Quarterly Report


Table of Contents

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, 2016  

OR

 

 

 

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

 

For the transition period from              to             

Commission file number 001-16317  

 

CONTANGO OIL & GAS COMPANY

(Exact name of registrant as specified in its charter)

 

 

 

 

DELAWARE

 

95-4079863

 

 

 

(State or other jurisdiction of
incorporation or organization)

 

(IRS Employer
Identification No.)

 

 

 

717 TEXAS AVENUE, SUITE 2900

HOUSTON, TEXAS

 

77002

(Address of principal executive offices)

 

(Zip Code)

 

(713) 236-7400

(Registrant’s telephone number, including area code)

Indicate by check mark whether 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 preceding 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 website, 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. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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  ☒

The total number of shares of common stock, par value $0.04 per share, outstanding as of November 2, 2016 was 25,262,152 .

 

 

 


 

Table of Contents

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2016

 

TABLE OF CONTENTS

 

 

 

 

 

 

 

 

    

    

   

Page

 

PART I—FINANCIAL INFORMATION  

 

 

 

 

 

 

 

Item 1.  

 

Consolidated Financial Statements

 

 

 

 

 

Consolidated Balance Sheets (unaudited) as of September 30, 2016 and December 31, 2015

 

3

 

 

 

Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2016 and 2015

 

4

 

 

 

Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2016 and 2015

 

5

 

 

 

Consolidated Statement of Shareholders’ Equity (unaudited) for the nine months ended September 30, 2016

 

6

 

 

 

Notes to the Unaudited Consolidated Financial Statements (unaudited)

 

7

 

Item 2.  

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

23

 

Item 3.  

 

Quantitative and Qualitative Disclosures about Market Risk

 

32

 

Item 4.  

 

Controls and Procedures

 

34

 

 

 

 

 

 

 

PART II—OTHER INFORMATION  

 

 

 

 

 

 

 

Item 1.  

 

Legal Proceedings

 

34

 

Item 1A.  

 

Risk Factors

 

34

 

Item 2.  

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

34

 

Item 3.  

 

Defaults upon Senior Securities

 

35

 

Item 4.  

 

Mine Safety Disclosures

 

35

 

Item 5.  

 

Other Information

 

35

 

Item 6.  

 

Exhibits

 

35

 

 

All references in this Quarterly Report on Form 10-Q to the “Company”, “Contango”, “we”, “us” or “our” are to Contango Oil & Gas Company and its subsidiaries.

2


 

Table of Contents

Item 1.   Consolidated Financial Statements

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except shares)

 

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

 

    

2016

    

2015

  

 

 

 

 

 

 

(unaudited)

 

CURRENT ASSETS:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

 —

 

$

 —

 

Accounts receivable, net

 

 

10,629

 

 

20,504

 

Prepaid expenses

 

 

1,510

 

 

1,228

 

Inventory

 

 

540

 

 

540

 

Total current assets

 

 

12,679

 

 

22,272

 

PROPERTY, PLANT AND EQUIPMENT:

 

 

 

 

 

 

 

Natural gas and oil properties, successful efforts method of accounting:

 

 

 

 

 

 

 

Proved properties

 

 

1,194,990

 

 

1,187,707

 

Unproved properties

 

 

32,283

 

 

16,439

 

Other property and equipment

 

 

1,081

 

 

1,081

 

Accumulated depreciation, depletion and amortization

 

 

(874,827)

 

 

(826,022)

 

Total property, plant and equipment, net

 

 

353,527

 

 

379,205

 

OTHER NON-CURRENT ASSETS:

 

 

 

 

 

 

 

Investments in affiliates

 

 

16,024

 

 

14,222

 

Other

 

 

1,430

 

 

1,057

 

Total other non-current assets

 

 

17,454

 

 

15,279

 

TOTAL ASSETS

 

$

383,660

 

$

416,756

 

 

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

39,908

 

$

36,358

 

Current derivative liability

 

 

2,133

 

 

 —

 

Current asset retirement obligations

 

 

4,430

 

 

4,603

 

Total current liabilities

 

 

46,471

 

 

40,961

 

NON-CURRENT LIABILITIES:

 

 

 

 

 

 

 

Long-term debt

 

 

62,463

 

 

115,446

 

Long-term derivative liability

 

 

267

 

 

 —

 

Asset retirement obligations

 

 

23,004

 

 

22,506

 

Total non-current liabilities

 

 

85,734

 

 

137,952

 

Total liabilities

 

 

132,205

 

 

178,913

 

COMMITMENTS AND CONTINGENCIES (NOTE 12)

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY:

 

 

 

 

 

 

 

Common stock, $0.04 par value, 50 million shares authorized, 30,280,418 shares issued and 24,995,692 shares outstanding at September 30, 2016, 24,636,936 shares issued and 19,381,146 shares outstanding at December 31, 2015

 

 

1,200

 

 

974

 

Additional paid-in capital

 

 

294,325

 

 

239,524

 

Treasury shares at cost (5,284,726 shares at September 30, 2016 and 5,255,790 shares at December 31, 2015)

 

 

(127,990)

 

 

(127,760)

 

Retained earnings

 

 

83,920

 

 

125,105

 

Total shareholders’ equity

 

 

251,455

 

 

237,843

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

 

$

383,660

 

$

416,756

 

 

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

3


 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 

 

September 30, 

 

 

    

2016

    

2015

 

2016

    

2015

 

 

 

(unaudited)

 

(unaudited)

 

REVENUES:

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil and condensate sales

 

$

4,946

 

$

9,500

 

$

17,164

 

$

35,882

 

Natural gas sales

 

 

12,011

 

 

16,020

 

 

31,283

 

 

48,130

 

Natural gas liquids sales

 

 

2,619

 

 

3,515

 

 

8,073

 

 

11,004

 

Total revenues

 

 

19,576

 

 

29,035

 

 

56,520

 

 

95,016

 

EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

8,158

 

 

9,036

 

 

22,782

 

 

29,919

 

Exploration expenses

 

 

444

 

 

407

 

 

1,088

 

 

11,814

 

Depreciation, depletion and amortization

 

 

15,166

 

 

38,386

 

 

49,586

 

 

112,271

 

Impairment and abandonment of oil and gas properties

 

 

1,165

 

 

235,150

 

 

4,268

 

 

237,667

 

General and administrative expenses

 

 

7,486

 

 

7,504

 

 

18,772

 

 

22,683

 

Total expenses

 

 

32,419

 

 

290,483

 

 

96,496

 

 

414,354

 

OTHER INCOME (EXPENSE):

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (loss) from investment in affiliates, net of income taxes

 

 

467

 

 

(375)

 

 

1,802

 

 

(562)

 

Interest expense

 

 

(989)

 

 

(785)

 

 

(3,045)

 

 

(2,315)

 

Gain on derivatives, net

 

 

913

 

 

2,011

 

 

736

 

 

2,001

 

Other income (expense)

 

 

18

 

 

4,288

 

 

(292)

 

 

5,278

 

Total other income (expense)

 

 

409

 

 

5,139

 

 

(799)

 

 

4,402

 

NET LOSS BEFORE INCOME TAXES

 

 

(12,434)

 

 

(256,309)

 

 

(40,775)

 

 

(314,936)

 

Income tax benefit (provision)

 

 

(51)

 

 

70,624

 

 

(410)

 

 

91,159

 

NET LOSS

 

$

(12,485)

 

$

(185,685)

 

$

(41,185)

 

$

(223,777)

 

NET LOSS PER SHARE:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.55)

 

$

(9.79)

 

$

(2.02)

 

$

(11.81)

 

Diluted

 

$

(0.55)

 

$

(9.79)

 

$

(2.02)

 

$

(11.81)

 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

22,881

 

 

18,966

 

 

20,370

 

 

18,948

 

Diluted

 

 

22,881

 

 

18,966

 

 

20,370

 

 

18,948

 

 

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

4


 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

September 30, 

 

 

    

2016

    

2015

 

 

 

 

 

 

 

 

 

 

 

(unaudited)

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net loss

 

$

(41,185)

 

$

(223,777)

 

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation, depletion and amortization

 

 

49,586

 

 

112,271

 

Impairment of natural gas and oil properties

 

 

4,137

 

 

237,656

 

Exploration expenses (recovery)

 

 

(2)

 

 

6,826

 

Deferred income taxes

 

 

 —

 

 

(92,328)

 

Loss (gain) on sale of assets

 

 

(11)

 

 

231

 

Loss (gain) from investment in affiliates

 

 

(1,802)

 

 

865

 

Stock-based compensation

 

 

4,315

 

 

5,008

 

Unrealized loss (gain) on derivative instruments

 

 

2,400

 

 

(999)

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Decrease in accounts receivable and other receivables

 

 

7,026

 

 

3,581

 

Increase in prepaid expenses

 

 

(282)

 

 

(5,198)

 

Decrease in accounts payable and advances from joint owners

 

 

(5,621)

 

 

(25,373)

 

Increase (decrease) in other accrued liabilities

 

 

2,384

 

 

(1,494)

 

Decrease in income taxes receivable, net

 

 

2,668

 

 

748

 

Other

 

 

(17)

 

 

1,233

 

Net cash provided by operating activities

 

$

23,596

 

$

19,250

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Natural gas and oil exploration and development expenditures

 

$

(19,849)

 

$

(70,389)

 

Sale of furniture & equipment

 

$

11

 

$

 —

 

Net cash used in investing activities

 

$

(19,838)

 

$

(70,389)

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Borrowings under credit facility

 

$

118,310

 

$

284,378

 

Repayments under credit facility

 

 

(171,293)

 

 

(233,168)

 

Net proceeds from equity offering

 

 

50,451

 

 

 —

 

Purchase of treasury stock

 

 

(230)

 

 

(71)

 

Debt issuance costs

 

 

(996)

 

 

 —

 

Net cash provided by (used in) financing activities

 

$

(3,758)

 

$

51,139

 

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

$

 —

 

$

 —

 

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

 

 —

 

 

 —

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

 —

 

$

 —

 

 

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

5


 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(in thousands, except number of shares)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Total

 

 

 

Common Stock

 

Paid-in

 

Treasury

 

Retained

 

Shareholders’

 

 

    

Shares

    

Amount

    

Capital

    

Stock

    

Earnings

    

Equity

 

 

 

(unaudited)

 

Balance at December 31, 2015

 

19,381,146

 

$

974

 

$

239,524

 

$

(127,760)

 

$

125,105

 

$

237,843

 

Equity offering

 

5,360,000

 

 

214

 

 

50,237

 

 

 —

 

 

 —

 

 

50,451

 

Treasury shares at cost

 

(28,936)

 

 

 —

 

 

 —

 

 

(230)

 

 

 —

 

 

(230)

 

Restricted shares activity

 

283,482

 

 

12

 

 

(11)

 

 

 —

 

 

 —

 

 

1

 

Stock-based compensation

 

 —

 

 

 —

 

 

4,575

 

 

 —

 

 

 —

 

 

4,575

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(41,185)

 

 

(41,185)

 

Balance at September 30, 2016

 

24,995,692

 

$

1,200

 

$

294,325

 

$

(127,990)

 

$

83,920

 

$

251,455

 

 

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

6


 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Organization and Business

 

Contango Oil & Gas Company (collectively with its subsidiaries, “Contango” or the “Company”) is a Houston, Texas based, independent oil and natural gas company. The Company’s business is to maximize production and cash flow from its onshore and offshore properties in the shallow waters of the Gulf of Mexico and to use that cash flow to explore, develop, exploit, produce and acquire crude oil and natural gas properties in the onshore Texas and Rocky Mountain regions of the United States.

 

The following table lists the Company’s primary producing areas as of September 30, 2016:

 

Location

    

Formation

Gulf of Mexico

 

Offshore Louisiana - water depths less than 300 feet

Madison and Grimes counties, Texas

 

Woodbine (Upper Lewisville)

Zavala and Dimmit counties, Texas

 

Buda / Austin Chalk

Weston County, Wyoming

 

Muddy Sandstone

Texas Gulf Coast

 

Conventional formations

Sublette County, Wyoming

 

Jonah Field (1)


(1)

Through a 37% equity investment in Exaro Energy III LLC (“Exaro”).  Production associated with this investment is not included in the Company’s reported production results for the three and nine months ended September 30, 2016.

 

Since October 2013, upon the merger with Crimson Exploration Inc., the Company has focused its drilling efforts on liquids-rich horizontal resource plays, such as the Woodbine in Southeast Texas, the Eagle Ford and Buda in South Texas, and the Muddy Sandstone in Wyoming. In addition, the Company has (i) operated producing properties in the Haynesville Shale, Mid Bossier and James Lime formations in East Texas and (ii) operated producing properties in the Denver Julesburg Basin (“DJ Basin”) in Weld and Adams counties in Colorado, which the Company believes may also be prospective in the Niobrara Shale oil play. In July 2016, the Company purchased one-half of the seller’s interest in approximately 12,100 gross undeveloped acres (approximately 5,000 net acres) in the Southern Delaware Basin of Texas for up to $25 million. The Company commenced drilling of its first well on this recently acquired acreage in October 2016.

 

During the three months ended September 30, 2016, we completed an underwritten public offering of 5,360,000 shares of our common stock for net proceeds of approximately $50.5 million. S ee Note 3 - "Acquisition and Underwritten Public Offering” for additional information.

 

Due to the current challenging commodity price environment, the Company has been focusing its 2016 capital program on: (i) the preservation of its healthy financial position; (ii) identification of opportunities for cost efficiencies in all areas of its operations; and (iii) maintaining core leases and continuing to identify new resource potential opportunities internally and, where appropriate, through acquisition. The Company will continuously monitor the commodity price environment, and, if warranted, make adjustments to its strategy as the year progresses. As noted previously, the Company recently began drilling its first well in the newly acquired Southern Delaware Basin acreage.

 

2. Summary of Significant Accounting Policies

 

The accounting policies followed by the Company are set forth in the notes to the Company’s audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K”) filed with the Securities and Exchange Commission (“SEC”). Please refer to the notes to the financial statements included in the 2015 Form 10-K for additional details of the Company’s financial condition, results of operations and cash flows. No material items included in those notes have changed except as a result of normal transactions in the interim or as disclosed within this report.

 

7


 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, pursuant to the rules and regulations of the SEC, including instructions to Quarterly Reports on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete annual financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of the unaudited consolidated financial statements have been included. All such adjustments are of a normal recurring nature. The consolidated financial statements should be read in conjunction with the 2015 Form 10-K. The consolidated results of operations for the nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

 

The Company’s consolidated financial statements include the accounts of Contango Oil & Gas Company and its subsidiaries, after elimination of all material intercompany balances and transactions. All wholly-owned subsidiaries are consolidated. Republic Exploration LLC (“REX”), a partially-owned oil and gas exploration and development affiliate which is not controlled by the Company, was proportionately consolidated prior to its dissolution as of December 31, 2015. The investment in Exaro by our wholly-owned subsidiary, Contaro Company (“Contaro”) is accounted for using the equity method of accounting, and therefore, the Company does not include its share of individual operating results, reserves or production in those reported for the Company’s consolidated results.

 

Impairment of Long-Lived Assets

 

Pursuant to GAAP, when circumstances indicate that proved properties may be impaired, the Company compares expected undiscounted future cash flows on a field by field basis to the unamortized capitalized cost of the asset. If the estimated future undiscounted cash flows based on the Company’s estimate of future reserves, natural gas and oil prices, operating costs and production levels from oil and natural gas reserves, are lower than the unamortized capitalized cost, then the capitalized cost is reduced to fair value. The factors used to determine fair value include, but are not limited to, estimates of proved and probable reserves, future commodity prices, the timing of future production and capital expenditures and a discount rate commensurate with the risk reflective of the lives remaining for the respective oil and gas properties. Additionally, the Company may use appropriate market data to determine fair value. The Company recognized no impairment of proved properties for the three months ended September 30, 2016 and approximately $0.7 million for impairment of proved properties for the nine months ended September 30, 2016. Substantially all of the non-cash impairment charge in the nine months ended September 30, 2016 was directly related to the decline in commodity prices and the resulting impact on estimated future net cash flows from associated reserves. The Company recognized $225.6 million impairment of proved properties for the three months ended September 30, 2015 and $227.6 million impairment of proved properties for the nine months ended September 30, 2015 also due to the decline in commodity prices and the resulting impact on estimated future net cash flows from associated reserves.

 

Unproved properties are reviewed quarterly to determine if there has been impairment of the carrying value, with any such impairment charged to expense in the period. The Company recognized impairment expense of approximately $1.1 million and approximately $3.4 million for the three and nine months ended September 30, 2016, respectively, related to partial impairment of unproved lease costs in non-core areas. The Company recognized impairment expense of approximately $9.5 million and $10.1 million for the three and nine months ended September 30, 2015, respectively, related to impairment and partial impairment of certain unproved properties and onshore prospects due primarily to the sustained low commodity price environment and expiring leases.

 

Net Loss Per Common Share

 

Basic net loss per common share is computed by dividing the net loss attributable to common stock by the weighted average number of common shares outstanding for the period. Diluted net loss per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Potential dilutive securities, including unexercised stock options and unvested restricted stock, have not been considered when their effect would be antidilutive. For the three and nine months ended September 30, 2016, 114,804 stock options and 437,355 restricted shares were excluded from dilutive shares due to the loss for the period. For the three and nine months ended September 30, 2015, 127,613 stock options and 423,820 restricted shares were excluded from dilutive shares due to the loss for the period.

 

8


 

Subsidiary Guarantees

 

Contango Oil & Gas Company, as the parent company (the “Parent Company”), has filed a registration statement on Form S-3 with the SEC to register, among other securities, debt securities that the Parent Company may issue from time to time. Any such debt securities would likely be guaranteed on a full and unconditional basis by each of the Company’s current subsidiaries and any future subsidiaries specified in any future prospectus supplement (each a “Subsidiary Guarantor”). Each of the Subsidiary Guarantors is wholly-owned by the Parent Company, either directly or indirectly. The Parent Company has no assets or operations independent of the Subsidiary Guarantors, and there are no significant restrictions upon the ability of the Subsidiary Guarantors to distribute funds to the Parent Company. The Parent Company has one wholly-owned subsidiary that is inactive and not a Subsidiary Guarantor. Finally, the Parent Company’s wholly-owned subsidiaries do not have restricted assets that exceed 25% of net assets as of the most recent fiscal year end that may not be transferred to the Parent Company in the form of loans, advances or cash dividends by such subsidiary without the consent of a third party.

 

 

 

Recent Accounting Pronouncements

 

In August 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update No. 2016-15: Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments. The main objective of this update is to reduce the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. This Update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The eight cash flow updates relate to the following issues: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; 6) distributions received from equity method investees; 7) beneficial interest in securitization transactions; and 8) separately identifiable cash flows and application of the predominance principle. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company will continue to assess the impact this may have on its statement of cash flows.

 

In May 2016, the FASB issued Accounting Standards Update No. 2016-12: Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients (ASU 2016-12). The core principle of the guidance in Topic 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments of ASU 2016-12 do not change that core principle. Rather, the amendments affect only the following narrow aspects of Topic 606: assessing the collectability criterion and accounting for contracts that do not meet the criteria for step 1, presentation of sales tax and other similar taxes collected from customers, noncash consideration, contract modifications at transition, completed contracts at transition, and technical correction. For public entities, ASU 2016-12 is effective for annual reporting periods after December 31, 2017. The provisions of this accounting update are not expected to have a material impact on the Company’s financial position or results of operations.

 

In March 2016, the FASB issued Accounting Standards Update No. 2016-09: Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). ASU 2016‑09 is part of an initiative to reduce complexity in accounting standards. The areas of simplification in ASU 2016‑09 involve several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. For public entities, ASU 2016-09 is effective for financial statements issued for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years; early application is permitted. The provisions of this accounting update are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 

In February 2016, the FASB issued Accounting Standards Update No. 2016-02: Leases (Topic 842) (ASU 2016-02). The main objective of ASU 2016-02 is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The main difference between previous GAAP and Topic 842 is the recognition of lease assets and lease

9


 

liabilities by lessees for those leases classified as operating leases. ASU 2016-02 requires lessees to recognize assets and liabilities arising from leases on the balance sheet. ASU 2016-02 further defines a lease as a contract that conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. Control over the use of the identified asset means that the customer has both (1) the right to obtain substantially all of the economic benefit from the use of the asset and (2) the right to direct the use of the asset. ASU 2016-02 requires disclosures by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. For public entities, ASU 2016-02 is effective for financial statements issued for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years; early application is permitted. The Company will continue to assess the impact this may have on its financial position, results of operations, and cash flows.

 

In January 2016, the FASB issued Accounting Standards Update No. 2016-01: Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01). The main objective of ASU 2016-01 is enhancing the reporting model for financial instruments to provide users of financial statements with more decision-useful information. The amendments in ASU 2016-01 make targeted improvements to GAAP by: (i) requiring equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) be measured at fair value with changes in fair value recognized in net income; (ii) simplifying the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (iii) exempting all non-public business entities from disclosing fair value information for financial instruments measured at amortized cost; (iv) eliminating requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet: (v) requiring public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (vi) requiring separate presentation in other comprehensive income the portion of the total change in fair value of a liability resulting from a change in the instrument- specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (vii) requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset; and (viii) clarifying that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. For public entities, ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years; early application is permitted. The provisions of this accounting update are not expected to have a material impact on the Company’s financial position or results of operations.

 

Further, management is closely monitoring the joint standard-setting efforts of the FASB and the International Accounting Standards Board. There are a large number of pending accounting standards that are being targeted for completion in 2016 and beyond. Because these pending standards have not yet been finalized, management is not able to determine the potential future impact that these standards will have, if any, on the Company's financial position, results of operations, or cash flows.

 

3. Acquisition and Underwritten Public Offering

 

In July 2016, the Company purchased one-half of the seller’s interest in approximately 12,100 gross undeveloped acres (approximately 5,000 net acres) in the Southern Delaware Basin of Texas (the “Acquisition”) for up to $25 million. The purchase price was comprised of $10 million in cash paid on July 26, 2016, and $10 million in carried well costs expected to be paid over the next 14 months. Certain additional payments contingent upon success could increase total consideration to $25 million.

 

During the three months ended September 30, 2016, the Company completed an underwritten public offering of 5,360,000 shares of its common stock for net proceeds of approximately $50.5 million. Proceeds from the offering were used to fund the portion of the purchase price paid at closing of the Acquisition and are expected to be used to fund drilling costs associated with the initial exploration and development of the acquired acreage. Pending such use, the Company used the proceeds of the offering to repay amounts outstanding under its revolving credit facility.

 

10


 

4. Fair Value Measurements

 

Pursuant to Accounting Standards Codification 820, Fair Value Measurements and Disclosures (ASC 820), the Company's determination of fair value incorporates not only the credit standing of the counterparties involved in transactions with the Company resulting in receivables on the Company's consolidated balance sheets, but also the impact of the Company's nonperformance risk on its own liabilities. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy assigns the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Level 2 measurements are inputs that are observable for assets or liabilities, either directly or indirectly, other than quoted prices included within Level 1. The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company classifies fair value balances based on the observability of those inputs.

 

The following table sets forth, by level within the fair value hierarchy, the Company’s financial assets and liabilities that were accounted for at fair value as of September 30, 2016. As required by ASC 820, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. There have been no transfers between Level 1, Level 2 or Level 3.

 

Fair value information for financial assets and liabilities was as follows as of September 30, 2016 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

Fair Value Measurements Using

 

 

    

Carrying   Value

    

Level 1

    

Level 2

    

Level 3

 

Derivatives

 

 

 

 

 

 

 

 

 

Commodity price contracts - assets

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

Commodity price contracts - liabilities

 

$

2,400

 

$

 —

 

$

2,400

 

$

 —

 

 

Derivatives listed above are recorded in “Current and long-term derivative liability” on the Company’s consolidated balance sheet and include swaps and costless collars that are carried at fair value. The Company records the net change in the fair value of these positions in "Gain on derivatives, net" in the Company's consolidated statements of operations. The Company is able to value the assets and liabilities based on observable market data for similar instruments, which resulted in the Company reporting its derivatives as Level 2. This observable data includes the forward curves for commodity prices based on quoted markets prices and implied volatility factors related to changes in the forward curves. As of December 31, 2015, there were no outstanding commodity price contracts. See Note 5 - "Derivative Instruments" for additional discussion of derivatives.

 

As of September 30, 2016, the Company's derivative contracts were with certain members of its bank group which are major financial institutions with investment grade credit ratings which are believed to have minimal credit risk. As such, the Company is exposed to credit risk to the extent of nonperformance by the counterparties in the derivative contracts discussed above; however, the Company does not anticipate such nonperformance.

 

Estimates of the fair value of financial instruments are made in accordance with the requirements of ASC 825, Financial Instruments. The estimated fair value amounts are determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The estimated fair value of cash, accounts receivable and accounts payable approximates their carrying value due to their short-term nature. The estimated fair value of the Company's credit facility with the Royal Bank of Canada and other lenders (the “RBC Credit Facility”) approximates carrying value because the facility interest rate approximates current market rates and is reset at least every six months. See Note 9 - "Long-Term Debt" for further information.

 

Impairments

 

Contango tests proved oil and natural gas properties for impairment when events and circumstances indicate a decline in the recoverability of the carrying value of such properties, such as a downward revision of the reserve

11


 

estimates or lower commodity prices. The Company estimates the undiscounted future cash flows expected in connection with the oil and gas properties on a field by field basis and compares such future cash flows to the unamortized capitalized costs of the properties. If the estimated future undiscounted cash flows are lower than the unamortized capitalized cost, the capitalized cost is reduced to its fair value. The factors used to determine fair value include, but are not limited to, estimates of proved and probable reserves, future commodity prices, the timing of future production and capital expenditures and a discount rate commensurate with the risk reflective of the lives remaining for the respective oil and gas properties. Additionally, the Company may use appropriate market data to determine fair value. Because these significant fair value inputs are typically not observable, impairments of long-lived assets are classified as a Level 3 fair value measure.

 

Asset Retirement Obligations

 

The initial measurement of asset retirement obligations at fair value is calculated using discounted cash flow techniques and based on internal estimates of future retirement costs associated with oil and gas properties. The factors used to determine fair value include, but are not limited to, estimated future plugging and abandonment costs and expected lives of the related reserves.

 

5. Derivative Instruments

 

The Company is exposed to certain risks relating to its ongoing business operations, such as commodity price risk. Derivative contracts are typically utilized to hedge the Company's exposure to price fluctuations and reduce the variability in the Company's cash flows associated with anticipated sales of future oil and natural gas production. The Company typically hedges a substantial, but varying, portion of anticipated oil and natural gas production for future periods. The Company believes that these derivative arrangements, although not free of risk, allow it to achieve a more predictable cash flow and to reduce exposure to commodity price fluctuations. However, derivative arrangements limit the benefit of increases in the prices of crude oil, natural gas and natural gas liquids sales. Moreover, because its derivative arrangements apply only to a portion of its production, the Company’s strategy provides only partial protection against declines in commodity prices. Such arrangements may expose the Company to risk of financial loss in certain circumstances. The Company continuously reevaluates its hedging programs in light of changes in production, market conditions and commodity price forecasts.

 

As of September 30, 2016, the Company’s natural gas derivative positions consisted of “swaps” and “costless collars”.  Swaps are designed so that the Company receives or makes payments based on a differential between fixed and variable prices for crude oil and natural gas. A costless collar consists of a purchased put option and a sold call option, which establishes a minimum and maximum price, respectively, that the Company will receive for the volumes under the contract.

 

It is the Company's policy to enter into derivative contracts only with counterparties that are creditworthy institutions deemed by management as competent and competitive market makers. The Company does not post collateral, nor is exposed to potential margin calls, under any of these contracts as they are secured under the RBC Credit Facility. See Note 9 - "Long-Term Debt" for further information regarding the RBC Credit Facility.

 

The Company has elected not to designate any of its derivative contracts for hedge accounting. Accordingly, derivatives are carried at fair value on the consolidated balance sheets as assets or liabilities, with the changes in the fair value included in the consolidated statements of operations for the period in which the change occurs. The Company records the net change in the mark-to-market valuation of these derivative contracts, as well as all payments and receipts on settled derivative contracts, in "Gain on derivatives, net" on the consolidated statements of operations.

 

12


 

The following derivative instruments were in place at September 30, 2016 (fair value in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity

    

Period

    

Derivative

    

Volume/Month

    

Price/Unit (1)

    

Fair Value

 

Natural Gas

 

Oct 2016

 

Swap

 

250,000 MMBtu

 

$

2.53

 

 

(105)

 

Natural Gas

 

Nov 2016 - Dec 2016

 

Swap

 

1,300,000 MMBtu

 

$

2.53

 

 

(1,270)

 

Natural Gas

 

Jan 2017 - Jul 2017

 

Collar

 

400,000 MMBtu

 

$

2.65 - 3.00

 

 

(689)

 

Natural Gas

 

Aug 2017 - Oct 2017

 

Collar

 

200,000 MMBtu

 

$

2.65 - 3.00

 

 

(106)

 

Natural Gas

 

Nov 2017 - Dec 2017

 

Collar

 

400,000 MMBtu

 

$

2.65 - 3.00

 

 

(230)

 

 

 

 

 

Total net fair value of derivative instruments

 

$

(2,400)

 


(1)   Commodity price derivatives based on Henry Hub NYMEX natural gas prices.

 

The following summarizes the fair value of commodity derivatives outstanding on a gross and net basis as of September 30, 2016 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Gross

    

Netting (1)

    

Total

 

Assets

 

$

 —

 

$

 —

 

$

 —

 

Liabilities

 

$

(2,400)

 

$

 —

 

$

(2,400)

 


(1)   Represents counterparty netting under agreements governing such derivatives.

 

As of December 31, 2015, the Company did not have any outstanding derivative positions.

 

The following table summarizes the effect of derivative contracts on the consolidated statements of operations for the three and nine months ended September 30, 2016 and 2015 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 

 

Nine Months Ended September 30, 

 

 

    

2016

    

2015

    

2016

    

2015

 

Crude oil contracts

 

$

 —

 

$

1,002

 

$

 —

 

$

1,002

 

Natural gas contracts

 

 

(619)

 

 

 —

 

 

3,136

 

 

 —

 

Realized gain (loss)

 

$

(619)

 

$

1,002

 

$

3,136

 

$

1,002

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Crude oil contracts

 

$

 —

 

$

1,009

 

$

 —

 

$

999

 

Natural gas contracts

 

 

1,532

 

 

 —

 

 

(2,400)

 

 

 —

 

Unrealized gain (loss)

 

$

1,532

 

$

1,009

 

$

(2,400)

 

$

999

 

Gain on derivatives, net

 

$

913

 

$

2,011

 

$

736

 

$

2,001

 

 

 

6. Stock-Based Compensation

 

During the nine months ended September 30, 2016, the Company had a stock-based compensation program in effect which allows for stock options and/or restricted stock to be awarded to officers, directors, consultants and employees. This program includes (i) the Company's Amended and Restated 2009 Incentive Compensation Plan (the “2009 Plan”); and (ii) the Crimson 2005 Stock Incentive Plan (the “2005 Plan” or "Crimson Plan"), which expired on February 25, 2015.

 

Effective September 1, 2015, all employees and board members entered into a salary replacement program (the “Salary Replacement Program”). The Salary Replacement Program reduced all office employees’ base salary by 10% and all board of director retainer and committee chairman fees by 10% and replaced the portion of the salary/fees being reduced with immediately vested common stock in a number of shares commensurate with the salary/fees reduction amount. These shares were to be issued immediately after the year for which the salary was reduced. The Company discontinued this policy effective September 1, 2016 and the compensation accrued as of that date was paid to employees and directors in cash.

 

13


 

Stock Options

 

Under the fair value method of accounting for stock options, cash flows from the exercise of stock options resulting from tax benefits in excess of recognized cumulative compensation cost (excess tax benefits) are classified as financing cash flows. For the nine months ended September 30, 2016 and 2015, there was no excess tax benefit recognized.

 

Compensation expense related to stock option grants are recognized over the stock option’s vesting period based on the fair value at the date the options are granted. The fair value of each option is estimated as of the date of grant using the Black-Scholes options-pricing model. No stock options were granted during the nine months ended September 30, 2016 or 2015.

 

During the nine months ended September 30, 2016, no stock options were exercised and 1,657 stock options were forfeited. During the nine months ended September 30, 2015, no stock options were exercised and stock options for 2,321 shares of common stock were forfeited.

 

Restricted Stock 

 

During the nine months ended September 30, 2016, the Company granted 40,876 shares of restricted common stock under the 2009 Plan for salaries replaced pursuant to the Salary Replacement Program for 2015. Of these, 38,943 shares were granted to employees, and 1,933 shares were granted to directors. Additionally, the Company granted 197,306 shares of restricted common stock to employees as part of their overall compensation package, which vest over four years, and 49,460 shares of restricted common stock to directors pursuant to the Company’s director compensation plan, which vest after one year. The weighted average fair value of the restricted shares granted during the nine months ended September 30, 2016, was $11.60 with a total fair value of approximately $3.3 million after adjustment for an estimated weighted average forfeiture rate of 3.5%. During the nine months ended September 30, 2016, 4,160 restricted shares were forfeited by former employees. The aggregate intrinsic value of restricted shares forfeited during the nine months ended September 30, 2016 was approximately $130 thousand. No shares of restricted common stock were granted or forfeited during the three months ended September 30, 2016. Approximately 0.6 million shares remain available for grant under the 2009 Plan as of September 30, 2016.

 

During the nine months ended September 30, 2015, the Company granted 270,091 shares of restricted common stock under the 2009 Plan. Of these, 242,887 shares were granted to employees as part of their overall compensation package, which vest over four years, and 27,204 shares were granted to directors pursuant to the Company’s director compensation plan, which vest after one year. Additionally, the Company issued the final 7,030 shares of restricted stock under the 2005 Plan to employees as part of their compensation package, which vest over four years. The weighted average fair value of the restricted shares granted during the nine months ended September 30, 2015, was $22.02 with a total fair value of approximately $6.1 million after adjustment for an estimated weighted average forfeiture rate of 4.9%. During the nine months ended September 30, 2015, 4,735 restricted shares were forfeited by former employees. The aggregate intrinsic value of restricted shares forfeited during the nine months ended September 30, 2015 was approximately $147 thousand. No shares of restricted common stock were granted and 216 restricted shares were forfeited by former employees during the three months ended September 30, 2015.

 

The Company recognized approximately $4.3 million and $5.0 million in stock compensation expense during the nine months ended September 30, 2016 and 2015, respectively, for restricted shares granted to its officers, employees and directors. As of September 30, 2016, an additional $5.9 million of compensation expense remained to be recognized over the remaining weighted-average vesting period of 2.4 years.  

 

In October 2016, two members of the Company’s management team had employment agreements that expired and were not renewed, resulting in the immediate vesting of 25,928 shares of unvested stock.

 

14


 

7. Other Financial Information

 

The following table provides additional detail for accounts receivable, prepaid expenses and other, and accounts payable and accrued liabilities which are presented on the consolidated balance sheets (in thousands):

 

 

 

 

 

 

 

 

 

 

    

September 30, 2016

    

December 31, 2015

 

Accounts receivable:

 

 

 

 

 

 

 

Trade receivable

 

$

5,876

 

$

7,530

 

Alta Resources

 

 

1,993

 

 

1,993

 

Joint interest billing

 

 

3,120

 

 

7,366

 

Income taxes receivable

 

 

 —

 

 

2,868

 

Other receivables

 

 

322

 

 

1,448

 

Allowance for doubtful accounts

 

 

(682)

 

 

(701)

 

Total accounts receivable

 

$

10,629

 

$

20,504

 

 

 

 

 

 

 

 

 

Prepaid expenses:

 

 

 

 

 

 

 

Prepaid insurance

 

$

800

 

$

900

 

Other prepaids

 

 

710

 

 

328

 

Total prepaid expenses

 

$

1,510

 

$

1,228

 

 

 

 

 

 

 

 

 

Accounts payable and accrued liabilities:

 

 

 

 

 

 

 

Royalties and revenue payable

 

$

17,299

 

$

17,906

 

Advances from partners

 

 

66

 

 

950

 

Accrued exploration and development

 

 

907

 

 

3,659

 

Accrued carried well costs

 

 

10,000

 

 

 —

 

Trade payable

 

 

3,740

 

 

8,053

 

Accrued LOE & workover expense

 

 

2,457

 

 

2,159

 

Accrued G&A and legal expense

 

 

3,366

 

 

2,596

 

Other accounts payable and accrued liabilities

 

 

2,073

 

 

1,035

 

Total accounts payable and accrued liabilities

 

$

39,908

 

$

36,358

 

 

Included in the table below is supplemental information about certain cash and non-cash transactions during the nine months ended September 30, 2016 and 2015 (in thousands):

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 

 

 

 

2016

    

 

2015

 

Cash payments:

 

 

 

 

 

 

Interest payments

$

2,935

 

$

2,231

 

Income tax payments (refunds)

$

(2,337)

 

$

100

 

Non-cash investing activities in the consolidated statements of cash flows:

 

 

 

 

 

 

Increase (decrease) in accrued capital expenditures

$

7,248

 

$

(19,411)

 

 

 

8. Investment in Exaro Energy III LLC

 

In April 2012, the Company entered into a Limited Liability Company Agreement (the “LLC Agreement”) in connection with the formation of Exaro. Pursuant to the LLC Agreement, as amended, the Company committed to invest up to $67.5 million in Exaro for an ownership interest of approximately 37%. The Company did not make any contributions during the nine months ended September 30, 2016. As of September 30, 2016, the Company had invested approximately $46.9 million.

 

15


 

The following table (in thousands) presents condensed balance sheet data for Exaro as of September 30, 2016 and December 31, 2015. The balance sheet data was derived from Exaro’s balance sheet as of September 30, 2016 and December 31, 2015 and was not adjusted to represent the Company’s percentage of ownership interest in Exaro. The Company’s share in the equity of Exaro at September 30, 2016 was approximately $15.9 million.

 

 

 

 

 

 

 

 

 

 

    

September 30, 2016

    

December 31, 2015

 

Current assets (1)

 

$

19,303

 

$

23,664

 

Non-current assets:

 

 

 

 

 

 

 

Net property and equipment

 

 

93,440

 

 

101,459

 

Other non-current assets

 

 

1,157

 

 

486

 

Total non-current assets

 

 

94,597

 

 

101,945

 

Total assets

 

$

113,900

 

$

125,609

 

 

 

 

 

 

 

 

 

Current liabilities

 

$

7,199

 

$

5,272

 

Non-current liabilities:

 

 

 

 

 

 

 

Long-term debt

 

 

59,228

 

 

78,500

 

Other non-current liabilities

 

 

3,646

 

 

2,891

 

Total non-current liabilities

 

 

62,874

 

 

81,391

 

Members' equity

 

 

43,827

 

 

38,946

 

Total liabilities & members' equity

 

$

113,900

 

$

125,609

 


(1)   Approximately $15.5 million and $14.4 million of current assets as of September 30, 2016 and December 31, 2015, respectively, is cash.

 

The following table (in thousands) presents the condensed results of operations for Exaro for the three and nine months ended September 30, 2016 and 2015. The results of operations for the three and nine months ended September 30, 2016 and 2015 were derived from Exaro's financial statements for the respective periods. The income statement data below was not adjusted to represent the Company’s ownership interest but rather reflects the results of Exaro as a company. The Company’s share in Exaro’s results of operations recognized for the three months ended September 30, 2016 and 2015 was a gain of $0.5 million, net of no tax expense, and a loss of $0.4 million, net of tax benefit of $0.2 million, respectively. The Company's share in Exaro's results of operations recognized for the nine months ended September 30, 2016 and 2015 was a gain of $1.8 million, net of no tax expense, and a loss of $0.6 million, net of tax benefit of $0.3 million, respectively.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 

 

Nine Months Ended September 30, 

 

 

    

2016

    

2015

    

2016

    

2015

 

Production:

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil (thousand barrels)

 

 

30

 

 

40

 

 

98

 

 

127

 

Gas (million cubic feet)

 

 

2,659

 

 

3,236

 

 

8,083

 

 

9,928

 

Total (million cubic feet equivalent)

 

 

2,839

 

 

3,477

 

 

8,671

 

 

10,691

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil and natural gas sales

 

$

8,242

 

$

7,881

 

$

20,730

 

$

31,731

 

Gain (loss) on derivatives

 

 

1,011

 

 

 —

 

 

(1,231)

 

 

 —

 

Other gain

 

 

 —

 

 

3,667

 

 

10,441

 

 

3,608

 

Less:

 

 

 

 

 

 

 

 

 

 

 

 

 

Lease operating expenses

 

 

3,969

 

 

4,467

 

 

11,513

 

 

12,946

 

Depreciation, depletion, amortization & accretion

 

 

2,880

 

 

7,229

 

 

8,705

 

 

20,147

 

General & administrative expense

 

 

671

 

 

724

 

 

2,605

 

 

2,586

 

Income (loss) from continuing operations

 

 

1,733

 

 

(872)

 

 

7,117

 

 

(340)

 

Net interest expense

 

 

(598)

 

 

(689)

 

 

(1,994)

 

 

(2,243)

 

Net income (loss)

 

$

1,135

 

$

(1,561)

 

$

5,123

 

$

(2,583)

 

 

Exaro's results of operations do not include income taxes because Exaro is treated as a partnership for tax purposes.

 

16


 

9. Long-Term Debt

 

RBC Credit Facility 

 

In October 2013, the Company entered into a $500 million four-year revolving credit facility with Royal Bank of Canada and other lenders. Effective October 28, 2016, as part of the regular redetermination schedule, the borrowing base under the RBC Credit Facility was reaffirmed at $140 million, which is unchanged from the redetermination amount on May 6, 2016. Also effective May 6, 2016, the RBC Credit Facility was amended to, among other things, extend the maturity of the facility from October 1, 2017 to October 1, 2019, increase the LIBOR, U.S. prime rate and federal funds rate margins to 2.5% - 4.0% and increase the commitment fee to 0.5%, regardless of the amount of the credit facility that is unused. The borrowing base under the facility is redetermined each November and May.

 

As of September 30, 2016 and December 31, 2015, the Company had approximately $62.5 million and $115.4 million, respectively, outstanding under the RBC Credit Facility and $1.9 million and $1.9 million, respectively, in outstanding letters of credit. As of September 30, 2016, borrowing availability under the RBC Credit Facility was $75.6 million.

 

Total interest expense under the RBC Credit Facility, including commitment fees, for the three and nine months ended September 30, 2016 was approximately $1.0 million and $3.0 million, respectively. Total interest expense under the RBC Credit Facility, including commitment fees, for the three and nine months ended September 30, 2015 was approximately $0.8 million and $2.3 million, respectively.

 

The RBC Credit Facility contains restrictive covenants which, among other things, restrict the declaration or payment of dividends by Contango and require a Current Ratio of greater than or equal to 1.0 and a Leverage Ratio of less than or equal to 3.50, both as defined in the RBC Credit Facility Agreement. As of September 30, 2016, the Company was in compliance with all financial covenants under the RBC Credit Facility, and at current commodity prices, does not expect any covenant compliance issues over the next twelve months. The RBC Credit Facility also contains events of default that may accelerate repayment of any borrowings and/or termination of the facility. Events of default include, but are not limited to, payment defaults, breach of certain covenants, bankruptcy, insolvency or change of control events.

 

The weighted average interest rate in effect at September 30, 2016 and December 31, 2015 was 3.9% and 2.4%, respectively. The RBC Credit Facility matures on October 1, 2019, at which time any outstanding balances will be due.

 

10. Income Taxes

 

The Company’s income tax provision for continuing operations consists of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 

 

Nine Months Ended September 30, 

 

 

    

2016

    

2015

 

2016

 

2015

 

Current tax provision:

 

 

 

 

 

 

 

 

 

Federal

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

State

 

 

51

 

 

(5)

 

 

410

 

 

517

 

Total

 

$

51

 

$

(5)

 

$

410

 

$

517

 

Deferred tax benefit:

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal

 

$

 —

 

$

(70,631)

 

$

 —

 

$

(91,254)

 

State

 

 

 —

 

 

(191)

 

 

 —

 

 

(725)

 

Total

 

$

 —

 

$

(70,822)

 

$

 —

 

$

(91,979)

 

Total tax provision (benefit):

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal

 

$

 —

 

$

(70,631)

 

$

 —

 

$

(91,254)

 

State

 

 

51

 

 

(196)

 

 

410

 

 

(208)

 

Total

 

$

51

 

$

(70,827)

 

$

410

 

$

(91,462)

 

Included in gain from investment in affiliates

 

$

 —

 

$

(203)

 

$

 —

 

$

(303)

 

Total income tax provision (benefit)

 

$

51

 

$

(70,624)

 

$

410

 

$

(91,159)

 

 

In recording deferred income tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets is

17


 

dependent upon the generation of future taxable income during the periods in which those deferred income tax assets would be deductible. The Company believes that after considering all the available objective evidence, both positive and negative, historical and prospective, with greater weight given to historical evidence, management is not able to determine that it is more likely than not that the deferred tax assets will be realized and, therefore, established a full valuation allowance at September 30, 2015. For the nine months ended September 30, 2016, the Company continues to fully value the net deferred tax asset. The Company will continue to assess the valuation allowance against deferred tax assets considering all available information obtained in future reporting periods.

 

 

11. Related Party Transactions

 

Republic Exploration LLC

 

Historically, REX, an entity owned 32.3% by Contango, participated with the Company in the drilling and development of certain prospects through participation agreements and joint operating agreements, which specified each participant’s working interest, net revenue interest and described when such interests were earned. The Company proportionately consolidated the results of REX in its consolidated financial statements prior to REX’s dissolution as of December 31, 2015.

 

Olympic Energy Partners

 

Mr. Joseph J. Romano, the Chairman of the Company’s board of directors, is also the President and Chief Executive Officer of Olympic Energy Partners LLC ("Olympic"). Olympic last participated with the Company in the drilling of wells in March 2010, and its ownership in Company-operated wells is limited to our Dutch and Mary Rose wells.

 

 

During the three and nine months ended September 30, 2016, Mr. Romano earned $17 thousand and $43 thousand for his service as a director of the Company, respectively. During the three and nine months ended September 30, 2015, Mr. Romano earned $13 thousand and $66 thousand for his service as a director of the Company, respectively.

 

During the years ended December 31, 2015 and 2014, Mr. Romano received 4,534 and 2,612 shares of restricted stock, respectively, which both vest 100% on the one-year anniversary of the date of grant, as part of his board of director compensation.  Additionally, in January 2016, Mr. Romano received 261 shares of restricted stock, pursuant to the Salary Replacement Program and an additional 9,892 shares of restricted stock in May 2016, which vest in one year, as part of his board of director compensation. The Company recognized compensation expense of approximately $30 thousand and $70 thousand related to the shares granted to Mr. Romano for the three and nine months ended September 30, 2016, respectively. During the three and nine months ended September 30, 2015, the Company recognized compensation expense of approximately $20 thousand and $82 thousand, respectively, related to the shares granted to Mr. Romano.

 

Below is a summary of payments received from (paid to) Olympic and REX in the ordinary course of business in the Company’s capacity as operator of the wells and platforms for the periods indicated. The Company made and received similar types of payments with other well owners (in thousands):