10.1 from our current report filed on Form 8-K filed on January 13, 2015).
10.12(a)   Security Agreement, dated as of January 8, 2015, by and between Lilis Energy, Inc. and Heartland Bank, as collateral agent.
10.12(b)   Form of Promissory Note from Lilis Energy, Inc. as Borrower to Heartland Bank as Payee, dated as of January 8, 2015.
10.12(c)   Subordination Agreement, dated as of January 8, 2015.
10.12(d)   Form of Mortgage from Lilis Energy, Inc. as Mortgagor to Heartland Bank as Mortgagee (Colorado Oil and Gas Properties).
10.12(e)   Form of Mortgage from Lilis Energy, Inc. as Mortgagor to Heartland Bank as Mortgagee (Nebraska Oil and Gas Properties).
10.12(f)   Form of Mortgage from Lilis Energy, Inc. as Mortgagor to Heartland Bank as Mortgagee (Wyoming Oil and Gas Properties).
10.13   Letter Agreement with holders of the Company’s 8% Senior Secured Convertible Debentures dated as
10.14   Employment Agreement with Eric Ulwelling.
10.15   Market Development Termination letter (dated August 1, 2014).
31.1   Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002
31.2   Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002
32.1   Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002
32.2   Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002

 

 

 

 

45

 

Exhibit 4.3

 

THIS WARRANT AND THE SECURITIES ISSUABLE UPON EXERCISE HEREOF HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE OR FOREIGN SECURITIES LAWS, AND MAY NOT BE PLEDGED, SOLD, OFFERED FOR SALE, TRANSFERRED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF REGISTRATION UNDER OR EXEMPTION FROM SUCH ACT AND ALL APPLICABLE STATE AND APPLICABLE FOREIGN SECURITIES LAWS.

Dated: January 8, 2015

WARRANT TO PURCHASE COMMON STOCK
OF
LILIS ENERGY, INC.

Expiring January 8, 2020

LILIS ENERGY, INC., a Nevada corporation (the “Company”), for value received, hereby certifies that HEARTLAND BANK, an Arkansas state bank, or its registered assigns (the “Purchaser”), is entitled to purchase from the Company 225,000 duly authorized shares (the “Warrant Shares”) of the Company’s common stock, par value $0.0001 per share (the “Common Stock”), at the purchase price per share of $2.50 (the “Initial Warrant Exercise Price”), at any time or from time to time on or before 3:00 p.m. Mountain Time on January 8, 2020 (the “Expiration Date”), all subject to the terms, conditions and adjustments set forth in this Warrant. Certain capitalized terms used herein are defined in Section 11 or elsewhere herein.

This Warrant is issued in connection with, and to induce the Holder to enter into, that certain Credit Agreement, dated as of January 8, 2015, by and among the Company, the Purchaser, and the other signatories thereto (as amended, restated or otherwise modified from time to time, the “Credit Agreement”).

1.EXERCISE OF WARRANT.

1.1                 Manner of Exercise; Payment. This Warrant may be exercised by the Holder, in whole or in part, at any time on or before the Expiration Date, by delivery and surrender of this Warrant to the Company at its Principal Office, accompanied by a subscription (in substantially the form attached as Exhibit A) duly executed by such Holder and accompanied by payment (a) in cash, (b) by certified check payable to the order of the Company, (c) by wire transfer of immediately available funds or (d) by Cashless Exercise, or by any combination of any of the foregoing methods set forth in Section 1.11.1(a) to (d); provided, however, that this Warrant may not be exercised on a Cashless Exercise basis in the event that there is an effective and available registration statement covering the resale of all Warrant Shares. Subject to the following paragraph in respect of a Cashless Exercise, such payment shall be in the amount obtained by multiplying (x) the number of Warrant Shares (without giving effect to any adjustment thereof) designated in such subscription by (y) the Warrant Exercise Price, and such Holder shall thereupon be entitled to receive the number of duly authorized Warrant Shares determined as provided in Sections 2, 3 and 4.

 
 

For purposes of this Section 1.1, the term “Cashless Exercise” means an exercise of this Warrant pursuant to which the Company issues to the Holder a number of Warrant Shares determined as follows:

X = Y ((A-B)/A)

Where:

X = the number of Warrant Shares to be issued to the Holder, subject to adjustment as provided in Section 2, 3 and 4.

Y = the total number of Shares designated in the applicable subscription as being subject to the Cashless Exercise (as adjusted as provided herein).

A = the Fair Market Value of the Shares.

B = the Warrant Exercise Price.

1.2                 When Exercise Effective.

(a)                Each exercise of this Warrant shall be deemed to have been effected immediately before the close of business on the Business Day on which this Warrant shall be deemed to have been delivered and surrendered to the Company, accompanied by payment, as provided in Section 1.1, and at such time the Person or Persons in whose name or names any certificate or certificates for Warrant Shares shall be issuable upon such exercise as provided in Section 1.3 shall be deemed to have become the holder or holders of record thereof.

(b)               Notwithstanding the foregoing, if an exercise of any portion of this Warrant is to be made in connection with a public offering or a sale of the Company (pursuant to a merger, sale of stock, or otherwise), the Holder may, upon written notice delivered to the Company concurrently with the delivery and surrender of this Warrant for exercise accompanied by payment, as provided in Section 1.1, elect that the exercise of all or any portion of this Warrant be conditioned upon the consummation of such transaction or event, in which case (i) such exercise shall not be deemed to be effective unless and until the consummation of such transaction or event occurs and (ii) such exercise may be revoked by the Holder at any time before the consummation of such transaction or event. If such transaction or event is not consummated and such exercise is so revoked, the Company shall promptly return the surrendered Warrant and any exercise price paid to such Holder, unless otherwise instructed by such Holder.

2
 

1.3                 Delivery of Share Certificates and New Warrant. As soon as practicable after each exercise of this Warrant, in whole or in part, and in any event within five Business Days thereafter, the Company at its sole expense (including the payment by it of any applicable issue taxes) shall update the shareholder register of the Company to reflect the number of duly authorized Warrant Shares to which such Holder shall be entitled upon such exercise and shall cause to be issued in the name of and delivered to the applicable Holder or, subject to Section 10, as such Holder (upon payment by such Holder of any applicable transfer taxes) may direct:

(a)                a certificate or certificates for the number of duly authorized Warrant Shares to which such Holder shall be entitled upon such exercise together with cash in lieu of any fraction of a share, as provided in Section 1.4 hereof; and

(b)               unless the purchase rights represented by this Warrant shall have expired or shall have been fully exercised, the Company shall, at the time of delivery of the certificate or certificates representing the Warrant Shares being issued in accordance with Section 1.3(a) hereof, deliver to the Holder a new Warrant evidencing the rights of the Holder to purchase the unexpired and unexercised Warrant Shares called for by this Warrant. Such new Warrant shall in all other respects be identical to this Warrant.

1.4                 No Fractional Shares or Scrip. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Warrant. As to any fraction of a share which the Holder would otherwise be entitled to purchase upon such exercise, the Company shall, at its election, either (i) pay a cash adjustment in respect of such final fraction in an amount equal to such fraction multiplied by the Fair Market Value per Warrant Share on the Business Day next preceding the date of such exercise or (ii) round up to the next whole share.

1.5                 Company to Reaffirm Obligations. The Company shall, at the time of each exercise of this Warrant, upon the request of the applicable Holder, acknowledge in writing its continuing obligation to afford to such Holder all rights to which such Holder is entitled after such exercise in accordance with the terms of this Warrant; provided, however, that if the Holder shall fail to make any such request, then such failure shall not affect the continuing obligation of the Company to afford such rights to such Holder.

1.6                 Continuation of Rights in Warrant Shares Following Exercise. Upon any exercise of this Warrant, all Warrant Shares issued in connection therewith shall continue to have the benefit of the provisions of Sections 7, 12, 13, 14 and 16 of this Warrant, and all of such rights shall inure to the benefit of the Holder thereof with respect thereto, as if this Warrant had not been exercised and the Holder thereof was a Holder with respect thereto.

2.ADJUSTMENT OF Warrant ShareS ISSUABLE UPON EXERCISE.

2.1                 General; Number of Warrant Shares; Warrant Exercise Price. The number of Warrant Shares that the Holder shall be entitled to receive upon each exercise hereof shall be determined by multiplying the number of Warrant Shares that would otherwise (but for the provisions of this Section 2) be issuable upon such exercise, as designated by the Holder pursuant to Section 1.1, by a fraction (a) the numerator of which is the Initial Warrant Exercise Price and (b) the denominator of which is the Warrant Exercise Price in effect on the date of such exercise. The “Warrant Exercise Price” shall initially be the Initial Warrant Exercise Price, and shall remain in effect until a further adjustment or readjustment thereof is required by this Section 2.

3
 

2.2                 Adjustments Upon Issuance of Additional Shares. If the Company at any time or from time to time after the date hereof issues or sells any Additional Shares (including any Additional Shares deemed to be issued pursuant to Section 2.3 or 2.4) without consideration or for consideration per share of Common Stock less than the Warrant Exercise Price in effect immediately before such issuance or sale, then, in each such case, subject to Section 2.7, the Warrant Exercise Price shall be reduced, concurrently with such issue or sale, to a price (calculated to the nearest cent) determined by multiplying the Warrant Exercise Price by a fraction:

(a)                the numerator of which shall be the sum of (i) the total number of shares of Common Stock outstanding immediately before such issue or sale (measured on a Fully-Diluted Basis), plus (ii) the number of shares of Common Stock that the aggregate consideration received by the Company for such Additional Shares would purchase at the Warrant Exercise Price in effect immediately before such issuance or sale; and

(b)               the denominator of which shall be the number of shares of Common Stock anticipated to be outstanding immediately after such issue or sale (measured on a Fully-Diluted Basis).

2.3                 Dividends and Distributions. If the Company at any time or from time to time after the date hereof declares, orders, pays or makes a dividend or other distribution (including any distribution of cash, other or additional stock or other securities or property, by way of dividend or spin-off, reclassification, recapitalization or similar corporate rearrangement or otherwise) on its Common Stock, other than a dividend payable in Additional Shares that is subject to Section 2.4, an Ordinary Cash Dividend, or a dividend payable to the Shareholders solely for the purpose of paying their individual income taxes (to the extent specifically contemplated by the Company’s Governing Documents), then, and in each such case, the Warrant Exercise Price shall be decreased, effective immediately after the effective time of such dividend or distribution, by the amount of cash and/or the fair market value (as determined by the Board of Directors in good faith) of any securities or other assets paid on each share of Common Stock subject to such dividend or distribution. “Ordinary Cash Dividends” means any cash dividend or cash distribution on the Common Stock which, when combined on a per share basis with the per share amounts of all other cash dividends and cash distributions paid on the Common Stock during the 365-day period ending on the date of declaration of such dividend or distribution (as adjusted to appropriately reflect any of the events referred to in other subsections of this Section 2.3 and excluding cash dividends or cash distributions that resulted in an adjustment to the Warrant Price or to the number of Common Stock issuable on exercise of each Warrant), does not exceed $0.30 per share of Common Stock.

2.4                 Treatment of Splits, Recapitalization, etc. If the Company at any time subdivides (by any stock split, stock dividend, recapitalization or otherwise) the outstanding Common Stock into a greater number of shares of Common Stock or makes a distribution to holders of Common Stock in the form of additional shares of Common Stock, then the Warrant Exercise Price in effect immediately before such subdivision shall be proportionately reduced.

4
 

2.5                 Computation of Consideration. For the purposes of this Section 2:

(a)                the consideration for the issue or sale of any Additional Shares shall, irrespective of the accounting treatment of such consideration:

(i)                insofar as it consists of cash, be computed at the gross amount of cash actually received by the Company, without deduction for any expenses paid or incurred by the Company or any commissions or compensation paid or concessions or discounts allowed to underwriters, dealers or others performing similar services in connection with such issue or sale;

(ii)              insofar as it consists of property (including securities) other than cash actually received by the Company, be computed at the Fair Market Value thereof at the time of such issue or sale;

(iii)             insofar as it consists (A) of services, at the value reasonably determined in good faith by the Board of Directors, or (B) neither of cash, nor of services, nor other property, be computed as having no value; and

(iv)             insofar as the Additional Shares are issued or sold together with other Capital Stock, property or assets of the Company for a consideration that covers both, be the portion of such consideration so received, computed as provided in clauses (i), (ii) and (iii) above, allocable to such Additional Shares, all as reasonably determined in good faith by the Board of Directors.

(b)               All calculations under this Section 2 shall be made to the nearest cent or to the nearest 1/100th of a share, as the case may be.

2.6                 Adjustment for Combinations, etc. If the outstanding shares of Common Stock shall be combined or consolidated, by reclassification, combination, reverse stock split or otherwise, into a lesser number of shares of Common Stock, then the Warrant Exercise Price in effect immediately before such combination or consolidation shall, concurrently with the effectiveness of such combination or consolidation, be proportionately increased.

2.7                 Minimum Adjustment of Warrant Exercise Price. If the amount of any adjustment of the Warrant Exercise Price required pursuant to this Section 2 would be less than 1% of the Warrant Exercise Price in effect at the time such adjustment is otherwise so required to be made, then such amount shall be carried forward and adjustment shall be made with respect thereto at the time of and together with any subsequent adjustment that, together with such amount and any other amount or amounts so carried forward, shall aggregate at least 1% of such Warrant Exercise Price.

5
 

3.CONSOLIDATION, MERGER, ETC.

3.1                 Adjustments for Consolidation, Merger, Sale of Assets, Reorganizations, etc. If after the date hereof, at any time while this Warrant is outstanding, the Company (a) shall consolidate with or merge into any other Person and shall not be the continuing or surviving corporation of such consolidation or merger, (b) shall permit any other Person to consolidate with or merge into the Company and the Company shall be the continuing or surviving Person but, in connection with such consolidation or merger, the Warrant Shares and/or shares of Common Stock shall be changed into or exchanged for stock or other securities of any other Person or cash or any other property, (c) shall transfer all or substantially all of its properties or assets to any other Person or (d) shall effect a capital reorganization or reclassification of the Warrant Shares and/or the Common Stock (other than a capital reorganization or reclassification to the extent that such capital reorganization or reclassification results in the issuance of Additional Shares for which adjustment to the Warrant Exercise Price is provided in Section 2.2) (together, a “Fundamental Transaction”), then, and in the case of each such Fundamental Transaction, notice shall be given to the Holder at least ten (10) days prior to consummation of such Fundamental Transaction, and the Holder shall be given the opportunity to exercise this Warrant in whole or in part on a Cashless Exercise basis. If the Holder chooses to exercise this Warrant at any time prior to the consummation of such Fundamental Transaction, the Holder shall be entitled to receive (at the aggregate Warrant Exercise Price in effect at the time of such exercise for all Warrant Shares issuable upon such exercise immediately before such consummation), in lieu of the Warrant Shares issuable upon such exercise before such consummation, the greatest amount of securities, cash or other property to which such Holder would actually have been entitled as an equity holder upon consummation of the Fundamental Transaction if such Holder had exercised the rights represented by this Warrant immediately prior thereto, subject to adjustments (subsequent to such consummation) as nearly equivalent as possible to the adjustments provided for in Sections 2, 3 and 4.

3.2                 Assumption of Obligations. Notwithstanding anything contained in this Warrant or in the Credit Agreement to the contrary, the Company shall not effect a Fundamental Transaction unless, before the consummation thereof, each Person (other than the Company) that may be required to deliver any units, stock, securities, cash or property upon the exercise of this Warrant as provided herein shall assume, by written instrument delivered to, and reasonably satisfactory to, the Holder, (a) the obligations of the Company under this Warrant (and if the Company shall survive the consummation of such transaction, such assumption shall be in addition to, and shall not release the Company from, any continuing obligations of the Company under this Warrant) and (b) the obligation to deliver to such Holder such units, stock, securities, cash or property as, in accordance with the foregoing provisions of this Section 3, such Holder may be entitled to receive. Nothing in this Section 3 shall be deemed to authorize the Company to enter into any transaction not otherwise permitted by the Credit Agreement. Nothing in this Section 3 shall be deemed to authorize the Company to enter into any transaction not otherwise permitted by the Credit Agreement.

4.OTHER DILUTIVE EVENTS.

If any event shall occur as to which the provisions of Sections 2 or 3 are not strictly applicable but with respect to which the failure to make any adjustment would not fairly protect the Purchaser and/or Holders or fairly preserve and give effect to the anti-dilution rights represented by this Warrant in accordance with its essential intent and principles, then, in each such case, at the request of the Holder, the Board of Directors shall adjust this Warrant to fairly preserve and give effect to the anti-dilution rights represented by this Warrant.

6
 

 

5.NO DILUTION OR IMPAIRMENT.

 

The Company shall not, by amendment of any of its Governing Documents or through any consolidation, merger, reorganization, transfer of assets, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may reasonably be requested by the Holder in order to protect the rights of the Holder against dilution or other impairment. Without limiting the generality of the foregoing, the Company (a) will not permit the par value (if any) of any Warrant Shares issuable upon the exercise of this Warrant, if applicable, to exceed the amount payable therefor upon such exercise, (b) will take all such action as may be necessary or appropriate in order that the Company may validly and legally issue Warrant Shares upon the exercise of this Warrant and (c) will not take any action that results in any adjustment of the Warrant Exercise Price if the total number of Warrant Shares issuable after such action upon exercise of this Warrant would exceed the total number of shares of Common Stock then authorized by the Company’s Governing Documents and available for the purpose of issuance upon such exercise.

6.ACCOUNTANTS’ REPORT AS TO ADJUSTMENTS.

In each case of any adjustment or readjustment in the Warrant Shares issuable upon the exercise of this Warrant, the Company at its sole expense shall, as promptly as reasonably practicable following such adjustment or readjustment, compute such adjustment or readjustment in accordance with the terms of this Warrant. The Company shall, as promptly as reasonably practicable following such adjustment or readjustment, mail a copy of each such computation to each Holder and shall, upon the written request at any time of any such Holder, furnish to such Holder a statement setting forth the Warrant Exercise Price at the time in effect and showing in reasonable detail how it was calculated. After receipt of such statement, such Holder shall have 30 days to review such statement, and shall have reasonable access to the books and records of the Company, and its personnel, during such 30-day period to the extent such records relate to, or such personnel was involved with, calculating such statement. On or before the last day of such 30-day period, such Holder may object to such statement by delivering to the Company a statement of objections, after which the Company and such Holder shall negotiate in good faith to resolve such objections. If such objections are not resolved within 15 days of such Holder’s delivery of such statement of objections, then the disputed matters shall be submitted for resolution to a Resolving Accountant. The Company and the Holder shall direct the Resolving Accountant to resolve such matters within 30 days of its engagement, and the determination of the Resolving Accountant shall be binding on such parties. The fees of the Resolving Accountant shall be borne by the Company or the Holder in a proportion to be determined by the Resolving Accountant, which proportion shall be based on the relative accuracy of the calculations set forth by such Persons.

7
 

7.REGISTRATION OF WARRANT AND Warrant ShareS.

7.1                 General. If any Common Stock or Other Securities required to be reserved for purposes of exercise of this Warrant require registration with or approval of any governmental authority under any federal or state law (other than the Securities Act) before such Common Stock or Other Securities may be issued upon exercise, then the Company shall, at its sole expense and as expeditiously as possible, cause such Common Stock and/or Other Securities to be duly registered or approved, as the case may be. At such time as any Common Stock or Other Securities issuable upon exercise of this Warrant are listed on any national securities exchange, the Company shall, at its sole expense, obtain promptly and maintain the approval for listing on each such exchange, upon official notice of issuance, any and all Warrant Shares of the same class and maintain the listing of such Warrant Shares after their issuance.

7.2                 Piggyback Registration.

(a)                If the Company at any time proposes to file on its behalf or on behalf of any of its Shareholders a registration statement under the Securities Act on any form (other than a registration statement on Form S-4 or S-8 or any successor form unless such forms are being used in lieu of or as the functional equivalent of, registration rights) for any Common Stock, whether for its own account or for the account of one or more Shareholders or other Persons, then it shall give written notice setting forth the terms of the proposed offering to all Holders at least 10 days before the initial filing with the Commission of such registration statement, and shall offer to include in such filing such Registrable Securities as any Holder thereof may request. Each Holder desiring to have Registrable Securities registered under this Section 7.2(a) will advise the Company in writing within 5 days after the date of receipt of such notice from the Company, setting forth the amount of Registrable Securities for which registration is requested. The Company shall thereupon include in such filing the number of Registrable Securities for which registration is so requested. Notwithstanding the provisions of this Section 7.1, the Company shall have the right at any time after it shall have given written notice pursuant to this Section 7.1 (irrespective of whether a written request for inclusion of any such securities shall have been made) to elect not to file any such proposed registration statement, or to withdraw the same after the filing but prior to the effective date thereof.

 

(b)               If the registration statement is for an underwritten offering, and the managing underwriters of the offering advise the Company in writing that, in their opinion, the number of securities requested to be included in such registration exceeds the number that can be sold in such offering without adversely affecting the marketability of the offering, then the Company shall include securities in such registration in the following order of priority: (i) first, any securities to be offered by the Company; (ii) second, any securities for which the Company has granted “demand” registration rights that have been exercised to any Person; (iii) third, any Registrable Securities and other securities for which the Company has, on or before the date hereof, granted “piggyback” registration rights (including the rights pursuant to Section 7.2 and that have been requested to be included in such registration, pro rata among the Persons requesting the inclusion of such securities on the basis of the number of such securities as to which registration was requested by each such Person; and (iv) fourth, any other securities for which the Company, after the date hereof, grants “piggyback” registration rights and that have been requested to be included in such registration, pro rata among the Persons requesting the inclusion of such securities on the basis of the number of such securities as to which registration was requested by each such Person.

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(c)               The Holders who are selling Registrable Securities in an underwritten offering shall not be required to make any representations or warranties to the Company or the underwriters (other than representations and warranties regarding such Holder or such Holder’s intended method of distribution) or to undertake any indemnification obligations to the Company or the underwriters with respect thereto, except as otherwise provided in Section 7.5.

7.3                 Expenses. The Company shall pay all Registration Expenses in connection with all registrations (which shall include any qualifications, notifications and exemptions) under this Section 7.

7.4                 Obligations of the Company. Whenever required under this Section 7 to effect the registration of any Registrable Securities, the Company shall, as expeditiously as reasonably possible:

(a)                furnish, at least five Business Days before filing such registration statement, a prospectus relating thereto or any amendments or supplements relating to such a registration statement or prospectus, to one counsel selected by the Requisite Holders (the “Holders’ Counsel”), copies of all such documents proposed to be filed (it being understood that such ten Business Day period need not apply to successive drafts of the same document proposed to be filed so long as such successive drafts are supplied to such counsel in advance of the proposed filing by a period of time that is customary and reasonable under the circumstances);

(b)               prepare and file with the Commission such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement;

(c)                notify in writing the Holders’ Counsel promptly (i) of the receipt by the Company of any notification with respect to any comments by the Commission with respect to such registration statement or prospectus or any amendment or supplement thereto or any request by the Commission for the amending or supplementing thereof or for additional information with respect thereto, (ii) of the receipt by the Company of any notification with respect to the issuance by the Commission of any stop order suspending the effectiveness of such registration statement or prospectus or any amendment or supplement thereto or the initiation of any action threatening any proceeding for that purpose and (iii) of the receipt by the Company of any notification with respect to the suspension of the qualification of such Registrable Securities for sale in any jurisdiction or the initiation of any action threatening the qualification of such Registrable Securities for sale in any jurisdiction;

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(d)               furnish to the Holders such number of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act and such other documents as they may reasonably request in order to facilitate the disposition of the Warrant and/or Warrant Shares owned by them;

(e)                use commercially reasonable efforts to register and to qualify the securities covered by such registration statement under such other securities or blue sky laws of such jurisdictions as shall be reasonably requested by the Holders; provided, however, that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process or subject itself to taxation in any such states or jurisdictions;

(f)                upon any underwritten public offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, with the managing underwriter of such offering, provided each Holder participating in such underwriting shall also enter into and perform its obligations under such underwriting agreement;

(g)               notify each Holder holding Registrable Securities covered by such registration statement at any time when a prospectus relating thereto is required to be delivered under the Securities Act of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing and, at the request of such Holder, prepare and file via EDGAR a supplement to or amendment of such prospectus pursuant to Rules 172 and 424(b) under the Securities Act so that such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing;

(h)              provide a transfer agent and registrar (which may be the same entity and which may be the Company) for such Registrable Securities; and

(i)                subject to all of the other provisions of this Agreement, use commercially reasonable efforts to take all other steps necessary to effect the registration of such Registrable Securities contemplated hereby.

The Company may suspend the use of a prospectus included in any registration statement filed pursuant to this Agreement if the Company is then in possession of material, non-public information, the disclosure of which the Board of Directors has reasonably determined in good faith would have a material adverse effect upon the Company. The Company shall promptly notify all Holders of Registrable Securities included in such registration statement upon such determination by the Board of Directors and, upon receipt of such notice, each such Holder shall immediately discontinue any sales of Registrable Securities pursuant to such registration statement.

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7.5                 Indemnification.

(a)                Indemnification by Company. In connection with any registration under Section 7, the Company shall indemnify, to the extent permitted by law, each Holder covered by a registration statement and each of its officers, directors, managers, partners, employees and Affiliates, against all losses, claims, damages and liabilities caused by any untrue, or alleged untrue, statement of a material fact contained in any registration statement or prospectus or notification or offering circular (and as amended or supplemented if the Company furnishes any amendments or supplements) or any preliminary prospectus or caused by any omission, or alleged omission, to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, except insofar as the same are caused by or contained in any information furnished in writing to the Company by such Holder expressly for use therein or by such Holder’s failure to deliver a copy of the registration statement or prospectus or any amendments or supplements thereto after the Company has furnished such Holder with copies of the same.

(b)               Indemnification by Holder. In connection with any registration under Section 7, the Holder shall indemnify, to the extent permitted by law, the Company and each of its officers, directors, managers, partners, employees and Affiliates, against all losses, claims, damages and liabilities caused by any untrue, or alleged untrue, statement of a material fact contained in any registration statement or prospectus or notification or offering circular (and as amended or supplemented if the Company furnishes any amendments or supplements) or any preliminary prospectus or caused by any omission, or alleged omission, to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, but only insofar as the same are caused by or contained in any information furnished in writing to the Company by such Holder expressly for use therein; provided, however, that the obligation to indemnify shall be limited to the net amount of proceeds received by the Holder from the sale of its Registrable Securities pursuant to such registration statement.

(c)                Procedures. Promptly upon receipt by an indemnified party of notice of the commencement of any action against such indemnified party in respect of which indemnity or reimbursement may be sought against any indemnifying party under this Warrant, the indemnified party shall notify the indemnifying party in writing of the commencement of such action (provided that the failure to give prompt notice shall not impair the indemnified party’s right to indemnification hereunder to the extent such failure has not prejudiced the indemnifying party). In case notice of commencement of any such action is given to the indemnifying party as above provided, the indemnifying party shall be entitled to participate in and, to the extent it may wish, jointly with any other indemnifying party similarly notified, to assume the defense of such action at its own expense, with counsel chosen by it and reasonably satisfactory to such indemnified party. The indemnified party has the right to employ separate counsel in any such action and participate in the defense of such action, but the fees and expenses of such counsel (other than reasonable costs of investigation) shall be paid by the indemnified party unless the indemnifying party either agrees to pay the same or fails to assume the defense of such action with counsel reasonably satisfactory to the indemnified party. No indemnifying party shall be liable for any settlement entered into without its consent, which consent shall not be unreasonably withheld.

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(d)               Contribution. If the indemnification provided for in this Section 7.4 is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, liability, claim, damage or expense referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party hereunder, shall contribute to the amount paid or payable by such indemnified party as a result of such loss, liability, claim, damage or expense in such proportion as is appropriate to reflect the relative fault of the indemnifying party, on the one hand, and of the indemnified party, on the other hand, in connection with the statements or omissions that resulted in such loss, liability, claim, damage or expense as well as any other relevant equitable considerations; provided, however, that in no event shall any contribution by a Holder under this Section 7.5(d) when combined with any amounts paid pursuant to Section 7.5(a) exceed the net proceeds from the offering received by such Holder, except in the case of intentional fraud by such Holder. The relative fault of the indemnifying party and of the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties’ relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission.

(e)                Survival. The obligations of the Company and Holders under this Section 7.5 shall survive the completion of any offering of securities in a registration statement under this Section 7 or otherwise.

8.AVAILABILITY OF INFORMATION.

The Company shall comply with the reporting requirements of Section 13 and 15(d) of the Exchange Act and all public information reporting requirements of the Commission (including Rule 144 promulgated by the Commission under the Securities Act) from time to time in effect and relating to the availability of an exemption from the Securities Act for the sale of any Restricted Securities. The Company shall also cooperate with each Holder holding Restricted Securities in supplying such information as may be necessary for such Holder to complete and file any information reporting forms presently or hereafter required by the Commission as a condition to the availability of an exemption from the Securities Act for the sale of any Restricted Securities.

9.COVENANTS OF THE COMPANY.

9.1                 Availability of Common Stock for Issuance. The Company shall not allot or issue Common Stock such that the number of authorized but unissued shares of Common Stock would at any time be insufficient to permit the exercise of this Warrant into shares of Common Stock. If at any time there are insufficient authorized but unissued shares of Common Stock to permit the exercise of the Warrant into Common Stock, the Company shall take all such corporate actions (including convening a general meeting of the Company) as may be necessary to authorize a sufficient number of additional shares of Common Stock for allotment and issuance in respect of any exercise of this Warrant.

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9.2                 Transfer Books. The Company shall not close its books against the transfer of this Warrant or any Warrant Shares in any manner which interferes with the timely exercise of this Warrant in accordance with the express terms hereof.

9.3                 Governmental Filings and Approvals. The Company shall assist and cooperate with the Holder in making any required governmental filings or obtaining any required governmental approvals before or in connection with any exercise of this Warrant (including making any filings required to be made by the Company).

10.OWNERSHIP, TRANSFER AND SUBSTITUTION OF WARRANTS.

10.1             Ownership of Warrants. The Company shall cause to be kept at its Principal Office a register for the registration and transfer of this Warrant. The names and addresses of the Holders, the transfer thereof and the names and addresses of any transferees of this Warrant shall be registered in such register. The Person(s) in whose names this Warrant shall be so registered shall be deemed and treated as the owner and Holder thereof for all purposes of this Warrant, and the Company shall not be affected by any notice or knowledge to the contrary.

10.2             Transfer and Exchange of Warrants. Subject to the transfer restrictions referred to in the legend herein, this Warrant and all rights hereunder are transferable, in whole or in part, without charge to the Holder, upon surrender of this Warrant with a properly executed assignment (in the form of Exhibit B) at the Company’s Principal Office. Upon such surrender and, if required, such payment, the Company at its expense shall execute and deliver a new Warrant or Warrants in the name of the assignee or assignees, as applicable, and in the denomination or denominations specified in Exhibit B, and this Warrant shall promptly be cancelled. Upon any assignment of only a portion of this Warrant, the Company will issue and deliver to the assignor a new Warrant or Warrants with respect to the portion of this Warrant not so transferred.

10.3             Replacement of Warrants. Upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of any Warrant and, in the case of any such loss, theft or destruction of any Warrant, upon delivery of indemnity satisfactory to the Company in form and amount (which shall be the only security the Company shall seek from such Person) or, in the case of any such mutilation, upon surrender of such Warrant for cancelation at the Company’s Principal Office, the Company at its sole expense shall execute and deliver, in lieu thereof, a new Warrant of like tenor and exercisable for an equivalent number of Warrant Shares as the Warrant so lost, stolen, destroyed, or mutilated, and dated the date hereof.

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11.DEFINITIONS.

As used herein, unless the context otherwise requires, the following terms have the following respective meanings:

Additional Shares” means any and all shares of Common Stock or Convertible Securities of the Company issued or sold (or, pursuant to Section 2.3, deemed to be issued) by the Company after the date hereof, whether or not subsequently reacquired or retired by the Company, other than (a) Common Stock issued upon conversion or exercise of, or in the form of dividends or interest paid in kind with respect to, Convertible Securities outstanding as of the date hereof (to the extent not amended or modified after the date hereof), or issued after the date hereof so long as the anti-dilution provisions of Section 2.2 were complied with or were inapplicable with respect to the initial issuance by the Company of such Convertible Securities, (b) any Warrant Shares (and the shares of Common Stock issuable pursuant to the Other Lender Warrants), (c) shares of Common Stock issued in connection with any dividend or distribution for which adjustment is made pursuant to Section 2.3 hereof, (d) any shares of Common Stock permitted to be issued by the Credit Agreement, or (e) any restricted shares of Common Stock or Common Stock issued upon exercise or conversion of Convertible Securities issued in connection with the Company’s 2012 Equity Incentive Plan, as amended, (f) any shares of Common Stock issued in connection with a bona fide business acquisition of or by the Company, whether by merger, consolidation, sale of assets, sale or exchange of stock, or issued in connection with any stock split, stock dividend, reclassification or similar non-economic event by the Company.

Appraised Value” means the value of any securities or other property as finally determined by the Appraiser, without premium for control or discount for minority interests, illiquidity or minority restrictions on transfer. The Appraiser shall be directed to determine the Appraised Value of such securities or property as soon as practicable, but in no event later than 30 days from the date of its selection. The determination of the Appraised Value by the Appraiser will be conclusive and binding on all parties to this Warrant. The Appraised Value of each Warrant Share at a time when (a) the Company is not a reporting company under the Exchange Act and (b) the Common Stock is not traded in the organized securities markets, shall, in all cases, be calculated by determining the Appraised Value of the entire Company taken as a whole (after giving effect to the repayment of any then outstanding Funded Debt), and by dividing that value by the aggregate number of shares of Common Stock then outstanding (measured on a Fully-Diluted Basis), without premium for control or discount for minority interests, illiquidity or restrictions on transfer. In no event shall the Appraised Value of a Warrant Share be less than the per share consideration received or receivable with respect to the applicable shares of Common Stock in connection with any pending Fundamental Transaction. The prevailing market prices for any security or property will not be dispositive of the Appraised Value thereof.

Appraiser” means a valuation firm selected by the Holder and reasonably acceptable to the Company. If the Holders and the Company cannot agree on an Appraiser within 15 days after the applicable Valuation Date, then, the Company, on the one hand, and the Holder, on the other hand, shall each select an Appraiser within 21 days of the applicable Valuation Date and those two Appraisers shall select within 25 days after the applicable Valuation Date an independent Appraiser to determine the Appraised Value. Any and all fees, costs and other expenses of the Appraiser(s) shall be borne by the Company.

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Average Market Value” means the average of the Closing Prices for the security in question for the 10 consecutive trading days immediately preceding the date of determination.

Board of Directors” means the Board of Directors of the Company or any other body that exercises ultimate executive authority over the business and affairs of the Company, including any executive committee of such Board of Directors.

Business Day” means any day other than a Saturday or a Sunday or a day on which commercial banking institutions in Little Rock, Arkansas are authorized or obligated by law or executive order to be closed. Any reference to “days” (unless Business Days are specified) shall mean calendar days.

Capital Stock” means, as to any Person, its units or membership interests, shares of common stock, preferred stock and/or any other capital stock, or other equity interests authorized from time to time, and any other securities, options, interests, participations or other equivalents (however designated) of or in such Person, whether voting or nonvoting, including options, warrants, phantom stock, stock appreciation rights, convertible notes or debentures, stock purchase rights and all agreements, instruments, documents and securities convertible, exercisable or exchangeable, in whole or in part, into any one or more of the foregoing. Unless the context indicates otherwise, references herein to Capital Stock refer to Capital Stock of the Company.

Closing Price” means, for any given trading day, (a) if the primary market for the security in question is a national securities exchange registered under the Exchange Act or some other market or quotation system in which last sale transactions are reported on a contemporaneous basis, then the last reported sales price of such security for such day, or, if there has not been a sale of such security on such trading day, then the highest closing or last bid quotation therefor on such trading day (excluding, in any case, any price that is not the result of bona fide arm’s length trading), or (b) if the primary market for the security in question is not an exchange or quotation system in which last sale transactions are contemporaneously reported, then the highest closing or last bona fide bid or asked quotation by disinterested Persons in the over-the-counter market on such trading day as reported by the Financial Industry Regulatory Authority through its interdealer quotation system or its successor or such other generally accepted source of publicly reported bid quotations as the Holder and the Company may designate.

Commission” means the Securities and Exchange Commission or any other federal agency at the time administering the Securities Act.

Common Stock” has the meaning given to such term in the introduction to this Warrant.

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Company” shall have the meaning given to such term in the introduction to this Warrant.

Convertible Securities” means any (i) evidences of indebtedness, (ii) options, rights, or warrants (other than this Warrant) to subscribe for, purchase or otherwise acquire shares of Common Stock, or (iii) other securities directly or indirectly convertible into or exchangeable for shares of Common Stock.

Credit Agreement” has the meaning given to such term in the introduction to this Warrant.

Exchange Act” means the Securities Exchange Act of 1934, or any similar federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect at the time.

Expiration Date” has the meaning given to such term in the introduction to this Warrant.

Fair Market Value” means (a) as to securities regularly traded on a national securities exchange or some other nationally-recognized market quotation system, the Average Market Value, and (b) as to all securities not regularly traded on a national securities exchange or some other nationally-recognized market quotation system and as to all other property, the fair market value of such securities or property as mutually agreed upon by the Company and the Holder, without premium for control and without discount for minority interests, illiquidity or restrictions on transfer, at the time of the transaction requiring the applicable determination of Fair Market Value pursuant to this Warrant (each such authorization, a “Valuation Event”); provided, however, that, if the Company and the Holder are unable to agree on any calculation of Fair Market Value in accordance with the provisions hereof within 30 days after the occurrence of any Valuation Event, then the Fair Market Value of such securities and/or other property will be its Appraised Value.

Fully-Diluted Basis” means at any time (a) as applied to any calculation of the number of securities of the Company, after giving effect to (i) all shares of Common Stock Stock of the Company outstanding at the time of determination, and (ii) all shares of Common Stock issuable upon the exercise of any Convertible Security or Option outstanding as of the date hereof (including any Incentive Award outstanding as of the date hereof), and (b) as applied to any calculation of value, after giving effect to the foregoing securities and the payment of any consideration payable upon the exercise of any Convertible Security or Option referred to in clause above if such Convertible Security or Option were exercisable at such time.

Fundamental Transaction” has the meaning given to such term in Section 3 of this Warrant.

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Funded Debt” means, with respect to any Person and without duplication, (a) all borrowed money of such Person, whether or not evidenced by bonds, debentures, notes or similar instruments, (b) all obligations of such Person as lessee under capital leases that have been or should be recorded as liabilities on a balance sheet of such Person in accordance with generally accepted accounting principles, consistently applied, (c) all obligations of such Person to pay the deferred purchase price of property or services (excluding trade accounts payable in the ordinary course of business and costs in excess of billings), (d) all indebtedness secured by a lien or other encumbrance on the property of such Person, whether or not such indebtedness shall have been assumed by such Person; provided, however, that if such Person has not assumed or otherwise become liable for such indebtedness, then such indebtedness shall be measured at the lesser of (i) Fair Market Value of such property securing such indebtedness at the time of determination and (ii) the amount of such indebtedness secured thereby, (e) all obligations, contingent or otherwise, with respect to the face amount of all letters of credit (whether or not drawn), bankers’ acceptances and similar obligations issued for the account of such Person, (f) all hedging obligations of such Person and (g) all contingent liabilities of such Person.

Governing Documents” means the Company’s articles of incorporation, as amended from time to time, and similar agreements and documents governing the rights and obligations of Shareholders and directors of the Company.

Holder” means the Purchaser and each of its successors and/or assigns that at any time holds or otherwise owns any portion of this Warrant or any Warrant Shares. If at any time there shall exist more than one Holder, then, with respect to any action, approval or consent of the Holder required or otherwise permitted pursuant to the provisions hereof, such action, approval or consent shall be deemed to have been taken, received or otherwise obtained if such action, approval or consent is taken, received or otherwise obtained by or from Requisite Holders, unless the context otherwise requires.

Holders’ Counsel” has the meaning given to such term in Section 7.4(b).

Information” has the meaning given to such term in Section 7.4(i).

Initial Warrant Exercise Price” has the meaning given to such term in the introduction to this Warrant.

Other Lender Warrants” means the Warrants to Purchase Common Stock of the Company being issued as of the date hereof to the other lenders that are parties to the Credit Agreement.

Person” means an individual, a partnership, a limited liability company, a corporation, an association, a joint stock company, a trust, a joint venture, an unincorporated organization or any federal, state, county or municipal governmental or quasi-governmental agency, department, commission, board, bureau, instrumentality or similar entity, foreign or domestic, having jurisdiction over either the Company or any Holder.

Principal Office” means the offices of the Company located at 1900 Grant Street, Suite #720, Denver, CO, 80203, or such other location as the Company may notify the Holders in writing.

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Purchaser” has the meaning given to such term in the introduction to this Warrant.

Registrable Securities” means (a) the Warrant Shares, and (b) all of the shares of Common Stock issued or issuable, directly or indirectly, with respect to the securities referred to in clause (a) above by way of a dividend or split in connection with a combination of shares, recapitalization, merger, consolidation or other reorganization or Fundamental Transaction. As to any particular Registrable Securities, such securities will cease to be Registrable Securities upon the earlier of (x) the date upon which such Registrable Securities have been registered under the Securities Act, and registered and qualified under the securities laws of all applicable states or (y) at such time as all of the Registrable Securities of a Holder are transferable without limitation or restriction by such Holder in a single brokerage transaction under the provisions of Rule 144 or any similar rule then in effect.

Registration Expenses” means all expenses incident to the Company’s performance of or compliance with Section 7, including all registration and filing fees (including fees of the Commission and a national stock exchange or national securities market), all fees and expenses of complying with state securities or blue sky laws, all word processing, duplicating and printing expenses, messenger and delivery expenses, the fees and disbursements of counsel for the Company and of its independent public accountants, including the expenses of any special audits or “cold comfort” letters in underwritten offerings required by or incident to such performance and compliance, the reasonable fees and disbursements of Holders’ Counsel retained by the Holders with respect to any Warrant and/or Warrant Shares being registered, the Company’s premiums and other costs of policies of insurance against liabilities arising out of the public offering of such securities and any fees and disbursements of underwriters customarily paid by issuers or sellers of securities, but excluding underwriting discounts and commissions and transfer taxes, if any, and excluding any underwriting or distribution expenses of the Holders or other expenses of the Holders not related to the Company’s compliance with Section 7.

Requisite Holders” means Holders that own or otherwise hold more than 50% of the Warrant Shares issuable upon exercise of this Warrant.

Resolving Accountant” means a certified public accounting firm, of local or regional recognition, jointly selected by the Company and the Holder, having no past or current business relationship with such Person (a “Qualified Firm”); provided, that if the Company and the Holder are unable to agree on a Resolving Accountant, either of such Persons may request the Denver, Colorado office of the American Arbitration Association to designate a Qualified Firm with offices in Colorado.

Restricted Securities” means all of the following: (a) any Warrants bearing the legend or legends contained herein or substantially similar thereto; (b) any Warrant Shares that have been issued upon the exercise of this Warrant and that are evidenced by a certificate or certificates bearing the applicable legend or legends contained herein or substantially similar thereto; and (c) unless the context otherwise requires, any Warrant Shares that are at the time issuable upon the exercise of this Warrant and that, when so issued, will be evidenced by a certificate or certificates bearing the applicable legend or legends contained herein or substantially similar thereto.

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Securities Act” means the Securities Act of 1933, or any similar federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be amended and in effect at the time.

Shareholder” means a holder of Common Stock.

Transfer” means any sale, transfer, issuance, assignment, pledge or other disposition or conveyance of Common Stock of the Company.

Valuation Date” means the applicable date in respect of the determination of Fair Market Value.

Warrant” means this Warrant to Purchase Common Stock of the Company, as the same may be amended, restated or otherwise modified from time to time, together with any and all replacement and/or substitute warrants issued with respect hereto.

Warrant Exercise Price” has the meaning given to such term in Section 2.1.

Warrant Shares” means any Common Stock or Other Securities issued or issuable in connection with any exercise of this Warrant, in each case as such number may be adjusted from time to time pursuant to the terms hereof.

12.REMEDIES.

The Company stipulates that the remedies at law available to the Holder in the event of any default or threatened default by the Company in the performance of or compliance with any of the terms of this Warrant are not and will not be adequate and that, to the fullest extent permitted, such terms may be specifically enforced by a decree for the specific performance of any agreement contained herein or by an injunction against a violation of any of the terms hereof or otherwise.

13.NO EFFECT ON LENDER RELATIONSHIP.

The Company acknowledges and agrees that, notwithstanding anything in this Warrant or the Credit Agreement to the contrary, nothing contained in this Warrant shall affect, limit or impair the rights and remedies of any Holder or any of its Affiliates (a) in its or their capacity as a lender or as agent for lenders to the Company or any of its Subsidiaries pursuant to any agreement under which the Company or any of its Subsidiaries has borrowed money, including the Credit Agreement or (b) in its or their capacity as a lender or as agent for lenders to any other Person who has borrowed money. Without limiting the generality of the foregoing, any such Person, in exercising its rights as a lender, including making its decision on whether to foreclose on any collateral security, will have no duty to consider (x) its or any of its Affiliates’ status as a Holder, (y) the interests of the Company or its Subsidiaries or (z) any duty it may have to any other Holders or any Shareholders, except as may be required under the applicable loan documents or by commercial law applicable to creditors generally. No consent, approval, vote or other action taken or required to be taken by any Holder in such capacity shall in any way impact, affect or alter the rights and remedies of the Purchaser or any of its Affiliates as a lender or agent for lenders.

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14.CONFLICTS OF INTEREST.

The Company acknowledges (a) that the Holder may, directly or indirectly, through ownership interests or lending relationships in a variety of enterprises, engage in activities that overlap with or compete with those in which the Company, directly or indirectly, may engage, and (b) that the Holder may have an interest in the same areas of corporate opportunity as the Company and its Affiliates. Therefore, the Holder shall to the fullest extent permitted by law have no duty to refrain from (i) providing financing or financial services to persons in the same or similar activities or lines of business as the Company or (ii) providing financing or financial services to any client, customer or vendor of the Company, and neither the Holder nor any officer, director or employee thereof shall, to the fullest extent permitted by law, be deemed to have breached any obligation to the Company solely by reason of the Holder engaging in any such activity.

15.NOTICES.

Any notice or request hereunder shall be in writing and may be given only by, and shall be deemed to have been received upon: (a) registered or certified mail, return receipt requested, on the date on which such notice or request is received as indicated in such return receipt; (b) delivery by a nationally recognized overnight courier, one Business Day after deposit with such courier; or (c) facsimile or other electronic transmission upon telephone or further electronic communication from the recipient acknowledging receipt (whether automatic or manual from recipient) of such facsimile or other electronic transmission. In the case of the Holder, such notices and communications shall be addressed to its address as set forth in the Credit Agreement for notices, unless the Holder shall notify the Company that notices and communications should be sent to a different address (or facsimile number or electronic mail address), in which case such notices and communications shall be sent to the address (or facsimile number or email address) specified by the Holder.

16.REPRESENTATIONS.

The Company represents and warrants to the Holder that neither the issuance of this Warrant nor the issuance of Warrant Shares upon exercise of this Warrant, or any rights of the Holder hereunder, violates or conflicts with, in any material respect, the Company’s Governing Documents or any agreement, document or instrument to which the Company (or any of its affiliates) is a party, except where such violation or conflict would not be expected to have a material adverse effect, and that no authorization, approval or other action by, or notice to, any other Person is required, except for those that have been obtained or made and are in full force and effect.

20
 

17.MISCELLANEOUS.

This Warrant and any term hereof may be changed, waived, discharged or terminated only by an instrument in writing signed by the Company and the Holder. This Warrant shall be construed, interpreted and enforced in accordance with, and governed by, the laws of the State of Arkansas without giving effect to doctrines relating to conflicts of laws. Unless the context of this Warrant clearly requires otherwise, references to the plural include the singular, references to the singular include the plural, the term “including” is not limiting, and the term “or” has, except where otherwise indicated, the inclusive meaning represented by the phrase “and/or.” Use of “herein,” “hereof,” “hereby” or similar terms refer to this Agreement as a whole. References herein to the “Holder” or “Holders” of this Warrant include the singular and the plural, it being understood that there may be one or more Holders of this Warrant at any particular time. References herein to Exhibits refer to the exhibits attached hereto, which are incorporated herein and made a part hereof. The section headings in this Warrant are for purposes of convenience only and shall not constitute a part hereof. This Warrant may be executed in counterparts. Faxed or portable document format (.pdf) copies of the manually executed signature pages to this Warrant will be fully binding and enforceable without the need for the delivery of the manually executed signature pages. This Warrant and all rights hereunder shall survive the termination of the Credit Agreement and the payment of all obligations thereunder. This Warrant and the rights evidenced hereby shall be binding upon and shall inure to the benefit of the parties hereto and their successors and assigns.

[SIGNATURE PAGE FOLLOWS]

21
 

IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed as of the date of this Warrant.

  COMPANY:
     
  LILIS ENERGY, INC.,
  a Nevada corporation
     
  By: /s/ Abraham Mirman
  Name: Abraham Mirman
  Title: CEO

 

The undersigned Holder is executing this Warrant
to acknowledge its obligations under Section 7:

 

HOLDER:

HEARTLAND BANK,

an Arkansas state bank

 

By: /s/ Phil Thomas  
Name: Phil Thomas  
Title: CLO/EVP  

22
 

Exhibit A

FORM OF SUBSCRIPTION

[To be executed only upon exercise of Warrant]

To [____________________________]

The undersigned registered Holder of the Warrant accompanied herewith hereby irrevocably exercises such Warrant for, and purchases thereunder, ______1 shares of Common Stock and herewith [___] makes a Cashless Exercise or [___] makes payment of [$_________ by [insert payment method]]. Such Holder further requests that the certificates for such shares of Common Stock be issued in the name of, and delivered to, _______________________, whose address is __________________________.

Dated:

  (Signature must conform in all respects to name of
Holder as specified on the face of Warrant)
   
   
  (Street Address)
   
   
  (City)               (State)               (Zip Code)

 

 

1 Insert here the number of shares of Common Stock called for on the face of this Warrant (or, in the case of a partial exercise, the portion thereof as to which this Warrant is being exercised), in either case without making any adjustment for Additional Shares or any other stock or Other Securities or property or cash which, pursuant to the adjustment provisions of this Warrant, may be delivered upon exercise. In the case of a partial exercise, a new Warrant or Warrants will be issued and delivered, representing the unexercised portion of the Warrant, to the Holder surrendering the Warrant.

Exhibit A - 1
 

Exhibit B

FORM OF ASSIGNMENT

[To be executed only upon transfer of Warrant]

For value received, the undersigned registered Holder of the within Warrant hereby sells, assigns and transfers unto _________________________ the rights represented by such Warrant to purchase _____2 shares of Common Stock of Lilis Energy, Inc. (the “Company”) to which and such Warrant relates, and appoints ____________________________ its attorney-in-fact to make such transfer on the books of the Company maintained for such purpose, with full power of substitution in the premises.

Dated:

  (Signature must conform in all respects to name of
Holder as specified on the face of Warrant)
   
   
  (Street Address)
   
   
  (City)               (State)               (Zip Code)

 

2 Insert here the number of shares of Common Stock called for on the face of this Warrant (or, in the case of a partial exercise, the portion thereof as to which this Warrant is being exercised), in either case without making any Adjustment for Additional Shares or any other stock or Other Securities or property or cash which, pursuant to the adjustment provisions of this Warrant, may be delivered upon exercise. In the case of a partial exercise, a new Warrant or Warrants will be issued and delivered, representing the unexercised portion of the Warrant, to the Holder surrendering the Warrant.

 

 

Exhibit B - 1

 

Exhibit 10.5

 

LILIS ENERGY, INC.
2012 EQUITY INCENTIVE PLAN

STOCK OPTION AWARD AGREEMENT

 

This Stock Option Award Agreement (the “Agreement”), is made as of the 1st day of October 2014, by and between Lilis Energy, Inc., a Nevada corporation (the “Company”), and Nuno Brandolini (the “Participant”).

WHEREAS, the Company desires to encourage and enable the Participant to acquire a proprietary interest in the Company through ownership of shares of the Company’s Common Stock, par value $0.0001 per share (the “Shares”), pursuant to the terms and conditions of the Company’s 2012 Equity Incentive Plan (the “Plan”) and this Agreement. Such ownership will provide the Participant with additional incentive to promote the success of the Company.

NOW, THEREFORE, in consideration of the mutual covenants hereinafter set forth and for other good and valuable consideration, the parties agree as follows:

1.             Definitions. For purposes of this Agreement, all capitalized terms used herein and not otherwise defined herein shall have the meanings ascribed to them in the Plan.

2.             Grant of Option. The Company hereby grants to the Participant options (the “Options”) to purchase 250,000 Shares at the exercise price (the “Exercise Price”) of $2.13 per Share, subject to the terms and conditions of this Agreement and the Plan.

3.             Expiration Date. The Options granted hereby shall expire upon the earlier of (a) five (5) years from the date the Options vest and become exercisable pursuant to Section 4 or (b) October 1, 2024 (such date being the “Expiration Date”). Except as may be otherwise set forth herein, the Options may not be exercised after the Expiration Date.

4.             Vesting. The Options shall be fully vested and exercisable by the Participant on the date first set forth herein.

5.             Separation from Service.

(a)                If the Participant’s service is terminated by the Company for Cause (as defined in the Plan), then all Options shall immediately terminate and no longer be exercisable.

(b)                If the Participant terminates his service, then all Options shall terminate and no longer be exercisable on the date that is 90 days after the date of termination of the Participant’s Continuous Service (as defined in the Plan), but not later than the Expiration Date.

(c)                If, before the Expiration Date, the Participant’s service is terminated by the Company other than for Cause (as defined in the Plan), upon a Change in Control (as defined in the Plan) of the Company or upon the death or Disability (as defined in the Plan) of the Participant, then all vested Options shall remain exercisable until the Expiration Date.

 

(d)                Notwithstanding anything herein to the contrary, in the event of Participant’s Disability (as defined in the Plan), the Participant may exercise the Options at any time within one (1) year after the Date of Termination (as defined in the Plan) but not later than the Expiration Date.

(e)                Notwithstanding anything herein to the contrary, in the event of Participant’s death or if a Participant should die within a period of 90 days after termination of the Participant’s Continuous Service for reason other than Cause (as defined in the Plan), the personal representatives of the Participant’s estate or the person or persons who shall have acquired the Options from the Participant by bequest or inheritance may exercise the Options at any time within one (1) year after the date of death, but not later than the Expiration Date.

6.             Sale, Merger or Dissolution. In the event of a Change in Control, the Company shall give the Participant notice thereof and the Options, whether or not currently vested and exercisable, shall become immediately vested and exercisable immediately prior to the effective date of such event, and the Board shall have the power and discretion to provide alternatives regarding the terms and conditions for the exercise of, or modification of, the Options in accordance with the Plan.

7.             Non-Assignability. The Option granted hereby and any right arising thereunder may not be transferred, assigned, pledged or hypothecated (whether by operation of law or otherwise), except by will or the applicable laws of descent and distribution, and the Options and any rights arising thereunder shall not be subject to execution, attachment or similar process. The Options shall be exercisable during the lifetime of the Participant only by the Participant. Any attempted assignment, transfer, pledge, hypothecation or other disposition of an Option not specifically permitted herein or in the Plan shall be null and void and without effect.

8.             Mode of Exercise.

(a)                The Options may be exercised by delivery of an irrevocable notice of exercise in by the Participant to the Company, stating the number of shares being purchased.

(b)               The right to receive the Shares of the Company’s Common Stock upon exercise of the Options shall be conditioned upon the delivery by the Participant of payment for shares and withholding taxes incurred by reason of the exercise and certain representations, if requested by the Administrator. Acceptable forms of consideration for exercising the Options may include:

(1)               cash, check or wire transfer (denominated in U.S. Dollars);

(2)               subject to the Company’s discretion to refuse for any reason and at any time to accept such consideration and subject to any conditions or limitations established by the Administrator, other shares of the Company’s Common Stock held by the Participant which have a Fair Market Value on the date of surrender equal to the aggregate exercise price of the Options to be exercised;

2
 

(3)               delivery of a notice that the Participant has placed a market sell order with a broker with respect to the Shares then issuable upon exercise of the Options, and that the broker has been directed to pay a sufficient portion of the net proceeds of the sale to the Company in satisfaction of the aggregate payments required; provided, that payment of such proceeds is then made to the Company upon settlement of such sale;

(4)               subject to the Company’s discretion to refuse for any reason and at any time to accept such consideration and subject to any conditions or limitations established by the Administrator, cashless “net exercise” arrangement pursuant to which the Company will reduce the number of shares issued upon exercise by the largest whole number of shares having an aggregate Fair Market Value that does not exceed the aggregate exercise price, together with required withholding amounts (if any), provided that the Company shall accept a cash or other payment from the Participant to the extent of any remaining balance not satisfied by such reduction in the number of whole shares to be issued;

(5)               such other consideration and method of payment for the issuance of Shares of Common Stock to the extent permitted by Applicable Laws and acceptable to the Administrator; and

(6)               any combination of the foregoing methods of payment.

9.             Recapitalization. The number of Shares covered by the Options and the Exercise Price shall be proportionately adjusted for any increase or decrease in the number or type of issued Shares resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company.  The conversion of any convertible securities of the Company shall not be deemed to have been “effected without receipt of consideration.”  Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive.  

10.           Plan Controlling. This Agreement is intended to conform in all respects with the requirements of the Plan. Inconsistencies between the requirements of this Agreement and the Plan shall be resolved according to the terms of the Plan. The Participant acknowledges receipt of a copy of the Plan.

11.           Rights Prior to Exercise of Option. The Participant shall not have any rights as a shareholder with respect to any Shares subject to the Option prior to the date on which he is recorded as the holder of such Shares on the records of the Company.

12.           Withholding Taxes. The Company shall have the right to require the Participant or his beneficiaries or legal representatives to remit to the Company, in cash, an amount sufficient to satisfy any federal, state and local withholding tax requirements, including upon the grant, vesting or exercise of this Option. Whenever payments under the Plan or this Agreement are to be made to any Participant in cash, such payments shall be net of any amounts sufficient to satisfy all applicable taxes, including without limitation, all applicable federal, state and local withholding tax requirements to be withheld or submitted by the Company concerning such payments. The Board may, in its sole discretion, allow the Participant to satisfy withholding tax obligations by electing to have the Company withhold from the Shares to be issued upon exercise of an Option that number of Shares having a Fair Market Value equal to the minimum amount required to be withheld.  The Fair Market Value of the Shares to be withheld shall be determined on the date that the amount of tax to be withheld is to be determined.

3
 

13.           Section 409A. The Options granted hereunder are intended to comply with or be exempt from the requirements of Code Section 409A, and the Agreement shall be interpreted accordingly. In no event, however, shall the Company be liable to the Participant for any tax, penalties or interest that may be due in respect of any the Options as a result of the application of Code Section 409A.

14.           Governing Law. This Agreement and all rights arising hereunder shall be governed by, and construed and interpreted in accordance with, the laws of the State of Colorado.

NEITHER THE PLAN NOR THIS AGREEMENT SHALL BE CONSTRUED AS GIVING THE PARTICIPANT THE RIGHT TO BE RETAINED IN THE EMPLOY OR SERVICE OF THE COMPANY OR ANY AFFILIATE THEREOF, NOR SHALL THEY INTERFERE IN ANY WAY WITH THE RIGHT OF THE COMPANY OR ANY AFFILIATE THEREOF, AS APPLICABLE, TO TERMINATE THE PARTICIPANT’S EMPLOYMENT OR SERVICE AT ANY TIME WITH OR WITHOUT CAUSE. 

* * * * *

 

4
 

 

Executed as of the day and year first above written. 

  LILIS ENERGY, INC.
     
  By: /s/ Eric Ulwelling
  Name: Eric Ulwelling
  Title: Chief Financial Officer
     
  PARTICIPANT
     
  /s/ Nuno Brandolini
  Nuno Brandolini

 

 

5

 

Exhibit 10.6

 

LILIS ENERGY, INC.
2012 EQUITY INCENTIVE PLAN

STOCK OPTION AWARD AGREEMENT

 

This Stock Option Award Agreement (the “Agreement”), is made as of the 1st day of October 2014, by and between Lilis Energy, Inc., a Nevada corporation (the “Company”), and Nuno Brandolini (the “Participant”).

WHEREAS, the Company desires to encourage and enable the Participant to acquire a proprietary interest in the Company through ownership of shares of the Company’s Common Stock, par value $0.0001 per share (the “Shares”), pursuant to the terms and conditions of the Company’s 2012 Equity Incentive Plan, as amended (the “Plan”), and this Agreement. Such ownership will provide the Participant with additional incentive to promote the success of the Company.

NOW, THEREFORE, in consideration of the mutual covenants hereinafter set forth and for other good and valuable consideration, the parties agree as follows:

1.             Definitions. For purposes of this Agreement, all capitalized terms used herein and not otherwise defined herein shall have the meanings ascribed to them in the Plan.

2.             Grant of Option. The Company hereby grants to the Participant options (the “Options”) to purchase 200,000 Shares at the exercise price (the “Exercise Price”) of $2.13 per Share, subject to the terms and conditions of this Agreement and the Plan.

3.             Expiration Date. The Options granted hereby shall expire upon the earlier of (a) five (5) years from the date the Options vest and become exercisable pursuant to Section 4 or (b) February 13, 2024 (such date being the “Expiration Date”). Except as may be otherwise set forth herein, the Options may not be exercised after the Expiration Date.

4.             Vesting. The Options shall vest and be exercisable by the Participant in accordance with the following schedule:

  Date   Number of Options Vested
       
  February 13, 2015   66,667 Options
       
  February 13, 2016   66,667 Options
       
  February 13, 2017   66,666 Options

5.             Separation from Service.

(a)                If the Participant’s service is terminated by the Company for Cause (as defined in the Plan), then all Options shall immediately terminate and no longer be exercisable.

 
 

(b)                If the Participant terminates his service, then all Options shall terminate and no longer be exercisable on the date that is 90 days after the date of termination of the Participant’s Continuous Service (as defined in the Plan), but not later than the Expiration Date. No Options shall vest following the date of termination of the Participant’s Continuous Service (as defined in the Plan).

(c)               If, before the Expiration Date, the Participant’s service is terminated by the Company other than for Cause (as defined in the Plan), upon a Change in Control (as defined in the Plan) of the Company or upon the death or Disability (as defined in the Plan) of the Participant, then, all unexercisable Options shall become exercisable and remain exercisable until the Expiration Date. All vested Options not exercised within the period described in the preceding sentence shall terminate.

(d)                Notwithstanding anything herein to the contrary, in the event of Participant’s Disability (as defined in the Plan), the Participant may exercise the Options at any time within one (1) year after the Date of Termination (as defined in the Plan) but not later than the Expiration Date.

(e)                Notwithstanding anything herein to the contrary, in the event of Participant’s death or if a Participant should die within a period of 90 days after termination of the Participant’s Continuous Service for reason other than Cause (as defined in the Plan), the personal representatives of the Participant’s estate or the person or persons who shall have acquired the Options from the Participant by bequest or inheritance may exercise the Options at any time within one (1) year after the date of death, but not later than the Expiration Date.

6.             Sale, Merger or Dissolution. In the event of a Change in Control, the Company shall give the Participant notice thereof and the Options, whether or not currently vested and exercisable, shall become immediately vested and exercisable immediately prior to the effective date of such event, and the Board shall have the power and discretion to provide alternatives regarding the terms and conditions for the exercise of, or modification of, the Options in accordance with the Plan.

7.             Non-Assignability. The Option granted hereby and any right arising thereunder may not be transferred, assigned, pledged or hypothecated (whether by operation of law or otherwise), except by will or the applicable laws of descent and distribution, and the Options and any rights arising thereunder shall not be subject to execution, attachment or similar process. The Options shall be exercisable during the lifetime of the Participant only by the Participant. Any attempted assignment, transfer, pledge, hypothecation or other disposition of an Option not specifically permitted herein or in the Plan shall be null and void and without effect.

8.             Mode of Exercise.

(a)                The Options may be exercised by delivery of an irrevocable notice of exercise in by the Participant to the Company, stating the number of shares being purchased.

2
 

(b)               The right to receive the Shares of the Company’s Common Stock upon exercise of the Options shall be conditioned upon the delivery by the Participant of payment for shares and withholding taxes incurred by reason of the exercise and certain representations, if requested by the Administrator. Acceptable forms of consideration for exercising the Options may include:

(1)               cash, check or wire transfer (denominated in U.S. Dollars);

(2)               subject to the Company’s discretion to refuse for any reason and at any time to accept such consideration and subject to any conditions or limitations established by the Administrator, other shares of the Company’s Common Stock held by the Participant which have a Fair Market Value on the date of surrender equal to the aggregate exercise price of the Options to be exercised;

(3)               delivery of a notice that the Participant has placed a market sell order with a broker with respect to the Shares then issuable upon exercise of the Options, and that the broker has been directed to pay a sufficient portion of the net proceeds of the sale to the Company in satisfaction of the aggregate payments required; provided, that payment of such proceeds is then made to the Company upon settlement of such sale;

(4)              subject to the Company’s discretion to refuse for any reason and at any time to accept such consideration and subject to any conditions or limitations established by the Administrator, cashless “net exercise” arrangement pursuant to which the Company will reduce the number of shares issued upon exercise by the largest whole number of shares having an aggregate Fair Market Value that does not exceed the aggregate exercise price, together with required withholding amounts (if any), provided that the Company shall accept a cash or other payment from the Participant to the extent of any remaining balance not satisfied by such reduction in the number of whole shares to be issued;

(5)               such other consideration and method of payment for the issuance of Shares of Common Stock to the extent permitted by Applicable Laws and acceptable to the Administrator; and

(6)               any combination of the foregoing methods of payment.

9.             Recapitalization. The number of Shares covered by the Options and the Exercise Price shall be proportionately adjusted for any increase or decrease in the number or type of issued Shares resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company.  The conversion of any convertible securities of the Company shall not be deemed to have been “effected without receipt of consideration.”  Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive.  

10.           Plan Controlling. This Agreement is intended to conform in all respects with the requirements of the Plan. Inconsistencies between the requirements of this Agreement and the Plan shall be resolved according to the terms of the Plan. The Participant acknowledges receipt of a copy of the Plan.

3
 

11.           Rights Prior to Exercise of Option. The Participant shall not have any rights as a shareholder with respect to any Shares subject to the Option prior to the date on which he is recorded as the holder of such Shares on the records of the Company.

12.           Withholding Taxes. The Company shall have the right to require the Participant or his beneficiaries or legal representatives to remit to the Company, in cash, an amount sufficient to satisfy any federal, state and local withholding tax requirements, including upon the grant, vesting or exercise of this Option. Whenever payments under the Plan or this Agreement are to be made to any Participant in cash, such payments shall be net of any amounts sufficient to satisfy all applicable taxes, including without limitation, all applicable federal, state and local withholding tax requirements to be withheld or submitted by the Company concerning such payments. The Board may, in its sole discretion, allow the Participant to satisfy withholding tax obligations by electing to have the Company withhold from the Shares to be issued upon exercise of an Option that number of Shares having a Fair Market Value equal to the minimum amount required to be withheld.  The Fair Market Value of the Shares to be withheld shall be determined on the date that the amount of tax to be withheld is to be determined.

13.           Section 409A. The Options granted hereunder are intended to comply with or be exempt from the requirements of Code Section 409A, and the Agreement shall be interpreted accordingly. In no event, however, shall the Company be liable to the Participant for any tax, penalties or interest that may be due in respect of any the Options as a result of the application of Code Section 409A.

14.           Governing Law. This Agreement and all rights arising hereunder shall be governed by, and construed and interpreted in accordance with, the laws of the State of Colorado.

NEITHER THE PLAN NOR THIS AGREEMENT SHALL BE CONSTRUED AS GIVING THE PARTICIPANT THE RIGHT TO BE RETAINED IN THE EMPLOY OR SERVICE OF THE COMPANY OR ANY AFFILIATE THEREOF, NOR SHALL THEY INTERFERE IN ANY WAY WITH THE RIGHT OF THE COMPANY OR ANY AFFILIATE THEREOF, AS APPLICABLE, TO TERMINATE THE PARTICIPANT’S EMPLOYMENT OR SERVICE AT ANY TIME WITH OR WITHOUT CAUSE. 

* * * * *

 

4
 

 

Executed as of the day and year first above written. 

  LILIS ENERGY, INC.
     
  By: /s/ Eric Ulwelling
  Name: Eric Ulwelling
  Title: Chief Financial Officer
     
  PARTICIPANT
     
  /s/ Nuno Brandolini
  Nuno Brandolini

 

 

5

 

Exhibit 10.7

 

AMENDMENT TO EMPLOYMENT AGREEMENT

 

This Amendment to Employment Agreement (this “Amendment”) is effective as of October 1, 2014, by and between Lilis Energy, Inc. (f/k/a Recovery Energy, Inc.), a Nevada corporation (the “Company”), and Abraham Mirman (“Executive”). Reference is made to that certain Employment Agreement by and between the Company and Executive effective as of September 16, 2013 (the “Employment Agreement”). All capitalized terms not defined herein shall have the meanings assigned to such terms in the Employment Agreement. The Company and Executive are referred to in this Amendment collectively as the “Parties.”

 

WHEREAS, the Parties desire to amend certain terms of the Employment Agreement as set forth below.

NOW, THEREFORE, in consideration of the promises and mutual covenants and agreements herein contained and intending to be legally bound hereby, the Parties hereby agree as follows:

1.      Name Change. The Company has changed its name to Lilis Energy, Inc. All reference to “Recovery Energy, Inc.” in the Employment Agreement shall be replaced with “Lilis Energy, Inc.” Any and all references to the “Company” in the Employment Agreement shall refer to Lilis Energy, Inc.

2.      Amendments to Article I. Article I shall be amended to:

a.In Section 1.9 (“Measurement Date”), change “December 31, 2014” to “December 31, 2015”; and
b.In Section 1.14 (“Service Period”), change “December 31, 2014” to “December 31, 2015”.

3.      Amendment to Article II. Article II shall be amended by replacing “President” in Section 2.2 with “Chief Executive Officer.”

4.      No Other Changes. Except as modified or supplemented by this Amendment, the Employment Agreement remains unmodified and in full force and effect.

5.      Miscellaneous.

(a) Governing Law. This Amendment is entered into under, and shall be governed for all purposes by, the laws of the State of Colorado, without regard to conflicts of laws principles thereof. With respect to any claim or dispute related to or arising under this Amendment, the parties hereto hereby consent to the exclusive jurisdiction, forum and venue of the state and federal courts located in the State of New York.

(b) Binding Effect. This Amendment is intended to bind and inure to the benefit of and be enforceable by Executive, the Company and their respective heirs, successors and assigns, except that Executive may not assign his rights or delegate his obligations hereunder without the prior written consent of the Company.

 

(c) Counterparts. This Amendment may be executed in counterparts, each of which shall be deemed an original and all of which together shall constitute one and the same instrument.

(d) Savings Clause. If any provision of this Amendment or the application thereof is held invalid, the invalidity shall not affect other provisions or applications of this Amendment or the Employment Agreement which can be given effect without the invalid provisions or applications and to this end the provisions of this Amendment and the Employment Agreement are declared to be severable.

(e) Entire Agreement. The Employment Agreement, this Amendment, and any and all award agreements entered into between the Executive and the Company with respect to the equity awards granted pursuant to the Employment Agreement and this Amendment, constitute the entire agreement of the parties with regard to the subject matter hereof, and together contain all the covenants, promises, representations, warranties and agreements between the parties with respect to employment of Executive by the Company.

[Signature page follows.]

 

2
 

IN WITNESS WHEREOF, the Parties hereto have caused this Amendment to Employment Agreement to be executed as of the date first above written.

 

  LILIS ENERGY, INC.
     
  By: /s/ Eric Ulwelling
    Eric Ulwelling
     
  EXECUTIVE:
     
  /s/ Abraham Mirman
  Abraham Mirman

 

 

3

 

Exhibit 10.10

 

SEPARATION AGREEMENT

 

This Separation Agreement (this “Agreement”) is effective as of the 11th day of December, 2014, by and between Lilis Energy, Inc. (“Lilis” or the “Company”) and Bruce White (“White”). As used herein, “Parties” means, collectively, Lilis and White, and “Party” means either Lilis or White.

 

RECITALS

 

WHEREAS, Lilis and White are parties to that certain Independent Director Appointment Agreement dated April 27, 2012 (the “Appointment Agreement”);

 

WHEREAS, Lilis and White agree that White has informed the Company that he did not wish to stand for re-election to the Board of Directors of Lilis, and that his term of office will therefore terminate as of the date of the next annual meeting of shareholders of the Company (the “Separation Date”);

 

WHEREAS, Lilis and White now desire to enter into this Agreement in order to provide for the terms of the termination of White’s service with the Company.

 

NOW, THEREFORE, in consideration of the provisions herein, and other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged by Lilis and White, the Parties agree as follows:

 

1.Termination of Service. Effective as of the Separation Date, White will no longer serve as a member of the Board of Directors of Lilis or on any of the committees of the Board of Directors of Lilis.

 

2.Other Business and Activities. From and after the Separation Date, White shall be free to pursue any other business and activities in any industry. It is expressly acknowledged and agreed that White shall hereafter have no duty to present any potential transactions to Lilis or to disclose any other business information to which he may be privy.

 

3.Relinquishment of Rights. It is expressly acknowledged and agreed that White and the Company shall each relinquish, waive, and forfeit (a) all rights he or it may have under the Appointment Agreement and (b) any and all rights or claims he or it may have to any compensation or otherwise arising on or after the date hereof; provided, however, that the foregoing shall in no way affect White’s rights with respect to any securities awarded pursuant to the Company’s 2012 Equity Incentive Plan, as amended (the “Plan”), which shall continue to be governed in accordance with the terms of the Plan.

 

4.General Release.

 

(a)White, for himself, and Lilis, for itself, and each Party for its respective affiliates, successors, heirs, subrogees, assigns, principals, agents, partners, employees, associates, attorneys and representatives, voluntarily, knowingly and intentionally releases and discharges the other Party and its respective predecessors, successors, parents, subsidiaries, affiliates and assigns and each of its respective officers, directors, principals, shareholders, agents, attorneys, board members, and employees from any and all claims, actions, liabilities, demands, rights, damages, costs, expenses, and attorneys’ fees (including but not limited to any claim of entitlement for attorneys’ fees under any contract, statute, or rule of law allowing a prevailing party or plaintiff to recover attorneys’ fees), of every kind and description from the date White became a director of Lilis through the date of execution of this Agreement, except as set forth in subparagraphs (b) and Section 5 below (the “Released Claims”).

 

(b)The Released Claims include but are not limited to those which arise out of, relate to, or are based upon: (i) White’s service as a director of Lilis and the termination thereof, (ii) statements, acts or omissions by the Parties whether in their individual or representative capacities, (iii) express or implied agreements between the Parties, including any commitment made by White to make investments in the Company, and claims under any severance plan, (iv) any stock or stock option grant, agreement, or plan, except as provided in this Agreement, (v) all federal, state, and municipal statutes, ordinances, and regulations, including, but not limited to, claims of discrimination based on race, color, national origin, age, sex, sexual orientation, religion, disability, veteran status, whistleblower status, public policy, or any other characteristic of White under the Age Discrimination in Employment Act, the Older Workers Benefit Protection Act, the Americans with Disabilities Act, the Equal Pay Act, Title VII of the Civil Rights Act of 1964 (as amended), the Employee Retirement Income Security Act of 1974, the Rehabilitation Act of 1973, the Worker Adjustment and Retraining Notification Act, or any other federal, state, or municipal law prohibiting discrimination or termination for any reason, (vi) state and federal common law, including but not limited to claims for breach of contract, defamation, or emotional distress, (vii) taxes, penalties, or interest assessed against vested or unvested compensation paid, provided, or granted to White by the Company, including all such claims that may arise based on the application of Code Section 409A, and (viii) any claim which was or could have been raised; provided, notwithstanding anything to the contrary in this Agreement, the “Released Claims” shall not include rights or obligations under this Agreement or matters arising out of or in connection with claims by governmental authorities or self-regulatory organizations involving actual or potential violations of the securities laws, rules or regulations applicable to Lilis.

 

 
 

 

(c)In connection with the releases provided in this Section 4, the Parties covenant and agree that they will not bring any claim whatsoever, whether known or unknown, developed or undeveloped, and whether asserted or un-asserted, against the other Party in any way arising from or related to the Released Claims, or to cause or otherwise assist any other person or business entity in bringing such claims. Nothing in this Separation Agreement shall, however, be deemed to interfere with the Parties’ ability to comply with obligations to report transactions to appropriate governmental, taxing, credit, lending, licensing, and/or registering agencies or professional bodies.

 

5.Indemnity.

 

(a)Indemnity. The Parties specifically agree that notwithstanding anything herein to the contrary, nothing in this Agreement alters, modifies or amends White’s rights to indemnification as set out in the Appointment Agreement, Lilis’s Certificate of Incorporation or Bylaws or the Nevada Corporation Law. The Company further agrees that if White is made a party or is threatened to be made a party to any action, suit or proceeding, whether civil, criminal, administrative or investigative (a “Proceeding”) by reason of the fact that White was a trustee, director or officer of the Company or any predecessor to the Company or any of their affiliates or served at the request of the Company, any predecessor to the Company or any of their affiliates as a trustee, director, officer, member, employee or agent of another corporation or a partnership, joint venture, limited liability company, trust or other enterprise, including, without limitation, service with respect to employee benefit plans, whether or not the basis of such Proceeding is alleged action in an official capacity as a trustee, director, officer, member, employee or agent while serving as a trustee, director, officer, member, employee or agent, White shall be indemnified and held harmless by the Company to the fullest extent authorized by Nevada law, as the same exists or may hereafter be amended, against all Expenses incurred or suffered by White in connection therewith, and such indemnification shall inure to the benefit of his heirs, executors and administrators.

 

(b)Expenses. As used in this Section 5, the term “Expenses” shall include, without limitation, damages, losses, judgments, liabilities, fines, penalties, excise taxes, settlements, and costs, attorneys' fees, accountants' fees, and disbursements and costs of attachment or similar bonds, investigations, and any expenses of establishing a right to indemnification under this Agreement.

 

(c)Enforcement. If a claim or request under this Section 5 is not paid by the Company or on its behalf, within 30 days after a written claim or request has been received by the Company, White may at any time thereafter bring suit against the Company to recover the unpaid amount of the claim or request and if successful in whole or in part, White shall be entitled to be paid also the expenses of prosecuting such suit. All obligations for indemnification hereunder shall be subject to, and paid in accordance with, applicable Nevada law.

 

(d)Advances of Expenses. Expenses incurred by White in connection with any Proceeding shall be paid by the Company in advance upon request of White that the Company pay such Expenses, but only in the event that White shall have delivered in writing to the Company (i) an undertaking to reimburse the Company for Expenses with respect to which White is not entitled to indemnification and (ii) a statement of his good faith belief that the standard of conduct necessary for indemnification by the Company has been met.

 

6.Representations and Warranties. Each of White and Lilis (except as to subparagraphs (f) and (g) below), severally and not jointly, warrants and represents as follows:

 

(a)He or it has read this Agreement and agrees to the conditions and obligations set forth in it.

 

(b)He or it voluntarily executes this Agreement (i) after having been advised to consult with legal counsel, (ii) after having had opportunity to consult with legal counsel and (iii) without being pressured or influenced by any statement, representation or omission of any person acting on behalf of the other or any of its officers, directors, employees, agents and attorneys.

 

(c)White has no knowledge of the existence of any lawsuit, charge or proceeding against Lilis or any of its officers, directors, employees or agents arising out of or otherwise connected with any of the matters herein released. Lilis has no knowledge of any lawsuit, charge or proceeding against White arising out of or otherwise connected with any of the matters herein released.

 

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(d)He or it has the individual, corporate, or entity power and authority to execute and deliver this Agreement and to perform its obligations hereunder and, if such Party is a corporation, limited liability company or partnership, the execution, delivery, and performance of this Agreement has been duly authorized by all necessary corporate, company or partnership action. This Agreement constitutes the legal, valid, and binding obligation of each Party.

 

(e)White admits, acknowledges, and agrees that White has been fully paid or provided all wages, compensation, salary, commissions, bonuses, expense reimbursements, stock, stock options, vacation, change in control benefits, severance benefits, deferred compensation, or other benefits from Lilis, which are or could be due to White under the terms of White’s service or otherwise. Lilis admits, acknowledges, and agrees that, other than the duties set forth in this Agreement, White has fully performed all his duties and obligations to Lilis, under the Appointment Agreement or otherwise.

 

(f)Applicable law provides that White shall have at least 21 days to consider this Agreement. In the event that White executes this Agreement prior to the 21st day after receipt of it, White expressly intends such execution as a waiver of any rights White has to review the Agreement for the full 21 days. In such event, White represents that such waiver is voluntary and made without any pressure, representations or incentives from Lilis for such early execution.

 

(g)White understands that this Agreement waives and releases any claims White may have under the Age Discrimination in Employment Act. White may revoke this Agreement for 7 calendar days following its execution, and this Agreement shall not become enforceable and effective against White or Lilis until 7 calendar days after such execution. If White chooses to revoke this Agreement, White must provide written notice to Lilis within 7 calendar days of White’s execution of this Agreement. If White does not revoke within the 7-day period, the right to revoke is lost.

 

7.Non-Disparagement.

 

(a)White agrees not to make to any person any statement that disparages the Company or its directors, officers, employees or affiliates or reflects negatively upon the Company, including, without limitation, statements regarding the Company’s financial condition, business practices, employment practices, or its predecessors, successors, subsidiaries, officers, directors, employees or affiliates.

 

(b)Lilis agrees not to make to any person any statement that disparages White or reflects negatively upon White, including, without limitation, statements regarding White’s financial condition, business practices, performance while at Lilis or otherwise.

 

8.Waiver of Jury Trial. EACH PARTY HERETO HEREBY IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY RIGHT HE OR IT MAY HAVE TO A TRIAL BY JURY IN ANY LEGAL PROCEEDING DIRECTLY OR INDIRECTLY RELATING TO THIS AGREEMENT, WHETHER BASED ON CONTRACT, TORT OR ANY OTHER THEORY. EACH PARTY HERETO (A) CERTIFIES THAT NO AGENT, ATTORNEY, REPRESENTATIVE OR ANY OTHER PERSON HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PERSON WOULD NOT SEEK TO ENFORCE THE FOREGOING WAIVER IN THE EVENT OF LITIGATION, AND (B) ACKNOWLEDGES THAT HE OR IT AND THE OTHER PARTY HERETO HAVE BEEN INDUCED TO ENTER INTO THIS AGREEMENT BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS IN THIS SECTION.

 

9.Successors. This Agreement shall be binding upon, and inure to the benefit of, any successor to Lilis or White.

 

10.Restricted Assignment. Neither Party may assign, transfer, or delegate this Agreement or any of its or his rights or obligations under this Agreement without the prior written consent of the other Party. Any attempted assignment, transfer, or delegation in violation of the preceding sentence shall be void and of no effect.

 

11.Waiver and Amendment. No term or condition of this Agreement shall be deemed waived other than by a writing signed by the Party against whom or which enforcement of the waiver is sought. Without limiting the generality of the preceding sentence, a Party’s failure to insist upon the other Party’s strict compliance with any provision of this Agreement or to assert any right that a Party may have under this Agreement shall not be deemed a waiver of that provision or that right. Any written waiver shall operate only as to the specific term or condition waived under the specific circumstances and shall not constitute a waiver of that term or condition for the future or a waiver of any other term or condition. No amendment or modification of this Agreement shall be deemed effective unless stated in a writing signed by the Parties.

 

12.Entire Agreement. This Agreement and the Stock Option Agreement contain the Parties’ entire agreement regarding the subject matter of this Agreement and supersedes all prior agreements and understandings between them regarding such subject matter (except as reserved herein). The Parties have made no agreements, representations, or warranties regarding the subject matter of this Agreement that are not set forth in this Agreement.

 

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13.Notice. Each notice or other communication required or permitted under this Agreement shall be in writing and transmitted, delivered, or sent by personal delivery, prepaid courier or messenger service (whether overnight or same-day), or prepaid certified United States mail (with return receipt requested), addressed (in any case) to the other Party at the address set forth as follows:

 

If to White,

 

__________________________________

 

__________________________________

 

__________________________________

 

If to Lilis,

 

Lilis Energy, Inc.

Attention: Chief Executive Officer

1900 Grant Street, Suite #720

Denver, CO 80203

 

Each notice or communication so transmitted, delivered, or sent in person, by courier or messenger service, or by certified United States mail shall be deemed given, received, and effective on the date delivered to or refused by the intended recipient (with the return receipt, or the equivalent record of the courier or messenger, being deemed conclusive evidence of delivery or refusal). Nevertheless, if the date of delivery is after 5:00 p.m. on a business day, the notice or other communication shall be deemed given, received, and effective on the next business day.

 

14.Severability. It is the desire of the Parties hereto that this Agreement be enforced to the maximum extent permitted by law. Should any provision contained herein be held unenforceable by a court of competent jurisdiction, the Parties hereby agree and consent that such provision shall be reformed to create a valid and enforceable provision to the maximum extent permitted by law; provided, however, if such provision cannot be reformed, it shall be deemed ineffective and deleted herefrom without affecting any other provision of this Agreement. This Agreement should be construed by limiting and reducing it only to the minimum extent necessary to be enforceable under then applicable law.

 

15.Title and Headings; Construction. Titles and headings to sections hereof are for the purpose of reference only and shall in no way limit, define or otherwise affect the provisions hereof. The words “herein,” “hereof,” “hereunder” and other compounds of the word “here” shall refer to the entire Agreement and not to any particular provision.

 

16.Governing Law; Jurisdiction. All matters or issues relating to the interpretation, construction, validity, and enforcement of this Agreement shall be governed by the laws of the State of Colorado, without giving effect to any choice-of-law principle that would cause the application of the laws of any jurisdiction other than Colorado. Jurisdiction and venue of any action or proceeding relating to this Agreement or any dispute shall be exclusively in Denver, Colorado.

 

17.Counterparts. This Agreement may be signed in counterparts, with the same effect as if both Parties had signed the same document. All counterparts shall be construed together to constitute one, and the same, document.

 

[Signature page follows.]

 

4
 

 

IN WITNESS WHEREOF, the Parties have executed this Agreement to be effective as of the date first above written.

 

  WHITE:
     
  /s/ Bruce White
  Name: Bruce White
     
  LILIS:
     
  Lilis Energy, Inc., a Nevada corporation
     
  By:  /s/ Eric Ulwelling
  Its: Chief Financial Officer
  Name: Eric Ulwelling

 

 

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Exhibit 10.11

 

SEPARATION AGREEMENT

 

This Separation Agreement (this “Agreement”) is effective as of the 11th day of December, 2014, by and between Lilis Energy, Inc. (“Lilis” or the “Company”) and Timothy Poster (“Poster”). As used herein, “Parties” means, collectively, Lilis and Poster, and “Party” means either Lilis or Poster.

 

RECITALS

 

WHEREAS, Lilis and Poster are parties to that certain Amended and Restated Independent Director Appointment Agreement dated April 27, 2012 (the “Appointment Agreement”);

 

WHEREAS, Lilis and Poster agree that Poster has informed the Company that he did not wish to stand for re-election to the Board of Directors of Lilis, and that his term of office will therefore terminate as of the date of the next annual meeting of shareholders of the Company (the “Separation Date”);

 

WHEREAS, Lilis and Poster now desire to enter into this Agreement in order to provide for the terms of the termination of Poster’s service with the Company.

 

NOW, THEREFORE, in consideration of the provisions herein, and other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged by Lilis and Poster, the Parties agree as follows:

 

1.Termination of Service. Effective as of the Separation Date, Poster will no longer serve as a member of the Board of Directors of Lilis or on any of the committees of the Board of Directors of Lilis.

 

2.Other Business and Activities. From and after the Separation Date, Poster shall be free to pursue any other business and activities in any industry. It is expressly acknowledged and agreed that Poster shall hereafter have no duty to present any potential transactions to Lilis or to disclose any other business information to which he may be privy.

 

3.Relinquishment of Rights. It is expressly acknowledged and agreed that Poster and the Company shall each relinquish, waive, and forfeit (a) all rights he or it may have under the Appointment Agreement and (b) any and all rights or claims he or it may have to any compensation or otherwise arising on or after the date hereof; provided, however, that the foregoing shall in no way affect Poster’s rights with respect to any securities awarded pursuant to the Company’s 2012 Equity Incentive Plan, as amended (the “Plan”), which shall continue to be governed in accordance with the terms of the Plan.

 

4.General Release.

 

(a)Poster, for himself, and Lilis, for itself, and each Party for its respective affiliates, successors, heirs, subrogees, assigns, principals, agents, partners, employees, associates, attorneys and representatives, voluntarily, knowingly and intentionally releases and discharges the other Party and its respective predecessors, successors, parents, subsidiaries, affiliates and assigns and each of its respective officers, directors, principals, shareholders, agents, attorneys, board members, and employees from any and all claims, actions, liabilities, demands, rights, damages, costs, expenses, and attorneys’ fees (including but not limited to any claim of entitlement for attorneys’ fees under any contract, statute, or rule of law allowing a prevailing party or plaintiff to recover attorneys’ fees), of every kind and description from the date Poster became a director of Lilis through the date of execution of this Agreement, except as set forth in subparagraphs (b) and Section 5 below (the “Released Claims”).

 

(b)The Released Claims include but are not limited to those which arise out of, relate to, or are based upon: (i) Poster’s service as a director of Lilis and the termination thereof, (ii) statements, acts or omissions by the Parties whether in their individual or representative capacities, (iii) express or implied agreements between the Parties, including any commitment made by Poster to make investments in the Company, and claims under any severance plan, (iv) any stock or stock option grant, agreement, or plan, except as provided in this Agreement, (v) all federal, state, and municipal statutes, ordinances, and regulations, including, but not limited to, claims of discrimination based on race, color, national origin, age, sex, sexual orientation, religion, disability, veteran status, whistleblower status, public policy, or any other characteristic of Poster under the Age Discrimination in Employment Act, the Older Workers Benefit Protection Act, the Americans with Disabilities Act, the Equal Pay Act, Title VII of the Civil Rights Act of 1964 (as amended), the Employee Retirement Income Security Act of 1974, the Rehabilitation Act of 1973, the Worker Adjustment and Retraining Notification Act, or any other federal, state, or municipal law prohibiting discrimination or termination for any reason, (vi) state and federal common law, including but not limited to claims for breach of contract, defamation, or emotional distress, (vii) taxes, penalties, or interest assessed against vested or unvested compensation paid, provided, or granted to Poster by the Company, including all such claims that may arise based on the application of Code Section 409A, and (viii) any claim which was or could have been raised; provided, notwithstanding anything to the contrary in this Agreement, the “Released Claims” shall not include rights or obligations under this Agreement or matters arising out of or in connection with claims by governmental authorities or self-regulatory organizations involving actual or potential violations of the securities laws, rules or regulations applicable to Lilis.

 

 
 

 

(c)In connection with the releases provided in this Section 4, the Parties covenant and agree that they will not bring any claim whatsoever, whether known or unknown, developed or undeveloped, and whether asserted or un-asserted, against the other Party in any way arising from or related to the Released Claims, or to cause or otherwise assist any other person or business entity in bringing such claims. Nothing in this Separation Agreement shall, however, be deemed to interfere with the Parties’ ability to comply with obligations to report transactions to appropriate governmental, taxing, credit, lending, licensing, and/or registering agencies or professional bodies.

 

5.Indemnity.

 

(a)Indemnity. The Parties specifically agree that notwithstanding anything herein to the contrary, nothing in this Agreement alters, modifies or amends Poster’s rights to indemnification as set out in the Appointment Agreement, Lilis’s Certificate of Incorporation or Bylaws or the Nevada Corporation Law. The Company further agrees that if Poster is made a party or is threatened to be made a party to any action, suit or proceeding, whether civil, criminal, administrative or investigative (a “Proceeding”) by reason of the fact that Poster was a trustee, director or officer of the Company or any predecessor to the Company or any of their affiliates or served at the request of the Company, any predecessor to the Company or any of their affiliates as a trustee, director, officer, member, employee or agent of another corporation or a partnership, joint venture, limited liability company, trust or other enterprise, including, without limitation, service with respect to employee benefit plans, whether or not the basis of such Proceeding is alleged action in an official capacity as a trustee, director, officer, member, employee or agent while serving as a trustee, director, officer, member, employee or agent, Poster shall be indemnified and held harmless by the Company to the fullest extent authorized by Nevada law, as the same exists or may hereafter be amended, against all Expenses incurred or suffered by Poster in connection therewith, and such indemnification shall inure to the benefit of his heirs, executors and administrators.

 

(b)Expenses. As used in this Section 5, the term “Expenses” shall include, without limitation, damages, losses, judgments, liabilities, fines, penalties, excise taxes, settlements, and costs, attorneys' fees, accountants' fees, and disbursements and costs of attachment or similar bonds, investigations, and any expenses of establishing a right to indemnification under this Agreement.

 

(c)Enforcement. If a claim or request under this Section 5 is not paid by the Company or on its behalf, within 30 days after a written claim or request has been received by the Company, Poster may at any time thereafter bring suit against the Company to recover the unpaid amount of the claim or request and if successful in whole or in part, Poster shall be entitled to be paid also the expenses of prosecuting such suit. All obligations for indemnification hereunder shall be subject to, and paid in accordance with, applicable Nevada law.

 

(d)Advances of Expenses. Expenses incurred by Poster in connection with any Proceeding shall be paid by the Company in advance upon request of Poster that the Company pay such Expenses, but only in the event that Poster shall have delivered in writing to the Company (i) an undertaking to reimburse the Company for Expenses with respect to which Poster is not entitled to indemnification and (ii) a statement of his good faith belief that the standard of conduct necessary for indemnification by the Company has been met.

 

6.Representations and Warranties. Each of Poster and Lilis (except as to subparagraphs (f) and (g) below), severally and not jointly, warrants and represents as follows:

 

(a)He or it has read this Agreement and agrees to the conditions and obligations set forth in it.

 

(b)He or it voluntarily executes this Agreement (i) after having been advised to consult with legal counsel, (ii) after having had opportunity to consult with legal counsel and (iii) without being pressured or influenced by any statement, representation or omission of any person acting on behalf of the other or any of its officers, directors, employees, agents and attorneys.

 

(c)Poster has no knowledge of the existence of any lawsuit, charge or proceeding against Lilis or any of its officers, directors, employees or agents arising out of or otherwise connected with any of the matters herein released. Lilis has no knowledge of any lawsuit, charge or proceeding against Poster arising out of or otherwise connected with any of the matters herein released.

 

2
 

 

(d)He or it has the individual, corporate, or entity power and authority to execute and deliver this Agreement and to perform its obligations hereunder and, if such Party is a corporation, limited liability company or partnership, the execution, delivery, and performance of this Agreement has been duly authorized by all necessary corporate, company or partnership action. This Agreement constitutes the legal, valid, and binding obligation of each Party.

 

(e)Poster admits, acknowledges, and agrees that Poster has been fully paid or provided all wages, compensation, salary, commissions, bonuses, expense reimbursements, stock, stock options, vacation, change in control benefits, severance benefits, deferred compensation, or other benefits from Lilis, which are or could be due to Poster under the terms of Poster’s service or otherwise. Lilis admits, acknowledges, and agrees that, other than the duties set forth in this Agreement, Poster has fully performed all his duties and obligations to Lilis, under the Appointment Agreement or otherwise.

 

(f)Applicable law provides that Poster shall have at least 21 days to consider this Agreement. In the event that Poster executes this Agreement prior to the 21st day after receipt of it, Poster expressly intends such execution as a waiver of any rights Poster has to review the Agreement for the full 21 days. In such event, Poster represents that such waiver is voluntary and made without any pressure, representations or incentives from Lilis for such early execution.

 

(g)Poster understands that this Agreement waives and releases any claims Poster may have under the Age Discrimination in Employment Act. Poster may revoke this Agreement for 7 calendar days following its execution, and this Agreement shall not become enforceable and effective against Poster or Lilis until 7 calendar days after such execution. If Poster chooses to revoke this Agreement, Poster must provide written notice to Lilis within 7 calendar days of Poster’s execution of this Agreement. If Poster does not revoke within the 7-day period, the right to revoke is lost.

 

7.Non-Disparagement.

 

(a)Poster agrees not to make to any person any statement that disparages the Company or its directors, officers, employees or affiliates or reflects negatively upon the Company, including, without limitation, statements regarding the Company’s financial condition, business practices, employment practices, or its predecessors, successors, subsidiaries, officers, directors, employees or affiliates.

 

(b)Lilis agrees not to make to any person any statement that disparages Poster or reflects negatively upon Poster, including, without limitation, statements regarding Poster’s financial condition, business practices, performance while at Lilis or otherwise.

 

8.Waiver of Jury Trial. EACH PARTY HERETO HEREBY IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY RIGHT HE OR IT MAY HAVE TO A TRIAL BY JURY IN ANY LEGAL PROCEEDING DIRECTLY OR INDIRECTLY RELATING TO THIS AGREEMENT, WHETHER BASED ON CONTRACT, TORT OR ANY OTHER THEORY. EACH PARTY HERETO (A) CERTIFIES THAT NO AGENT, ATTORNEY, REPRESENTATIVE OR ANY OTHER PERSON HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PERSON WOULD NOT SEEK TO ENFORCE THE FOREGOING WAIVER IN THE EVENT OF LITIGATION, AND (B) ACKNOWLEDGES THAT HE OR IT AND THE OTHER PARTY HERETO HAVE BEEN INDUCED TO ENTER INTO THIS AGREEMENT BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS IN THIS SECTION.

 

9.Successors. This Agreement shall be binding upon, and inure to the benefit of, any successor to Lilis or Poster.

 

10.Restricted Assignment. Neither Party may assign, transfer, or delegate this Agreement or any of its or his rights or obligations under this Agreement without the prior written consent of the other Party. Any attempted assignment, transfer, or delegation in violation of the preceding sentence shall be void and of no effect.

 

11.Waiver and Amendment. No term or condition of this Agreement shall be deemed waived other than by a writing signed by the Party against whom or which enforcement of the waiver is sought. Without limiting the generality of the preceding sentence, a Party’s failure to insist upon the other Party’s strict compliance with any provision of this Agreement or to assert any right that a Party may have under this Agreement shall not be deemed a waiver of that provision or that right. Any written waiver shall operate only as to the specific term or condition waived under the specific circumstances and shall not constitute a waiver of that term or condition for the future or a waiver of any other term or condition. No amendment or modification of this Agreement shall be deemed effective unless stated in a writing signed by the Parties.

 

12.Entire Agreement. This Agreement and the Stock Option Agreement contain the Parties’ entire agreement regarding the subject matter of this Agreement and supersedes all prior agreements and understandings between them regarding such subject matter (except as reserved herein). The Parties have made no agreements, representations, or warranties regarding the subject matter of this Agreement that are not set forth in this Agreement.

 

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13.Notice. Each notice or other communication required or permitted under this Agreement shall be in writing and transmitted, delivered, or sent by personal delivery, prepaid courier or messenger service (whether overnight or same-day), or prepaid certified United States mail (with return receipt requested), addressed (in any case) to the other Party at the address set forth as follows:

 

If to Poster,

 

__________________________________

 

__________________________________

 

__________________________________

 

If to Lilis,

 

Lilis Energy, Inc.
Attention: Chief Executive Officer
1900 Grant Street, Suite #720
Denver, CO 80203

 

Each notice or communication so transmitted, delivered, or sent in person, by courier or messenger service, or by certified United States mail shall be deemed given, received, and effective on the date delivered to or refused by the intended recipient (with the return receipt, or the equivalent record of the courier or messenger, being deemed conclusive evidence of delivery or refusal). Nevertheless, if the date of delivery is after 5:00 p.m. on a business day, the notice or other communication shall be deemed given, received, and effective on the next business day.

 

14.Severability. It is the desire of the Parties hereto that this Agreement be enforced to the maximum extent permitted by law. Should any provision contained herein be held unenforceable by a court of competent jurisdiction, the Parties hereby agree and consent that such provision shall be reformed to create a valid and enforceable provision to the maximum extent permitted by law; provided, however, if such provision cannot be reformed, it shall be deemed ineffective and deleted herefrom without affecting any other provision of this Agreement. This Agreement should be construed by limiting and reducing it only to the minimum extent necessary to be enforceable under then applicable law.

 

15.Title and Headings; Construction. Titles and headings to sections hereof are for the purpose of reference only and shall in no way limit, define or otherwise affect the provisions hereof. The words “herein,” “hereof,” “hereunder” and other compounds of the word “here” shall refer to the entire Agreement and not to any particular provision.

 

16.Governing Law; Jurisdiction. All matters or issues relating to the interpretation, construction, validity, and enforcement of this Agreement shall be governed by the laws of the State of Colorado, without giving effect to any choice-of-law principle that would cause the application of the laws of any jurisdiction other than Colorado. Jurisdiction and venue of any action or proceeding relating to this Agreement or any dispute shall be exclusively in Denver, Colorado.

 

17.Counterparts. This Agreement may be signed in counterparts, with the same effect as if both Parties had signed the same document. All counterparts shall be construed together to constitute one, and the same, document.

 

[Signature page follows.]

 

4
 

 

IN WITNESS WHEREOF, the Parties have executed this Agreement to be effective as of the date first above written.

 

  POSTER:
     
  /s/ Timothy Poster
  Name: Timothy Poster
     
  LILIS:
     
  Lilis Energy, Inc., a Nevada corporation
     
  By:  /s/ Eric Ulwelling
  Its: Chief Financial Officer
  Name: Eric Ulwelling

 

 

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Exhibit 10.12(a)

 

SECURITY AGREEMENT

THIS SECURITY AGREEMENT (as it may be amended or modified from time to time in accordance with the terms hereof, the “Security Agreement”) is entered into as of January 8, 2015 by and between LILIS ENERGY, INC., a Nevada corporation (“Borrower”), and HEARTLAND BANK, an Arkansas state bank in its capacity as collateral agent pursuant to the Credit Agreement (as hereinafter defined) (“Agent”).

PRELIMINARY STATEMENT

Borrower, Agent and the lenders from time to time a party thereto (each a “Lender”; and collectively, the “Lenders”) are entering into that certain Credit Agreement dated of even date herewith (as it may be amended or modified from time to time, the “Credit Agreement”), providing, subject to the terms and conditions thereof, for extensions of credit to be made by the Lenders to the Borrower. To induce the Lenders to enter into and extend credit to the Borrower under the Credit Agreement, Borrower is entering into this Security Agreement.

ACCORDINGLY, Borrower, Agent and the Lenders, hereby agree as follows:

ARTICLE I

DEFINITIONS

SECTION 1.1. Terms Defined in Credit Agreement. All capitalized terms used herein and not otherwise defined shall have the meanings assigned to such terms in the Credit Agreement.

SECTION 1.2. Terms Defined in Code. Terms defined in the Code which are not otherwise defined in this Security Agreement are used herein as defined in the Code as in effect on the date hereof.

SECTION 1.3. Definitions of Certain Terms Used Herein. As used in this Security Agreement, in addition to the terms defined in the Preliminary Statement, the following terms shall have the following meanings:

Accounts” means all rights to payment for goods sold or leased or services rendered by Borrower, whether or not earned by performance, together with all security interests or other security held by or granted to Borrower to secure such rights to payment.

Article” means a numbered article of this Security Agreement, unless another document is specifically referenced.

Chattel Paper” means any writing or group of writings which evidences both a monetary obligation and a security interest in or a lease of specific goods.

 

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Code” shall mean the Uniform Commercial Code, as the same may, from time to time, be enacted and in effect in the State of Arkansas; provided, that, to the extent that the Code is used to define any term herein or in any Loan Document and such term is defined differently in different Articles or Divisions of the Code, the definition of such term contained in Article or Division 9 shall govern; provided further, that in the event that, by reason of mandatory provisions of law, any or all of the attachment, perfection, or priority of, or remedies with respect to, Agent’s Lien on any Collateral is governed by the Uniform Commercial Code in effect in a jurisdiction other than the State of Arkansas, the term “Code” shall mean the Uniform Commercial Code as enacted and in effect in such other jurisdiction solely for purposes of the provisions thereof relating to such attachment, perfection, priority, or remedies and for purposes of definitions relating to such provisions.

Collateral” means all Accounts, Chattel Paper, Documents, Equipment, Fixtures, General Intangibles, Investment Property, Instruments, Inventory, Pledged Deposits, Stock Rights and Other Collateral, wherever located, in which Borrower now has or hereafter acquires any right or interest, and the proceeds, insurance proceeds and products thereof, together with all books and records, customer lists, credit files, computer files, programs, printouts and other computer materials and records related thereto.

Control” shall have the meaning set forth in Chapter 8 of the Code as in effect from time to time.

Documents” means all documents of title and goods evidenced thereby, including without limitation all bills of lading, dock warrants, dock receipts, warehouse receipts and orders for the delivery of goods, and also any other document which in the regular course of business or financing is treated as adequately evidencing that the person in possession of it is entitled to receive, hold and dispose of the document and the goods it covers.

Equipment” means all equipment, machinery, furniture and goods used or usable by Borrower in its business and all other tangible personal property (other than Inventory), and all accessions and additions thereto, including, without limitation, all Fixtures.

Exhibit” refers to a specific exhibit to this Security Agreement, unless another document is specifically referenced.

First Perfected means, with respect to any Lien purported to be created in any Collateral pursuant to this Agreement, such Lien is the most senior lien to which such Collateral is subject (subject only to Liens permitted under the Credit Agreement).

Fixtures” means all goods which become so related to particular real estate that an interest in such goods arises under any real estate law applicable thereto, including, without limitation, all trade fixtures.

General Intangibles” means all intangible personal property (other than Accounts) including, without limitation, all contract rights, rights to receive payments of money, choses in action, causes of action, judgments, tax refunds and tax refund claims, patents, trademarks, trade names, copyrights, licenses, franchises, computer programs, software, goodwill, customer and supplier contracts, interests in general or limited partnerships, joint ventures or limited liability companies, reversionary interests in pension and profit sharing plans and reversionary, beneficial and residual interests in trusts, leasehold interests in real or personal property, rights to receive rentals of real or personal property and guarantee and indemnity claims.

 

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Investment Property” means stock or other securities, whether certificated or uncertificated, of any other Person, or any direct or indirect loan, advance or capital contribution by such Person to any other Person, or any other item which would be classified as an “investment” on a balance sheet of such Person prepared in accordance with GAAP, including any direct or indirect contribution by such Person of property or assets to a joint venture, partnership or other business entity in which such Person retains an interest.

Instruments” means all negotiable instruments (as defined in §3-104 of the Code as in effect from time to time), certificated and uncertificated securities and any replacements therefor and Stock Rights related thereto, and other writings which evidence a right to the payment of money and which are not themselves security agreements or leases and are of a type which in the ordinary course of business are transferred by delivery with any necessary endorsement or assignment, including, without limitation, all checks, drafts, notes, bonds, debentures, government securities, certificates of deposit, letters of credit, preferred and common stocks, options and warrants.

Inventory” means all goods held for sale or lease, or furnished or to be furnished under contracts of service, or consumed in Borrower’s business, including without limitation raw materials, intermediates, work in process, packaging materials, finished goods, semi-finished inventory, scrap inventory, manufacturing supplies and spare parts, all such goods that have been returned to or repossessed by or on behalf of Borrower, and all such goods released to Borrower or to third parties under trust receipts or similar documents.

Lender” shall have the meaning set forth in the Preliminary Statement, and each of their respective successors and assigns.

Obligations” or “Secured Obligations” mean any and all existing and future indebtedness, obligation and liability of every kind, nature and character, direct or indirect, absolute or contingent (including all renewals, extensions and modifications thereof and all fees, costs and expenses incurred by Agent or any Lender in connection with the preparation, administration, collection or enforcement thereof), of Borrower to Agent or any Lender arising under or pursuant to this Security Agreement, the Credit Agreement and the promissory note or notes issued or hereafter issued under the Credit Agreement (including, without limitation, the Obligations as defined in the Credit Agreement.)

Other Collateral” means any property of Borrower, other than real estate, not included within the defined terms Accounts, Chattel Paper, Documents, Equipment, Fixtures, General Intangibles, Instruments, Inventory, Investment Property, Pledged Deposits and Stock Rights, including, without limitation, all cash on hand and all deposit accounts or other deposits (general or special, time or demand, provisional or final) with any bank or other financial institution, it being intended that the Collateral include all property of Borrower other than real estate and other property excluded in Article II herein from the definition of Collateral.

Person” shall mean an individual, partnership, joint venture, corporation, limited liability company, joint stock company, bank, trust, unincorporated organization and/or a government or any department or agency thereof.

 

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Pledged Deposits” means all time deposits of money, whether or not evidenced by certificates, which Borrower may from time to time designate as pledged to Agent, for the benefit of the Lenders, as security for any Obligation, and all rights to receive interest on said deposits.

Receivables” means the Accounts, Chattel Paper, Documents, Investment Property, Instruments or Pledged Deposits, and any other rights or claims to receive money which are General Intangibles or which are otherwise included as Collateral.

Section” means a numbered section of this Security Agreement, unless another document is specifically referenced.

Security” has the meaning set forth in Chapter 8 of the Code as in effect from time to time

Stock Rights” means any securities, dividends or other distributions and any other right or property which Borrower shall receive or shall become entitled to receive for any reason whatsoever with respect to, in substitution for or in exchange for any securities or other ownership interests in a corporation, partnership, joint venture or limited liability company constituting Collateral and any securities, any right to receive securities and any right to receive earnings, in which Borrower now has or hereafter acquires any right, issued by an issuer of such securities.

The foregoing definitions shall be equally applicable to both the singular and plural forms of the defined terms.

ARTICLE II

GRANT OF SECURITY INTEREST

Borrower hereby pledges, assigns and grants to Agent, for the benefit of the Lenders, a security interest in all of Borrower’s right, title and interest in and to the Collateral to secure the prompt and complete payment and performance of the Secured Obligations. Notwithstanding anything herein to the contrary, “Collateral” shall exclude:

(i) any Equipment subject to any Lien securing purchase money Debt or a Capitalized Lease to the extent that such contract, instrument or agreement evidencing such purchase money Debt or Capitalized Lease restricts the granting of a Lien in such Equipment to Agent only for so long as the grant of such security interest shall constitute or result in a breach, termination or default under such contract, instrument or agreement; provided, that, such security interest shall attach immediately and automatically at such time as the restriction ceases to exist by virtue of termination or expiration or such consent has been obtained and provided, further that, the Collateral shall include any and all proceeds arising from such excluded Equipment to the extent such inclusion does not constitute or result in a breach, termination or default under the aforementioned contract;

 

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(ii) any lease, license or other agreement or contract or any property subject to a purchase money security interest or similar arrangement, in each case permitted to be incurred under the Credit Agreement, to the extent that a grant of a security interest or Lien therein would require a consent not obtained or violate or invalidate such lease, license or agreement or contract or purchase money arrangement or similar arrangement or create a right of termination in favor of any other party thereto (other than Borrower), in each case after giving effect to the applicable anti-assignment provisions of the UCC and other applicable law and other than Proceeds and receivables thereof, the assignment of which is expressly deemed effective under the UCC or other applicable law notwithstanding such prohibition.

ARTICLE III

REPRESENTATIONS AND WARRANTIES

Borrower represents and warrants to Agent and the Lenders that:

SECTION 3.1. Title, Authorization, Validity and Enforceability. Borrower has good and valid rights in and title to, or a valid leasehold interest in, the Collateral with respect to which it has purported to grant a security interest hereunder, free and clear of all Liens except for Liens permitted under Section 4.1(f), and has full power and authority to grant to Agent, for the benefit of the Lenders, the security interest in such Collateral pursuant hereto. The execution and delivery by Borrower of this Security Agreement has been duly authorized by proper corporate proceedings, and this Security Agreement constitutes a legal, valid and binding obligation of Borrower and creates a security interest which is enforceable against Borrower in all now owned and hereafter acquired Collateral (except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium, fraudulent transfer and conveyance or similar laws and general equitable principles affecting the enforcement of creditors' rights generally, regardless of whether considered in a proceeding in equity or at law); provided however, in the case of the certificated pledged securities, when stock certificates representing such pledged securities are delivered to the Agent and in the case of the other Collateral, when financing statements and other filings in appropriate form are filed and other actions are taken, this Agreement shall constitute, and will at all times constitute, security interest which is enforceable against Borrower in all now owned and hereafter acquired Collateral.

SECTION 3.2. Conflicting Laws and Contracts. Neither the execution and delivery by Borrower of this Security Agreement, the creation and perfection of the security interest in the Collateral granted hereunder, nor compliance with the terms and provisions hereof will violate any law, rule, regulation, order, writ, judgment, injunction, decree or award binding on Borrower or Borrower’s articles or certificate of incorporation or by-laws, the provisions of any indenture, instrument or agreement to which Borrower is a party or is subject, or by which it, or its property, is bound, or conflict with or constitute a default thereunder, or result in the creation or imposition of any Lien pursuant to the terms of any such indenture, instrument or agreement (other than any Lien of Agent, for the benefit of the Lenders).

SECTION 3.3. Principal Location. Borrower’s mailing address, and the location of its chief executive office and of the books and records relating to the Receivables, is disclosed in Exhibit A. Borrower has no other places of business except those set forth in Exhibit A. The State in which Borrower was originally, and is still, incorporated is Nevada.

 

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SECTION 3.4. Property Locations. The Inventory, Equipment and Fixtures are located solely at the locations described in Exhibit A. All of said locations are owned by Borrower except for locations (i) which are leased by Borrower as lessee and designated in Part B of Exhibit A and (ii) at which Inventory is held in a public warehouse or is otherwise held by a bailee or on consignment as designated in Part C of Exhibit A, with respect to which Inventory Borrower has delivered bailment agreements, warehouse receipts, financing statements or other documents satisfactory to Agent to protect Agent’s security interest in such Inventory.

SECTION 3.5. No Other Names. Except as set forth on Schedule 3.5, Borrower has not conducted business under any name except the name in which it has executed this Security Agreement.

SECTION 3.6. No Default. No Default or Event of Default exists.

SECTION 3.7. Accounts and Chattel Paper. The names of the obligors, amounts owing, due dates and other information with respect to the Accounts and Chattel Paper are and will be correctly stated in all records of Borrower relating thereto and in all invoices and reports with respect thereto furnished to Agent by Borrower from time to time in all material respects. As of the time when each Account or each item of Chattel Paper arises, Borrower shall be deemed to have represented and warranted that such Account or Chattel Paper, as the case may be, and all records relating thereto, are genuine and in all material respects what they purport to be.

SECTION 3.8. Filing Requirements. None of the Equipment is covered by any certificate of title, except for the vehicles described in Part A of Exhibit B. None of the Collateral is of a type for which security interests or liens may be perfected by filing under any federal statute except for (i) the vehicles described in Part B of Exhibit B and (ii) patents, trademarks and copyrights held by Borrower and described in Part C of Exhibit B. The legal description, county and street address of the property on which any Fixtures are located is set forth in Exhibit C together with the name and address of the record owner of each such property.

SECTION 3.9. No Financing Statements. No financing statement describing all or any portion of the Collateral which has not lapsed or been terminated naming Borrower as debtor has been filed in any jurisdiction except (i) financing statements naming Agent, for the benefit of the Lenders, as the secured party, (ii) as described in Exhibit D and (iii) as permitted by Section 4.1(f).

SECTION 3.10. Federal Employer Identification Number. Borrower’s Federal employer identification number is 74-3231613.

SECTION 3.11. Pledged Securities and Other Investment Property. Exhibit E sets forth a complete and accurate list of the Instruments, Securities and other Investment Property delivered to Agent. Borrower is the direct and beneficial owner of each Instrument, Security and other type of Investment Property listed on Exhibit E as being owned by it, free and clear of any Liens, except for the security interest granted to Agent, for the benefit of the Lenders, hereunder. Borrower further represents and warrants that (i) all such Instruments, Securities or other types of Investment Property which are shares of stock in a corporation or ownership interests in a partnership or limited liability company have been (to the extent such concepts are relevant with respect to such Instrument, Security or other type of Investment Property) duly and validly issued, are fully paid and non-assessable and (ii) with respect to any certificates delivered to Agent representing an ownership interest in a partnership or limited liability company, either such certificates are Securities as defined in Article 8 of the Code of the applicable jurisdiction as a result of actions by the issuer or otherwise, or, if such certificates are not Securities, Borrower has so informed Agent so that Agent may take steps to perfect its security interest therein as a General Intangible.

 

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SECTION 3.12. Deposit Accounts. Exhibit F sets forth a complete and accurate list of all bank accounts maintained by Borrower with any Person.

ARTICLE IV

COVENANTS

From the date of this Security Agreement, and thereafter until this Security Agreement is terminated:

SECTION 4.1. General.

(a) Inspection. Borrower will permit Agent or any Lender, by its representatives and agents, to inspect the Collateral pursuant to Section 8.14 of the Credit Agreement.

(b) Taxes. Borrower will pay when due all taxes, assessments and governmental charges and levies upon the Collateral, except those which are being contested in good faith by appropriate proceedings and for which adequate reserves have been set aside and with respect to which no Lien exists.

(c) Records and Reports; Notification of Default. Borrower will maintain complete and accurate books and records with respect to the Collateral, and furnish to Agent or any Lender such records relating to the Collateral as Agent shall from time to time request. Borrower will give prompt notice in writing to Agent of the occurrence of any Default or Event of Default and of any other development, financial or otherwise, which might materially and adversely affect the Collateral.

(d) Financing Statements and Other Actions; Defense of Title. Borrower will execute and deliver to Agent all financing statements and other documents and take such other actions as may from time to time be requested by Agent in order to maintain a First Perfected security interest in and, in the case of Investment Property, Control of, the Collateral. Borrower will take any and all actions necessary to defend title to the Collateral against all persons and to defend the security interest of Agent in the Collateral and the priority thereof against any Lien not expressly permitted hereunder or under the Credit Agreement.

(e) Disposition of Collateral. Borrower will not sell, lease or otherwise dispose of the Collateral except dispositions in the ordinary course of business, provided, however, that any such dispositions shall be subject to Section 4.2(b) of the Credit Agreement and at the time of such disposition, no Default or Event of Default exists or would result from such disposition.

 

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(f) Liens. Borrower will not create, incur, or suffer to exist any Lien on the Collateral except (i) the security interest created by this Security Agreement, (ii) existing Liens described in Exhibit D and (iii) other Liens permitted pursuant to Section 9.2 of the Credit Agreement.

(g) Change in Location or Name. Borrower will not (i) have any material Inventory, Equipment or Fixtures or proceeds or products thereof (other than Inventory and proceeds thereof disposed of as permitted by Section 4.1(e)) at a location other than a location specified in Exhibit A, (ii) maintain records relating to the Receivables at a location other than at the location specified on Exhibit A, (iii) maintain a place of business at a location other than a location specified on Exhibit A, (iv) change its name or taxpayer identification number or (v) change its mailing address, unless Borrower shall have given Agent not less than thirty (30) days’ prior written notice thereof, and Agent shall have determined that such change will not adversely affect the validity, perfection or priority of Agent’s security interest in the Collateral.

(h) Other Financing Statements. Borrower will not authorize the filing of any financing statement naming it as debtor covering all or any portion of the Collateral, except as permitted by Section 4.1(f) or as Agent shall agree to in writing.

SECTION 4.2. Receivables.

(a) Certain Agreements on Receivables. Borrower will not make or agree to make any discount, credit, rebate or other reduction in the original amount owing on a Receivable or accept in satisfaction of a Receivable less than the original amount thereof unless approved by Agent in its reasonable discretion.

(b) Collection of Receivables. Except as otherwise provided in this Security Agreement, but subject to Section 8.21 of the Credit Agreement, Borrower will collect and enforce, at Borrower’s sole expense, all amounts due or hereafter due to Borrower under the Receivables.

(c) Delivery of Invoices. Borrower will deliver to Agent immediately upon its request after the occurrence of a Default or Event of Default duplicate invoices with respect to each Account bearing such language of assignment as Agent shall specify.

(d) Disclosure of Counterclaims on Receivables. If (i) any discount, credit or agreement to make a rebate or to otherwise reduce the amount owing on a Receivable exists or (ii) if, to the knowledge of Borrower, any dispute, setoff, claim, counterclaim or defense exists or has been asserted or threatened with respect to a Receivable, Borrower will disclose such fact to Agent in writing in connection with the inspection by Agent of any record of Borrower relating to such Receivable and in connection with any invoice or report furnished by Borrower to Agent relating to such Receivable.

SECTION 4.3. Inventory and Equipment.

(a) Maintenance of Goods. Borrower will do all things reasonably necessary to maintain, preserve, protect and keep the Inventory and the Equipment in good repair and working and saleable condition.

 

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(b) Insurance. Borrower will maintain insurance in accordance with Section 8.11 of the Credit Agreement.

(c) Titled Vehicles. Borrower will give Agent notice of its acquisition of any vehicle covered by a certificate of title and deliver to Agent, upon request, the original of any vehicle title certificate and do all things necessary to have the Lien of Agent noted on any such certificate.

SECTION 4.4. Instruments, Securities, Chattel Paper, Documents and Pledged Deposits. Borrower will (i) deliver to Agent immediately upon execution of this Security Agreement the originals of all Chattel Paper, Securities and Instruments constituting Collateral (if any then exist), (ii) hold in trust for Agent upon receipt and immediately thereafter deliver to Agent any Chattel Paper, Securities and Instruments constituting Collateral, (iii) upon the designation of any Pledged Deposits (as set forth in the definition thereof), deliver to Agent such Pledged Deposits which are evidenced by certificates included in the Collateral endorsed in blank, marked with such legends and assigned as Agent shall specify, and (iv) upon Agent’s request, after the occurrence and during the continuance of a Default or Event of Default, deliver to Agent (and thereafter hold in trust for Agent upon receipt and immediately deliver to Agent) any Document evidencing or constituting Collateral.

SECTION 4.5. Uncertificated Securities and Certain Other Investment Property. Borrower will permit Agent from time to time to cause the appropriate issuers (and, if held with a securities intermediary, such securities intermediary) of uncertificated securities or other types of Investment Property not represented by certificates which are Collateral to mark their books and records with the numbers and face amounts of all such uncertificated securities or other types of Investment Property not represented by certificates and all rollovers and replacements therefor to reflect the Lien of Agent granted pursuant to this Security Agreement. Borrower will take any actions necessary to cause (i) the issuers of uncertificated securities which are Collateral and which are Securities and (ii) any financial intermediary other than Agent which is the holder of any Investment Property which is Collateral, to cause Agent to have and retain Control over such Securities or other Investment Property; provided however, unless there shall occur and be continuing an Event of Default, the Agent hereby instructs each such issuer and financial intermediary that it may take instructions from Borrower to the extent not inconsistent with this Agreement. Without limiting the foregoing, Borrower will, with respect to Investment Property held with a financial intermediary other than Agent, cause such financial intermediary to enter into a Control Agreement with Agent in form and substance satisfactory to Agent.

SECTION 4.6. Stock and Other Ownership Interests.

(a) Changes in Capital Structure of Issuers. Borrower will not (i) permit or suffer any issuer of privately held corporate securities or other ownership interests in a corporation, partnership, joint venture or limited liability company constituting Collateral to dissolve, liquidate, retire any of its capital stock or other Instruments or Securities evidencing ownership, reduce its capital or merge or consolidate with any other entity, or (ii) vote any of the Instruments, Securities or other Investment Property in favor of any of the foregoing.

 

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(b) Issuance of Additional Securities. Borrower will not permit or suffer the issuer of privately held corporate securities or other ownership interests in a corporation, partnership, joint venture or limited liability company constituting Collateral to issue any such securities or other ownership interests, any right to receive the same or any right to receive earnings, except to Borrower.

(c) Registration of Pledged Securities and other Investment Property. Borrower will permit any Pledged Securities and other Investment Property to be registered in the name of Agent or its nominee at any time following an Event of Default at the option of Agent.

(d) Exercise of Rights in Pledged Securities and other Investment Property. Borrower will permit Agent or its nominee at any time after the occurrence of an Event of Default to exercise all voting and corporate rights relating to the Collateral, including, without limitation, exchange, subscription or any other rights, privileges, or options pertaining to any corporate securities or other ownership interests or Investment Property in or of a corporation, partnership, joint venture or limited liability company constituting Collateral and the Stock Rights as if it were the absolute owner thereof.

SECTION 4.7. Pledged Deposits. Borrower will not withdraw all or any portion of any Pledged Deposit or fail to rollover said Pledged Deposit without the prior written consent of Agent.

SECTION 4.8. Deposit Accounts. Borrower will enter into a control agreement regarding any deposit account of Borrower maintained with a bank or financial institution pursuant to which such bank or financial institution acknowledges the security interest of Agent, for the benefit of Lenders, in such bank account, and agrees to comply with instructions originated by Agent after the occurrence of an Event of Default directing disposition of the funds in such bank account without further consent from Borrower, and agrees to subordinate and limit any security interest such bank may have in such bank account on terms satisfactory to Agent.

SECTION 4.9. Federal, State or Municipal Claims. Borrower will notify Agent of any Collateral which constitutes a claim against the United States government or any state or local government or any instrumentality or agency thereof, the assignment of which claim is expressly restricted by federal, state or municipal law in a manner that would not permit Agent to obtain a Security Interest therein under the Code.

ARTICLE V

DEFAULT

SECTION 5.1. Default. The occurrence of any one or more of the following events shall constitute a default:

(a) any representation, warranty, certification or statement made or deemed to have been made by Borrower in this Security Agreement, shall prove to have been incorrect in any material respect when made;

 

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(b) any covenant, agreement or condition contained in this Security Agreement is not fully and timely performed, observed or kept in all material respects;

(c) the occurrence of any “Event of Default” under, and as defined in, the Credit Agreement; and

(d) any limited partnership interests or ownership interests in a limited liability company which are included within the Collateral shall at any time constitute a Security or the issuer of any such interests shall take any action to have such interests treated as a Security unless (i) all certificates or other documents constituting such Security have been delivered to Agent and such Security is properly defined as such under Article 8 of the Code of the applicable jurisdiction, whether as a result of actions by the issuer thereof or otherwise, or (ii) Agent has entered into a control agreement with the issuer of such Security or with a securities intermediary relating to such Security and such Security is defined as such under Article 8 of the Code of the applicable jurisdiction, whether as a result of actions by the issuer thereof or otherwise.

SECTION 5.2. Acceleration and Remedies. Upon the acceleration of the Obligations under the Credit Agreement, the Obligations shall immediately become due and payable without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived, and Agent, upon the written instruction of the Majority Lenders, may exercise any or all of the following rights and remedies:

(a) Those rights and remedies provided in this Security Agreement, the Credit Agreement, or any other Loan Document, provided that this Section 5.2(a) shall not be understood to limit any rights or remedies available to Agent or the Lenders prior to a Default or Event of Default.

(b) Those rights and remedies available to a secured party under the Code (whether or not the Code applies to the affected Collateral) or under any other applicable law (including, without limitation, any law governing the exercise of a bank’s right of setoff or bankers’ lien) when a debtor is in default under a security agreement.

(c) Without notice except as specifically provided in Section 7.1 or elsewhere herein, sell, lease, assign, grant an option or options to purchase or otherwise dispose of the Collateral or any part thereof in one or more parcels at public or private sale, for cash, on credit or for future delivery, and upon such other terms as Agent may deem commercially reasonable.

SECTION 5.3. Borrower’s Obligations Upon Default. Upon the request of Agent after the occurrence of an Event of Default, Borrower will:

(a) Assembly of Collateral. Assemble and make available to Agent the Collateral and all records relating thereto at any place or places specified by Agent.

(b) Secured Party Access. Permit Agent, by Agent’s representatives and agents, to enter any premises where all or any part of the Collateral, or the books and records relating thereto, or both, are located, to take possession of all or any part of the Collateral and to remove all or any part of the Collateral.

 

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SECTION 5.4. License. Agent, for the benefit of the Lenders, is hereby granted a license or other right to use, following the occurrence and during the continuance of a Default or Event of Default, without charge, Borrower’s labels, patents, copyrights, rights of use of any name, trade secrets, trade names, trademarks, service marks, customer lists and advertising matter, or any property of a similar nature, as it pertains to the Collateral, in completing production of, advertising for sale, and selling any Collateral, and, following the occurrence and during the continuance of a Default or Event of Default, Borrower’s rights under all licenses and all franchise agreements shall inure to Agent’s benefit, for the benefit of the Lenders. In addition, Borrower hereby irrevocably agrees that Agent, upon the written instruction of the Majority Lenders, may, following the occurrence and during the continuance of an Event of Default, sell any of Borrower’s Inventory directly to any Person, including without limitation Persons who have previously purchased Borrower’s Inventory from Borrower and in connection with any such sale or other enforcement of Agent’s and Lenders’ rights under this Agreement, may sell Inventory which bears any trademark owned by or licensed to Borrower and any Inventory that is covered by any copyright owned by or licensed to Borrower and Agent may finish any work in process and affix any trademark owned by or licensed to Borrower and sell such Inventory as provided herein.

ARTICLE VI

WAIVERS, AMENDMENTS AND REMEDIES

No delay or omission of Agent or any Lender to exercise any right or remedy granted under this Security Agreement shall impair such right or remedy or be construed to be a waiver of any Default or Event of Default or an acquiescence therein, and any single or partial exercise of any such right or remedy shall not preclude any other or further exercise thereof or the exercise of any other right or remedy. No waiver, amendment or other variation of the terms, conditions or provisions of this Security Agreement whatsoever shall be valid unless in writing signed by Agent and then only to the extent in such writing specifically set forth. All rights and remedies contained in this Security Agreement or by law afforded shall be cumulative and all shall be available to Agent and the Lenders until the Secured Obligations have been paid in full.

ARTICLE VII

GENERAL PROVISIONS

SECTION 7.1. Notice of Disposition of Collateral. Borrower hereby waives notice of the time and place of any public sale or the time after which any private sale or other disposition of all or any part of the Collateral may be made. To the extent such notice may not be waived under applicable law, any notice made shall be deemed reasonable if sent to Borrower, addressed as set forth in Article IX, at least ten days prior to (i) the date of any such public sale or (ii) the time after which any such private sale or other disposition may be made.

 

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SECTION 7.2. Compromises and Collection of Collateral. Borrower and Agent recognize that setoffs, counterclaims, defenses and other claims may be asserted by obligors with respect to certain of the Receivables, that certain of the Receivables may be or become uncollectable in whole or in part and that the expense and probability of success in litigating a disputed Receivable may exceed the amount that reasonably may be expected to be recovered with respect to a Receivable. In view of the foregoing, Borrower agrees that Agent may at any time and from time to time, if an Event of Default has occurred and is continuing and upon the written instruction of the Majority Lenders, compromise with the obligor on any Receivable, accept in full payment of any Receivable such amount as Agent in its sole discretion shall determine or abandon any Receivable, and any such action by Agent shall be commercially reasonable so long as Agent acts in good faith based on information known to it at the time it takes any such action.

SECTION 7.3. Secured Party Performance of Borrower Obligations. Without having any obligation to do so, Agent may perform or pay any obligation which Borrower has agreed to perform or pay in this Security Agreement and Borrower shall reimburse Agent for any amounts paid by Agent pursuant to this Section 7.3. Borrower’s obligation to reimburse Agent pursuant to the preceding sentence shall be a Secured Obligation payable on demand.

SECTION 7.4. Authorization for Secured Party to Take Certain Action. Borrower irrevocably authorizes Agent at any time and from time to time in the sole discretion of Agent and appoints Agent as its attorney in fact (i) to file such financing statements and financing statement amendments, without notice to Borrower, in all jurisdictions Agent deems appropriate necessary or desirable in Agent’s sole discretion to perfect and to maintain the perfection and priority of Agent’s security interest in the Collateral, (ii) to indorse and collect any cash proceeds of the Collateral, (iii) to file a carbon, photographic or other reproduction of this Security Agreement or any financing statement with respect to the Collateral as a financing statement in such offices as Agent in its sole discretion deems necessary or desirable to perfect and to maintain the perfection and priority of Agent’s security interest in the Collateral, (iv) to contact and enter into one or more agreements with the issuers of uncertificated securities which are Collateral and which are Securities or with financial intermediaries holding other Investment Property as may be necessary or advisable to give Agent Control over such Securities or other Investment Property, (v) subject to the terms of Section 8.21 of the Credit Agreement, to enforce payment of the Receivables in the name of Agent or Borrower, (vi) to apply the proceeds of any Collateral received by Agent to the Secured Obligations in such order as Agent shall determine in its sole discretion, and (vii) to discharge past due taxes, assessments, charges, fees or Liens on the Collateral (except for such Liens as are specifically permitted hereunder), and Borrower agrees to reimburse Agent on demand for any payment made or any expense incurred by Agent in connection therewith, provided that this authorization shall not relieve Borrower of any of its obligations under this Security Agreement or under the Credit Agreement.

SECTION 7.5. Specific Performance of Certain Covenants. Borrower acknowledges and agrees that a breach of any of the covenants contained in Sections 4.1(e), 4.1(f), 4.4, 5.3, or 7.7 will cause irreparable injury to Agent and the Lenders, that neither Agent nor any Lender has any adequate remedy at law in respect of such breaches and therefore agrees, without limiting the right of Agent and the Lenders to seek and obtain specific performance of other obligations of Borrower contained in this Security Agreement, that the covenants of Borrower contained in the Sections referred to in this Section 7.5 shall be specifically enforceable against Borrower.

 

SECURITY AGREEMENT (Lilis Energy, Inc.) Page 13
 
 

SECTION 7.6. Use and Possession of Certain Premises. Upon the occurrence of an Event of Default, Agent shall be entitled to occupy and use any premises owned or leased by Borrower where any of the Collateral or any records relating to the Collateral are located for a reasonable period in order to effectuate its rights and remedies hereunder or under law, without any obligation to pay Borrower for such use and occupancy.

SECTION 7.7. Dispositions Not Authorized. Borrower is not authorized to sell or otherwise dispose of the Collateral except as set forth in Section 4.1(e) and notwithstanding any course of dealing between Borrower, Agent and the Lenders or other conduct of Agent or any Lender, no authorization to sell or otherwise dispose of the Collateral (except as set forth in Section 4.1(e)) shall be binding upon Agent or any Lender unless such authorization is in writing signed by the Majority Lenders.

SECTION 7.8. Benefit of Agreement. The terms and provisions of this Security Agreement shall be binding upon and inure to the benefit of Borrower, Agent and the Lenders and their respective successors and assigns, except that Borrower shall not have the right to assign its rights or delegate its obligations under this Security Agreement or any interest herein, without the prior written consent of the Majority Lenders.

SECTION 7.9. Survival of Representations. All representations and warranties of Borrower contained in this Security Agreement shall survive the execution and delivery of this Security Agreement.

SECTION 7.10. Taxes and Expenses. Any taxes (including income taxes) payable or ruled payable by Federal or State authority in respect of this Security Agreement shall be paid by Borrower, together with interest and penalties, if any. Borrower shall reimburse Agent and any Lender for any and all out-of-pocket expenses and internal charges (including reasonable attorneys’, auditors’ and accountants’ fees and reasonable time charges of attorneys, paralegals, auditors and accountants who may be employees of Agent or any Lender) paid or incurred by Agent or any Lender in connection with the preparation, execution, delivery, administration, collection and enforcement of this Security Agreement and in the audit, analysis, administration, collection, preservation or sale of the Collateral (including the expenses and charges associated with any periodic or special audit of the Collateral). Any and all costs and expenses incurred by Borrower in the performance of actions required pursuant to the terms hereof shall be borne solely by Borrower.

SECTION 7.11. Headings. The title of and section headings in this Security Agreement are for convenience of reference only, and shall not govern the interpretation of any of the terms and provisions of this Security Agreement.

SECTION 7.12. Termination. This Security Agreement shall continue in effect (notwithstanding the fact that from time to time there may be no Secured Obligations outstanding) until (i) the Credit Agreement has terminated pursuant to its express terms and (ii) all of the Secured Obligations have been indefeasibly paid and performed in full and no commitments of any Lender which would give rise to any Secured Obligations are outstanding. Upon the occurrence of the events specified in the preceding sentence, the Collateral shall be released from the Liens created hereby, and this Security Agreement and all obligations (other than those expressly stated to survive such termination) of Agent and Borrower hereunder shall terminate, all without delivery of any instrument or any further action by any party, and all rights to the Collateral shall revert to Borrower. Upon any such termination, the Agent shall deliver to Borrower any Collateral held by the Agent hereunder, and execute and deliver to Borrower such documents as Borrower shall reasonably request to evidence such termination, all at Borrower’s sole cost and expense.

 

SECURITY AGREEMENT (Lilis Energy, Inc.) Page 14
 
 

SECTION 7.13. Entire Agreement. This Security Agreement embodies the entire agreement and understanding between Borrower, Agent and the Lenders relating to the Collateral and supersedes all prior agreements and understandings between Borrower, Agent and the Lenders relating to the Collateral.

SECTION 7.14. GOVERNING LAW. THIS SECURITY AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF ARKANSAS AND THE UNITED STATES OF AMERICA.

ARTICLE VIII

NOTICES

SECTION 8.1. Sending Notices. Any notice required or permitted to be given under this Security Agreement shall be sent (and deemed received) in the manner and to the addresses set forth in Section 11.4 of the Credit Agreement.

SECTION 8.2. Change in Address for Notices. Each of Borrower and Agent may change the address for service of notice upon it by a notice in writing to the other parties or as otherwise permitted by the Credit Agreement.

[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]

 

SECURITY AGREEMENT (Lilis Energy, Inc.) Signature Page

 
 

IN WITNESS WHEREOF, Borrower and Agent have executed this Security Agreement as of the date first above written.

  BORROWER:
     
  LILIS, INC.,
  a Delaware corporation
     
  By:  /s/ Abraham Mirman
  Name: Abraham Mirman
  Title: CEO
     
  AGENT:
     
  HEARTLAND BANK,
  an Arkansas state bank
     
  By:  /s/ Phil Thomas
  Name: Phil Thomas
  Title: CLO/EVP

  

SECURITY AGREEMENT (Lilis Energy, Inc.) Page 16

 
 

 

SCHEDULE 3.5

 

Recovery Energy, Inc.

Universal Holdings, Inc.

 

SECURITY AGREEMENT (Lilis, Inc.) Page 17

 
 

 

EXHIBIT A

(See Sections 3.3, 3.4, and 4.1(g) of Security Agreement) 

Principal Place of Business and Mailing Address:

1900 Grant Street, Suite #720, Denver, CO, 80203

 

Location(s) of Receivables Records (if different from Principal Place of Business above):

20 Broadhollow Road, Suite 3011B, Melville, NY, 11747

 

Locations of Inventory and Equipment and Fixtures: 

Lilis Lease # Lessor Lessee Twnshp Range Section Legal Description County / State Recording Bk PG/Doc #
10003 Palmco, CW Palm Farms & Charles Wayne Palm Edward Mike Davis, LLC 17 57 18 Lots 1(49.46), 2(49.73), NE,
E2NW, less 86.83, SE less 52.59
Banner, NE 2158 1331-1334
      17 57 19 Lots 1(50.39), 2(50.73), E2NW Banner, NE