ITEM 7. 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 the financial statements and the notes thereto contained
elsewhere in this Report. Certain information contained in the discussion and analysis set forth below includes forward-looking statements
that involve risks and uncertainties – See “CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS”.
Overview
We are an independent oil and natural gas company
based in Texas and formed in 2017 that is focused on the acquisition, development, exploration, production and divestiture of oil and
natural gas properties in the Permian Basin. The Permian Basin is located in west Texas and southeastern New Mexico and is characterized
by high oil and liquids-rich natural gas content, multiple vertical and horizontal target horizons, extensive production histories, long-lived
reserves and historically high drilling success rates. Pogo’s properties are in the Grayburg-Jackson Field in Eddy County, New
Mexico, which is a sub-area of the Permian Basin. Pogo focuses primarily on production through waterflooding recovery methods.
Pogo is a limited liability company and is not
subject to federal and state income taxes. However, it must file informational tax returns and all taxable income or loss flows through
to the owners in their individual tax returns.
The Company’s assets as mentioned above
consist of contiguous leasehold positions of approximately 13,700 gross (13,700 net) acres with an average working interest of 100%.
We operate 100% of the net acreage across the Company’s assets, all of which is net operated acreage of vertical wells with average
depths of approximately 3,810 feet.
Our average daily production for the year ended
December 31, 2023, was 1,022 barrel of oil equivalent (“BOE”) per day, and for the year ended December 31, 2022, was 1,296
BOE per day. The decrease in production is due to an increase in well downtime and the conveyance of the 10% Override royalty interest
to Pogo Royalty.
Impact of Coronavirus (“COVID-19”)
The COVID-19 pandemic resulted in a severe worldwide
economic downturn, significantly disrupting the demand for oil throughout the world, and created significant volatility, uncertainty
and turmoil in the oil and gas industry. The decrease in demand for oil, combined with pressures on the global supply-demand balance
for oil and related products, resulted in oil prices declining significantly in late February 2020. Since mid-2020, oil prices have improved,
with demand steadily increasing despite the uncertainties surrounding the COVID-19 variants, which have continued to inhibit a full global
demand recovery. In addition, worldwide oil inventories are, from a historical perspective, very low and supply increases from the Organization
of the Petroleum Exporting Countries (“OPEC”), Russia and other oil producing nations are not expected to be sufficient to
meet forecasted oil demand growth in 2023, with many OPEC countries not able to produce at their OPEC agreed upon quota levels due to
their lack of capital investments over the past few years in developing incremental oil supplies.
Global oil price levels will ultimately depend
on various factors and consequences beyond the Company’s control, such as: (i) the effectiveness of responses to combat the COVID-19
virus and their impact on domestic and worldwide demand, (ii) the ability of OPEC, Russia and other oil producing nations to manage the
global oil supply, (iii) the timing and supply impact of any Iranian sanction relief on Iran’s ability to export oil, (iv) additional
actions by businesses and governments in response to the pandemic, (v) the global supply chain constraints associated with manufacturing
delays, and (vi) political stability of oil consuming countries.
We continue to assess the impact of the COVID-19
pandemic on our company and may modify our response as the impact of COVID-19 continues to evolve.
Certain prior year financial statements are not
comparable to our current year financial statements due to the adoption of fresh start accounting as a result of the Acquisition. References
to “Successor” relate to the financial position and results of operations of HNR Acquisition Corp subsequent to November 15,
2023. References to “Predecessor” relate to the financial position and results of operations of HNR Acquisition Corp prior
to, and including, November 14, 2023.
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Selected Factors That Affect Our Operating
Results
Our revenues, cash flows from operations and
future growth depend substantially upon:
● the timing and success of production and development activities;
● the prices for oil and natural gas;
● the quantity of oil and natural gas production from our wells;
● the level of our operating expenses.
In addition to the factors that affect companies
in our industry generally, the location of substantially all of our acreage discussed above subjects our operating results to factors
specific to these regions. These factors include the potential adverse impact of weather on drilling, production and transportation activities,
particularly during the winter and spring months, as well as infrastructure limitations, transportation capacity, regulatory matters
and other factors that may specifically affect one or more of these regions.
The price at which our oil and natural gas production
are sold typically reflects either a premium or discount to the New York Mercantile Exchange (“NYMEX”) benchmark price. Thus,
our operating results are also affected by changes in the oil price differentials between the applicable benchmark and the sales prices
we receive for our oil production. Our oil price differential to the NYMEX benchmark price during the years ended December 31, 2023 and
2022, was $(4.95) and $0.88 per barrel, respectively. Our natural gas price differential during the years ended December 31, 2023 and
2022, was $(0.06) and $(2.13) per one thousand cubic feet (“Mcf”), respectively. Fluctuations in our price differentials
and realizations are due to several factors such as gathering and transportation costs, takeaway capacity relative to production levels,
regional storage capacity, gain/loss on derivative contracts and seasonal refinery maintenance temporarily depressing demand.
Market Conditions
The price that we receive for the oil and natural
gas we produce is largely a function of market supply and demand. Because our oil and gas revenues are heavily weighted toward oil, we
are more significantly impacted by changes in oil prices than by changes in the price of natural gas. World-wide supply in terms of output,
especially production from properties within the United States, the production quota set by OPEC, and the strength of the U.S. dollar
can adversely impact oil prices.
Historically, commodity prices have been volatile,
and we expect the volatility to continue in the future. Factors impacting the future oil supply balance are world-wide demand for oil,
as well as the growth in domestic oil production.
Prices for various quantities of natural gas
and oil that we produce significantly impact our revenues and cash flows. The following table lists average NYMEX prices for oil and
natural gas for the years ended December 31, 2023, and 2022.
For the years ended December 31,
Average NYMEX Prices (1)
Natural gas (per Mcf) $ 2.54 $ 6.42
(1) Based on average NYMEX closing prices.
For the year ended December 31, 2023, the average
NYMEX oil pricing was $77.64 per barrel of oil or 18% lower than the average NYMEX price per barrel for the year ended December 31, 2022.
Our settled derivatives decreased our realized oil price per barrel by $3.63 and $17.58 in the years ended December 31, 2023, and 2022,
respectively. Our average realized oil price per barrel after reflecting settled derivatives and location differentials was $69.06 for
the year ended December 31, 2023 compared to $78.09 for the year ended December 31, 2022.
The average NYMEX natural gas pricing for the
year ended December 31, 2023, was $2.54 per Mcf, or 60% lower than the average NYMEX price per Mcf for the year ended December 31, 2022.
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Pogo Royalty Overriding Royalty Interest Transaction
Effective July 1, 2023, the Predecessor
transferred to Pogo Royalty, a related party, an assigned and undivided overriding royalty interest (“ORRI”) equal in
amount to ten percent (10%) of Pogo Resources, LLC’s and LH Operating, LLC’s interest all oil, gas and minerals in,
under and produced from each lease. The consideration received for the 10% ORRI was $10. Thus, a loss of $816,011 was recorded as a
result of the conveyance during the period from January 1, 2023 to November 14, 2023 of the Predecessor. Additionally, because of
this transaction, our reserve balance was decreased as well our current net production volumes and revenues. Additional details are discussed in
Note 1 and Note 12 of notes to the consolidated financial statements.
Results of Operations
For the year ended December 31, 2023, 97% and
3% of sales volumes from the assets were attributable to crude and natural gas, respectively. As of December 31, 2023, the company was
continuing development of the Seven River waterflood interval. Further, as of December 31, 2023, the Company owned an interest in approximately
341 gross (341 net) producing wells.
The following table sets forth selected operating
data for the periods indicated. Average sales prices are derived from accrued accounting data for the relevant period indicated.
Successor Predecessor
Revenues
Average sales prices:
Oil net of settled oil derivatives (per Bbl) 62.45 73.75 78.09
Expenses
Costs and expenses (per BOE):
Production taxes, transportation, and processing $ 5.20 $ 5.80 $ 7.36
Depreciation, depletion, and amortization expense 8.09 4.10 3.41
Accretion of asset retirement obligations 0.25 2.32 3.33
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Oil and Natural Gas Sales
Our revenues vary from year to year primarily
as a result of changes in realized commodity prices and production volumes. On a combined Successor and Predecessor basis, for the year
ended December 31, 2023, our oil and natural gas sales decreased 34% from the year ended December 31, 2022, driven by a 24% decrease in
realized prices, excluding the effect of settled commodity derivatives, and an 21% decrease in production volumes. The lower average price
in the combined year ended December 31, 2023 compared to 2022, was driven by lower average NYMEX oil and natural gas prices. Realized
production from oil and gas properties decreased due to an increase in well downtime and due to the July 1, 2023 conveyance of
the 10% overriding royalty interest to Pogo Royalty.
Production for the comparable periods is set
forth in the following table:
For the year ended December 31,
Production:
Average daily production:
Derivative Contracts
We enter into commodity derivatives instruments
to manage the price risk attributable to future oil production.
We recorded a gain on derivative contracts of
$392,675 on a combined Successor and Predecessor basis for the year ended December 31, 2023 compared to a loss of $4,793,790 for the
year ended December 31, 2022 (Predecessor). Lower commodity prices in 2023, resulted in realized losses of $1,266,277 on a combined Successor
and Predecessor basis for the year ended December 31, 2023 compared to realized losses of $6,978,790 for the year ended December 31,
2022. On a combined Successor and Predecessor basis for the year ended December 31, 2023, our average realized oil price per barrel after
reflecting settled derivatives was $73.82, compared to $78.09 the year ended December 31, 2022 (Predecessor).
As of December 31, 2023, we ended the period
with a $467,687 net derivative asset compared to $1,191,354 as of December 31, 2022.
Other Revenue
Other revenue was $571,189 on a combined Successor
and Predecessor basis for the year ended December 31, 2023, compared to $255,952 for the year ended December 31, 2022 (Predecessor).
The increase is due to a full period related to a new contract that the Predecessor entered into to provide water services to a third-party
effective September 1, 2022.
Lease Operating Expenses
Lease operating expenses were $10,146,119 on a
combined Successor and Predecessor basis for the year ended December 31, 2023, compared to $8,418,739 for the year ended December 31,
2022. On a per unit basis, production expenses increased 53% from $17.79 per BOE for the combined Successor and Predecessor year ended
December 31, 2023, to $27.20 per BOE for the combined Successor and Predecessor year ended December 31, 2023, due to increases in proactive
maintenance activities, higher labor costs, and increased oil field service and supplies costs. Additionally, because of the conveyance
of the 10% ORRI in July 2023, the net production volumes decreased, which increases the “per BOE” amounts.
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Production Taxes, Transportation and Processing
We pay production taxes, transportation and processing
costs based on realized oil and natural gas sales. Production taxes, transportation and processing costs were $2,343,862 on a combined
Successor and Predecessor basis for the year ended December 31, 2023, compared to $3,484,477 for the year ended December 31, 2022. As
a percentage of oil and natural gas sales, these costs were 9% in both periods. Production taxes, transportation, and processing as a
percent of total oil and natural gas sales are consistent with historical trends.
Depletion, Depreciation and Amortization
Depletion, depreciation and amortization (“DD&A”) was
$1,849,876 on a combined Successor and Predecessor basis for the year ended December 31, 2023, compared to $1,613,402 for the year ended
December 31, 2022. DD&A was $4.53 per BOE on a combined Successor and Predecessor basis for the year ended December 31, 2023, compared
to $3.41 per BOE for the year ended December 31, 2022. The aggregate increase in DD&A expense for the year ended December 31, 2023
compared to 2022 was driven by a 33% increase in the DD&A rate per BOE, partially offset by a 21% decrease in production levels. The
increase in the DD&A rate per BOE was driven by the increase in the oil and gas properties balance due to the development of the Seven
Rivers waterflood interval and the decrease in the reserves balance due to the conveyance of the 10% overriding royalty interest to Pogo
Royalty.
Accretion of Asset Retirement Obligations
Accretion expense was $859,102 on a combined Successor
and Predecessor basis for the year ended December 31, 2023, compared to $1,575,296 for the year ended December 31, 2022. Accretion expense
was $2.32 per BOE for the on a combined Successor and Predecessor basis for the year ended December 31, 2023, compared to $3.33 per BOE
for the year ended December 31, 2022. The aggregate decrease in accretion expense for the fiscal year ended December 31, 2023 compared
to 2022 was driven by changes in certain assumptions, specifically the inflation factor and discount rate as a result of the acquisition
date where we revised our estimates as part of its fair value estimates for the acquired business.
General and Administrative
General and administrative expenses were $7,253,384 on a combined Successor
and Predecessor basis for the year ended December 31, 2023, compared to $2,953,202 for the year ended December 31, 2022. The increase
for general and administrative expenses is primarily due to increased cost of outsourced legal, professional, and accounting services as
a result of the transaction disclosed in Note 1 in the notes to the consolidated financial statements and the costs of being a public
company. The general and administrative expense total of $3,553,117 for the period from November 15, 2023 to December 31, 2023 for the
Successor includes $1,500,000 from the 138,122 shares of Class A common stock issued to White Lion for the commitment fee on the Common
Stock Purchase Agreement, $910,565 in stock-based compensation to certain Founders under the Founder Pledge Agreement, and $135,400 in
other stock-based compensation.
Acquisition costs
Acquisition costs were $9,999,860 during the Successor period from
November 15, 2023 to December 31, 2023, and included an aggregate of $7,854,660 in costs related to the Forward Purchase Agreement and
the Non-Redemption Agreements, due diligence and broker fees related to closing the Purchase.
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Interest Expense and amortization of debt
discount
Interest expense was $1,043,312 for the period
from November 15, 2023 to December 31, 2023 (Successor), $1,834,208 for the period from January 1, 2023 to November 14, 2023 (Predecessor),
compared to $1,076,060 for the year ended December 31, 2022. The Successor period interest expense is driven by the Senior Secured Term
loan entered into as part of the Closing, and the Private Notes Payable. The increase in the Predecessor period from January 1, 2023 to
November 15, 2023 compared to the year ended December 31, 2022 was primarily due to an increase in the average amount of the Predecessor’
revolving credit facility outstanding and an increase in the weighted average interest rate. The revolving credit facility was not assumed
in the Acquisition.
Amortization of debt discount was $1,191,553
period from November 15, 2023 to December 31, 2023 (Successor), and attributable to deferred finance costs paid on the Senior Secured
Term Loan, and discounts associated with the Private Notes Payable during 2023.
Change in fair value of forward purchase agreement
The change in fair value of forward purchase
agreement consisted of a gain of $3,268,581 for the period from November 15, 2023 to December 31, 2023 for the Successor related to the
inputs used in the Company’s fair value estimate of the FPA Put Option. The key inputs to the fair value estimate include the Company’s
stock price, which declined during the Successor period, and the likelihood, timing and price of a potential dilutive offering.
Change in fair value of warrant liabilities
The change in fair value of warrant liabilities
consisted of a gain of $187,704 for the period from November 15, 2023 to December 31, 2023 for the Successor related to fluctuations
in the trading price of the Company’s warrants, a portion of which are accounted for as liabilities due to the redemption provisions
in those issued to Private Note holders.
Loss on asset sales
Loss on asset sales was $816,011 on a combined
Successor and Predecessor basis for the year ended December 31, 2023, compared to $0 for the year ended December 31, 2022. The increase
was due to the loss that was recognized as a result of the conveyance of the 10% overriding royalty interest to Pogo Royalty in July 2023.
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Liquidity and Capital Resources
Liquidity
Our main sources of liquidity have been internally
generated cash flows from operations and credit facility borrowings. Our primary use of capital has been for the development of oil and
gas properties and the return of initial invested capital to our owners. We continually monitor potential capital sources for opportunities
to enhance liquidity or otherwise improve our financial position.
As of December 31, 2023, we had outstanding debt of $27,680,703 under
our Senior Secured Term Loan, $15,000,000 under the Seller Promissory Note, and $3,469,500 of outstanding private notes payable. A total
of $7,627,102 of this is due within one year. As of December 31, 2023, we had $3,505,454 of cash and cash equivalents on hand, of which
$2,600,000 is in an escrow account pursuant to the requirements of the Senior Secured Term Loan. At December 31, 2023, we had $3,505,454 in cash and a working capital
deficit of $13,300,601. These conditions raise substantial doubt about our ability to continue as a going concern within one year after
the date that the financial statements are issued.
The Company had positive cash flow from operations
of $8,675,037 for the year ended December 31, 2023 on a pro forma basis of the combined Successor and Predecessor periods. Additionally,
management’s plans to alleviate this substantial doubt include improving profitability through streamlining costs, maintaining
active hedge positions for its proven reserve production, and the issuance of additional shares of Class A common stock through. We have
a three-year Common Stock Purchase Agreement with a maximum funding limit of $150,000,000 that can fund our operations and production
growth, and be used to reduce liabilities, subject the Company’s Form S-1 Registration Statement, which is in the review process,
being declared effective by the Securities and Exchange Commission (“SEC”). However, we may seek additional access to capital
and liquidity. We cannot assure you, however, that any additional capital will be available to us on favorable terms or at all. Our capital
expenditures could be curtailed if our cash flows decline from expected levels.
Cash Flows
Sources and uses of cash for the years ended
December 31, 2023, and 2022, are as follows:
Successor Predecessor
Operating Activities
The decrease in net cash flow provided by operating
activities on a combined Successor and Predecessor basis for the year ended December 31, 2023, as compared to 2022 is primarily due to
decreased net income as a result of decreased prices and production volumes, and higher general and administrative and acquisition costs
associated with public filings and the closing of the Acquisition.
Investing Activities
Net cash provided by investing activities in the Successor period was
primarily due to Trust Account withdrawals associated with the Closing in November 2023 of $49,362,479, partially offset by the cash paid
to the Sellers of Pogo of $30,827,804 at the Closing, net of cash acquired. Cash flows used in investing activities in the Predecessor
period ending November 14, 2023 consisted of $6,769,557 of cash paid for oil and gas property costs, which was a decrease from $16,891,856
in the year ended December 31, 2022, primarily due to significant expenditures in the previous year to
upgrade certain wells and meet compliance requirements.
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Financing Activities
Net cash used by financing activities during the Successor period were
primarily related to the redemptions of common stock of Public Shares at Closing of $44,737,839, partially offset by the net proceeds
from the Senior Secured Term Loan of $27,191,008.
Off Balance Sheet Arrangements
As of December 31, 2023 and 2022, the Company
did not have any off-balance sheet arrangements, as defined in the rules and regulations of the Securities and Exchange Commission (“SEC”).
Contractual Obligations
We have contractual commitments under our Senior
Secured Term Loan, the Seller Promissory Note and the Private Notes Payable which include periodic interest payments. See Note 5 to our
interim condensed consolidated unaudited financial statements. We have contractual commitments that may require us to make payments upon
future settlement of our commodity derivative contracts. See Note 4 to our interim condensed consolidated unaudited financial statements.
Our other liabilities represent current and noncurrent other liabilities
that are primarily comprised of environmental contingencies, asset retirement obligations and other obligations for which neither the
ultimate settlement amounts nor their timings can be precisely determined in advance.
Critical Accounting Estimates
The following is a discussion of our most critical accounting estimates,
judgements and uncertainties that are inherent in the Company’s application of GAAP.
Successful Efforts Method of Accounting
We utilize the successful efforts method of accounting for crude oil
and gas producing activities as opposed to the alternate acceptable full cost method. In general, we believe that net assets and net income
are more conservatively measured under the successful efforts method of accounting for crude oil and gas producing activities than under
the full cost method, particularly during periods of active exploration. The critical difference between the successful efforts method
of accounting and the full cost method is that under the successful efforts method, exploratory dry holes and geological and geophysical
exploration costs are charged against earnings during the periods in which they occur; whereas, under the full cost method of accounting,
such costs and expenses are capitalized as assets, pooled with the costs of successful wells and charged against the earnings of future
periods as a component of depletion expense.
Proved Reserve Estimates
Estimates of our proved reserves included in this report are prepared in accordance with GAAP and SEC guidelines. The accuracy of a proved
reserve estimate is a function of:
● the quality and quantity of available data;
● the interpretation of that data;
● the accuracy of various mandated economic assumptions; and
● the judgment of the persons preparing the estimate.
Our proved reserve information included in this filing as of December
31, 2023 and 2022, was prepared by independent petroleum engineers. Because these estimates depend on many assumptions, all of which may
substantially differ from future actual results, proved reserve estimates will be different from the quantities of oil and gas that are
ultimately recovered. In addition, results of drilling, testing and production after the date of an estimate may justify, positively or
negatively, material revisions to the estimate of proved reserves.
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It should not be assumed that the standardized measure included as
of December 31, 2023, is the current market value of our estimated proved reserves. In accordance with SEC requirements, we based the
2023 standardized measure on a twelve-month average of commodity prices on the first day of each month in 2023 and prevailing costs on
the date of the estimate. Actual future prices and costs may be materially higher or lower than the prices and costs utilized in the estimate.
See Note 12 of notes to the consolidated financial statements for additional information.
Our estimates of proved reserves materially impact depletion expense.
If the estimates of proved reserves decline, the rate at which we records depletion expense will increase, reducing future net income.
Such a decline may result from lower commodity prices, which may make it uneconomical to drill for and produce higher cost fields. In
addition, a decline in proved reserve estimates may impact the outcome of our assessment of our proved properties for impairment.
Impairment of Proved Oil and Gas Properties
We review our proved properties to be held and used whenever management
determines that events or circumstances indicate that the recorded carrying value of the properties may not be recoverable. Management
assesses whether or not an impairment provision is necessary based upon estimated future recoverable proved reserves, commodity price
outlooks, production and capital costs expected to be incurred to recover the reserves, discount rates commensurate with the nature of
the properties and net cash flows that may be generated by the properties. Proved oil and gas properties are reviewed for impairment at
the level at which depletion of proved properties is calculated. See Note 2 of notes to the consolidated financial statements.
Asset Retirement Obligations
We have significant obligations to remove tangible equipment and facilities
and to restore the land at the end of crude oil and natural gas production operations. Our removal and restoration obligations are primarily
associated with plugging and abandoning wells. Estimating the future restoration and removal costs is difficult and requires management
to make estimates and judgments because most of the removal obligations are many years in the future and contracts and regulations often
have vague descriptions of what constitutes removal. Asset removal technologies and costs are constantly changing, as are regulatory,
political, environmental, safety and public relations considerations.
Inherent in the present value calculation are
numerous assumptions and judgments including the ultimate settlement amounts, credit-adjusted discount rates, timing of settlement and
changes in the legal, regulatory, environmental and political environments. To the extent future revisions to these assumptions impact
the present value of the existing asset retirement obligations, a corresponding adjustment is generally made to the crude oil and natural
gas property or other property and equipment balance. See Note 5 of notes to the consolidated financial statements.
Litigation and Environmental Contingencies
We make judgments and estimates in recording liabilities for ongoing
litigation and environmental remediation. Actual costs can vary from such estimates for a variety of reasons. The costs to settle litigation
can vary from estimates based on differing interpretations of laws and opinions and assessments on the amount of damages. Similarly, environmental
remediation liabilities are subject to change because of changes in laws and regulations, developing information relating to the extent
and nature of site contamination and improvements in technology. A liability is recorded for these types of contingencies if we determine
the loss to be both probable and reasonably estimable. See Note 9 of notes to the consolidated financial statements.
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Forward Purchase Agreement Valuation
The Company has determined
that the FPA Put Option, including the Maturity Consideration, within the Forward Purchase Agreement is (i) a freestanding financial
instrument and (ii) a liability (i.e., an in-substance written put option). This liability was recorded as a liability at fair value
on the consolidated balance sheet as of the reporting date in accordance with ASC 480. The fair value of the liability was estimated
using a Monte-Carlo Simulation in a risk-neutral framework. Specifically, the future stock price is simulated assuming a Geometric Brownian
Motion (“GBM”). For each simulated path, the forward purchase value is calculated based on the contractual terms and then
discounted back to present. Finally, the value of the forward is calculated as the average present value over all simulated paths. The
model also considered the likelihood of a dilutive offering of common stock.
Derivative Instruments
The Company uses derivative financial instruments to mitigate its exposure
to commodity price risk associated with oil prices. The Company’s derivative financial instruments are recorded on the consolidated
balance sheets as either an asset or a liability measured at fair value. The Company has elected not to apply hedge accounting for its
existing derivative financial instruments, and as a result, the Company recognizes the change in derivative fair value between reporting
periods currently in its consolidated statements of operations. The fair value of the Company’s derivative financial instruments
is determined using industry-standard models that consider various inputs including: (i) quoted forward prices for commodities, (ii) time
value of money and (iii) current market and contractual prices for the underlying instruments, as well as other relevant economic
measures. Realized gains and losses from the settlement of derivative financial instruments and unrealized gains and unrealized losses
from valuation changes in the remaining unsettled derivative financial instruments are reported in a single line item as a component of
revenues in the consolidated statements of operations. Cash flows from derivative contract settlements are reflected in operating activities
in the accompanying consolidated statements of cash flows. See Note 4 for additional information about the Company’s derivative
instruments.
New Accounting Pronouncements
The effects of new accounting pronouncements
are discussed in Note 2 to the consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
We are a smaller reporting company as defined
by Rule 12b-2 of the Exchange Act and are not required to provide the information otherwise required under this item.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
This information appears following Item 16
of this report and is included herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are controls
and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed
in our reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive
Officer (Principal Executive Officer), Chief Financial Officer (Principal Financial Officer) and Controller (Principal Accounting Officer),
as appropriate to allow timely decisions regarding required disclosure.
As required by Rules 13a-15 and 15d-15 under the Exchange
Act, our Chief Executive Officer (Principal Executive Officer), Chief Financial Officer (Principal Financial Officer) and Controller (Principal
Accounting Officer) carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures
as of December 31, 2023. Based upon his evaluation, our Chief Executive Officer (Principal Executive Officer), Chief Financial Officer
(Principal Financial Officer) and Controller (Principal Accounting Officer) concluded that, our disclosure controls and procedures were
not effective related to the lack of sufficient accounting personnel to manage the Company’s financial accounting process, lack
of segregation of duties, proper accounting for complex financial instruments and lack of design and implementation of controls related
to oil and gas activities which combined constituted a material weakness in our internal control over financial reporting. As a result,
we performed additional analysis as deemed necessary to ensure that our financial statements were prepared in accordance with U.S. generally
accepted accounting principles. Accordingly, management believes that the financial statements included in this Annual Report on Form
10-K present fairly in all material respects our financial position, results of operations and cash flows for the period presented.
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A material weakness is a deficiency, or combination
of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement
of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. Management concluded
that a deficiency in internal control over financial reporting existed relating to the lack of sufficient accounting personnel to manage
the Company’s financial accounting process, lack of segregation of duties, proper accounting for complex financial instruments and
lack of design and implementation of controls related to oil and gas activities constituted a material weakness as defined in the SEC
regulations.
Management’s Report on Internal Controls Over Financial Reporting
As required by SEC rules and regulations implementing
Section 404 of the Sarbanes-Oxley Act, our management is responsible for establishing and maintaining adequate internal control over
financial reporting. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of our consolidated financial statements for external reporting purposes in accordance with
GAAP. Our internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of our company, (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP,
and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors, and (3)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that
could have a material effect on the consolidated financial statements.
Management assessed the effectiveness of our
internal control over financial reporting at December 31, 2023. In making these assessments, management used the criteria set forth by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013). Based
on our assessments and those criteria, management determined that we did not maintain effective internal control over financial reporting
as of December 31, 2023 due to the material weakness in our internal control over financial reporting described above.
This Annual Report on Form 10-K does not include
an attestation report on internal control over financial reporting from our independent registered public accounting firm due to our
status as an emerging growth company under the JOBS Act.
Changes in Internal Control over Financial Reporting
During the most recently completed fiscal quarter,
there has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange
Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We plan
to enhance our processes to identify and appropriately apply applicable accounting requirements to better evaluate and understand the
nuances of the complex accounting standards that apply to our financial statements. Our plans at this time include providing enhanced
access to accounting literature, research materials and documents and increased communication among our personnel and third-party professionals
with whom we consult regarding complex accounting applications. The elements of our remediation plan can only be accomplished over time,
and we can offer no assurance that these initiatives will ultimately have the intended effects.
ITEM 9B. OTHER INFORMATION.
During the three months ended December 31, 2023,
none of our directors or officers (as defined in Rule 16a-1(f) of the Exchange Act) adopted, modified or terminated a “Rule 10b5-1
trading arrangement” or a “non-Rule 10b5-1 trading arrangement” as such terms are defined under Item 408 of Regulation
S-K.
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT
INSPECTIONS.
Not applicable.
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PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors and Executive Officers
Our Board of Directors consists of five directors. Three of the five
directors are independent. Our current directors and executive officers are as follows:
Name Age Title
Dante Caravaggio 67 Chief Executive Officer, President and Director
Mitchell B. Trotter 65 Chief Financial Officer and Director
David M. Smith 69 General Counsel and Secretary
Joseph V. Salvucci Sr 68 Director and Chairman
Joseph V. Salvucci Jr. 39 Director
Byron Blount 66 Director
Dante Caravaggio — Chief Executive
Officer, President and Director. Mr. Caravaggio joined the company and has served as our Chief Executive Officer, President, and
Director since December 2023. Since April 2021, Mr. Caravaggio has served as Chairman of SWI Excavating, one of the leading regional
underground utility contractors in Colorado. From January 2020 to April 2022, Mr. Caravaggio served on the board of directors of McCarl’s
Inc., a leading energy constructor in the northeast United States. Prior to joining McCarl’s Inc., Mr. Caravaggio was Senior Vice
President, Hydrocarbons Americas for KBR (US) since January 2018. Prior to his role with KBR (US), Mr. Caravaggio held a number of roles
as an executive and project manager with Parsons Corp. and Jacobs Engineering, overseeing upstream and downstream hydrocarbon projects.
Mr. Caravaggio received his MBA at Pepperdine University in Malibu, California and his BS and MS in Petroleum Engineering at the University
of Southern California.
Mr. Caravaggio is qualified to serve as
CEO and as a member of our board of directors based on our review of his qualifications, attributes, and skills, including his oil and
gas management experience and oil and gas acquisition experience.
Mitchell B. Trotter — Chief
Financial Officer and Director. Mr. Trotter joined the company and has served as our Senior Vice President of Finance since
October 2022 and became Chief Financial Officer and Director in November 2023. Mr. Trotter has 41 years of experience
beginning his career in 1981 as an auditor with Coopers & Lybrand for seven years. He then served as CFO of two private
investor backed private companies where the first was in real estate development and the latter in the engineering and construction industry.
For the next 30 years, Mr. Trotter served in various CFO and Controller positions with three publicly traded companies in the
engineering and construction services industry which were: Earth Tech to 2002; Jacobs Engineering to 2017; and AECOM to 2022. In those
roles Mr. Trotter managed up to 400 plus staff across six continents supporting global operations with clients in multiple industries
across private, semi-public and public sectors. Mr. Trotter earned his BS Accounting from Virginia Tech in 1981 and his MBA from
Virginia Commonwealth University in 1994. He professional credentials are: Certified Public Accountant in Virginia; Certified Management
Accountant; and Certified in Financial Management.
David M. Smith, Esq. — Vice President, General
Counsel and Secretary of the Company. Mr. Smith has served as our General Counsel and Secretary since November 2023.Mr.
Smith is a licensed attorney in Texas with over 40 years’ experience in the legal field of oil and gas exploration and production,
manufacturing, purchase and sale agreements, exploration agreements, land and leaseholds, right of ways, pipelines, surface use, joint
operating agreements, joint interest agreements, participation agreements and operations as well as transactional and litigation experience
in oil and gas, real estate, bankruptcy and commercial industries. Mr. Smith purchased 142,500 HNRA shares as a founder. Mr. Smith has
represented a number of companies in significant oil and gas transactions, mergers and acquisitions, intellectual property research and
development and sales in the oil and gas drilling business sector. Mr. Smith began his career by serving in a land and legal capacity
as Vice President of Land and, subsequently, as President of a public Canadian company until beginning his legal practice as a partner
with several law firms and ultimately creating his own independent legal practice. Mr. Smith holds a degree in Finance from Texas A&M
University, a Doctor of Jurisprudence from South Texas College of Law and is licensed before the Texas Supreme Court.
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Joseph V. Salvucci, Sr. — Independent
Director and Chairman of the Board. Joseph V. Salvucci, Sr. has served as a member of our board of directors since December 2021.
JVS Alpha Property, LLC, an entity which the majority is beneficially owned by Mr. Salvucci, with the balance owned by his immediate
family, purchased 940,000 HNRA shares as a founder. Mr. Salvucci acquired PEAK Technical Staffing USA (“PEAK”), peaktechnical.com
in 1986 and has grown the business to be a premier provider of USA-based contract engineers and technical specialists, on assignment
worldwide through a comprehensive, customer focused, enterprise-wide Managed Staffing Solution. During his 35-year tenure as owner of
the company, PEAK has expanded from Pittsburgh to do business in all 50 States, Canada, Europe, South America, India, and the Philippines.
He served 10 years on the board of directors culminating as President and Board Chairman of the National Technical Services Association,
a trade association representing 300,000 contractors on assignment in the technical staffing industry that later merged with the American
Staffing Association. He is an active member of the Young Presidents Organization (YPO GOLD), formerly known as the World Presidents
Organization (WPO) and has served as a member of the WPO International Board, as well as chairman of East Central US (ECUS) Region and
Pittsburgh chapters as Chairman of the Board. As a 1976 Civil Engineering graduate of the University of Pittsburgh, he was a member of
the Triangle (Engineering) Fraternity and its Alumni Association. He earned the Triangle Fraternity Distinguished Alumnus Citation in
2011 and currently serves on the Board of Directors. After earning the rank of Eagle Scout in 1970, he has remained active with the Boy
Scouts of America, having served as the founding Chairman of the Board of the Pittsburgh Chapter of the National Eagle Scout Association,
earning the NOESA (National Outstanding Eagle Scout Award) and the Silver Beaver Award and is past VP of Development and a board member
of the Laurel Highlands Council in Western Pennsylvania. He was awarded the Manifesting the Kingdom of God Award by the Catholic Diocese
of Pittsburgh in 2011. He was awarded the “Big Mac Award” from the Ronald McDonald Charities. As well as earning his BS in
Civil Engineering from the University of Pittsburgh in 1976 and attended Harvard Business School’s OPM 33, graduating in 2003.
Joseph V. Salvucci, Jr. — Independent
Director. Joseph V. Salvucci, Jr. has served as a member of our board of directors since December 2021. Mr. Salvucci began
his career with PEAK Technical Staffing USA in November 2010 and is currently serving as the Chief Executive Officer overseeing
nine branches with several hundred employees, and managing strategic initiatives for the company, including Staff Training, Career Pathing,
and Organic Growth. Mr. Salvucci Jr received his Executive MBA from the University of Pittsburgh. In addition to his responsibilities
as President/COO of PEAK, Mr. Salvucci serves on the board of Temporary Services Insurance Limited, a Workers’ Compensation
company serving staffing companies.
Byron Blount — Independent
Director. Mr. Blount joined the board of directors and is the chair of the audit committee since November 2023. Mr. Blount has extensive
experience in finance, investments, and acquisitions. He was Managing Director for the Blackstone Real Estate Group from 2011 to 2021
where he: had Primary Asset Management responsibilities for several industries and portfolio companies; oversaw the onboarding of acquisitions
and establishment of Blackstone-affiliated portfolio companies; and had Primary Disposition responsibilities for several portfolios and
companies across several industries. Mr. Blount was the LXR/Blackstone Executive Vice President from 2005 to 2010. His primary responsibilities
involved: underwriting and acquisition of domestic and international property and mortgage loan portfolios; asset management; renovation
and reconstruction projects, debt, and business model restructuring; and dispute resolution. He was a Principal of Colony Capital from
1993 to 2004 and was responsible for sourcing and structuring new investments, consummating transactions valued in excess of $5 billion.
His Primary Acquisitions responsibilities included domestic and international acquisitions of real property, distressed mortgage debt,
and real estate-related assets and entities. From 1987 to 1992, Mr. Blount was Vice President of WSGP which was formed to capitalize
on the struggles of the US Savings and Loan industry and the FSLIC. He was responsible for structuring and managing/working out new investment
opportunities, generally acquired from failed financial institutions. He graduated from University of Southern California in 1982 with
a B.S. in Business Administration. Mr. Blount earned his MBA from University of Southern California’s Marshall School of Business
in 1987 and is a member Beta Gamma Sigma (International Business Honor Society).
Family Relationships
There are no family relationships between any
of our officers and directors, except that Mr. Joseph V. Salvucci, Sr. and Mr. Joseph V. Salvucci, Jr. are father and son,
respectively.
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Number and Terms of Office of Officers and Directors
Our board of directors has five directors. Our
board of directors is divided into two classes with only one class of directors being elected in each year and each class (except for
those directors appointed prior to our first annual meeting of stockholders) serving a two-year term. The class I directors consist of
Dante Caravaggio and Joseph V. Salvucci, Jr., and their term will expire at our first annual meeting of stockholders. The class II directors
consist of Mitchell Trotter, Byron Blount, and Joseph V. Salvucci, Sr. and their term will expire at the second annual meeting of stockholders.
Our officers are elected by the board of directors
and serve at the discretion of the board of directors, rather than for specific terms of office. Our board of directors is authorized
to appoint persons to the offices set forth in our bylaws as it deems appropriate. Our bylaws provide that our officers may consist of
a Chief Executive Officer, President, Chief Financial Officer, Vice Presidents, Secretary, Assistant Secretaries, Treasurer and such
other offices as may be determined by the board of directors.
Director Independence
The NYSE American listing standards require that
a majority of our board of directors be independent. An “independent director” is defined generally as a person other than
an officer or employee of the company or its subsidiaries or any other individual having a relationship which in the opinion of the company’s
board of directors, would interfere with the director’s exercise of independent judgment in carrying out the responsibilities of
a director. Of the current members of our board of directors, Messrs. Salvucci Sr., Salvucci Jr., and Byron Blount are each considered
an “independent director” under the NYSE American listing standards and applicable SEC rules. Our independent directors will
have regularly scheduled meetings at which only independent directors are present.
Committees of the Board of Directors
The standing committees of our Board of Directors
consist of an audit committee (the “Audit Committee”), a compensation committee (the “Compensation Committee”),
and a Nominating and Corporate Governance Committee (the “Nominating Committee”). The Audit Committee, Compensation Committee,
and the Nominating Committee report to the Board of Directors.
Audit Committee
The members of our Audit Committee are Messrs.
Blount and Salvucci Sr., and Mr. Blount serves as chairman of the Audit Committee. As a smaller reporting company under the NYSE
American listing standards, we are required to have at least two members on the Audit Committee. The rules of the NYSE American and Rule 10A-3
of the Exchange Act require that the audit committee of a listed company be comprised solely of independent directors. Each of Messrs.
Salvucci Sr. and Blount qualifies as an independent director under applicable rules. Each member of the Audit Committee is financially
literate and our board of directors has determined that Mr. Blount qualifies as an “audit committee financial expert” as
defined in applicable SEC rules.
We have adopted an audit committee charter, which
details the principal functions of the audit committee, including:
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Compensation Committee
The members of our Compensation Committee are
Messrs. Salvucci Sr., Salvucci, Jr., and Blount. Mr. Salvucci, Jr. serves as chairman of the Compensation Committee. Under the NYSE
American listing standards and applicable SEC rules, we are required to have at least two members on the Compensation Committee, all
of whom must be independent.
We have adopted a compensation committee charter,
which details the principal functions of the compensation committee, including:
● reviewing our executive compensation policies and plans;
The charter also provides that the Compensation
Committee may, in its sole discretion, retain or obtain the advice of a compensation consultant, legal counsel or other adviser and will
be directly responsible for the appointment, compensation and oversight of the work of any such adviser. However, before engaging or
receiving advice from a compensation consultant, external legal counsel or any other adviser, the compensation committee will consider
the independence of each such adviser, including the factors required by the NYSE American and the SEC.
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Nominating and Corporate Governance Committee
The members of our Nominating Committee are Messrs.
Blount, Salvucci Sr. and Salvucci Jr. Mr. Salvucci Jr. serves as chair of Nominating Committee.
The primary purposes of our Nominating Committee
is to assist the board in:
The Nominating Committee
is governed by a charter that complies with the rules of the NYSE American.
A copy of each of our Nominating Committee Charter,
Compensation Committee Charter, and Audit Committee Charter are accessible at https://hnra-nyse.com/.
Director Nominations
Our Nominating Committee will recommend to the
board of directors candidates for nomination for election at the annual meeting of the stockholders. The board of directors will also
consider director candidates recommended for nomination by our stockholders during such times as they are seeking proposed nominees to
stand for election at the next annual meeting of stockholders (or, if applicable, a special meeting of stockholders).
We have not formally established any specific,
minimum qualifications that must be met or skills that are necessary for directors to possess. In general, in identifying and evaluating
nominees for director, the board of directors considers educational background, diversity of professional experience, knowledge of our
business, integrity, professional reputation, independence, wisdom, and the ability to represent the best interests of our stockholders.
Compensation Committee Interlocks and Insider
Participation
None of our future executive officers currently
serves, and in the past year has not served, as a member of the board of directors or compensation committee of any entity that has one
or more executive officers serving on our board of directors.
Code of Ethics
We have adopted a Code of Ethics applicable to
our directors, officers and employees. The Code of Ethics is available on our website accessible at https://hnra-nyse.com/. In