Forward Looking Statements

This Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements other than statements of historical facts included in and incorporated by reference into this Form 10-Q are forward-looking statements. When used in this Form 10-Q, the words "will", "expect", "anticipate", "intend", "plan", "believe", "seek", "estimate" and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Forward-looking statements in this Form 10-Q include statements regarding our expected future revenue, income, production, liquidity, cash flows, reclamation and other liabilities, expenses and capital projects, future capital expenditures and future transactions. Because these forward-looking statements involve risks and uncertainties, actual results could differ materially from those expressed or implied by these forward-looking statements due to a variety of factors, including those associated with our ability to find oil and natural gas reserves that are economically recoverable, the volatility of oil, natural gas liquids and natural gas prices, declines in the values of our properties that have resulted in and may in the future result in additional ceiling test write downs, our ability to replace reserves and sustain production, our estimate of the sufficiency of our existing capital sources, our ability to raise additional capital to fund cash requirements for our participation in oil and gas properties and for future acquisitions, the uncertainties involved in estimating quantities of proved oil and natural gas reserves, in prospect development and property acquisitions or dispositions and in projecting future rates of production or future reserves, the timing of development expenditures and drilling of wells, hurricanes and other natural disasters and the operating hazards attendant to the oil and gas and minerals businesses. In particular, careful consideration should be given to cautionary statements made in the "Risk Factors" section of our 2019 Annual Report on Form 10-K and other quarterly reports on Form 10-Q filed with the SEC, all of which are incorporated herein by reference. The Company undertakes no duty to update or revise any forward-looking statements.





General Overview

U.S. Energy Corp. ("U.S. Energy", the "Company", "we" or "us") is a Wyoming corporation organized in 1966. We are an independent energy company focused on the acquisition and development of oil and natural gas producing properties in the continental United States. Our business activities are currently focused in South Texas and the Williston Basin in North Dakota.

We have historically explored for and produced oil and natural gas through a non-operator business model. As a non-operator, we rely on our operating partners to propose, permit, drill, complete and produce oil and natural gas wells. Before a well is drilled, the operator provides all oil and natural gas interest owners in the designated well the opportunity to participate in the drilling and completion costs and revenues of the well on a pro-rata basis. Our operating partners also produce, transport, market and account for all oil and natural gas production.





Recent Developments

On March 1, 2020, we acquired all of the issued and outstanding equity interests of New Horizon Resources LLC ("New Horizon"), whose assets include acreage and operated producing properties in North Dakota (the "Properties"). The consideration paid at closing consisted of 59,498 shares of our common stock, $150,000 in cash and the assumption of certain liabilities (the "Acquisition"). The Properties consist of nine gross wells (five net wells) and approximately 1,300 net acres located primarily in McKenzie and Divide Counties, North Dakota, which are 100% held by production, average a 63% working interest and produced approximately 30 net barrels of oil equivalent per day (88% oil) for the six-month period ended December 31, 2019.





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Legal Proceedings

APEG II, our largest shareholder holding approximately 42% of our outstanding common stock, and its general partner, APEG Energy II, GP (together with APEG II, "APEG") are involved in litigation with us and our former Chief Executive Officer, David Veltri. For more detail regarding such litigation, please see the sections Litigation-APEG II Litigation and -Litigation with Former Chief Executive Officer in Note 8-Commitments, Contingencies and Related-Party Transactions in the Notes to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this report.

Critical Accounting Policies and Estimates

The preparation of our condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States ("GAAP") requires us 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. Actual results may differ from these estimates under different assumptions or conditions. A summary of our significant accounting policies is detailed in Part II, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations of our 2019 Annual Report on Form 10-K filed with the SEC on March 30, 2020.

Recently Issued Accounting Standards

Please refer to the section entitled Recently Adopted Accounting Pronouncements under Note 1 - Organization, Operations and Significant Accounting Policies in the Notes to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this report for additional information on recently issued accounting standards and our plans for adoption of those standards.





Results of Operations

Comparison of our Statements of Operations for the Three Months Ended March 31,


                                 2020 and 2019

During the three months ended March 31, 2020, we recorded a net loss of $306 thousand as compared to net income of $15 thousand for the three months ended March 31, 2019. In the following sections we discuss our revenue, operating expenses, and non-operating income, for the three months ended March 31, 2020 compared to the three months ended March 31, 2019.

Revenue. Presented below is a comparison of our oil and gas sales, production quantities and average sales prices for the three months ended March 31, 2020 and 2019 (dollars in thousands, except average sales prices):





                                    Three months ended
                                         March 31,             Change
                                     2020          2019        Amount        Percent

        Revenue:
        Oil                       $      855     $  1,415     $    (560 )         -40 %
        Natural gas and liquids           68          146           (78 )         -53 %

        Total                     $      923     $  1,561     $    (638 )         -41 %

        Production quantities:
        Oil (Bbls)                    20,305       25,352        (5,047 )         -20 %
        Gas (Mcfe)                    40,313       53,261       (12,498 )         -24 %
        BOE                           27,204       34,229        (7,205 )         -22 %

        Average sales prices:
        Oil (Bbls)                $    42.11     $  55.82     $  (13.72 )         -24 %
        Gas (Mcfe)                      1.69         2.73         (1.04 )         -38 %
        BOE                       $    34.16     $  45.59     $  (11.43 )         -25 %




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The decrease in our oil and gas revenue of $638 thousand for the three months ended March 31, 2020 as compared to the three months ended March 31, 2019 was attributed to a decrease in prices on a barrels of oil equivalent ("BOE") basis of 25%, and a decrease in production quantities on a BOE basis of 22%. Our revenues are heavily weighted to oil as 93% and 91% of our revenues for the three-month periods ended March 31, 2020 and 2019, respectively are from oil sales.

For the three months ended March 31, 2020, we produced 27,204 BOE, or an average of 297 BOE per day, as compared to 34,229 BOE or 380 BOE per day during the comparable period in 2019. This reduction of 7,205 BOE was mainly attributable to production declines from new wells drilled in our South Texas properties in late 2018 and early 2019. Compared to the prior year, production from our South Texas properties declined by 11,253 BOE. This decrease was partially offset by increases in production from our North Dakota properties of 4,047 BOE, which includes 313 BOE from the properties acquired from New Horizon and the result of two new wells drilled in 2019 and well workovers.





Oil and Gas Production Costs. Presented below is a comparison of our oil and gas
production costs for the three months ended March 31, 2020 and 2019 (dollars in
thousands):



                                     Three months ended
                                          March 31,                     Change
                                    2020            2019         Amount       Percent

        Production taxes          $      66       $      98     $    (32 )         -33 %
        Lease operating expense         408             467          (59 )         -13 %

        Total                     $     474       $     565     $    (91 )         -16 %

For the three months ended March 31, 2020, production taxes decreased by $32 thousand or 33% compared to the comparable period in 2019. This decrease was primarily attributable to the reduction in oil and natural gas production and revenue. Production taxes were $2.43/BOE and $2.86/BOE for the three months ended March 31, 2020 and 2019, respectively. During the three months ended March 31, 2020, lease operating expenses decreased by $59 thousand when compared to the three months ended March 31, 2019 as the result of reduced field activity. Lease operating expenses on a per BOE basis were $15.00 and $13.64 for the three months ended March 31, 2020 and 2019, respectively. The increase in lease operating expense on a per BOE basis is due to the production decline from wells drilled in our South Texas properties in late 2018 and early 2019.

Depreciation, Depletion and Amortization. Our depreciation, depletion and amortization ("DD&A") rate for the three months ended March 31, 2020 was $3.89 per BOE compared to $4.73 per BOE for the three months ended March 31, 2019. Our DD&A rate can fluctuate as a result of changes in drilling and completion costs, impairments, divestitures, changes in the mix of our production, the underlying proved reserve volumes and estimated costs to drill and complete proved undeveloped reserves.

Impairment of Oil and Natural Gas Properties. During the three months ended March 31, 2020 and 2019, the net capitalized cost of our oil and natural gas properties did not exceed the full cost ceiling limitation; therefore, we did not record an impairment charge.





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General and Administrative Expenses. Presented below is a comparison of our general and administrative expenses for the three months ended March 31, 2020 and 2019 (dollars in thousands):





                                     Three months ended
                                          March 31,                           Change
                                   2020               2019            Amount          Percent

Compensation and benefits,
including directors            $        223       $        292     $        (69 )            -24 %
Professional fees                       234                443             (209 )            -47 %
Insurance and other                     115                113                2                2 %

Total                          $        572       $        848     $       (276 )            -33 %

General and administrative expenses decreased by $276 thousand during the first quarter of 2020 as compared to the first quarter of 2019. The decrease was primarily attributable to a $209 thousand reduction in professional fees due a reduction in litigation costs in the APEG II litigation of $314 thousand. See Litigation-APEG II Litigation and -Litigation with Former Chief Executive Officer in Note 8-Commitments, Contingencies and Related-Party Transactions in the Notes to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this report. The decrease in litigation costs were partially offset by an increase in accounting fees of $104 thousand. Compensation and benefits decreased $69 thousand as the result of a reduction in headcount.

Non-Operating Income (Expense). Presented below is a comparison of our non-operating income (expense) for the three months ended March 31, 2020 and 2019 (dollars in thousands):





                                     Three months ended
                                          March 31,                           Change
                                   2020               2019            Amount          Percent

Unrealized (loss) gain on
marketable equity securities            (76 )               12              (88 )           -733 %
Warrant revaluation (loss)
gain                                     (6 )                8              (14 )           -186 %
Rental property loss                    (17 )              (14 )             (3 )             21 %
Other income                             28                 50              (22 )            -44
Interest, net                             -                (21 )             21              N/A %

Total other income (expense)   $        (71 )     $         35     $       (106 )           -303 %

During the three months ended March 31, 2020, we recognized an unrealized loss on marketable equity securities of $76 thousand as a result of the decline in value of shares we are holding in Anfield Energy.

During the three months ended March 31, 2020, we recognized a warrant revaluation loss of $6 thousand as compared to a gain of $8 thousand during the three months ended March 31, 2019. The decrease was attributable to an increase in the warrant liability primarily as a result of an increase in the value of our common stock.

During the three months ended March 31, 2020 and 2019, we recognized gains of $25 thousand and $50 thousand, respectively from the partial recovery of a deposit written off in 2018. See Note 7-Write-off of Deposit in the Notes to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this report.

Interest, net decreased by $21 thousand during the three months ended March 31, 2020 compared to the comparable period in 2019. The decrease was attributable to the repayment of our credit facility, which was repaid in full on March 1, 2019.





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Non-GAAP Financial Measures-Adjusted EBITDA

Adjusted EBITDA represents income (loss) from continuing operations as further modified to eliminate depreciation, depletion accretion and amortization, stock-based compensation expense, unrealized gains and loss on marketable equity securities, gains and losses on warrant revaluation, income taxes, interest expense net of interest income, and other items set forth in the table below. Adjusted EBITDA also excludes certain items that we believe affect the comparability of operating results and items that are generally one-time in nature or whose timing and/or amount cannot be reasonably estimated.

Adjusted EBITDA is a non-GAAP measure that is presented because we believe it provides useful additional information to investors and analysts as a performance measure. In addition, adjusted EBITDA is widely used by professional research analysts and others in the valuation, comparison, and investment recommendations of companies in the oil and natural gas exploration and production industry, and many investors use the published research of industry research analysts in making investment decisions. Adjusted EBITDA should not be considered in isolation or as a substitute for net income (loss), income (loss) from operations, net cash provided by operating activities, or profitability or liquidity measures prepared under GAAP. Because adjusted EBITDA excludes some, but not all items that affect net income (loss) and may vary among companies, the adjusted EBITDA amounts presented may not be comparable to similar metrics of other companies.





The following table provides reconciliations of income (loss) from continuing
operations to adjusted EBITDA for the three months ended March 31, 2020 and
2019:



                                                                  2020        2019
                                                                  (in thousands)
  Income (loss) from continuing operations (GAAP)               $    (306 )   $  15
  Depreciation, depletion, accretion and amortization                 142       202
  Unrealized loss (gain) loss on marketable equity securities          76       (12 )
  Loss (gain) on warrant revaluation                                    6        (8 )
  Stock-based compensation expense                                     42        13
  Interest, net                                                         -        21

  Adjusted EBITDA (Non-GAAP)                                    $     (40 )   $ 231

Liquidity and Capital Resources





The following table sets forth certain measures of our liquidity as of March 31,
2020 and December 31, 2019:



                                  March 31, 2020       December 31, 2019      Change
                                                    (in thousands)
    Cash and equivalents         $          1,136     $             1,532     $  (396 )
    Working capital (1)                     1,149                   1,470        (321 )
    Total assets                           13,664                  13,467        (260 )
    Total shareholders' equity              9,185                   9,210         (15 )
    Select Ratios:
    Current ratio (2)                  1.9 to 1.0              2.2 to 1.0




  (1) Working capital is computed by subtracting total current liabilities from
      total current assets.
  (2) The current ratio is computed by dividing total current assets by total
      current liabilities.

As of March 31, 2020, we had a working capital surplus of $1.1 million compared to a working capital surplus of $1.5 million as of December 31, 2019, a decrease of $321 thousand. This decrease was primarily attributable to cash used in operating activities of $181 thousand and cash payments totaling $183 thousand for the acquisition of New Horizon and repayment of New Horizon's credit facility.





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As of March 31, 2020, we had cash and cash equivalents of $1.1 million and accounts payable and accrued liabilities of $1.0 million. As of May 6, 2020, we had cash and cash equivalents of $1.2 million and accounts payable and accrued liabilities of approximately $0.7 million. Since the beginning of the dispute discussed in Note 8-Commitments, Contingencies and Related-Party Transactions in the Notes to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this report we have incurred approximately $1.2 million in expenses for litigation and the forensic accounting investigation, all but $14 thousand of which were incurred prior to December 31, 2019.

In early March 2020, the NYMEX WTI crude oil price decreased significantly and has remained at historically low levels. Currently, we do not have any commodity derivative contracts in place to mitigate the effect of lower commodity prices on our revenues. Lower oil and natural gas prices not only decrease our revenues, but an extended decline in oil or gas prices may materially and adversely affect our future business, financial position, cash flows, results of operations, liquidity, ability to finance planned capital expenditures and the oil and natural gas reserves that we can economically produce.

Lower crude prices could also affect the realizability of our oil and gas properties. In the calculation of the ceiling test as of March 31, 2020, we used $55.77 per barrel for oil and $2.30 per mcf for natural gas (as further adjusted for differentials related to property, specific gravity, quality, local markets and distance from markets) to compute the future cash flows of our producing properties. The discount factor used was 10%. These prices represent the average of first day of the month prices for oil and natural gas for each month in the twelve-month period ended March 31, 2020. If current depressed prices continue, it is likely that the Company will experience ceiling test write-downs in 2020, as higher prices from last year and the first three months of 2020 used in the calculation of the average price are replaced with current lower pricing. To determine the possible effect of lower prices on the ceiling test, the Company re-ran the reserves as of March 31, 2020 using the May 6, 2020 forward strip price as further adjusted for differentials. As of May 6, 2020, the WTI front month price for crude oil was $23.82 and the 12-month strip price was $29.21. The Company determined that by using the forward strip prices the Company would have incurred a ceiling test write-down of approximately $1.0 million as of March 31, 2020.

In February 2020, we began a process to sell our building and land in Riverton, Wyoming, which is no longer needed for our operations and is currently leased to third parties. We are working with a large national commercial real estate firm to market the property which we expect to begin in the second fiscal quarter of 2020. We cannot be certain that we will be able to complete the sale of the property in 2020 and cannot estimate the amount of expected proceeds.

If we have needs for financing in 2020, alternatives that we will consider in addition to cash flow from ongoing operations would potentially include refinancing into a new reserve-based credit facility, selling all or a partial interest in our oil and natural gas assets, selling our marketable equity securities, issuing shares of our common stock for cash or as consideration for acquisitions, and other alternatives, as we determine how to best meet our financial objectives.





Cash Flows



The following table summarizes our cash flows for the three months ended March
31, 2020 and 2019:



                                               2020        2019       Change
                                                      (in thousands)
            Net cash provided by (used in):
            Operating activities              $ (181 )   $    108     $  (289 )
            Investing activities                (128 )       (187 )        59
            Financing activities                 (87 )     (1,005 )       918

Operating Activities. Cash used in operating activities for the three months ended March 31, 2020 was $181 thousand as compared to cash provided by operating activities $108 thousand for the comparable period in 2019. The decrease in cash provided by operating activities is attributable to a decrease of $215 thousand in income from operations due to reductions in oil and natural gas revenues as a result of declines in commodity prices and production.

Investing Activities. Cash used in investing activities for the three months ended March 31, 2020 was $128 thousand as compared to $187 thousand for the comparable period in 2019. During the three months ended March 31, 2020 we used cash of $122 thousand in the acquisition of New Horizon. Cash used in investing activities in 2019 was primarily related to expenditures for drilling in our South Texas properties.





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Financing Activities. Cash used in financing activities for the three months ended March 31, 2020 was $87 thousand as compared to cash used in financing activities of $1,005 thousand for the comparable period in 2019. The use of cash in financing activities during the three months ended March 31, 2020 was due to repayment of the New Horizon credit facility and payments made on our insurance premium finance note payable. Cash used in financing activities in 2019 were primarily attributable to the repayment of $937 thousand outstanding under our credit facility.

Off-Balance Sheet Arrangements

As part of our ongoing business, we have not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities ("SPEs"), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

We evaluate our transactions to determine if any variable interest entities exist. If it is determined that we are the primary beneficiary of a variable interest entity, that entity will be consolidated in our consolidated financial statements. We have not been involved in any unconsolidated SPE transactions during the periods covered by this report.

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