NOTES TO CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2018
(UNAUDITED)
NOTE 1 ORGANIZATION AND NATURE OF BUSINESS
Northern Oil and Gas, Inc. (the “Company,” “Northern,” “our” and words of similar import), a Delaware corporation, is an independent energy company engaged in the acquisition, exploration, exploitation, development and production of crude oil and natural gas properties. The Company’s common stock trades on the NYSE American market under the symbol “NOG”.
Northern’s principal business is crude oil and natural gas exploration, development, and production with operations in North Dakota and Montana that primarily target the Bakken and Three Forks formations in the Williston Basin of the United States. The Company acquires leasehold interests that comprise of non-operated working interests in wells and in drilling projects within its area of operations.
NOTE 2 SIGNIFICANT ACCOUNTING POLICIES
The financial information included herein is unaudited which has been derived from the Company’s audited financial statements for the year ended
December 31, 2017
. However, such information includes all adjustments (consisting of normal recurring adjustments and change in accounting principles) that are, in the opinion of management, necessary for a fair presentation of financial position, results of operations and cash flows for the interim periods. The results of operations for interim periods are not necessarily indicative of the results to be expected for an entire year.
Certain information, accounting policies, and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted in this Form 10-Q pursuant to certain rules and regulations of the Securities and Exchange Commission (“SEC”). The condensed financial statements should be read in conjunction with the audited financial statements for the year ended
December 31, 2017
, which were included in the Company’s Annual Report on Form 10-K for the fiscal year ended
December 31, 2017
.
Use of Estimates
The preparation of financial statements under GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates relate to proved crude oil and natural gas reserve volumes, future development costs, estimates relating to certain crude oil and natural gas revenues and expenses, fair value of derivative instruments, impairment of oil and natural gas properties, and deferred income taxes. Actual results may differ from those estimates.
Cash and Cash Equivalents
Northern considers highly liquid investments with insignificant interest rate risk and original maturities to the Company of three months or less to be cash equivalents. Cash equivalents consist primarily of interest-bearing bank accounts. The Company’s cash positions represent assets held in checking and money market accounts. These assets are generally available on a daily or weekly basis and are highly liquid in nature. Due to the balances being greater than
$250,000
, the Company does not have FDIC coverage on the entire amount of bank deposits. The Company believes this risk is minimal. In addition, the Company is subject to Security Investor Protection Corporation (“SIPC”) protection on a vast majority of its financial assets.
Accounts Receivable
Accounts receivable are carried on a gross basis, with no discounting. The Company regularly reviews all aged accounts receivable for collectability and establishes an allowance as necessary for individual balances. Accounts receivable not expected to be collected within the next twelve months are included within Other Noncurrent Assets, Net on the condensed balance sheets.
As of
June 30, 2018
and
December 31, 2017
, the Company included accounts receivable of
$5.3 million
and
$5.5 million
, respectively, in Other Noncurrent Assets, Net due to their long-term nature.
The allowance for doubtful accounts at
June 30, 2018
and
December 31, 2017
was
$5.2 million
and
$5.6 million
, respectively.
Advances to Operators
The Company participates in the drilling of crude oil and natural gas wells with other working interest partners. Due to the capital intensive nature of crude oil and natural gas drilling activities, the working interest partner responsible for conducting the drilling operations may request advance payments from other working interest partners for their share of the costs. The Company expects such advances to be applied by working interest partners against joint interest billings for its share of drilling operations within
90 days
from when the advance is paid.
Other Property and Equipment
Property and equipment that are not crude oil and natural gas properties are recorded at cost and depreciated using the straight-line method over their estimated useful lives of
three
to
seven
years. Expenditures for replacements, renewals, and betterments are capitalized. Maintenance and repairs are charged to operations as incurred. Long-lived assets, other than crude oil and natural gas properties, are evaluated for impairment to determine if current circumstances and market conditions indicate the carrying amount may not be recoverable. The Company has not recognized any impairment losses on non-crude oil and natural gas long-lived assets. Depreciation expense was
$31,668
and
$41,313
for the three months ended
June 30, 2018
and
2017
, respectively. Depreciation expense was
$67,185
and
$85,787
for the six months ended
June 30, 2018
and
2017
, respectively.
Oil and Gas Properties
Northern follows the full cost method of accounting for crude oil and natural gas operations whereby all costs related to the exploration and development of crude oil and natural gas properties are capitalized into a single cost center (“full cost pool”). Such costs include land acquisition costs, geological and geophysical expenses, carrying charges on non-producing properties, costs of drilling directly related to acquisition, and exploration activities. Internal costs that are capitalized are directly attributable to acquisition, exploration and development activities and do not include costs related to production, general corporate overhead or similar activities. Costs associated with production and general corporate activities are expensed in the period incurred. Capitalized costs are summarized as follows for the
three and six
months ended
June 30, 2018
and
2017
, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Capitalized Certain Payroll and Other Internal Costs
|
$
|
182,081
|
|
|
$
|
240,771
|
|
|
$
|
352,931
|
|
|
$
|
445,644
|
|
Capitalized Interest Costs
|
38,170
|
|
|
33,000
|
|
|
73,235
|
|
|
71,768
|
|
Total
|
$
|
220,251
|
|
|
$
|
273,771
|
|
|
$
|
426,166
|
|
|
$
|
517,412
|
|
As of
June 30, 2018
, the Company held leasehold interests in the Williston Basin on acreage located in North Dakota and Montana targeting the Bakken and Three Forks formations.
Proceeds from property sales will generally be credited to the full cost pool, with no gain or loss recognized, unless such a sale would significantly alter the relationship between capitalized costs and the proved reserves attributable to these costs. A significant alteration would typically involve a sale of
25%
or more of the proved reserves related to a single full cost pool. In the
six
months ended
June 30, 2018
and
2017
, there were no property sales that resulted in a significant alteration.
Under the full cost method of accounting, the Company is required to perform a ceiling test each quarter. The test determines a limit, or ceiling, on the book value of the proved oil and gas properties. Net capitalized costs are limited to the lower of unamortized cost net of deferred income taxes, or the cost center ceiling. The cost center ceiling is defined as the sum of (a) estimated future net revenues, discounted at
10%
per annum, from proved reserves, based on the trailing twelve-month unweighted average of the first-day-of-the-month price, adjusted for any contract provisions or financial derivatives designated as hedges for accounting purposes, if any, that hedge the Company’s oil and natural gas revenue, and excluding the estimated abandonment costs for properties with asset retirement obligations recorded on the balance sheet, (b) the cost of properties not being amortized, if any, and (c) the lower of cost or market value of unproved properties included in the cost being amortized, including related deferred taxes for differences between the book and tax basis of the oil and natural gas properties. If the net book value, including related deferred taxes, exceeds the ceiling, an impairment or non-cash writedown is required.
The Company did not have any ceiling test impairment for the three and six months ended
June 30, 2018
and
2017
, respectively. Impairment charges affect the Company’s reported net income but do not reduce the Company’s cash flow. If a significantly lower pricing environment reoccurs, the Company expects it could be required to writedown the value of its oil and
natural gas properties. In addition to commodity prices, the Company’s production rates, levels of proved reserves, future development costs, transfers of unevaluated properties and other factors will determine the Company’s actual ceiling test calculation and impairment analyses in future periods.
Capitalized costs associated with impaired unproved properties and capitalized costs related to properties having proved reserves, plus the estimated future development costs and asset retirement costs, are depleted and amortized on the unit-of-production method. Under this method, depletion is calculated at the end of each period by multiplying total production for the period by a depletion rate. The depletion rate is determined by dividing the total unamortized cost base plus future development costs by net equivalent proved reserves at the beginning of the period. The costs of unproved properties are withheld from the depletion base until such time as they are either developed or abandoned. When proved reserves are assigned or the property is considered to be impaired, the cost of the property or the amount of the impairment is added to costs subject to depletion and full cost ceiling calculations. For the three months ended
June 30, 2018
and
2017
, the Company expired leases of
$1.2 million
and
$5.9 million
, respectively. For the six months ended
June 30, 2018
and
2017
, the Company expired leases of
$5.0 million
and
$9.6 million
, respectively.
Asset Retirement Obligations
The Company accounts for its abandonment and restoration liabilities under Financial Accounting Standards Board (“FASB”) ASC Topic 410, “Asset Retirement and Environmental Obligations” (“FASB ASC 410”), which requires the Company to record a liability equal to the fair value of the estimated cost to retire an asset upon initial recognition. The asset retirement liability is recorded in the period in which the obligation meets the definition of a liability, which is generally when the asset is placed into service. When the liability is initially recorded, the Company increases the carrying amount of oil and natural gas properties by an amount equal to the original liability. The liability is accreted to its present value each period, and the capitalized cost is depreciated consistent with depletion of reserves. Upon settlement of the liability or the sale of the well, the liability is reversed. These liability amounts may change because of changes in asset lives, estimated costs of abandonment or legal or statutory remediation requirements.
Business Combinations
The Company accounts for its acquisitions that qualify as a business using the acquisition method under FASB ASC Topic 805, “Business Combinations.” Under the acquisition method, assets acquired and liabilities assumed are recognized and measured at their fair values. The use of fair value accounting requires the use of significant judgment since some transaction components do not have fair values that are readily determinable. The excess, if any, of the purchase price over the net fair value amounts assigned to assets acquired and liabilities assumed is recognized as goodwill. Conversely, if the fair value of assets acquired exceeds the purchase price, including liabilities assumed, the excess is immediately recognized in earnings as a bargain purchase gain.
Debt Issuance Costs
Debt issuance costs include origination, legal and other fees to issue debt in connection with the Company’s term loan credit agreement, senior secured notes, senior unsecured notes and prior revolving credit facility. These debt issuance costs are amortized over the term of the related financing using the straight-line method, which approximates the effective interest method (see Note 4). The amortization of debt issuance costs for the three months ended
June 30, 2018
and
2017
was
$1.3 million
and
$1.0 million
, respectively. The amortization of debt issuance costs for the six months ended
June 30, 2018
and
2017
was
$2.6 million
and
$1.9 million
, respectively.
Bond Premium/Discount on Senior Notes
On May 13, 2013, the Company recorded a bond premium of
$10.5 million
in connection with the “
8.000%
Senior Notes Due 2020” (see Note 4). This bond premium is being amortized over the term of the related financing using the straight-line method, which approximates the effective interest method. The amortization of the bond premium for the three months ended
June 30, 2018
and
2017
was
$0.2 million
and
$0.4 million
, respectively.
The amortization of the bond premium for the six months ended
June 30, 2018
and
2017
was
$0.5 million
and
$0.7 million
, respectively.
On May 18, 2015, the Company recorded a bond discount of
$10.0 million
in connection with the “
8.000%
Senior Notes Due 2020” (see Note 4). This bond discount is being amortized over the term of the related financing using the straight-line method, which approximates the effective interest method. The amortization of the bond discount for the three months ended
June 30, 2018
and
2017
was
$0.2 million
and
$0.5 million
, respectively. The amortization of the bond discount for the six months ended
June 30, 2018
and
2017
was
$0.7 million
and
$1.0 million
, respectively.
Revenue Recognition
The Company adopted ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
and the series of related accounting standard updates that followed, on January 1, 2018 using the modified retrospective method of adoption. Adoption of the ASU did not require an adjustment to the opening balance of equity and did not change the Company's amount and timing of revenues.
The Company’s revenues are primarily derived from its interests in the sale of oil and natural gas production. The Company recognizes revenue from its interests in the sales of oil and natural gas in the period that its performance obligations are satisfied. Performance obligations are satisfied when the customer obtains control of product, when the Company has no further obligations to perform related to the sale, when the transaction price has been determined and when collectability is probable. The sales of oil and natural gas are made under contracts which the third-party operators of the wells have negotiated with customers, which typically include variable consideration that is based on pricing tied to local indices and volumes delivered in the current month. The Company receives payment from the sale of oil and natural gas production from one to three months after delivery. At the end of each month when the performance obligation is satisfied, the variable consideration can be reasonably estimated and amounts due from customers are accrued in trade receivables, net in the balance sheets. Variances between the Company’s estimated revenue and actual payments are recorded in the month the payment is received, however, differences have been and are insignificant. Accordingly, the variable consideration is not constrained.
The Company does not disclose the value of unsatisfied performance obligations under its contracts with customers as it applies the practical exemption in accordance with ASC 606. The exemption, as described in ASC 606-10-50-14(a), applies to variable consideration that is recognized as control of the product is transferred to the customer. Since each unit of product represents a separate performance obligation, future volumes are wholly unsatisfied and disclosure of the transaction price allocated to remaining performance obligations is not required.
The Company’s oil is typically sold at delivery points under contracts terms that are common in our industry. The Company's natural gas produced is delivered by the well operators to various purchasers at agreed upon delivery points under a limited number of contract types that are also common in our industry. However, under these contracts, the natural gas may be sold to a single purchaser or may be sold to separate purchasers. Regardless of the contract type, the terms of these contracts compensate the well operators for the value of the oil and natural gas at specified prices, and then the well operators will remit payment to the Company for its share in the value of the oil and natural gas sold.
A wellhead imbalance liability equal to the Company’s share is recorded to the extent that the Company’s well operators have sold volumes in excess of its share of remaining reserves in an underlying property. However, for the
three and six
months ended
June 30, 2018
and
2017
, the Company’s natural gas production was in balance, meaning its cumulative portion of natural gas production taken and sold from wells in which it has an interest equaled its entitled interest in natural gas production from those wells.
The Company’s disaggregated revenue has
two
revenue sources which are oil sales and natural gas and NGL sales and only operates in
one
geographic area, the Williston Basin in North Dakota and Montana. Oil sales for the three months ended
June 30, 2018
and
2017
were
$101.0 million
and
$43.5 million
, respectively. Natural gas and NGL sales for the three months ended
June 30, 2018
and
2017
were
$8.0 million
and
$4.8 million
, respectively.
Concentrations of Market and Credit Risk
The future results of the Company’s crude oil and natural gas operations will be affected by the market prices of crude oil and natural gas. The availability of a ready market for crude oil and natural gas products in the future will depend on numerous factors beyond the control of the Company, including weather, imports, marketing of competitive fuels, proximity and capacity of crude oil and natural gas pipelines and other transportation facilities, any oversupply or undersupply of crude oil, natural gas and liquid products, the regulatory environment, the economic environment, and other regional and political events, none of which can be predicted with certainty.
The Company operates in the exploration, development and production sector of the crude oil and natural gas industry. The Company’s receivables include amounts due from purchasers of its crude oil and natural gas production. While certain of these customers are affected by periodic downturns in the economy in general or in their specific segment of the crude oil or natural gas industry, the Company believes that its level of credit-related losses due to such economic fluctuations have been immaterial.
The Company manages and controls market and counterparty credit risk. In the normal course of business, collateral is not required for financial instruments with credit risk. Financial instruments which potentially subject the Company to credit risk consist principally of temporary cash balances and derivative financial instruments. The Company maintains cash and cash equivalents in bank deposit accounts which, at times, may exceed the federally insured limits. The Company has not experienced any significant
losses from such investments. The Company attempts to limit the amount of credit exposure to any one financial institution or company. The Company believes the credit quality of its counterparties is generally high. In the normal course of business, letters of credit or parent guarantees may be required for counterparties which management perceives to have a higher credit risk.
Stock-Based Compensation
The Company records expense associated with the fair value of stock-based compensation. For fully vested stock and restricted stock grants, the Company calculates the stock-based compensation expense based upon estimated fair value on the date of grant. In determining the fair value of performance-based share awards subject to market conditions, the Company utilizes a Monte Carlo simulation prepared by an independent third party. For stock options, the Company uses the Black-Scholes option valuation model to calculate stock-based compensation at the date of grant. Option pricing models require the input of highly subjective assumptions, including the expected price volatility. Changes in these assumptions can materially affect the fair value estimate.
Stock Issuance
The Company records any stock-based compensation awards issued to non-employees and other external entities for goods and services at either the fair market value of the goods received or services rendered or the instruments issued in exchange for such services, whichever is more readily determinable.
Income Taxes
The Company’s income tax expense, deferred tax assets and deferred tax liabilities reflect management’s best assessment of estimated current and future taxes to be paid. The Company estimates for each interim reporting period the effective tax rate expected for the full fiscal year and uses that estimated rate in providing for income taxes on a current year-to-date basis. The Company’s only taxing jurisdiction is the United States (federal and state).
Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating the Company’s ability to recover its deferred tax assets, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, the Company begins with historical results and incorporates assumptions about the amount of future state and federal pretax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates the Company is using to manage the underlying businesses.
Accounting standards require the consideration of a valuation allowance for deferred tax assets if it is “more likely than not” that some component or all of the benefits of deferred tax assets will not be realized. In assessing the need for a valuation allowance for the Company’s deferred tax assets, a significant item of negative evidence considered was the cumulative book loss over the three-year period ended
June 30, 2018
, driven primarily by the full cost ceiling impairments over that period. Additionally, the Company’s revenue, profitability and future growth are substantially dependent upon prevailing and future prices for oil and natural gas. The markets for these commodities continue to be volatile. Changes in oil and natural gas prices have a significant impact on the value of the Company’s reserves and on its cash flows. Due to these factors, management has placed a lower weight on the prospect of future earnings in its overall analysis of the valuation allowance.
In determining whether to establish a valuation allowance on the Company’s deferred tax assets, management concluded that the objectively verifiable evidence of cumulative negative earnings for the three-year period ended
June 30, 2018
, is difficult to overcome with any forms of positive evidence that may exist. Accordingly, the valuation allowance against the Company’s deferred tax asset at
June 30, 2018
and
December 31, 2017
was
$249.6 million
and
$227.0 million
, respectively.
Net Income (Loss) Per Common Share
Basic earnings per share (“EPS”) are computed by dividing net income (loss) (the numerator) by the weighted average number of common shares outstanding for the period (the denominator). Diluted EPS is computed by dividing net income (loss) by the weighted average number of common shares and potential common shares outstanding (if dilutive) during each period. Potential common shares include stock options and restricted stock. The number of potential common shares outstanding relating to stock options and restricted stock is computed using the treasury stock method.
The reconciliation of the denominators used to calculate basic EPS and diluted EPS for the
three and six
months ended
June 30, 2018
and
2017
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Weighted Average Common Shares Outstanding – Basic
|
196,140,610
|
|
|
61,643,862
|
|
|
131,039,552
|
|
|
61,545,555
|
|
Plus: Potentially Dilutive Common Shares Including Stock Options and Restricted Stock
|
—
|
|
|
242,090
|
|
|
—
|
|
|
383,244
|
|
Weighted Average Common Shares Outstanding – Diluted
|
196,140,610
|
|
|
61,885,952
|
|
|
131,039,552
|
|
|
61,928,799
|
|
|
|
|
|
|
|
|
|
Restricted Stock and Stock Options Excluded From EPS Due To The Anti-Dilutive Effect
|
367,329
|
|
|
575,229
|
|
|
301,721
|
|
|
350,870
|
|
As of
June 30, 2018
and
2017
, potentially dilutive shares from stock option awards were
250,000
and
391,872
, respectively. These options were all exercisable at
June 30, 2018
and
2017
. The Company also has potentially dilutive shares from restricted stock awards outstanding of
3,327,127
and
2,102,264
at
June 30, 2018
and
2017
, respectively.
Derivative Instruments and Price Risk Management
The Company uses derivative instruments to manage market risks resulting from fluctuations in the prices of crude oil. The Company enters into derivative contracts, including price swaps, caps and floors, which require payments to (or receipts from) counterparties based on the differential between a fixed price and a variable price for a fixed quantity of crude oil without the exchange of underlying volumes. The notional amounts of these financial instruments are based on expected production from existing wells. The Company may also use exchange traded futures contracts and option contracts to hedge the delivery price of crude oil at a future date.
The Company follows the provisions of FASB ASC 815, “Derivatives and Hedging” as amended. It requires that all derivative instruments be recognized as assets or liabilities on the balance sheet, measured at fair value and marked-to-market at the end of each period. Any realized gains and losses on settled derivatives, as well as mark-to-market gains or losses, are aggregated and recorded to gain (loss) on derivative instruments, net on the condensed statements of operations. See Note 11 for a description of the derivative contracts into which the Company has entered.
Impairment
Long-lived assets to be held and used are required to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Proved oil and natural gas properties accounted for using the full cost method of accounting are excluded from this requirement but continue to be subject to the full cost method’s impairment rules. There was
no
impairment of other long-lived assets recorded for the
three and six
months ended
June 30, 2018
and
2017
.
Supplemental Cash Flow Information
The following reflects the Company’s supplemental cash flow information:
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
2018
|
|
2017
|
Supplemental Cash Items:
|
|
|
|
Cash Paid During the Period for Interest
|
$
|
35,063,530
|
|
|
$
|
30,634,506
|
|
Cash Paid During the Period for Income Taxes
|
—
|
|
|
—
|
|
|
|
|
|
Non-cash Investing Activities:
|
|
|
|
Oil and Natural Gas Properties Included in Accounts Payable
|
80,096,568
|
|
|
65,167,643
|
|
Capitalized Asset Retirement Obligations
|
593,381
|
|
|
862,911
|
|
Compensation Capitalized on Oil and Gas Properties
|
107,372
|
|
|
143,030
|
|
Issuance of Common Stock - Acquisitions of Oil and Natural Gas Properties
|
15,240,000
|
|
|
—
|
|
|
|
|
|
Non-cash Financing Activities:
|
|
|
|
Exchange transactions - non-cash securities issued:
|
|
|
|
Issuance of 8.50% Second Lien Notes due 2023
|
344,279,000
|
|
|
—
|
|
Issuance of Common Stock - fair value at issuance date
|
279,314,160
|
|
|
—
|
|
|
|
|
|
Exchange Transactions - non-cash securities exchanged:
|
|
|
|
8.00% Unsecured Senior Notes due 2020 - carrying value
|
(543,683,185
|
)
|
|
—
|
|
New Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) that are adopted by the Company as of the specified effective date. If not discussed, management believes that the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company’s financial statements upon adoption.
In May 2014, the FASB issued a comprehensive new revenue recognition standard that supersedes the revenue recognition requirements in Topic 605,
Revenue Recognition,
and industry-specific guidance in Subtopic 932-605,
Extractive Activities-Oil and Gas-Revenue Recognition
. The core principle of the new guidance is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for transferring those goods or services. The new standard also requires significantly expanded disclosure regarding the qualitative and quantitative information of an entity's nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The standard creates a five-step model that requires companies to exercise judgment when considering the terms of a contract and all relevant facts and circumstances. The standard allows for several transition methods: (a) a full retrospective adoption in which the standard is applied to all of the periods presented, or (b) a modified retrospective adoption in which the standard is applied only to the most current period presented in the financial statements, including additional disclosures of the standard's application impact to individual financial statement line items. In March, April, May and December 2016, the FASB issued new guidance in Topic 606,
Revenue from Contracts with Customers,
to address the following potential implementation issues of the new revenue standard: (a) to clarify the implementation guidance on principal versus agent considerations, (b) to clarify the identification of performance obligations and the licensing implementation guidance and (c) to address certain issues in the guidance on assessing collectability, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition. This standard is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company previously followed the sales method of accounting for oil and natural gas production, which is generally consistent with the revenue recognition provision of the new standard. The majority of our revenue arrangements generally consist of a single performance obligation to transfer promised goods or services. Based on our evaluation process and review of our arrangements with operators who act as an intermediary and enter into contracts with purchasers who are the ultimate customers, the timing and amount of revenue recognized based on the standard is consistent with our revenue recognition policy under previous guidance. The Company adopted the new standard effective January 1, 2018, using the modified retrospective approach, and has expanded its financial statement disclosures in order tocomply with the standard. The Company has processes and controls to ensure we recognize revenue in accordance with the appropriate accounting treatment and to generate the disclosures required under the new standard in the first quarter of 2018. We have determined the adoption of the standard did not have a material impact on our results of operations, cash flows, or financial position.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The standard requires lessees to recognize the assets and liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The new guidance is effective for annual and interim reporting periods beginning after December 15, 2018. The amendments should be applied at the beginning of the earliest period presented using a modified retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. The Company is currently evaluating the impact of the new guidance on its financial statements, however, based on its current operating leases, it is not expected to have a material impact.
In May 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which simplifies the accounting for share-based payments granted to nonemployees for goods and services. This guidance will better align the treatment of share-based payments to nonemployees with the requirements for such share-based payments granted to employees. This guidance is effective for all public entities for fiscal years beginning after December 15, 2018, including interim periods within that year. The Company is currently in the process of evaluating this new standard update.
NOTE 3 CRUDE OIL AND NATURAL GAS PROPERTIES
The value of the Company’s crude oil and natural gas properties consists of all acquisition costs (including cash expenditures and the value of stock consideration), drilling costs and other associated capitalized costs. Acquisitions are accounted for as purchases and, accordingly, the results of operations are included in the accompanying condensed statements of operations from the closing date of the acquisition. Purchase prices are allocated to acquired assets based on their estimated fair value at the time of the acquisition. Acquisitions have been funded with internal cash flow, bank borrowings and the issuance of debt and equity securities. Development capital expenditures and purchases of properties that were in accounts payable and not yet paid in cash at
June 30, 2018
and
December 31, 2017
were approximately
$80.1 million
and
$85.0 million
, respectively.
Acquisitions
On April 25, 2018, the Company entered into a purchase and sale agreement with Salt Creek Oil and Gas, LLC, to acquire
64
gross,
5.5
net producing (PDP) wells,
31
gross,
1.5
net drilling and completing (PDNP) wells and
1,319
net acres located in McKenzie and Mountrail counties of North Dakota in the Company’s core development area. The acquisition expanded the Company’s footprint in the core of the Williston Basin. On June 4, 2018, the Company closed the transaction for consideration of
$60.0 million
which is comprised of
$44.7 million
of cash consideration and
$15.2 million
of common stock consideration. The results of operations from the June 4, 2018 closing date through June 30, 2018, represented approximately
$1.7 million
of revenue and
$0.3 million
of direct operating expenses. No material transaction costs were incurred in connection with this purchase and there was
no
goodwill recorded from this acquisition. The following table reflects a preliminary estimate of the fair values of the net assets and liabilities as of the date of acquisition, which are subject to customary post-closing adjustments, during the period ended
June 30, 2018
:
|
|
|
|
|
|
|
|
(in thousands)
|
Fair value of net assets:
|
|
|
Proved oil and natural gas properties
|
|
$
|
59,978
|
|
Asset retirement cost
|
|
154
|
|
Total assets acquired
|
|
60,132
|
|
Asset retirement obligations
|
|
(154
|
)
|
Net assets acquired
|
|
$
|
59,978
|
|
|
|
|
Fair value of consideration paid for net assets:
|
|
|
Cash consideration
|
|
$
|
44,738
|
|
Issuance of common stock (6 million shares at $2.54 per share)
|
|
15,240
|
|
Total fair value of consideration transferred
|
|
$
|
59,978
|
|
Unproved Properties
All properties that are not classified as proved properties are considered unproved properties and, thus, the costs associated with such properties are not subject to depletion. Once a property is classified as proved, all associated acreage and drilling costs are subject to depletion.
The Company historically has acquired its properties by purchasing individual or small groups of leases directly from mineral owners, from landmen, or lease brokers, which leases historically have not been subject to specified drilling projects, and by purchasing lease packages in identified project areas controlled by specific operators. The Company generally participates in drilling activities on a heads up basis by electing whether to participate in each well on a well-by-well basis at the time wells are proposed for drilling.
Unproved properties not being amortized comprise approximately
11,371
net acres and
14,377
net acres of undeveloped leasehold interests at
June 30, 2018
and
December 31, 2017
, respectively. The Company believes that the majority of its unproved costs will become subject to depletion within the next
five years
by proving up reserves relating to the acreage through exploration and development activities, by impairing the acreage that will expire before the Company can explore or develop it further or by determining that further exploration and development activity will not occur. The timing by which all other properties will become subject to depletion will be dependent upon the timing of future drilling activities and delineation of its reserves.
The Company assesses all items classified as unproved property on an annual basis, or if certain circumstances exist, more frequently, for possible impairment or reduction in value. The assessment includes consideration of the following factors, among others: intent to drill, remaining lease term, geological and geophysical evaluations, drilling results and activity, the assignment of proved reserves, and the economic viability of development if proved reserves are assigned. During any period in which these factors indicate an impairment, the cumulative costs incurred to date for such property and all or a portion of the associated leasehold costs are transferred to the full cost pool and are then subject to depletion and amortization. For the
six
months ended
June 30, 2018
and
2017
, the Company included
$0.1 million
and
$0.1 million
, respectively, related to expiring leases within costs subject to the depletion calculation.
NOTE 4 LONG-TERM DEBT
The Company’s long-term debt consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2018
|
|
Principal Balance
|
|
Unamortized Net Discount
|
|
Debt Issuance Costs, Net
|
|
Long-term Debt, Net
|
8% Senior Notes
|
$
|
149,560,000
|
|
|
$
|
(218,413
|
)
|
|
$
|
(1,159,378
|
)
|
|
148,182,209
|
|
Second Lien Notes
|
344,279,000
|
|
|
—
|
|
|
(4,810,488
|
)
|
|
339,468,512
|
|
Term Loan Credit Agreement
|
360,000,000
|
|
|
—
|
|
|
(12,883,065
|
)
|
|
347,116,935
|
|
Total
|
$
|
853,839,000
|
|
|
$
|
(218,413
|
)
|
|
$
|
(18,852,931
|
)
|
|
$
|
834,767,656
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
Principal Balance
|
|
Unamortized Net Discount
|
|
Debt Issuance Costs, Net
|
|
Long-term Debt, Net
|
8% Senior Notes
|
$
|
700,000,000
|
|
|
$
|
(1,197,954
|
)
|
|
$
|
(6,847,557
|
)
|
|
691,954,489
|
|
Term Loan Credit Agreement
|
300,000,000
|
|
|
—
|
|
|
(12,630,267
|
)
|
|
287,369,733
|
|
Total
|
$
|
1,000,000,000
|
|
|
$
|
(1,197,954
|
)
|
|
$
|
(19,477,824
|
)
|
|
$
|
979,324,222
|
|
Exchange Agreements
On January 31, 2018, Northern entered into an exchange agreement (as amended, the “Exchange Agreement”) with holders (the “Supporting Noteholders”) of approximately
$496.7 million
, or
71%
, of the aggregate principal amount of the Company’s outstanding
8.000%
Senior Notes due
June 1, 2020
(the “Outstanding Notes”), pursuant to which the Supporting Noteholders agreed to exchange all of the Outstanding Notes held by each such Supporting Noteholder for approximately
$155.0 million
of the Company’s common stock and approximately
$344.3 million
in aggregate principal amount of new
8.500%
Senior Secured Second Lien Notes due 2023 (the “Second Lien Notes”) (such exchange, the “Exchange Transaction”).
On May 15, 2018 (the “Exchange Closing Date”), pursuant to the Exchange Agreement, the Company completed the Exchange Transaction and issued
103,249,915
shares of common stock and
$344.3 million
of Second Lien Notes in exchange for the Outstanding Notes. Separately, but in connection with the Exchange Transaction, the Company and certain investors had previously entered into subscription agreements (the “Subscription Agreements”) whereby such investors agreed to purchase up to
$52.0 million
of common stock at
$1.50
per share. Pursuant to the Subscription Agreements, on the Exchange Closing Date, the Company issued
34,666,668
shares of common stock to such investors.
In June 2018, the Company entered into
five
independent, separately negotiated exchange agreements with holders of the Company’s
8.000%
Senior Notes due
June 1, 2020
(the “2020 Notes”). Pursuant to each such exchange agreement, the Company agreed to issue the holder shares of its common stock in exchange for certain 2020 Notes held by such holder. In total, during the three months ended June 30, 2018, the Company issued
18.5 million
shares of common stock in exchange for
$53.8 million
in principal amount of the 2020 Notes pursuant to these five agreements. Pursuant to each of these exchange agreements, with the exception of one covering
$3.0 million
principal amount of 2020 Notes, the Company subjected the holders to a restricted sale period on the shares of common stock issued to them. These restricted sale periods are of varying lengths and subject to varying exceptions. Generally, if at the end of the applicable restricted sale period the Company’s common stock trades below specified levels, the Company may be required to pay the applicable holder additional consideration either in the form of cash or additional shares of common stock. The value of this liability is carried on the Company’s balance sheet as the derivative exchange liability, the value of which is based on Monte Carlo simulations which considered various inputs including (i) the Company’s common stock price, (ii) risk-free rates based on U.S. Treasury rates, (iii) volatility of the Company’s common stock, and (iv) expected average daily trading volumes. As of
June 30, 2018
, the Company’s debt exchange derivative liability related to these agreements was
$10.9 million
. However, these provisions in the exchange agreements are subject to exceptions and contingencies which can reduce or terminate this liability for the Company.
Term Loan Credit Agreement
On November 1, 2017 (the “Effective Date”), the Company entered into a term loan credit agreement with TPG Specialty Lending, Inc., as administrative agent and collateral agent (in such capacities, the “Agent”), and the lenders from time to time party thereto. The term loan credit agreement, as amended, provides for the issuance of an aggregate principal amount of up to
$500,000,000
in term loans to the Company, consisting of (i)
$300,000,000
in initial term loans that were made on the Effective Date (the “Initial Loans”), (ii)
$100,000,000
in delayed draw term loans available to the Company, subject to satisfaction of certain conditions precedent described therein, for a period of
18
months after the Effective Date (the “Delayed Draw Loans”), and (iii) up to
$100,000,000
in incremental term loans on an uncommitted basis and subject, among other things, to one or more lenders agreeing in the future to make such loans (the “Incremental Loans”) (the Initial Loans, Delayed Draw Loans and the Incremental Loans, collectively, the “Loans”). Amounts borrowed and repaid under the term loan credit agreement may not be reborrowed. All borrowings under the term loan credit agreement will mature on November 1, 2022. In addition to the
$300.0 million
in Initial Loans, the Company borrowed
$60.0 million
of Delayed Draw Loans on May 15, 2018. Pursuant to the terms of the 2L Indenture (described below), the Company cannot currently borrow in excess of
$400.0 million
under the term loan credit agreement.
Borrowings under the term loan credit agreement bear interest at a rate per annum equal to the “Adjusted LIBO Rate” (subject to a
1.00%
floor) plus a
7.75%
per annum margin. The “Adjusted LIBO Rate” is equal to the product of: (i)
three
-month LIBOR multiplied by (ii) the statutory reserve rate. Upon the occurrence and continuance of an event of default all outstanding Loans shall bear interest at a rate equal to
3.00%
per annum plus the then-effective rate of interest. Interest is payable on the last business day of each March, June, September and December.
A commitment fee will be paid on the unused amount of the delayed draw commitments based on an annual rate of
2.00%
(the “Commitment Fee”). The term loan credit agreement also requires the Company to prepay the loans with
100.00%
of the net cash proceeds received from certain asset sales, swap terminations, incurrences of borrowed money indebtedness, equity issuances, casualty events and extraordinary receipts, subject to certain exceptions and specified reinvestment rights. Prepayments (including mandatory prepayments), terminations, refinancing, reductions and accelerations under the term loan credit agreement are subject to the payment of a yield maintenance amount for any such prepayment, termination, refinancing, reduction or acceleration occurring prior to May 15, 2020 (or, with respect to any Delayed Draw Loan, prior to the
two
-year anniversary of the funding of such Delayed Draw Loan) that allows the lenders to attain approximately the same yield as if such Loan remained outstanding for the entire
two
-year period, as applicable, plus a call protection amount equal to the product of the principal amount of Loans so prepaid, terminated, refinanced, reduced or accelerated multiplied by (i)
4.0%
for any such prepayment, termination, refinancing, reduction or acceleration occurring, (A) with respect to the Initial Loans, on or prior to May 15, 2021, or (B) with respect to Delayed Draw Loans, on or prior to the
36
-month anniversary of the funding of such Delayed Draw Loan, or (ii)
2.0%
for any such prepayment, termination, refinancing, reduction or acceleration occurring, (A) with respect to the Initial Loans, after May 15, 2021 and on or prior to May 15, 2022, or (B) with respect to Delayed Draw Loans, after the
36
-month anniversary but on or prior to the
48
-month anniversary of the funding of such Delayed Draw Loan, in each case, as set forth in the term loan credit
agreement. Additionally, to the extent that the Loans are refinanced in full or the delayed draw commitments are terminated or reduced prior to the date that is
18
months after the Effective Date, the Company will be required to pay a yield maintenance amount in respect of the Commitment Fee that would have accrued on the delayed draw commitments as set forth in the term loan credit agreement.
The term loan credit agreement contains negative covenants that limit the Company’s ability, among other things, to pay cash dividends, incur additional indebtedness, sell assets, enter into certain derivatives contracts, change the nature of our business or operations, merge, consolidate, or make certain types of investments and require the outstanding principal amount of the Company’s
8.00%
senior unsecured notes due 2020 to be no more than
$30.0 million
by March 1, 2020. In addition, the term loan credit agreement requires that the Company comply with the following financial covenants: (i) as of any date of determination, the ratio of Total PDP PV-10 (as defined in the term loan credit agreement) plus the aggregate amount of all unrestricted cash and cash equivalents (in accounts subject to control agreements) to the amount of Senior Secured Debt (as defined in the term loan credit agreement) shall not be less than
1.30
to
1.00
, (ii) as of the last day of any fiscal quarter, the ratio of Net Senior Secured Debt (as defined in the term loan credit agreement) to EBITDAX (as defined in the term loan credit agreement) for the period of four fiscal quarters then ending on such day will not be greater than
3.75
to
1.00
and (iii) as of any date of determination the Company’s unrestricted cash and cash equivalents (in accounts subject to control agreements) plus the aggregate undrawn delayed draw commitments available to the Company shall not be less than
$20.0 million
.
The obligations of the Company under the term loan credit agreement may be accelerated upon the occurrence of an Event of Default (as defined in the term loan credit agreement). Events of Default include customary events for a financing agreement of this type, including, without limitation, payment defaults, the inaccuracy of representations and warranties, defaults in the performance of affirmative or negative covenants, defaults on other indebtedness of the Company or its subsidiaries, bankruptcy or related defaults, defaults related to judgments and the occurrence of a Change in Control (as defined in the term loan credit agreement).
The Company’s obligations under the term loan credit agreement are secured by mortgages on substantially all of the oil and gas properties of the Company subject to the limitations set forth in the term loan credit agreement. In connection with the term loan credit agreement, the Company entered into a guaranty and collateral agreement in favor of the Agent for the secured parties, pursuant to which the obligations of the Company under the term loan credit agreement and any swap agreements entered into with swap counterparties are secured by a first-priority security interest in substantially all of the assets of the Company.
On May 15, 2018, in connection with the Exchange Transaction, the Company entered into a second amendment to the term loan credit agreement (the “Second Amendment”) . The Second Amendment revised the call protection and yield maintenance provisions to provide as described above, and also revised certain covenants in the term loan credit agreement to reflect the covenants in the 2L Indenture (as defined below).
Second Lien Notes
On May 15, 2018 (the “2L Closing Date”), the Company issued Second Lien Notes with an aggregate principal amount of
$344.3 million
. The terms of the Second Lien Notes include those stated in the Indenture entered into by the Company and Wilmington Trust, National Association, as trustee (the “2L Indenture”), on the 2L Closing Date. The Second Lien Notes are the senior secured obligations of the Company and rank equal in right of payment to all existing and future senior indebtedness of the Company and its subsidiaries. The Second Lien Notes are secured by second priority security interests in substantially all assets of the Company, subject to the exceptions set forth in the Company’s existing term loan credit agreement and certain customary post-closing delivery periods. The Second Lien Notes will be guaranteed by all of the Company’s direct and indirect subsidiaries that guarantee indebtedness under any other indebtedness for borrowed money of the Company or any of the Company’s subsidiary guarantors. As of
June 30, 2018
, the Company does not have any subsidiaries. The Second Lien Notes will mature on May 15, 2023.
Interest on the Second Lien Notes will accrue at a rate of
8.500%
per annum payable in cash quarterly in arrears on first day of each calendar quarter. Beginning on July 1, 2018, the interest rate will be increased by
1.000%
per annum, which increase shall be payable in kind (the “PIK Component”). Commencing with the fiscal quarter ending June 30, 2018, if the Company’s total debt to EBITDAX ratio is (i) less than
3.00
to
1.00
as of the end of the fiscal quarter, the PIK Component shall cease accruing effective as of the next interest payment date, or (ii) greater than or equal to
3.00
to
1.00
as of the last day of such fiscal quarter or if the Company fails to deliver financial statements, the PIK Component shall continue to accrue (or, if then not accruing, automatically commence accruing as of the next interest payment date) and be payable quarterly. Additionally, if the Company incurs junior lien or unsecured debt with a cash interest rate in excess of
9.500%
, the cash rate on the Second Lien Notes will be increased by such excess. Default interest will be payable in cash on demand at the then applicable interest rate plus
3.000%
per annum.
The Company may redeem all or a portion of any of the Second Lien Notes at the following redemption prices during the following time periods (plus accrued and unpaid interest on the Second Lien Notes redeemed): (i) from and after May 15, 2018 until May 15, 2021,
104%
, (ii) on and after May 15, 2021 until May 15, 2022,
102%
, and (iii) on and after May 15, 2022,
100%
; provided that any redemption of Second Lien Notes (or the acceleration of Second Lien Notes) prior to May 15, 2020 shall also be accompanied by a make whole premium. Subject to the terms of an intercreditor agreement, the Company is also required to offer to prepay the Second Lien Notes with
100%
of the net cash proceeds of asset sales, casualty events and condemnations in excess of
$20.0 million
not required to be used to pay down the loans under the term loan credit agreement, subject to customary exclusions and reinvestment provisions consistent with the term loan credit agreement. Mandatory prepayment offers will be subject to payment of the make whole premium and redemption price set forth above, as applicable.
If a change of control occurs, the Company will be required to offer to repurchase the Second Lien Notes at the repurchase price of
101%
of the principal amount of repurchased Second Lien Notes (subject to the prepayment provisions of the term loan credit agreement). The Second Lien Notes contain negative covenants that are based upon the negative covenants set forth in the term loan credit agreement, taking into account differences to reflect the changed capital structure of the Company and the second lien nature of the Second Lien Notes, which negative covenants limit the Company’s ability, among other things, to pay cash dividends, incur additional indebtedness, sell assets, enter into certain derivatives contracts, change the nature of its business or operations, merge, consolidate, make certain types of investments, amend the term loan credit agreement and other debt documents, and incur any additional debt on a subordinated or junior basis to the term loan credit agreement and on a senior basis to the Second Lien Notes, and require the outstanding principal amount of the Company’s
8.00%
senior unsecured notes due 2020 to be no more than
$30.0 million
by March 1, 2020. The Second Lien Notes do not include any financial maintenance covenants.
The obligations of the Company under the Second Lien Notes may be accelerated upon the occurrence of an Event of Default (as such term is defined in the 2L Indenture). Events of Default include customary events for a capital markets debt financing of this type, including, without limitation, payment defaults, the inaccuracy of representations and warranties, defaults in the performance of affirmative or negative covenants, defaults on other indebtedness of the Company or its subsidiaries (including an event of default under the term loan credit agreement), bankruptcy or related defaults, defaults related to judgments and the occurrence of a Change of Control (as such term is defined in the 2L Indenture).
8.000%
Senior Notes Due 2020
On May 18, 2012, the Company issued at par value
$300.0 million
aggregate principal amount of
8.000%
senior unsecured notes due
June 1, 2020
(the “Original Notes”). On May 13, 2013, the Company issued at a price of
105.25%
of par an additional
$200.0 million
aggregate principal amount of
8.000%
senior unsecured notes due
June 1, 2020
(the “2013 Follow-on Notes”). On May 18, 2015, the Company issued at a price of
95.000%
of par an additional
$200.0 million
aggregate principal amount of
8.000%
senior unsecured notes due
June 1, 2020
(the “2015 Mirror Notes” and, together with the Original Notes and the 2013 Follow-on Notes, the “Notes”). Interest is payable on the Notes semi-annually in arrears on each of June 1 and December 1. The Company currently does not have any subsidiaries and, as a result, the Notes are not currently guaranteed. Any subsidiaries the Company forms in the future may be required to unconditionally guarantee, jointly and severally, payment obligation under the Notes on a senior unsecured basis. The issuance of the Original Notes resulted in net proceeds to the Company of approximately
$291.2 million
, the issuance of the 2013 Follow-on Notes resulted in net proceeds to the Company of approximately
$200.1 million
, and the issuance of the 2015 Mirror Notes resulted in net proceeds to the Company of approximately
$184.9 million
. Collectively, the net proceeds are in use to fund the Company’s exploration, development and acquisition program and for general corporate purposes (including repayment of borrowings that were outstanding under the Revolving Credit Facility at the time the Notes were issued).
Since June 1, 2017, the Company has been authorized to redeem some or all of the Notes at redemption prices (expressed as percentages of principal amount) equal to
102%
plus accrued and unpaid interest to the redemption date. Beginning on June 1, 2018, the applicable redemption price will equal the principal amount, plus accrued and unpaid interest to the redemption date.
The Original Notes and the 2013 Follow-on Notes are governed by an Indenture, dated as of May 18, 2012, by and among the Company and Wilmington Trust, National Association (the “Original Indenture”). The 2015 Mirror Notes are governed by an Indenture, dated as of May 18, 2015, by and among the Company and Wilmington Trust, National Association (the “Mirror Indenture”). The terms and conditions of the Mirror Indenture conform, in all material respects, to the terms and conditions set forth in the Original Indenture. As such, the Mirror Indenture, together with the Original Indenture, are referred to herein as the “Indenture.”
The Indenture restricts the Company’s ability to: (i) incur additional debt or enter into sale and leaseback transactions; (ii) pay distributions on, redeem or, repurchase equity interests; (iii) make certain investments; (iv) incur liens; (v) enter into transactions with affiliates; (vi) merge or consolidate with another company; and (vii) transfer and sell assets. These covenants are subject to a number of exceptions and qualifications. If at any time when the Notes are rated investment grade by both Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Services and no Default (as defined in the Indenture) has occurred and is continuing, many of such covenants will terminate and the Company and its subsidiaries (if any) will cease to be subject to such covenants.
The Indenture contains customary events of default, including:
|
|
•
|
default in any payment of interest on any Note when due, continued for
30 days
;
|
|
|
•
|
default in the payment of principal of or premium, if any, on any Note when due;
|
|
|
•
|
failure by the Company to comply with its other obligations under the Indenture, in certain cases subject to notice and grace periods;
|
|
|
•
|
payment defaults and accelerations with respect to other indebtedness of the Company and certain of its subsidiaries, if any, in the aggregate principal amount of
$25.0 million
or more;
|
|
|
•
|
certain events of bankruptcy, insolvency or reorganization of the Company or a significant subsidiary or group of restricted subsidiaries that, taken together, would constitute a significant subsidiary;
|
|
|
•
|
failure by the Company or any significant subsidiary or group of restricted subsidiaries that, taken together, would constitute a significant subsidiary to pay certain final judgments aggregating in excess of
$25.0 million
within
60 days
; and
|
|
|
•
|
any guarantee of the Notes by a guarantor ceases to be in full force and effect, is declared null and void in a judicial proceeding or is denied or disaffirmed by its maker.
|
NOTE 5 COMMON AND PREFERRED STOCK
The Company’s Certificate of Incorporation authorizes the issuance of up to
455,000,000
shares. The shares are classified in
two
classes, consisting of
450,000,000
shares of common stock, par value
$0.001
per share, and
5,000,000
shares of preferred stock, par value
$0.001
per share. The board of directors is authorized to establish one or more series of preferred stock, setting forth the designation of each such series, and fixing the relative rights and preferences of each such series. The Company has neither designated nor issued any shares of preferred stock.
Common Stock
The following is a schedule of changes in the number of shares of common stock outstanding during the
six
months ended
June 30, 2018
and the year ended
December 31, 2017
:
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2018
|
|
Year Ended December 31, 2017
|
Beginning Balance
|
66,791,633
|
|
|
63,259,781
|
|
Restricted Stock Grants
|
3,153,302
|
|
|
911,355
|
|
Debt Exchanges
|
121,774,822
|
|
|
—
|
|
Equity Offerings and Acquisitions
|
102,926,019
|
|
|
—
|
|
Legal Settlement
|
—
|
|
|
3,000,000
|
|
Other Surrenders - Tax Obligations
|
(153,421
|
)
|
|
(270,510
|
)
|
Other Forfeitures
|
(892,086
|
)
|
|
(108,993
|
)
|
Ending Balance
|
293,600,269
|
|
|
66,791,633
|
|
2018 Activity
During the
six
months ended
June 30, 2018
,
0.2 million
shares of common stock were surrendered by certain employees of the Company to cover tax obligations in connection with their restricted stock awards. The total value of these shares was approximately
$0.3 million
, which is based on the market prices on the dates the shares were surrendered.
During January 2018,
0.9 million
shares of common stock were forfeited in connection with the resignation of the Company’s former interim chief executive officer and chief financial officer. The total amount of share-based compensation expense that was reversed in connection with his resignation was approximately
$1.2 million
.
Exchange Transactions
On May 15, 2018, as a part of closing the Exchange Agreement (see Note 4), the Company issued
103.2 million
shares of the Company’s common stock to the Supporting Noteholders as partial consideration for their exchange of the Outstanding Notes.
In June 2018, the Company issued
18.5 million
shares of the Company’s common stock to various noteholders, through privately negotiated exchange transactions, as consideration for the exchange of the Outstanding Notes (See Note 4).
Equity Offerings
On April 10, 2018, the Company completed an underwritten public offering of common stock (the “Public Offering”) pursuant to which it issued
58.7 million
shares of common stock and received net proceeds of
$84.5 million
after underwriting discounts, commissions, and offering expenses. On April 16, 2018, the underwriters exercised their option to purchase an additional
3.6 million
shares and the Company received additional net proceeds of
$5.2 million
after underwriting discounts.
On May 15, 2018, in connection with the closing of the Exchange Agreement, the Company issued
34.7 million
shares to various investors through subscription agreements for net proceeds of
$52.0 million
.
Acquisition Agreement
On June 4, 2018, the Company issued
6.0 million
shares of common stock as a part of the purchase price for the purchase of oil and gas properties under the purchase and sale agreement with Salt Creek Oil and Gas, LLC (See Note 3).
Stock Repurchase Program
In May 2011, the Company’s board of directors approved a stock repurchase program to acquire up to
$150.0 million
of the Company’s outstanding common stock. The stock repurchase program allows the Company to repurchase its shares from time to time in the open market, block transactions and in negotiated transactions.
During the
three and six
months ended
June 30, 2018
and
June 30, 2017
, the Company did not repurchase shares of its common stock under the stock repurchase program. The Company’s accounting policy upon the repurchase of shares is to deduct its par value from Common Stock and to reflect any excess of cost over par value as a deduction from Additional Paid-in Capital.
NOTE 6 STOCK OPTIONS/STOCK-BASED COMPENSATION AND WARRANTS
The Company maintains its 2013 Incentive Plan (the “2013 Plan”) to provide a means whereby the Company may be able, by granting equity and other types of awards, to attract, retain and motivate capable and loyal employees, non-employee directors, consultants and advisors of the Company, for the benefit of the Company and its shareholders. As of
June 30, 2018
, there were
780,552
shares available for future awards under the 2013 Plan.
Restricted Stock Awards
During the
six
months ended
June 30, 2018
, the Company issued
950,355
restricted shares of common stock subject only to time-based vesting under the 2013 Plan as compensation to officers, employees and directors of the Company. Unvested restricted shares vest over various terms with all restricted shares vesting no later than June 2021. As of
June 30, 2018
, there was approximately
$2.6 million
of total unrecognized compensation expense related to such unvested restricted stock that will be recognized over a weighted-average period of approximately
1.2
years. The Company has historically assumed a
zero
percent
forfeiture rate, thus recognizing forfeitures as they occur, for restricted stock due to the small number of officers, employees and directors that have received restricted stock awards.
The following table reflects the outstanding restricted stock awards subject only to time-based vesting and activity related thereto for the
six
months ended
June 30, 2018
:
|
|
|
|
|
|
|
|
|
Six Months Ended
June 30, 2018
|
|
Number of
Shares
|
|
Weighted-Average Grant Date Fair Value (per Award)
|
Restricted Stock Awards:
|
|
|
|
Restricted Shares Outstanding at Beginning of Period
|
1,721,533
|
|
|
$
|
3.65
|
|
Shares Granted
|
950,355
|
|
|
2.64
|
|
Lapse of Restrictions
|
(623,775
|
)
|
|
3.20
|
|
Shares Forfeited
|
(892,086
|
)
|
|
4.00
|
|
Restricted Shares Outstanding at End of Period
|
1,156,027
|
|
|
$
|
2.78
|
|
Stock Option Awards
The following table reflects the outstanding stock option awards and the activity related thereto for the
six
months ended
June 30, 2018
:
|
|
|
|
|
|
|
|
|
|
|
Stock Option Awards
(1)
|
|
Weighted-Average Exercise Price
|
|
Weighted Average Contractual Term
|
Outstanding as of 12/31/2017
|
250,000
|
|
|
$
|
2.79
|
|
|
1.0
|
Granted
|
—
|
|
|
—
|
|
|
|
Exercised
|
—
|
|
|
—
|
|
|
|
Expired or canceled
|
—
|
|
|
—
|
|
|
|
Forfeited
|
—
|
|
|
—
|
|
|
|
Outstanding as of 6/30/2018
|
250,000
|
|
|
$
|
2.79
|
|
|
0.4
|
____________
(1)
All of the stock options outstanding were vested and exercisable at the end of the period.
Performance Stock Awards
On June 1, 2018, the Company granted performance stock awards as compensation to certain officers and employees of the Company. The performance stock awards are restricted and vest contingent on the continued service of the recipients through the vesting date, March 15, 2021. Additionally, the performance stock awards include awards that vest based on two separate defined performance criteria. Shares under the Performance-Based Restricted Share Grant I (“Performance Award I”) vest contingent on the Company’s fourth quarter annualized Adjusted EBITDA as compared to specified targets. Performance Award I contains both service and performance vesting conditions. The Company assessed the probability of achieving the performance condition as of June 30, 2018 using its internal financial forecasts. Shares under the Performance-Based Restricted Share Grant II (“Performance Award II”) vest contingent on the Company’s average closing stock price for the last
twenty
trading days of 2018 compared to specified targets. Performance Award II contains both service and market vesting conditions. A Monte Carlo simulation prepared by an independent third party is utilized to determine the grant date fair value of Performance Award II.
Shares under Performance Award I vest contingent on the Company’s fourth quarter annualized Adjusted EBITDA as compared to specified targets, as follows:
|
|
|
|
Performance
|
|
Aggregate Shares Vested
|
Less than Target I
|
|
0 shares
|
Target I to Target II
|
|
327,500 shares
|
Target II to Target III
|
|
660,000 shares
|
Greater than or equal to Target III
|
|
997,500 shares
|
The following table summarizes the Performance Award I activity for the
six
months ended
June 30, 2018
:
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2018
|
|
Number of
Shares
|
|
Weighted-Average Grant Date Fair Value (per Award)
|
Outstanding as of 12/31/2017
|
—
|
|
|
$
|
—
|
|
Shares Granted
|
997,500
|
|
|
2.70
|
|
Lapse of Restrictions
|
—
|
|
|
—
|
|
Shares Forfeited
|
—
|
|
|
—
|
|
Outstanding as of 6/30/2018
|
997,500
|
|
|
$
|
2.70
|
|
The fair value of the Performance Award I is estimated using the fair value on the grant date. The Company records the expense of the Performance Award I on a straight-line basis over the requisite service period. Any Performance Award I awards that do not become earned will terminate, expire and otherwise be forfeited by the participants. For the three and
six
months ended
June 30, 2018
, the Company recorded compensation expense related to Performance Award I awards of
$0.2 million
. At
June 30, 2018
, there was
$2.5 million
of total unrecognized compensation expense related to these awards.
Shares under Performance Award II vest contingent on the Company’s average closing stock price for the last
twenty
trading days of 2018 compared to specified targets, as follows:
|
|
|
|
Performance
|
|
Aggregate Shares Vested
|
Less than Target I
|
|
0 shares
|
Target I to Target II
|
|
327,500 shares
|
Target II to Target III
|
|
660,000 shares
|
Greater than or equal to Target III
|
|
997,500 shares
|
The following table summarizes the Performance Award II activity for the
six
months ended
June 30, 2018
:
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2018
|
|
Number of
Shares
|
|
Weighted-Average Grant Date Fair Value (per Award)
|
Outstanding as of 12/31/2017
|
—
|
|
|
$
|
—
|
|
Shares Granted
|
997,500
|
|
|
1.67
|
|
Lapse of Restrictions
|
—
|
|
|
—
|
|
Shares Forfeited
|
—
|
|
|
—
|
|
Outstanding as of 6/30/2018
|
997,500
|
|
|
$
|
1.67
|
|
The fair value of the Performance Award II is estimated using a Monte Carlo simulation at the grant date. The Company records the expense of the Performance Award I on a straight-line basis over the requisite service period. Any Performance Award II awards that do not become earned will terminate, expire and otherwise be forfeited by the participants. For the three and
six
months ended
June 30, 2018
, the Company recorded compensation expense related to Performance Award II awards of
$0.1 million
. At
June 30, 2018
, there was
$1.5 million
of total unrecognized compensation expense related to these awards.
The assumptions used to estimate the fair value of the Performance Award II granted as of the date presented are as follows:
|
|
|
|
|
|
June 1, 2018
|
Risk-free interest rate
|
2.10
|
%
|
Dividend yield
|
—
|
%
|
Expected volatility
|
100.00
|
%
|
Company's closing stock price on grant date
|
$
|
2.70
|
|
Fair value per Performance Award II
|
$
|
1.67
|
|
On June 1, 2018, the Company granted performance stock awards consisting of an aggregate of
176,100
shares as compensation to certain directors of the Company. These performance stock awards are set up with the same specified targets as the Performance Award II for officers and employees described above. These performance stock awards are restricted and vest contingent on continued service of the recipient through the vesting date of March 15, 2019, and dependent on the performance relative to the stock price targets for the Performance Award II. At
June 30, 2018
, there was
$0.3 million
of total unrecognized compensation expense related to these awards.
NOTE 7 RELATED PARTY TRANSACTIONS
Exchange Agreement
On January 31, 2018, the Company entered into an exchange agreement that was subsequently amended on each of March 20, 2018 and April 2, 2018 (as amended, the “Exchange Agreement”) with holders (the “Supporting Noteholders”) of approximately
$497.0 million
, or
71%
, of the aggregate principal amount of its outstanding
8.000%
Senior Notes due 2020 (the “Outstanding Notes”), pursuant to which the Supporting Noteholders agreed to exchange all of the Outstanding Notes held by each such Supporting Noteholder for approximately
$155.0 million
of its common stock and approximately
$344.0 million
in aggregate principal amount of new senior secured second lien notes due 2023 (the “Second Lien Notes”) (the “Exchange Transaction”). Closing under the Exchange Agreement occurred on May 15, 2018.
TRT Holdings, Inc. (“TRT”), Cresta Investments, LLC and Robert B. Rowling (together, the “TRT Noteholders”) are Supporting Noteholders and received, upon consummation of the Exchange Transaction, in the aggregate, approximately
54.6 million
shares of the Company’s common stock and approximately
$125.3 million
aggregate principal amount of Second Lien Notes in exchange for the
$204.7 million
of Outstanding Notes that they exchanged. Two of the Company’s directors, Michael Frantz and Mike Popejoy, are employed by TRT, and each of the TRT Noteholders individually beneficially owned in excess of
5%
of the Company’s outstanding common stock when the Exchange Agreement was entered into. The principal amounts of any Second Lien Notes held by the TRT Noteholders as of
June 30, 2018
are included in the Company’s long-term debt balances, and the Company’s interest expense includes interest attributable to any Outstanding Notes and Second Lien Notes held by TRT during the applicable period.
The obligations of the Supporting Noteholders under the Exchange Agreement were subject to the conditions set forth in the Exchange Agreement, which were satisfied at or prior to closing, including: (a) the successful completion of an equity transaction (the “Equity Raise”) comprised of
$140.0 million
in gross proceeds from the sale of the Company’s common stock, including the funding of up to
$52.0 million
of commitments received under the Subscription Agreements (as defined below); (b) the Company’s reincorporation in the State of Delaware and approval of its Delaware certificate of incorporation; (c) the Company’s receipt of the requisite stockholder approvals required by the NYSE American for (i) the issuance of the common stock in the Exchange Transaction and Equity Raise to the extent required and (ii) the reincorporation; (d) the Company obtaining the requisite consent of the lenders under the Company’s first lien term loan credit agreement (the “Term Loan Credit Agreement”) (including pursuant to an amendment to the terms thereof) to permit the Exchange Transaction; and (e) entry into a customary intercreditor agreement between the administrative agent for the Term Loan Credit Agreement and the trustee for the Second Lien Notes.
Subscription Agreements and Equity Raise
On January 31, 2018, and in connection with the Exchange Transaction, the Company and Bahram Akradi (the Chairman of its board of directors), Michael Reger (who subsequently joined the Company as an executive officer in May 2018), TRT and certain other investors each entered into subscription agreements (the “Subscription Agreements”) whereby such investors agreed to purchase up to
$40.0 million
of the Company’s common stock at a price per share equal to the lowest price per share in the Equity Raise, and subject to the closing of the Exchange Transaction. Pursuant to their respective Subscription Agreements, Mr. Akradi purchased
$12.0 million
of the Company’s common stock, Mr. Reger purchased
$10.0 million
of the Company’s common stock,
and TRT purchased
$10.0 million
of the Company’s common stock. Based on the pricing of the Equity Raise, the lowest price of which was
$1.50
per share, Mr. Akradi purchased
8.0 million
shares, Mr. Reger purchased
6.7 million
shares and TRT purchased
6.7 million
shares. Mr. Akradi and TRT each beneficially owned in excess of
5%
of the Company’s outstanding common stock when their respective Subscription Agreements were entered into.
On April 10, 2018, to satisfy, in part, the Company’s obligation to complete the Equity Raise, the Company completed an underwritten public offering (the “Offering”), whereby it sold
58,666,667
shares of its common stock at a public offering price of
$1.50
per share. As part of the Offering, Mr. Akradi purchased
1.0 million
shares of the Company’s common stock from the underwriters of the Offering for an aggregate purchase price of
$1.5 million
. Mr. Akradi beneficially owned in excess of
5%
of the Company’s outstanding common stock when he purchased such shares.
Registration Rights
In accordance with the terms of the Exchange Agreement, at the closing of the Exchange Transaction, the Company entered into registration rights agreements with (i) the Supporting Noteholders, including the TRT Noteholders, pursuant to which the Company agreed to file with the SEC a registration statement registering for resale the shares of common stock and the Second Lien Notes issued in the Exchange Transaction, and (ii) the TRT Noteholders and an affiliate of TRT, pursuant to which the Company agreed to file with the SEC a registration statement registering for resale all of the shares of common stock held by the TRT Noteholders and such affiliate, excluding shares of common stock that the TRT Noteholders received pursuant to the Exchange Transaction. The required registration statements were filed and declared effective by the SEC during the quarter ended
June 30, 2018
.
The Company’s Audit Committee is responsible for approving all transactions involving related parties, including each of the transactions identified above.
NOTE 8 COMMITMENTS & CONTINGENCIES
Litigation
The Company is engaged in various proceedings incidental to the normal course of business. Due to their nature, such legal proceedings involve inherent uncertainties, including but not limited to, court rulings, negotiations between affected parties and governmental intervention. Based upon the information available to the Company and discussions with legal counsel, it is the Company’s opinion that the outcome of the various legal actions and claims that are incidental to its business will not have a material impact on the Company’s financial position, results of operations or cash flows. Such matters, however, are subject to many uncertainties, and the outcome of any matter is not predictable with assurance.
The Company’s interests in certain crude oil and natural gas leases from the State of North Dakota are subject to an ongoing dispute over the ownership of minerals underlying the bed of the Missouri River within the boundaries of the Fort Berthold Reservation. The ongoing dispute is between the State of North Dakota and three affiliated tribes, both of whom have purported to lease mineral rights in tracts of riverbed within the reservation boundaries. In the event the ongoing dispute results in a final judgment that is adverse to the Company’s interests, the Company would be required to reverse approximately
$5.3 million
in revenue (net of accrued taxes) that has been accrued since the first quarter of 2013 based on the Company’s purported interest in the crude oil and natural gas leases at issue. Due to the long-term nature of this title dispute, the
$5.3 million
in accounts receivable is included in “Other Noncurrent Assets, Net” on the condensed balance sheets. The Company fully maintains the validity of its interests in the crude oil and natural gas leases.
On August 18, 2016, plaintiff Jeffrey Fries, individually and on behalf of all others similarly situated, filed a class action complaint in the United States District Court for the Southern District of New York against the Company, Michael Reger (the Company’s former chief executive officer), and Thomas Stoelk (the Company’s former chief financial officer and interim chief executive officer) as defendants. An amended complaint was filed by plaintiffs in July 2017. Defendants (including the Company) filed a motion to dismiss the amended complaint in August 2017. The court granted the Company’s motion to dismiss in January 2018, but permitted plaintiff the opportunity to further amend the complaint. A second amended complaint was filed by plaintiffs in January 2018. Defendants (including the Company) filed a motion to dismiss the second amended complaint in March 2018, and the Company is awaiting the court’s decision on that motion to dismiss. The complaint purports to bring a federal securities class action on behalf of a class of persons who acquired the Company’s securities between March 1, 2013 and August 15, 2016, and seeks to recover damages caused by defendants’ alleged violations of the federal securities laws and to pursue remedies under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The Company intends to continue to vigorously defend itself in this matter.
NOTE 9 INCOME TAXES
The Company utilizes the asset and liability approach to measuring deferred tax assets and liabilities based on temporary differences existing at each balance sheet date using currently enacted tax rates. A valuation allowance for the Company’s deferred tax assets is established if, in management’s opinion, it is more likely than not that a valuation allowance is needed, looking at both positive and negative factors. Due to uncertainty surrounding the realization of its deferred tax assets, the Company has continued to record a valuation allowance against its net deferred tax assets.
The income tax provision (benefit) for the
three and six
months ended
June 30, 2018
and
2017
consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Current Income Tax Provision (Benefit)
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Deferred Income Tax Provision (Benefit)
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
(19,180,000
|
)
|
|
4,699,000
|
|
|
(18,560,000
|
)
|
|
10,649,000
|
|
State
|
(4,228,000
|
)
|
|
424,000
|
|
|
(4,091,000
|
)
|
|
960,000
|
|
Valuation Allowance
|
23,408,000
|
|
|
(5,123,000
|
)
|
|
22,651,000
|
|
|
(11,609,000
|
)
|
Total Income Tax Provision (Benefit)
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Income tax provision (benefit) during interim periods is based on applying an estimated annual effective income tax rate to year-to-date income (loss), plus any unusual or infrequently occurring items that are recorded in the interim period. The provision for the three and six-month periods ended June 30, 2018, differ from the amount that would be provided by applying the statutory U.S. federal income tax rate of 21% to income before income taxes. The lower effective tax rate in 2018 and 2017 relates to the valuation allowance placed on the net deferred tax assets, in addition to state income taxes and estimated permanent differences.
The Company’s May 15, 2018 closing under the Exchange Agreement and related transactions triggered an ownership change within the meaning of Section 382 of the Internal Revenue Code (“IRC”) due to the share issuances that resulted from the Exchange Agreement and related transactions. In general, an ownership change, as defined in IRC Section 382, results from a transaction or series of transactions over a three-year period resulting in an ownership change of more than 50% of the outstanding stock of a company by certain stockholders or public groups. Since the Company has experienced an ownership change, utilization of net operating losses and other tax carryforward attributes are subject to an annual limitation, which is determined by first multiplying the value of the Company’s common stock at the time of the ownership change by the applicable long-term, tax-exempt rate, plus any built-in gains recognized within five years following the ownership change. Any such limitation is still being evaluated and may result in the expiration of a significant portion of the Company’s tax attributes. Any carryforward attributes that expire prior to utilization will be removed from deferred tax assets with a corresponding adjustment to the valuation allowance upon finalization of the limitation analysis, which will be completed prior to the end of the fiscal year. Due to the existence of the valuation allowance, it is not expected that any possible limitation will have an impact on the results of operations of the Company.
On December 22, 2017, the United States enacted the Tax Cuts and Jobs Act (“the Act”) which made significant changes that affect the Company, resulting in significant modifications to existing law. The Company’s financial statements for the year ended December 31, 2017 and for the quarter ended
June 30, 2018
reflect certain effects of the Act which includes a reduction in the corporate tax rate from 35% to 21% effective January 1, 2018, as well as other changes.
The Act also repeals the corporate alternative minimum tax for tax years beginning after December 31, 2017 and provides that prior alternative minimum tax credits will be refundable. The Company has credits that are expected to be refunded between 2018 and 2021 as a result of the Act and monetization opportunities under current tax laws.
The Act is a comprehensive tax reform bill containing a number of other provisions that either currently or in the future could impact the Company. The Company has completed the analysis of the Act and does not expect a material change due to the transition impacts. Any changes that do arise due to changes in interpretations of the Act, legislative action to address questions that arise because of the Act, changes in accounting standards for income taxes or related interpretations in response to the Act, or any updates or changes to estimates the Company has utilized to calculate the transition impacts will be disclosed in future periods as they arise. The effect of certain limitations effective for the tax year 2018 and forward, specifically related to the deductibility of executive compensation and interest expense, have been evaluated.
Tax benefits are recognized only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate settlement. Unrecognized tax benefits are tax benefits claimed in the Company’s tax returns that do not meet these recognition and measurement standards. The Company has no liabilities for unrecognized tax benefits.
The Company’s policy is to recognize potential interest and penalties accrued related to unrecognized tax benefits within income tax expense. For the three and six months ended
June 30, 2018
and
2017
, the Company did not recognize any interest or penalties in its condensed statements of operations, nor did it have any interest or penalties accrued in its condensed balance sheet at
June 30, 2018
and December 31, 2017 relating to unrecognized benefits.
The tax years 2017, 2016 and 2015 remain open to examination for federal and state income tax purposes.
NOTE 10 FAIR VALUE
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The Company uses a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Financial Assets and Liabilities
As required, financial assets and liabilities are classified in their entirety 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 requires judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. The following tables set forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at June 30, 2018 Using
|
|
Quoted Prices In Active Markets for Identical Assets (Liabilities)
(Level 1)
|
|
Significant Other Observable Inputs
(Level 2)
|
|
Significant Unobservable Inputs
(Level 3)
|
Commodity Derivatives – Current Asset (crude oil swaps)
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Commodity Derivatives – Noncurrent Asset (crude oil swaps)
|
—
|
|
|
—
|
|
|
—
|
|
Commodity Derivatives – Current Liabilities (crude oil swaps)
|
—
|
|
|
(43,644,644
|
)
|
|
—
|
|
Commodity Derivatives – Noncurrent Liabilities (crude oil swaps)
|
—
|
|
|
(28,611,421
|
)
|
|
—
|
|
Debt Exchange Derivatives – Current Liabilities
|
—
|
|
|
—
|
|
|
(10,923,000
|
)
|
Total
|
$
|
—
|
|
|
$
|
(72,256,065
|
)
|
|
$
|
(10,923,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at December 31, 2017 Using
|
|
Quoted Prices In Active Markets for Identical Assets (Liabilities)
(Level 1)
|
|
Significant Other Observable Inputs
(Level 2)
|
|
Significant Unobservable Inputs
(Level 3)
|
Commodity Derivatives – Current Asset (crude oil swaps)
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Commodity Derivatives – Noncurrent Asset (crude oil swaps)
|
—
|
|
|
—
|
|
|
—
|
|
Commodity Derivatives – Current Liabilities (crude oil swaps)
|
—
|
|
|
(18,681,891
|
)
|
|
—
|
|
Commodity Derivatives – Noncurrent Liabilities (crude oil swaps)
|
—
|
|
|
(11,496,929
|
)
|
|
—
|
|
Total
|
$
|
—
|
|
|
$
|
(30,178,820
|
)
|
|
$
|
—
|
|
The Level 2 instruments presented in the tables above consist of commodity derivative instruments (see Note 11). The fair value of the Company’s derivative financial instruments is determined based upon future prices, volatility and time to maturity, among other things. Counterparty statements are utilized to determine the value of the commodity derivative instruments and are reviewed and corroborated using various methodologies and significant observable inputs. The Company’s and the counterparties’ nonperformance risk is evaluated. The fair value of all derivative contracts is reflected on the condensed balance sheet. The current derivative asset and liability amounts represent the fair values expected to be settled in the subsequent twelve months.
The Company had embedded derivatives related to its separately negotiated exchange agreements with holders of the Company’s 2020 Notes. The exchange agreements contained provisions whereby if at the end of the applicable restricted sale period the Company’s common stock trades below specified levels, the Company may be required to pay additional consideration to the holder in the form of cash or additional shares of common stock. The Company determined these provisions were not clearly and closely related to the shares of common stock issued and therefore, bifurcated these embedded features and reflected them at fair value in the financial statements. Prior to their settlements, the fair values of these embedded derivatives were determined using a Monte Carlo simulation which considered various inputs including (i) the Company’s common stock price, (ii) risk-free rates based on U.S. Treasury rates, (iii) volatility of the Company’s common stock, and (iv) expected average daily trading volumes. The expected volatility and average daily trading volumes used in the valuation were unobservable in the marketplace and significant to the valuation methodology, and the embedded derivatives’ fair value was therefore designated as Level 3 in the valuation hierarchy. At
June 30, 2018
, the Company recorded a debt exchange derivative liability of
$10.9 million
.
Fair Value of Other Financial Instruments
The Company’s financial instruments, including certain cash and cash equivalents, accounts receivable and accounts payable, are carried at cost, which approximates fair value due to the short-term maturity of these instruments.
The carrying amount of the Company’s long-term debt reported in the condensed balance sheet at
June 30, 2018
is
$834.8 million
, which includes
$148.2 million
of senior unsecured notes,
$339.5 million
of second lien notes, and
$347.1 million
of borrowings under the Company’s term loan credit agreement (see Note 4). The fair value of the Company’s senior unsecured notes and second lien notes, which are publicly traded, is
$149.2 million
and
$364.1 million
at
June 30, 2018
, respectively. The Company’s term loan credit agreement approximates its fair value because of its floating rate structure.
Non-Financial Assets and Liabilities
The Company estimates asset retirement obligations pursuant to the provisions of FASB ASC 410. 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 natural gas properties. Given the unobservable nature of the inputs, including plugging costs and reserve lives, the initial measurement of the asset retirement obligations liability is deemed to use Level 3 inputs. Asset retirement obligations incurred during the
six
months ended
June 30, 2018
were approximately
$0.6 million
.
The Company accounts for acquisitions of oil and natural gas properties under the acquisition method of accounting. Accordingly, the Company conducts assessments of net assets acquired and recognizes amounts for identifiable assets acquired and liabilities assumed at the estimated acquisition date fair values, while transaction costs associated with the acquisitions are expensed as incurred. The Company makes various assumptions in estimating the fair values of assets acquired and liabilities assumed. The most significant assumptions relate to the estimated fair value of oil and natural gas properties. The fair value of these properties is measured using a discounted cash flow model that converts future cash flows to a single discounted amount. These assumptions
represent Level 3 inputs under the fair value hierarchy. See Note 3 for additional discussion of the Company's acquisitions of oil and natural gas properties during the
six
months ended
June 30, 2018
and discussion of the significant inputs to the valuations.
Though the Company believes the methods used to estimate fair value are consistent with those used by other market participants, the use of other methods or assumptions could result in a different estimate of fair value. There were
no
transfers of financial assets or liabilities between Level 1, Level 2 or Level 3 inputs for the
six
months ended
June 30, 2018
.
NOTE 11 DERIVATIVE INSTRUMENTS AND PRICE RISK MANAGEMENT
The Company utilizes commodity swap contracts, basis swaps, swaptions and collars (purchased put options and written call options) to (i) reduce the effects of volatility in price changes on the crude oil commodities it produces and sells, (ii) reduce commodity price risk and (iii) provide a base level of cash flow in order to assure it can execute at least a portion of its capital spending.
All derivative instruments are recorded on the Company’s balance sheet as either assets or liabilities measured at their fair value (see Note 10). The Company has not designated any derivative instruments as hedges for accounting purposes and does not enter into such instruments for speculative trading purposes. If a derivative does not qualify as a hedge or is not designated as a hedge, the changes in the fair value are recognized in the revenues section of the Company’s condensed statements of operations as a gain or loss on derivative instruments. Mark-to-market gains and losses represent changes in fair values of derivatives that have not been settled. The Company’s cash flow is only impacted when the actual settlements under the derivative contracts result in making or receiving a payment to or from the counterparty. These cash settlements represent the cumulative gains and losses on the Company’s derivative instruments for the periods presented and do not include a recovery of costs that were paid to acquire or modify the derivative instruments that were settled.
The following table presents cash settlements on matured or liquidated derivative instruments and non-cash gains and losses on open derivative instruments for the periods presented. Cash receipts and payments below reflect proceeds received upon early liquidation of derivative positions and gains or losses on derivative contracts which matured during the period, calculated as the difference between the contract price and the market settlement price of matured contracts. Non-cash gains and losses below represent the change in fair value of derivative instruments which continue to be held at period-end and the reversal of previously recognized non-cash gains or losses on derivative contracts that matured or were liquidated during the period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Cash Received (Paid) on Settled Derivatives
|
$
|
(12,266,857
|
)
|
|
$
|
2,341,030
|
|
|
$
|
(20,396,994
|
)
|
|
$
|
2,245,371
|
|
Non-Cash Mark-to-Market Gain (Loss) on Derivatives
|
(29,935,931
|
)
|
|
14,172,002
|
|
|
(42,077,245
|
)
|
|
31,228,544
|
|
Gain (Loss) on Derivative Instruments, Net
|
$
|
(42,202,788
|
)
|
|
$
|
16,513,032
|
|
|
$
|
(62,474,239
|
)
|
|
$
|
33,473,915
|
|
The Company has master netting agreements on individual crude oil contracts with certain counterparties and therefore the current asset and liability are netted on the balance sheet and the non-current asset and liability are netted on the balance sheet for contracts with these counterparties.
As of
June 30, 2018
, the Company had a total volume on open commodity swaps of
7.5 million
barrels at a weighted average price of approximately
$55.60
per barrel. The following table reflects the weighted average price of open commodity swap derivative contracts as of
June 30, 2018
, by year with associated volumes.
|
|
|
|
|
|
|
|
Year
|
|
Volumes (Bbl)
|
|
Weighted
Average Price ($)
|
2018
|
|
2,003,660
|
|
|
57.83
|
|
2019
|
|
3,160,000
|
|
|
55.85
|
|
2020
|
|
1,730,980
|
|
|
52.55
|
|
2021 and beyond
|
|
631,600
|
|
|
55.67
|
|
The following table sets forth the amounts, on a gross basis, and classification of the Company’s outstanding derivative financial instruments at
June 30, 2018
and
December 31, 2017
, respectively. Certain amounts may be presented on a net basis on the condensed financial statements when such amounts are with the same counterparty and subject to a master netting arrangement.
|
|
|
|
|
|
|
|
|
|
|
|
Type of Crude Oil Contract
|
|
Balance Sheet Location
|
|
June 30, 2018 Estimated Fair Value
|
|
December 31, 2017 Estimated Fair Value
|
Derivative Liabilities:
|
|
|
|
|
|
|
|
|
Swap Contracts
|
|
Current Liabilities
|
|
$
|
(43,644,644
|
)
|
|
$
|
(18,681,891
|
)
|
Swap Contracts
|
|
Noncurrent Liabilities
|
|
(28,611,421
|
)
|
|
(11,496,929
|
)
|
Total Derivative Liabilities
|
|
|
|
$
|
(72,256,065
|
)
|
|
$
|
(30,178,820
|
)
|
The use of derivative transactions involves the risk that the counterparties will be unable to meet the financial terms of such transactions. When the Company has netting arrangements with its counterparties that provide for offsetting payables against receivables from separate derivative instruments these assets and liabilities are netted on the balance sheet. The tables presented below provide reconciliation between the gross assets and liabilities and the amounts reflected on the balance sheet. The amounts presented exclude derivative settlement receivables and payables as of the balance sheet dates.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated Fair Value at June 30, 2018
|
|
Gross Amounts of
Recognized Assets (Liabilities)
|
|
Gross Amounts Offset
in the Balance Sheet
|
|
Net Amounts of Assets (Liabilities) Presented in the Balance Sheet
|
Offsetting of Derivative Assets:
|
|
|
Current Assets
|
$
|
12,921
|
|
|
$
|
(12,921
|
)
|
|
$
|
—
|
|
Noncurrent Assets
|
13,659
|
|
|
(13,659
|
)
|
|
—
|
|
Total Derivative Assets
|
$
|
26,580
|
|
|
$
|
(26,580
|
)
|
|
$
|
—
|
|
|
|
|
|
|
|
Offsetting of Derivative Liabilities:
|
|
|
|
Current Liabilities
|
$
|
(43,657,565
|
)
|
|
$
|
12,921
|
|
|
$
|
(43,644,644
|
)
|
Noncurrent Liabilities
|
(28,625,080
|
)
|
|
13,659
|
|
|
(28,611,421
|
)
|
Total Derivative Liabilities
|
$
|
(72,282,645
|
)
|
|
$
|
26,580
|
|
|
$
|
(72,256,065
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated Fair Value at December 31, 2017
|
|
Gross Amounts of
Recognized Assets (Liabilities)
|
|
Gross Amounts Offset
in the Balance Sheet
|
|
Net Amounts of Assets (Liabilities) Presented in the Balance Sheet
|
Offsetting of Derivative Assets:
|
|
|
Current Assets
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Non-Current Assets
|
—
|
|
|
—
|
|
|
—
|
|
Total Derivative Assets
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
Offsetting of Derivative Liabilities:
|
|
|
|
Current Liabilities
|
$
|
(18,681,891
|
)
|
|
$
|
—
|
|
|
$
|
(18,681,891
|
)
|
Non-Current Liabilities
|
(11,496,929
|
)
|
|
—
|
|
|
(11,496,929
|
)
|
Total Derivative Liabilities
|
$
|
(30,178,820
|
)
|
|
$
|
—
|
|
|
$
|
(30,178,820
|
)
|
All of the Company’s outstanding derivative instruments are covered by International Swap Dealers Association Master Agreements (“ISDAs”) entered into with BP Energy Company, Macquarie Bank Limited, and Fifth Third Bank. The Company’s obligations under the derivative instruments are secured pursuant to the term loan credit agreement and related agreements, and no additional collateral had been posted by the Company as of
June 30, 2018
. The ISDAs may provide that as a result of certain circumstances, such as cross-defaults, a counterparty may require all outstanding derivative instruments under an ISDA to be settled
immediately. See Note 10 for the aggregate fair value of all derivative instruments that were in a net liability position at
June 30, 2018
and
December 31, 2017
.
In June 2018, the Company entered into
five
independent, separately negotiated exchange agreements with holders of the Company’s 2020 Notes. Pursuant to each such exchange agreement, the Company agreed to issue the holder shares of its common stock in exchange for certain 2020 Notes held by such holder. The Company subjected the holders to various restrictions on the sale of the shares of common stock issued to them. These restrictions are of varying lengths and subject to varying exceptions
.
As compensation for the inability to sell shares during the restricted period, the exchange agreements contained provisions whereby, if at the end of the applicable restricted sale period the Company’s common stock trades below specified levels, the Company may be required to pay additional consideration to the holder in the form of cash or additional shares of common stock. In connection with these provisions, for the three and
six
months ended
June 30, 2018
, the Company recorded a debt exchange derivative liability of
$10.9 million
which was included in the loss on the extinguishment of debt on the condensed statement of operations.
NOTE 12 SUBSEQUENT EVENTS
Pivotal Acquisition
On July 17, 2018, the Company entered into
two
Purchase and Sale Agreements (the “Pivotal Purchase Agreements”) with affiliates of Pivotal Petroleum Partners, namely
Pivotal Williston Basin, LP and Pivotal Williston Basin II, LP, pursuant to which the Company agreed to acquire, effective as of June 1, 2018, certain oil and gas properties and interests, subject to typical closing conditions. Upon closings under their respective Purchase Agreement, Pivotal Williston Basin, LP will receive initial consideration of
$15.75 million
and
5,930,100
shares of common stock and Pivotal Williston Basin II, LP will receive initial consideration of
$52.65 million
and
19,823,478
shares of common stock. In each case, the cash portion of the initial consideration is subject to adjustment resulting from pre- and post- effective date revenue and expense allocation and procedures relating to customary title and environmental matters.
The obligations of the parties to complete the transactions contemplated by each Pivotal Purchase Agreement is subject to the satisfaction or waiver of customary closing conditions set forth in the Pivotal Purchase Agreements.
Under the Pivotal Purchase Agreements, the Company has agreed to issue an aggregate of
25,753,578
shares of common stock at closing and may in the future issue up to a maximum of
16,046,421
additional shares of its common stock. The additional shares would be issued only if the Company elects to use shares of its common stock to satisfy certain monthly payment obligations that may arise based on the average daily volume weighted average price of a share of the Company’s common stock as measured against specified reference prices for 12 of the 13 calendar months following closing.
W Resources Acquisition
On July 27, 2018, the Company entered into a Purchase and Sale Agreement (the “WR Purchase Agreement”) with WR Operating LLC (“Seller”), pursuant to which the Company has agreed to acquire, effective as of July 1, 2018, certain oil and gas properties and interests. Upon closing under the WR Purchase Agreement, Seller will receive initial consideration of
$100.0 million
in cash and
56,371,899
shares of common stock. The cash portion of the initial consideration is subject to adjustment resulting from pre- and post-effective date revenue and expense allocation and procedures relating to customary title and environmental matters.
The obligations of the parties to complete the transactions contemplated by the WR Purchase Agreement are subject to the satisfaction or waiver of customary closing conditions set forth in the WR Purchase Agreement.
Under the WR Purchase Agreement, the Company has agreed to issue
56,371,899
shares of common stock at closing and may in the future issue up to a maximum of
2,669,937
additional shares of its common stock, representing a total number of shares not to exceed
19.9%
of the number of shares of common stock issued and outstanding as of July 27, 2018. The additional shares would be issued only if the Company elects to use shares of its common stock to satisfy certain monthly payment obligations that may arise based on the average daily volume weighted average price of a share of the Company’s common stock as measured against specified reference prices for 12 of the 13 calendar months following closing. To the extent such monthly payment obligations arise and exceed the value of the maximum number of additional shares, the Company would be required to satisfy such obligations in cash.