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On February 13th, 2014, Lucas Energy (LEI) filed a 10Q for the quarter ending December 31st, 2013. In my previous article, I mentioned that Lucas may be turning the corner based on the advertised results of the workover program, but advised investors to remain cautious. I purchased a speculative position; however, I have since sold as stated in the comments on my previous article. I currently have no position in LEI and I am glad I have sold. This most recent 10Q for the last quarter of CY 2013 is an operational disaster and all but confirms that Lucas is unable to be an effective operator of oil wells. It is very telling that this 10Q was not accompanied by a press release and that the stockholders' meeting was held before this 10Q was released.
Based on last quarter's operational update, I made the assumption that Lucas would exit 2013 at around a net 250 BOPD.
At the end of December 2013, Lucas was producing an average of approximately 150 net barrels of oil equivalent per day (BOEPD) from 59 active well bores, of which 16 wells accounted for more than 80% of our production.
Calling this a miss is the understatement of the year. October 2013 production averaged 177 BOPD and yet after the workovers mentioned in the operational update Lucas managed to lose 27 BOPD compared to October. These workovers and new wells were what led me to expect a 250 BOPD 2013 exit rate. Lucas ended up spending $300,000 on workovers this quarter and spent a net of $1.95 million in capex and still ended up losing a significant percentage of their production.
LOE and G&A continue to be sky high. Current quarter recurring LOE is $17.90/BOE. Obviously this is much higher if you include workovers. G&A is the real killer here. G&A comes in this quarter at an astonishing $951,332 which translates into $65.42/BOE. For a company with only 12 employees, each one is making an average of $26,425 per month. Obviously there are some non-employee G&A costs in here, but employee compensation likely makes up the majority of this line item.
Spending money of this magnitude with negative results shows up harshly on the cash flow statement and on the balance sheet. The cash flow deficit from operations before balance sheet changes continues to expand. This quarter Lucas used $343,000 in operations. As stated in my other articles, this is unacceptable given the industry standard of high operating margins associated with operating oil wells. Expenses are simply a minute fraction of revenue generated by the sale of oil. Margins are supposed to be high.
As a result of the continued, expanding cash flow deficit and huge capex spend, working capital has deteriorated materially. In the previous quarter, LEI had a positive working capital of $1.1 million. This quarter, working capital has swung to a $2.1 million deficit. The accounts payable balance alone is almost larger than the entire sum of current assets. This combined with the cash flow deficit could put Lucas in a liquidity crunch rather quickly. Lucas is going to have to pay off those accounts payable likely within the next quarter. Given that accounts payable is almost as large as current assets and that the company loses cash from simply operating, where is the cash going to come from? In the 10Q, the company has disclosed that they are unable to find additional capital:
The Company's strategy had been to access modest sums of relatively-cheap capital to provide for limited development activity and to re-enter the capital markets upon an improvement in the Company's financial condition. To date we have been unable to locate long-term investors to raise capital for the Company in connection with this deliberate, low-impact grow-over-time stance. The Company believes it must now establish a sustained program of asset development, and specifically, begin to develop its Eagle Ford reserves.
External capital is unavailable because of the poor results and given these results, anyone investing would likely want to be secured against established production. They are unable to be secured because of the 2013 secured loan which has encumbered all assets. Any saving capital would likely have to come as equity injections from the majority shareholders. Do they want to continue to throw money down the well?
The 10Q brings us a new revelation by way of a statement where it is finally realized that the company is simply not capable of operating oil wells effectively. From the 10Q:
The Company initiated a work-over program in the fall of 2013 in an effort to stabilize rapidly declining production. These efforts stemmed the production decline to a degree, and while improvements have been made in overall field operating and general and administrative expenses, the Company maintains flat production and continues to make minimal progress in increasing operating profits.
I believe that the company is misguided in wanting to develop its Eagle Ford reserves. As I have previously stated numerous times, LEI only has a 15% working interest with Marathon (MRO) holding the balance. The leases are HBP and Marathon has stated that most of their development is going to be infill drilling. They also have some 200,000 acres to make sure they HBP. HBP acreage with marginal wells on it is likely to be low on the list. Marathon also has the incentive to simply wait Lucas out until Lucas must take a fire sale price. There's no rush for Marathon. It's hard to believe that anyone other than Marathon would purchase this 15% WI. Buying such a small interest in what is mainly PUD HBP acreage makes the buyer completely submissive to Marathon's desires. That's not something most would want.
On the flip side, the Eagle Ford acreage may be their only hope as it looks like the Austin Chalk horizontals that they drilled failed to increase production for any significant period of time. I previously thought a JV in the Austin Chalk was the best way going forward, but those results aren't conducive to getting a JV in the Austin Chalk acreage. They should have raised more equity when they did the mandatory raise required by the loan agreement and found a JV partner before they did any Austin Chalk work. Spreading risk before you start is the whole point of the JV.
Specifically, in December 2013, the Company stated that it is actively reviewing a number of opportunities for strategic partnership, acquisitions, and mergers with a focus on development of reserves, increasing revenue, and improving shareholder value. We have escalated these activities in the first quarter of calendar 2014 and engaged an investment banking firm to assist in that process and are actively discussing a number of potential transactions with a simple objective: create an entity of the necessary size and financial mass to develop the significant reserves at our disposal. We have not entered into any pending or definitive transactions to date.
Given the self-admitted operational failure of this company, the only hope for shareholders of Lucas is some sort of joint venture with another operator or a buyout. With the current financial situation of the company, it doesn't seem like either of those are likely given the sharks in the oilfield. Sharks will wait for the fire sale prices. The PUDs are burdened by Marathon, and existing production is burdened by high decline and high LOE. They gave everyone a look at what Austin Chalk horizontals would do on their acreage. Everything is burdened by the repayment of the 2013 loan. Lucas doesn't really have any bargaining tools.
That being said, poor acquisitions/deals are always made in the oilfield during booms and even more so now that ZIRP has made capital so cheap. As a result, it would be foolish to completely rule out JVs or a buyout; however, I think the possibilities are remote. If you are in the stock now, I think that is the only thing you are betting on because the operational portion of this company is a total disaster. Good luck and do your own due diligence.