20150930 10Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

 

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

 

For the quarterly period ended September 30, 2015 

OR

 

 

 

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

 

For the transition period from              to             

Commission file number 001-16317 

CONTANGO OIL & GAS COMPANY

(Exact name of registrant as specified in its charter)

 

 

 

 

 

 

 

DELAWARE

 

95-4079863

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

 

 

717 TEXAS, SUITE 2900

HOUSTON, TEXAS

 

77002

(Address of principal executive offices)

 

(Zip Code)

(713) 236-7400

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

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

 

 

 

 

 

 

Large accelerated filer

 

Accelerated filer

Non-accelerated filer

 

Smaller reporting company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

The total number of shares of common stock, par value $0.04 per share, outstanding as of November 2, 2015 was 19,403,080.

1

 


 

 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2015 

TABLE OF CONTENTS

 

 

 

 

 

 

 

 

 

 

Page

 

PART I—FINANCIAL INFORMATION

 

Item 1.

Consolidated Financial Statements

 

 

Consolidated Balance Sheets (unaudited) as of September 30, 2015 and December 31, 2014

 

Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2015 and 2014

 

Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2015 and 2014

 

Consolidated Statement of Shareholders’ Equity (unaudited) for the nine months ended September 30, 2015

 

Notes to the Unaudited Consolidated Financial Statements (unaudited)

Item 2.

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

20 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

30 

Item 4.

Controls and Procedures

31

 

 

 

 

PART II—OTHER INFORMATION

 

Item 1.

Legal Proceedings

31

Item 1A.

Risk Factors

32

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

32

Item 3.

Defaults upon Senior Securities

32

Item 4.

Mine Safety Disclosures

32

Item 5.

Other Information

32

Item 6.

Exhibits

32

 

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

2

 


 

 

 

 

Item 1. Consolidated Financial Statements

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except shares)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30,

 

December 31,

 

 

2015

 

2014

 

 

 

 

 

 

 

 

 

(unaudited)

CURRENT ASSETS:

 

 

 

 

 

 

Cash and cash equivalents

 

$

 —

 

$

 —

Accounts receivable, net

 

 

21,335 

 

 

25,309 

Prepaid expenses and other

 

 

8,139 

 

 

1,941 

Inventory

 

 

540 

 

 

2,166 

Current deferred tax asset

 

 

 —

 

 

1,624 

Total current assets

 

 

30,014 

 

 

31,040 

PROPERTY, PLANT AND EQUIPMENT:

 

 

 

 

 

 

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

 

 

 

 

 

 

Proved properties

 

 

1,184,699 

 

 

1,138,054 

Unproved properties

 

 

23,732 

 

 

35,783 

Other property and equipment

 

 

1,133 

 

 

1,084 

Accumulated depreciation, depletion and amortization

 

 

(764,789)

 

 

(426,298)

Total property, plant and equipment, net

 

 

444,775 

 

 

748,623 

OTHER NON-CURRENT ASSETS:

 

 

 

 

 

 

Investments in affiliates

 

 

61,369 

 

 

62,085 

Other

 

 

1,214 

 

 

1,667 

Total other non-current assets

 

 

62,583 

 

 

63,752 

TOTAL ASSETS

 

$

537,372 

 

$

843,415 

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

47,445 

 

$

92,892 

Current asset retirement obligations

 

 

6,417 

 

 

4,123 

Total current liabilities

 

 

53,862 

 

 

97,015 

NON-CURRENT LIABILITIES:

 

 

 

 

 

 

Long-term debt

 

 

114,569 

 

 

63,359 

Deferred tax liability

 

 

 —

 

 

93,952 

Asset retirement obligations

 

 

20,314 

 

 

21,623 

Total non-current liabilities

 

 

134,883 

 

 

178,934 

Total liabilities

 

 

188,745 

 

 

275,949 

COMMITMENTS AND CONTINGENCIES (NOTE 11)

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY:

 

 

 

 

 

 

Common stock, $0.04 par value, 50 million shares authorized, 24,644,924 shares issued and 19,410,700 shares outstanding at September 30, 2015, 24,372,538 shares issued and 19,148,000 shares outstanding at December 31, 2014

 

 

974 

 

 

963 

Additional paid-in capital

 

 

238,276 

 

 

233,278 

Treasury shares at cost (5,234,224 shares at September 30, 2015 and 5,224,538 shares at December 31, 2014)

 

 

(127,596)

 

 

(127,525)

Retained earnings

 

 

236,973 

 

 

460,750 

Total shareholders’ equity

 

 

348,627 

 

 

567,466 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

 

$

537,372 

 

$

843,415 

 

 

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

 

 

3

 


 

 

 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts) 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(unaudited)

 

(unaudited)

REVENUES:

 

 

 

 

 

 

 

 

 

 

 

 

Oil and condensate sales

 

$

9,500 

 

$

37,662 

 

$

35,882 

 

$

111,102 

Natural gas sales

 

 

16,020 

 

 

21,676 

 

 

48,130 

 

 

87,547 

Natural gas liquids sales

 

 

3,515 

 

 

8,214 

 

 

11,004 

 

 

27,579 

Total revenues

 

 

29,035 

 

 

67,552 

 

 

95,016 

 

 

226,228 

EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

9,036 

 

 

13,797 

 

 

29,919 

 

 

36,426 

Exploration expenses

 

 

407 

 

 

(4,713)

 

 

11,814 

 

 

33,071 

Depreciation, depletion and amortization

 

 

38,386 

 

 

40,550 

 

 

112,271 

 

 

114,853 

Impairment and abandonment of oil and gas properties

 

 

235,150 

 

 

6,693 

 

 

237,667 

 

 

23,259 

General and administrative expenses

 

 

7,504 

 

 

6,821 

 

 

22,683 

 

 

26,485 

Total expenses

 

 

290,483 

 

 

63,148 

 

 

414,354 

 

 

234,094 

OTHER INCOME (EXPENSE):

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

(375)

 

 

1,287 

 

 

(562)

 

 

4,387 

Interest expense

 

 

(785)

 

 

(672)

 

 

(2,315)

 

 

(2,077)

Gain (loss) on derivatives, net

 

 

2,011 

 

 

1,734 

 

 

2,001 

 

 

(1,488)

Other income (expense)

 

 

4,288 

 

 

48 

 

 

5,278 

 

 

(148)

Total other income

 

 

5,139 

 

 

2,397 

 

 

4,402 

 

 

674 

NET INCOME (LOSS) BEFORE INCOME TAXES

 

 

(256,309)

 

 

6,801 

 

 

(314,936)

 

 

(7,192)

Income tax benefit (provision)

 

 

70,624 

 

 

(3,137)

 

 

91,159 

 

 

5,244 

NET INCOME (LOSS)

 

$

(185,685)

 

$

3,664 

 

$

(223,777)

 

$

(1,948)

NET INCOME (LOSS) PER SHARE:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(9.79)

 

$

0.19 

 

$

(11.81)

 

$

(0.10)

Diluted

 

$

(9.79)

 

$

0.19 

 

$

(11.81)

 

$

(0.10)

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

18,966 

 

 

19,077 

 

 

18,948 

 

 

19,074 

Diluted

 

 

18,966 

 

 

19,122 

 

 

18,948 

 

 

19,074 

 

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

4

 


 

 

 

 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands) 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

September 30,

 

 

2015

 

2014

 

 

 

 

 

 

 

 

 

(unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

Net loss

 

$

(223,777)

 

$

(1,948)

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

 

 

 

 

 

 

Depreciation, depletion and amortization

 

 

112,271 

 

 

114,853 

Impairment of natural gas and oil properties

 

 

237,656 

 

 

22,688 

Exploration expenses

 

 

6,826 

 

 

31,594 

Deferred income taxes

 

 

(92,328)

 

 

(3,485)

Loss on sale of assets

 

 

231 

 

 

 —

Loss (gain) from investment in affiliates

 

 

865 

 

 

(6,750)

Stock-based compensation

 

 

5,008 

 

 

3,333 

Unrealized gain on derivative instruments

 

 

(999)

 

 

(1,494)

Changes in operating assets and liabilities:

 

 

 

 

 

 

Decrease in accounts receivable and other receivables

 

 

3,581 

 

 

18,703 

Increase in prepaid expenses

 

 

(5,198)

 

 

(606)

Increase (decrease) in accounts payable and advances from joint owners

 

 

(25,373)

 

 

2,393 

Decrease in other accrued liabilities

 

 

(1,494)

 

 

(2,489)

Decrease in income taxes receivable, net

 

 

748 

 

 

466 

Other

 

 

1,233 

 

 

(422)

Net cash provided by operating activities

 

$

19,250 

 

$

176,836 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

Natural gas and oil exploration and development expenditures

 

$

(70,389)

 

$

(146,699)

Distributions from affiliates

 

 

 —

 

 

5,365 

Net cash used in investing activities

 

$

(70,389)

 

$

(141,334)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

Borrowings under credit facility

 

$

284,378 

 

$

352,558 

Repayments under credit facility

 

 

(233,168)

 

 

(388,144)

Proceeds from exercised options

 

 

 —

 

 

120 

Excess tax benefit from exercise of stock options

 

 

 —

 

 

Purchase of treasury stock

 

 

(71)

 

 

(4)

Debt issuance costs

 

 

 —

 

 

(35)

Net cash provided by (used in) financing activities

 

$

51,139 

 

$

(35,502)

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

$

 —

 

$

 —

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

 

 —

 

 

 —

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

 —

 

$

 —

 

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

 

5

 


 

 

 

 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(in thousands, except number of shares)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Total

 

 

Common Stock

 

Paid-in

 

Treasury

 

Retained

 

Shareholders’

 

 

Shares

 

Amount

 

Capital

 

Stock

 

Earnings

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(unaudited)

Balance at December 31, 2014

 

19,148,000 

 

$

963 

 

$

233,278 

 

$

(127,525)

 

$

460,750 

 

$

567,466 

Treasury shares at cost

 

(9,686)

 

 

 —

 

 

 —

 

 

(71)

 

 

 —

 

 

(71)

Restricted shares activity

 

272,386 

 

 

11 

 

 

(10)

 

 

 —

 

 

 —

 

 

Stock-based compensation

 

 —

 

 

 —

 

 

5,008 

 

 

 —

 

 

 —

 

 

5,008 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(223,777)

 

 

(223,777)

Balance at September 30, 2015

 

19,410,700 

 

$

974 

 

$

238,276 

 

$

(127,596)

 

$

236,973 

 

$

348,627 

 

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

6

 


 

 

 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Organization and Business

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

The following table lists the Company's primary producing areas as of September 30, 2015:

 

 

 

 

Location

 

Formation

Gulf of Mexico

 

Offshore Louisiana – water depths less than 300 feet

Madison and Grimes counties, Texas

 

Woodbine (Upper Lewisville)

Zavala and Dimmit counties, Texas

 

Buda / Austin Chalk

Texas Gulf Coast

 

Conventional formations

Sublette County, Wyoming

 

Jonah Field (1)

 

(1)

Through a 37% equity investment in Exaro Energy III LLC (“Exaro”). Production from this entity is not included in the Company’s reported production results for the three or nine months ended September 30, 2015, or in its reported reserves as of December 31, 2014.

The Company intends to grow reserves and production by further exploiting the unproved resource potential on its existing onshore property base with specific activity in any particular area or time, to be a function of drilling success, commodity prices and/or prevailing service costs. In addition, the Company owns developed and undeveloped acreage in several regions that it believes provides additional unproved resource potential that could provide significant long-term growth in production and reserves.

Due to the current challenging commodity price environment, the Company focused its 2015 capital program on: (i) the preservation of its strong and flexible financial position, including limiting its overall capital expenditure budget; (ii) dedicating capital primarily to de-risking and/or delineating strategic projects (i.e. versus field development); (iii) the identification of opportunities for cost and production efficiencies in all areas of its operations; and (iv) continuing to identify and, when appropriate, pursue the expansion of its resource potential through opportunistic acquisitions.

The following table lists the primary areas to which the Company has allocated capital during 2015:

 

 

 

 

Location

 

Formation

Madison and Grimes counties, Texas

 

Woodbine (Upper and Lower Lewisville)

Weston County, Wyoming

 

Muddy Sandstone

Fayette and Gonzales counties, Texas

 

Navarro / Buda / Austin Chalk

 

2. Summary of Significant Accounting Policies

The accounting policies followed by the Company are set forth in the notes to the Company’s audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2014 (the “2014 Form 10-K”) filed with the Securities and Exchange Commission (“SEC”). Please refer to the notes to the financial statements included in the 2014 Form 10-K for additional details of the Company’s financial condition, results of operations and cash flows. No material items included in those notes have changed except as a result of normal transactions in the interim or as disclosed within this report.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, pursuant to the rules and regulations of the SEC, including instructions to Quarterly Reports on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete annual financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of the unaudited consolidated financial statements have been included. All such adjustments are of a normal recurring nature. The consolidated financial statements

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should be read in conjunction with the 2014 Form 10-K. The consolidated results of operations for the nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

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

Impairment of Long-Lived Assets

Pursuant to GAAP, when circumstances indicate that proved properties may be impaired, the Company compares expected undiscounted future net cash flows on a field by field basis to the unamortized capitalized cost of the asset. If the future undiscounted net cash flows based on the Company’s estimate of future natural gas and oil prices and operating costs and anticipated production from risk adjusted proved, probable and possible reserves, are lower than the unamortized capitalized cost, then the capitalized cost is reduced to fair value. The Company recognized approximately $225.6 million and $227.6 million for impairment of proved properties for the three and nine months ended September 30, 2015, respectively. Substantially all of the non-cash impairment charge in the quarter ended September 30, 2015 is directly related to the decline in commodity prices and the resulting impact on estimated future net cash flows from associated reserves. Approximately $196.5 million of the total proved property impairment for both the three and the nine months ended September 30, 2015 is attributable to the Madison/Grimes counties and Zavala/Dimmit/Karnes counties properties.  No impairment of proved properties was recognized for the three and nine months ended September 30, 2014.

 

If oil and/or natural gas prices decline further from forecasted strip prices existing at September 30, 2015, and upon which the third quarter impairment was calculated, we may be required to record additional non-cash impairment in the future, thereby impacting our financial results for that period.

Unproved properties are reviewed quarterly to determine if there has been impairment of the carrying value, with any such impairment charged to expense in the period. The Company recognized impairment expense of approximately $9.5 million and $10.1 million for the three and nine months ended September 30, 2015, respectively, related to impairment and partial impairment of certain unproved properties and onshore prospects due primarily to the sustained low commodity price environment and expiring leases. Approximately $8.2 million of the total for the three and nine months ended September 30, 2015 is related to unproved lease cost amortization of the Elm Hill project in Fayette and Gonzales counties Texas.

On April 29, 2014, the Company reached total depth on its Ship Shoal 255 well, and no commercial hydrocarbons were found. As a result, for the nine months ended September 30, 2014, the Company recognized a total of $31.6 million in exploration expense for the cost of drilling the well and $15.6 million in impairment expense, including $3.5 million related to leasehold costs and $12.1 million related to the platform located at Block Ship Shoal 263, which was expected to be used by the Ship Shoal 255 well, had it been successful.

The Company recognized impairment expense of approximately $6.7 million and $7.1 million for the three and nine month periods ended September 30, 2014, respectively, related to impairment and partial impairment of certain unproved properties due to expiring leases and leases not likely to be drilled.

Net Income (Loss) Per Common Share

Basic net income (loss) per common share is computed by dividing income (loss) attributable to common stock by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Potential dilutive securities, including unexercised stock options and unvested restricted stock, have not been considered when their effect would be antidilutive. For the three and nine months ended September 30, 2015, 127,613 stock options and 423,820 restricted shares were excluded from dilutive shares due to the loss for the period. For the three months ended September 30, 2014, 114,934 stock options and 98,269 restricted shares were excluded from dilutive shares as they were antidilutive. For the nine months ended September 30, 2014, 130,348 stock options and 299,501 restricted shares were excluded from the dilutive shares due to the loss for the period. 

Subsidiary Guarantees

Contango Oil & Gas Company, as the parent company (the “Parent Company”), has filed a registration statement on Form S-3 with the SEC to register, among other securities, debt securities that the Parent Company may issue from time to time. Any such debt securities would likely be guaranteed on a full and unconditional basis by each of Crimson Exploration Inc., Crimson Exploration Operating, Inc., Contango Energy Company, Contango Operators, Inc., Contango Mining Company, Conterra Company, Contaro Company, Contango Alta Investments, Inc., Contango Venture Capital Corporation and any other of

8

 


 

 

our future subsidiaries specified in any future prospectus supplement (each a “Subsidiary Guarantor”). Each of the Subsidiary Guarantors is wholly-owned by the Parent Company, either directly or indirectly. The Parent Company has no assets or operations independent of the Subsidiary Guarantors, and there are no significant restrictions upon the ability of the Subsidiary Guarantors to distribute funds to the Parent Company. The Parent Company has one wholly-owned subsidiary that is inactive and not a Subsidiary Guarantor. Finally, the Parent Company’s wholly-owned subsidiaries do not have restricted assets that exceed 25% of net assets as of the most recent fiscal year end that may not be transferred to the Parent Company in the form of loans, advances or cash dividends by such subsidiary without the consent of a third party.

 

Recent Accounting Pronouncements 

In September 2015, the FASB issued Accounting Standards Update No. 2015-16: Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments (ASU 2015-16). ASU 2015-16 is part of an initiative to reduce complexity in accounting standards, and requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. In addition, the amendments of this update require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the changes to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. Furthermore, ASU 2015-16 requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustments to the provisional amounts had been recognized as of the acquisition date. For public entities, ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The provisions of this accounting update are not expected to have a material impact on the Company’s financial position or results of operations.

In June 2015, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update No. 2015-10: Technical Corrections and Improvements (ASU 2015-10). ASU 2015-10 is part of an initiative to clarify the Accounting Standards Codification (Codification), correct unintended application of guidance, and make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. ASU 2015-10 covers a wide range of topics in the Codification and is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015; early adoption is permitted. The Company is currently evaluating the provisions of this accounting update and assessing the impact, if any, it may have on its financial position and results of operations.

In January 2015, the FASB issued Accounting Standards Update No. 2015-01: Income Statement – Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items (ASU 2015-01). ASU 2015-01 is part of an initiative to reduce complexity in accounting standards. This update eliminates from generally accepted accounting principles the concept of extraordinary items, which eliminates the requirements for reporting entities to consider whether an underlying event or transaction is extraordinary. However, this will not result in a loss of information as the presentation and disclosure guidance for items that are unusual in nature or occur infrequently will be retained. ASU 2015-01 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015; early application is permitted. The provisions of this accounting update are not expected to have a material impact on the Company’s financial position or results of operations.

In August 2014, the FASB issued Accounting Standards Update No. 2014-15: Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. (ASU 2014-15). ASU 2014-15 asserts that management should evaluate whether there are relevant conditions or events that are known and reasonably knowable that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued or are available to be issued when applicable. If conditions or events at the date the financial statements are issued raise substantial doubt about an entity’s ability to continue as a going concern, disclosures are required which will enable users of the financial statements to understand the conditions or events as well as management’s evaluation and plan. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter; early application is permitted. The provisions of this accounting update are not expected to have a material impact on the Company’s financial position or results of operations.

In May 2014, the FASB and the International Accounting Standards Board jointly issued new accounting guidance for recognition of revenue Accounting Standards Update No. 2014-09: Revenue from Contracts with Customers (Topic 606) (ASU 2014-09). This new guidance replaces virtually all existing U.S. GAAP and International Financial Reporting Standards guidance on revenue recognition. ASU 2014-09 is effective for fiscal years beginning after December 15, 2017. This new guidance applies to all periods presented. Early adoption is not allowed under  U.S. GAAP. The new guidance requires companies to make more estimates and use more judgment than under current accounting guidance. The Company does not anticipate that the implementation of this new guidance will have a material impact on the Company’s consolidated financial position or results of operations for the periods presented.

9

 


 

 

3. Fair Value Measurements

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

The following table sets forth, by level within the fair value hierarchy, the Company’s financial assets and liabilities that were accounted for at fair value as of September 30, 2015. As required by ASC 820, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. There have been no transfers between Level 1, Level 2 or Level 3.

Fair value information for financial assets and liabilities was as follows as of September 30, 2015 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

Fair Value Measurements Using

 

 

Carrying Value

 

Level 1

 

Level 2

 

Level 3

Derivatives

 

 

 

 

 

 

 

 

Commodity price contracts - assets

 

$

999 

 

$

 —

 

$

999 

 

$

 —

Commodity price contracts - liabilities

 

$

 —

 

$

 —

 

$

 —

 

$

 —

Derivatives listed above are recorded in “Prepaid expenses and other” on the Company’s consolidated balance sheet and include collars that are carried at fair value. The Company records the net change in the fair value of these positions in "Gain (loss) on derivatives, net" in the Company's consolidated statements of operations. The Company is able to value the assets and liabilities based on observable market data for similar instruments, which resulted in the Company reporting its derivatives as Level 2. This observable data includes the forward curves for commodity prices based on quoted markets prices and implied volatility factors related to changes in the forward curves. As of December 31, 2014, there were no outstanding commodity price contracts. See Note 4 - "Derivative Instruments" for additional discussion of derivatives.

As of September 30, 2015, the Company's derivative contracts were with major financial institutions with investment grade credit ratings which are believed to have minimal credit risk. As such, the Company is exposed to credit risk to the extent of nonperformance by the counterparties in the derivative contracts discussed above; however, the Company does not anticipate such nonperformance.

Estimates of the fair value of financial instruments are made in accordance with the requirements of ASC 825, Financial Instruments. The estimated fair value amounts are determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The estimated fair value of cash, accounts receivable and accounts payable approximates their carrying value due to their short-term nature. The estimated fair value of the Company's credit facility with the Royal Bank of Canada and other lenders (the “RBC Credit Facility”) approximates carrying value because the facility interest rate approximates current market rates and is reset at least every three months. See Note 8 - "Long-Term Debt" for further information.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company tests its proved oil and natural gas properties for impairment when events and circumstances indicate a decline in the recoverability of the carrying value of such properties, such as a downward revision of the reserve estimates or lower commodity prices. An impairment loss is indicated if the sum of the expected future undiscounted net cash flows based on the Company’s estimate of future natural gas and oil prices and operating costs and anticipated production from risk adjusted proved, probable and possible reserves, are lower than the unamortized capitalized cost. In this circumstance, the capitalized cost is reduced to fair value.

For the three and nine months ended September 30, 2015, the Company recognized approximately $225.6 million and $227.6 million for impairment of proved properties, respectively. Substantially all of the non-cash impairment charge in the

10

 


 

 

quarter ended September 30, 2015 is directly related to the decline in commodity prices and the resulting impact on estimated future net cash flows from associated reserves.

It is reasonably possible that the estimate of undiscounted future net cash flows may change in the future resulting in the need to impair carrying values. The primary factors that may affect estimates of future cash flows are (i) commodity futures prices, (ii) increases or decreases in production and capital costs, (iii) future reserve adjustments, both positive and negative, to proved reserves and appropriate risk-adjusted probable and possible reserves and (iv) results of future drilling activities.

4. Derivative Instruments

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

As of September 30, 2015, the Company’s crude oil derivative positions consisted of costless put/call “collars.” A costless collar consists of a sold call, which establishes a maximum price the Company will receive for the volumes under contract, and a purchased put that establishes a minimum price.

It is the Company's policy to enter into derivative contracts only with counterparties that are creditworthy institutions deemed by management as competent and competitive market makers. The Company does not post collateral, nor is exposed to potential margin calls, under any of these contracts as they are secured under the RBC Credit Facility. See Note 8 - "Long-Term Debt" for further information regarding the RBC Credit Facility.

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

The following derivative contracts were in place at September 30, 2015 (fair value in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity

 

Period

 

Derivative

 

Volume/Month

 

Price/Unit (1)

 

Fair Value

Crude Oil

 

Oct 2015 - Dec 2015

 

Collar

 

35,000 Bbls

 

$55.00 - $65.15

 

 

999 

 

 

 

 

Total net fair value of derivative instruments

 

$

999 

 

(1)

Commodity derivatives based on NYMEX West Texas Intermediate crude oil prices.

 

The following summarizes the fair value of commodity derivatives outstanding on a gross and net basis as of September 30, 2015 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross

 

Netting (1)

 

Total

Assets

 

$

999 

 

$

 —

 

$

999 

Liabilities

 

$

 —

 

$

 —

 

$

 —

 

(1)

Represents counterparty netting under agreements governing such derivatives.

As of December 31, 2014, the Company did not have any outstanding derivative positions.

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The following table summarizes the effect of derivative contracts on the consolidated statements of operations for the three and nine months ended September 30, 2015 and 2014 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2015

 

2014

 

2015

 

2014

Crude oil contracts

 

 

$

1,002 

 

$

(214)

 

$

1,002 

 

$

(1,385)

Natural gas contracts

 

 

 

 —

 

 

(15)

 

 

 —

 

 

(1,597)

Realized gain (loss)

 

 

$

1,002 

 

$

(229)

 

$

1,002 

 

$

(2,982)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Crude oil contracts

 

 

$

1,009 

 

$

1,773 

 

$

999 

 

$

1,538 

Natural gas contracts

 

 

 

 —

 

 

190 

 

 

 —

 

 

(44)

Unrealized gain

 

 

$

1,009 

 

$

1,963 

 

$

999 

 

$

1,494 

Gain (loss) on derivatives, net

 

 

$

2,011 

 

$

1,734 

 

$

2,001 

 

$

(1,488)

 

5. Stock-Based Compensation

During the nine months ended September 30, 2015, the Company had a stock-based compensation program which allows for stock options and/or restricted stock to be awarded to officers, directors, consultants and employees. This program includes (i) the Company's Amended and Restated 2009 Incentive Compensation Plan (the “2009 Plan”); and (ii) the Crimson 2005 Stock Incentive Plan (the “2005 Plan” or "Crimson Plan") adopted in conjunction with the merger with Crimson Exploration Inc. in October 2013 (the “Merger”), which expired on February 25, 2015.

Stock Options

Under the fair value method of accounting for stock options, cash flows from the exercise of stock options resulting from tax benefits in excess of recognized cumulative compensation cost (excess tax benefits) are classified as financing cash flows. For the nine months ended September 30, 2015, there was no excess tax benefit recognized. For the nine months ended September 30, 2014, there was an insignificant excess tax benefit recognized.

Compensation expense related to stock option grants are recognized over the stock option’s vesting period based on the fair value at the date the options are granted. The fair value of each option is estimated as of the date of grant using the Black-Scholes options-pricing model. No stock options were granted during the nine months ended September 30, 2015 or 2014.

During the nine months ended September 30, 2015, no stock options were exercised and stock options for 2,321 shares of common stock were forfeited by former employees. During the nine months ended September 30, 2014, 4,165 stock options were exercised and stock options for 594 shares of common stock were forfeited.

Restricted Stock

During the nine months ended September 30, 2015, the Company granted 270,091 shares of restricted common stock under the 2009 Plan. Of these,  242,887 shares were granted to employees as part of their overall compensation package, which vest over four years, and 27,204 shares were granted to directors pursuant to the Company’s director compensation plan, which vest after one year. Additionally, the Company issued the final 7,030 shares of restricted stock under the 2005 Plan to employees as part of their compensation package, which vest over four years. The weighted average fair value of the restricted shares granted during the nine months ended September 30, 2015, was $22.02 with a total fair value of approximately $6.1 million after adjustment for an estimated weighted average forfeiture rate of 4.9%. Approximately 0.9 million shares remain available for grant under the 2009 Plan as of September 30, 2015.

During the nine months ended September 30, 2015, 4,735 restricted shares were forfeited by former employees. The aggregate intrinsic value of restricted shares forfeited during the nine months ended September 30, 2015 was approximately $147  thousand.

During the nine months ended September 30, 2015, the Company recognized approximately $5.0 million in stock-based compensation expense for the vesting of restricted shares previously granted to its officers, employees and directors. Included in this amount was approximately $1.1 million related to the accelerated vesting of restricted shares due to a reduction in force implemented in August of 2015. As of September 30, 2015, an additional  $8.5 million of compensation expense remained to be recognized over the remaining weighted-average vesting period of 2.4 years.

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6. Other Financial Information

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2015

 

December 31, 2014

Accounts receivable:

 

 

 

 

 

 

Trade receivable

 

$

9,637 

 

$

13,926 

Receivable for Alta Resources distribution

 

 

1,993 

 

 

1,993 

Joint interest billing

 

 

6,091 

 

 

4,096 

Income taxes receivable

 

 

2,868 

 

 

3,274 

Other receivables

 

 

1,323 

 

 

2,610 

Allowance for doubtful accounts

 

 

(577)

 

 

(590)

Total accounts receivable

 

$

21,335 

 

$

25,309 

 

 

 

 

 

 

 

Prepaid expenses and other:

 

 

 

 

 

 

Prepaid insurance

 

$

1,417 

 

$

1,242 

Deposit (1)

 

 

5,000 

 

 

 —

Other

 

 

1,722 

 

 

699 

Total prepaid expenses and other

 

$

8,139 

 

$

1,941 

 

 

 

 

 

 

 

Accounts payable and accrued liabilities:

 

 

 

 

 

 

Royalties and revenue payable

 

$

21,035 

 

$

31,653 

Accrued exploration and development

 

 

7,127 

 

 

26,538 

Trade payables

 

 

7,151 

 

 

17,282 

Advances from partners

 

 

3,504 

 

 

8,334 

Accrued general and administrative expenses

 

 

4,194 

 

 

6,258 

Other accounts payable and accrued liabilities

 

 

4,434 

 

 

2,827 

Total accounts payable and accrued liabilities

 

$

47,445 

 

$

92,892 

 

(1)

Non-refundable deposit related to potential asset purchase.

Included in the table below is supplemental information about certain cash and non-cash transactions during the nine months ended September 30, 2015 and 2014 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

 

2015

 

2014

Cash payments:

 

 

 

 

 

Interest payments

 

 

2,231 

 

2,224 

Income tax payments

 

 

100 

 

136 

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

 

 

 

 

 

Decrease in accrued capital expenditures

 

 

(19,411)

 

(3,677)

 

 

 

 

 

 

 

 

7. Investment in Exaro Energy III LLC

In April 2012, the Company entered into a Limited Liability Company Agreement (the “LLC Agreement”) in connection with the formation of Exaro. Pursuant to the LLC Agreement, as amended, the Company committed to invest up to $67.5 million in Exaro for an ownership interest of approximately 37%. As of December 31, 2014, the Company had invested approximately $46.9 million. No additional contributions were made during the nine months ended September 30, 2015.

13

 


 

 

The following table (in thousands) presents condensed balance sheet data for Exaro as of September 30, 2015 and December 31, 2014. The balance sheet data was derived from Exaro’s balance sheet as of September 30, 2015 and December 31, 2014 and was not adjusted to represent the Company’s percentage of ownership interest in Exaro. The Company’s share in the equity of Exaro at September 30, 2015 was approximately $60.3 million.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2015

 

December 31, 2014

Current assets

 

$

27,534 

 

$

35,013 

Non-current assets:

 

 

 

 

 

 

Net property and equipment

 

 

226,286 

 

 

233,997 

Restricted cash escrow account

 

 

 —

 

 

577 

Other non-current assets

 

 

659 

 

 

1,779 

Total non-current assets

 

 

226,945 

 

 

236,353 

Total assets

 

$

254,479 

 

$

271,366 

 

 

 

 

 

 

 

Current liabilities

 

$

4,369 

 

$

9,405 

Non-current liabilities:

 

 

 

 

 

 

Long-term debt

 

 

84,500 

 

 

94,500 

Other non-current liabilities

 

 

1,576 

 

 

1,084 

Total non-current liabilities

 

 

86,076 

 

 

95,584 

Members' equity

 

 

164,034 

 

 

166,377 

Total liabilities & members' equity

 

$

254,479 

 

$

271,366 

 

The following table (in thousands) presents the condensed results of operations for Exaro for the three and nine months ended September 30, 2015 and 2014. The results of operations for the three and nine months ended September 30, 2015 and 2014 were derived from Exaro's financial statements for the respective periods. The income statement data below was not adjusted to represent the Company’s ownership interest but rather reflects the results of Exaro as a company. The Company's share in Exaro's results of operations recognized for the three months ended September 30, 2015 and 2014 was a loss of $0.4 million, net of tax benefit of $0.2 million, and a gain of $1.3 million, net of tax expense of $0.7 million, respectively. The Company’s share of Exaro’s results of operations recognized for the nine months ended September 30, 2015 and 2014 was a loss of $0.6 million, net of tax benefit of $0.3 million, and a gain of $4.4  million, net of tax expense of $2.4 million, respectively.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2015

 

2014

 

2015

 

2014

 

Production:

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil (thousand barrels)

 

 

40 

 

 

42 

 

 

127 

 

 

125 

 

Gas (million cubic feet)

 

 

3,236 

 

 

3,371 

 

 

9,928 

 

 

9,824 

 

Total (million cubic feet equivalent)

 

 

3,477 

 

 

3,627 

 

 

10,691 

 

 

10,576 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil and natural gas sales

 

$

7,881 

 

$

19,090 

 

$

31,731 

 

$

61,380 

 

Other gain (loss)

 

 

3,667 

 

 

955 

 

 

3,608 

 

 

(1,037)

 

Less:

 

 

 

 

 

 

 

 

 

 

 

 

 

Lease operating expenses

 

 

4,467 

 

 

5,463 

 

 

12,946 

 

 

16,875 

 

Depreciation, depletion, amortization & accretion

 

 

7,229 

 

 

7,294 

 

 

20,147 

 

 

19,420 

 

General & administrative expense

 

 

724 

 

 

730 

 

 

2,586 

 

 

2,680 

 

Income (loss) from continuing operations

 

 

(872)

 

 

6,558 

 

 

(340)

 

 

21,368 

 

Net interest expense

 

 

(689)

 

 

(1,195)

 

 

(2,243)

 

 

(3,161)

 

Net income (loss)

 

$

(1,561)

 

$

5,363 

 

$

(2,583)

 

$

18,207 

 

 

Included in Other gain (loss) are realized and unrealized gains and losses attributable to derivatives, whose value is likely to change based on future oil and gas prices. Exaro's results of operations do not include income taxes because Exaro is treated as a partnership for tax purposes.

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8. Long-Term Debt

RBC Credit Facility

In October 2013, the Company entered into a $500 million four-year revolving credit facility with Royal Bank of Canada and other lenders with an initial hydrocarbon supported borrowing base of $275 million. As part of the regular redetermination schedule, the Company’s bank group redetermined the Company’s borrowing base at $225 million effective May 7, 2015, primarily due to lower commodity prices and the impact of the significant reduction in the Company’s drilling program in 2015.  The next regular scheduled redetermination is expected to be completed mid-November. Due to the lower commodity price environment and the reduced capital program, the Company expects some reduction in the borrowing base. Based on preliminary discussions with its agent bank and their borrowing base recommendation currently being considered by the remaining lenders under the facility, the Company expects that the proposed borrowing base will not impact its liquidity position in a material adverse way. 

As of September 30, 2015 and December 31, 2014, the Company had approximately $114.6 million and $63.4 million, respectively, outstanding under the RBC Credit Facility and $1.9 million and $1.9 million, respectively, in outstanding letters of credit. As of September 30, 2015, borrowing availability under the RBC Credit Facility was $108.5 million.

Borrowings under the RBC Credit Facility bear interest at a rate that is dependent upon LIBOR, the U.S. prime rate, or the federal funds rate, plus a margin dependent upon the amount outstanding. Additionally, the Company must pay a commitment fee on the amount of the facility that remains unused, which varies from .375% to .5%, depending on the amount of the credit facility that is unused. Total interest expense under the RBC Credit Facility, including commitment fees, for the three and nine months ended September 30, 2015 was approximately $0.8 million and $2.3 million, respectively. Total interest expense under the RBC Credit Facility, including commitment fees, for the three and nine months ended September 30, 2014 was approximately $0.7 million and $2.1 million, respectively.

The RBC Credit Facility contains restrictive covenants which, among other things, restrict the declaration or payment of dividends by Contango and require the maintenance of a minimum current ratio and a maximum leverage ratio. As of September 30, 2015, the Company was in compliance with all covenants under the RBC Credit Facility. The RBC Credit Facility also contains events of default that may accelerate repayment of any borrowings and/or termination of the facility. Events of default include, but are not limited to, payment defaults, breach of certain covenants, bankruptcy, insolvency or change of control events. As a condition to borrow funds or issue letters of credit under the RBC Credit Facility,  the Company must remain in compliance with the restrictive covenants.  The Company also must make certain representations and warranties to its bank lenders at the time of each borrowing, including representations about the Company’s solvency.  If the Company does not meet its financial ratios or is unable to give the required representations, then the Company will need a waiver or amendment from its bank lenders in order to continue to be able to borrow or issue letters of credit under the RBC Credit Facility. Although the Company believes its bank lenders are well secured under the terms of the RBC Credit Facility, there is no assurance that the bank lenders would provide any waiver or amendment in the future should either become conditions to further lending.

The weighted average interest rate in effect at September 30, 2015 and December 31, 2014 was 2.12% and 1.96%, respectively. The RBC Credit Facility matures on October 1, 2017, at which time any outstanding balances will be due.

15

 


 

 

9. Income Taxes

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2015

 

2014

 

2015

 

2014

 

Current tax provision (benefit):

 

 

 

 

 

 

 

 

 

Federal

 

$

 —

 

$

 —

 

$

 —

 

$

(524)

 

State

 

 

(5)

 

 

414 

 

 

517 

 

 

1,127 

 

Total

 

$

(5)

 

$

414 

 

$

517 

 

$

603 

 

Deferred tax provision (benefit):

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal

 

$

(70,631)

 

$

3,651 

 

$

(91,254)

 

$

(2,775)

 

State

 

 

(191)

 

 

(235)

 

 

(725)

 

 

(710)

 

Total

 

$

(70,822)

 

$

3,416 

 

$

(91,979)

 

$

(3,485)

 

Total tax provision (benefit):

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal

 

$

(70,631)

 

$

3,651 

 

$

(91,254)

 

$

(3,299)

 

State

 

 

(196)

 

 

179 

 

 

(208)

 

 

417 

 

Total

 

$

(70,827)

 

$

3,830 

 

$

(91,462)

 

$

(2,882)

 

Included in gain (loss) from investment in affiliates

 

$

(203)

 

$

693 

 

$

(303)

 

$

2,362 

 

Total income tax provision (benefit)

 

$

(70,624)

 

$

3,137 

 

$

(91,159)

 

$

(5,244)

 

 

In recording deferred income tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those deferred income tax assets would be deductible. The Company believes that after considering all the available objective evidence, both positive and negative, historical and prospective, with greater weight given to historical evidence, management is not able to determine that it is more likely than not that the deferred tax assets will be realized and, therefore, has established a valuation allowance of $17.5 million to reduce the net deferred tax asset to zero at September 30, 2015. The Company will continue to assess the valuation allowance against deferred tax assets considering all available information obtained in future reporting periods.

 

 

10. Related Party Transactions

Juneau Exploration L.P.

In April 2012, Mr. Brad Juneau, the sole manager of the general partner of Juneau Exploration L.P. (“JEX”), joined the Company’s Board of Directors. On January 1, 2013 the Company entered into an advisory agreement with JEX (the "Contaro Advisory Agreement"). Under the Contaro Advisory Agreement, JEX provided advisory services to Contaro in connection with Contaro's investment in Exaro; Mr. Juneau served on the Board of Managers of Exaro; and JEX, was paid a monthly fee of $10,000 and was entitled to receive a 1% fee of the cash profit earned by Contaro.

On March 19, 2014, Mr. Juneau resigned from the Company’s board of directors. As a result, the Contaro Advisory Agreement was terminated effective as of March 19, 2014.

Olympic Energy Partners

In December 2012, Mr. Joseph J. Romano was elected President and Chief Executive Officer of the Company and in April 2013 was named Chairman of the Company. Upon the Merger with Crimson Exploration Inc. (“Crimson”) on October 1, 2013, Mr. Romano resigned as President and Chief Executive Officer, but remains Chairman. Mr. Romano is also the President and Chief Executive Officer of Olympic Energy Partners LLC ("Olympic").

JEX, affiliates of JEX, and Olympic historically participated with the Company in the drilling and development of certain prospects through participation agreements and joint operating agreements, which specify each participant’s working interest ("WI"), net revenue interest ("NRI"), and describe when such interests are earned, as well as allocate an overriding royalty interest ("ORRI") of up to 3.33% to benefit the employees of JEX, excluding Mr. Juneau, except where otherwise noted. Olympic last participated with the Company in the drilling of wells in March 2010, and its ownership in Company-operated wells is limited to its Dutch and Mary Rose wells.

16

 


 

 

Republic Exploration LLC

In his capacity as sole manager of the general partner of JEX, Mr. Juneau also controls the activities of REX, an entity owned 34.4% by JEX, 32.3% by Contango and 33.3% by a third party which contributed other assets to REX. REX generates and evaluates offshore exploration prospects and has historically participated with the Company in the drilling and development of certain prospects through participation agreements and joint operating agreements, which specify each participant’s working interest, net revenue interest and describe when such interests are earned, as well as allocate an overriding royalty interest of up to 3.33% to benefit the employees of JEX. The Company proportionately consolidates the results of REX in its consolidated financial statements.

As of September 30, 2015, Olympic, JEX, REX and JEX employees owned the following interests in the Company's offshore wells.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Olympic

 

JEX

 

REX

 

JEX Employees

 

 

WI

NRI

 

WI

NRI

 

WI

NRI

 

ORRI

Dutch #1 - #5

 

3.53% 
2.84% 

 

1.88% 
1.51% 

 

—%

—%

 

2.02%

Mary Rose #1

 

3.61% 
2.70% 

 

2.01% 
1.51% 

 

—%

—%

 

2.79%

Mary Rose #2 - #3

 

3.61% 
2.58% 

 

2.01% 
1.44% 

 

—%

—%

 

2.79%

Mary Rose #4

 

2.34% 
1.70% 

 

1.31% 
0.95% 

 

—%

—%

 

1.82%

Mary Rose #5

 

2.56% 
1.87% 

 

1.43% 
1.04% 

 

—%

—%

 

1.82%

Ship Shoal 263

 

—%

—%

 

—%

—%

 

—%

—%

 

3.33%

Vermilion 170

 

—%

—%

 

4.30% 
3.35% 

 

12.50% 
9.74% 

 

3.33%

 

 

During the three and nine months ended September 30, 2015, Mr. Romano earned $13 thousand and $66 thousand, respectively, for his service as a director of the Company. During the three and nine months ended September 30, 2014, Mr. Romano earned $26 thousand and $78 thousand, respectively, for his service as a director of the Company. During the three months ended March 31, 2014, Mr. Juneau earned $12 thousand, for his service as a director of the Company, and on March 19, 2014, Mr. Juneau resigned from the board of directors.

 

During the quarter ended December 31, 2013, Mr. Romano and Mr. Juneau each received 1,622 shares of restricted stock, which vest 100% on the one-year anniversary of the date of grant, as part of their board of director compensation. In April 2014, the board of directors accelerated the vesting of Mr. Juneau's 1,622 shares which would have otherwise been forfeited upon his resignation in March 2014. The Company recognized compensation expense of approximately $71