NOTES TO CONDENSED FINANCIAL STATEMENTS
MARCH 31, 2017
(UNAUDITED)
NOTE 1 ORGANIZATION AND NATURE OF BUSINESS
Northern Oil and Gas, Inc. (the “Company,” “Northern,” “our” and words of similar import), a Minnesota 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 MKT 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. As of
March 31, 2017
, approximately
82%
of Northern’s
151,672
total net acres were developed.
NOTE 2 SIGNIFICANT ACCOUNTING POLICIES
The financial information included herein is unaudited, except for the balance sheet as of
December 31, 2016
, which has been derived from the Company’s audited financial statements for the year ended
December 31, 2016
. 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, 2016
, which were included in the Company’s Annual Report on Form 10-K for the fiscal year ended
December 31, 2016
.
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 and money market funds. 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 customer 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
March 31, 2017
and
December 31, 2016
, the Company included accounts receivable of
$6.8 million
in Other Noncurrent Assets, Net due to their long-term nature.
The allowance for doubtful accounts at both
March 31, 2017
and
December 31, 2016
was
$4.9 million
.
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
$44,474
and
$52,654
for the
three
months ended
March 31, 2017
and
2016
, 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 the 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
months ended
March 31, 2017
and
2016
, respectively.
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2017
|
|
2016
|
Capitalized Certain Payroll and Other Internal Costs
|
$
|
204,873
|
|
|
$
|
782,162
|
|
Capitalized Interest Costs
|
38,768
|
|
|
130,924
|
|
Total
|
$
|
243,641
|
|
|
$
|
913,086
|
|
As of
March 31, 2017
, 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
three
months ended
March 31, 2017
and
2016
, 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
months ended
March 31, 2017
. As a result of low commodity prices and their effect on the proved reserve values of properties, the Company recorded a non-cash ceiling test impairment for the
three
months ended
March 31, 2016
of
$104.3 million
. The impairment charge affected the Company’s reported net income but did not reduce the Company’s cash flow. If a significantly lower pricing environment reoccurs, the Company’s expects it could be required to further 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 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
March 31, 2017
and
2016
, the Company expired leases of
$3.8 million
and
$2.0 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. 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 credit facility and senior unsecured notes. These debt issuance costs are being 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
March 31, 2017
and
2016
was
$0.9 million
and
$1.0 million
, respectively.
There was no write-off of debt issuance costs for the
three
months ended
March 31, 2017
. During the
three
months ended
March 31, 2016
,
$1.1 million
of debt issuance costs were written-off as a result of a reduction in the borrowing base of the Revolving Credit Facility that became effective in May 2016.
Unamortized debt issuance costs associated with the Company’s revolving credit facility, which amounted to
$1.4 million
and
$1.6 million
as of
March 31, 2017
and
December 31, 2016
, respectively, are reflected in “Other Noncurrent Assets, Net” on the condensed balance sheets.
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
March 31, 2017
and
2016
was
$0.4 million
in each period.
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
March 31, 2017
and
2016
was
$0.5 million
in each period.
Revenue Recognition
The Company recognizes crude oil and natural gas revenues from its interests in producing wells when production is delivered to, and title has transferred to, the purchaser and to the extent the selling price is reasonably determinable. The Company uses the sales method of accounting for natural gas balancing of natural gas production and would recognize a liability if the existing proven reserves were not adequate to cover the current imbalance situation. For the
three
months ended
March 31, 2017
and
2016
, 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.
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 has been and will continue to be immaterial to the Company’s results of operations over the long-term.
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
March 31, 2017
, 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. Prices for oil and natural gas may fluctuate widely in response to relatively minor changes in the supply of and demand for oil and natural gas and a variety of additional factors that are beyond the Company’s control. 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
March 31, 2017
, 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
March 31, 2017
and
December 31, 2016
was
$334.8 million
and
$341.3 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
months ended
March 31, 2017
and
2016
are as follows:
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2017
|
|
2016
|
Weighted Average Common Shares Outstanding – Basic
|
61,446,156
|
|
|
60,964,029
|
|
Plus: Potentially Dilutive Common Shares Including Stock Options and Restricted Stock
|
525,967
|
|
|
—
|
|
Weighted Average Common Shares Outstanding – Diluted
|
61,972,123
|
|
|
60,964,029
|
|
|
|
|
|
Restricted Stock and Stock Options Excluded From EPS Due To The Anti-Dilutive Effect
|
124,018
|
|
|
911,861
|
|
As of
March 31, 2017
and
2016
, potentially dilutive shares from stock option awards were
391,872
, respectively. These options were all exercisable at
March 31, 2017
and
2016
. The Company also has potentially dilutive shares from restricted stock awards outstanding of
1,837,822
and
2,620,020
at
March 31, 2017
and
2016
, 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 in 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. Crude 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
months ended
March 31, 2017
and
2016
.
New Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the 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 August 2015, the FASB issued Accounting Standards Update (ASU) No. 2015-14, Revenue from Contracts with Customers - Deferral of the Effective Date,
which approved a one year deferral of ASU 2014-09 for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early application is permitted as of the original effective date for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company will adopt this ASU on January 1, 2018. The Company is evaluating the impact of this ASU on its financial statements and, based on the continuing evaluation of its revenue streams, this ASU is not expected to have a material impact on its financial statements. The Company expects it will use the modified retrospective approach to implementation.
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 2016, the FASB issued ASU No. 2016-11, Revenue Recognition and Derivatives and Hedging: Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting. This guidance rescinds SEC Staff Observer comments that are codified in Topic 606, Revenue Recognition, and Topic 932, Extractive Activities--Oil and Gas. This amendment is effective upon adoption of Topic 606. The Company is in the process of evaluating the impact of this guidance on its financial statements.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments
.
This guidance provides guidance of eight specific cash flow issues. This amendment is effective for periods after December 15, 2017, with early adoption permitted. The Company is in the process of evaluating the impact of this guidance on its financial statements.
In December 2016, the FASB issued ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. This guidance updates narrow aspects of the guidance issued in Update 2014-09. This amendment is effective for periods after December 15, 2017, with early adoption permitted. The Company is in the process of evaluating the impact of this guidance on its financial statements.
In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which clarifies the definition of a business to provide guidance in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 provides a screen to determine when a set of assets is not a business, requiring that when substantially all fair value of gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar identifiable assets, the set of assets is not a business. A framework is provided to assist in evaluating whether both an input and a substantive process are present for the set to be a business. ASU 2017-01 is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. No disclosures are required at transition and early adoption is permitted. The Company is in the process of evaluating the impact of this guidance on its financial statements.
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
March 31, 2017
and
December 31, 2016
were approximately
$57.1 million
and
$50.7 million
, respectively.
Acquisitions
For the
three
months ended
March 31, 2017
, the Company acquired approximately
371
net acres, for an average cost of approximately
$607
per net acre, in its key prospect areas in the form of effective leases.
For the
three
months ended
March 31, 2016
, the Company acquired approximately
764
net acres, for an average cost of approximately
$1,214
per net acre, in its key prospect areas in the form of effective leases.
Unproved Properties
Unproved properties not being amortized comprise approximately
23,100
net acres and
26,432
net acres of undeveloped leasehold interests at
March 31, 2017
and
December 31, 2016
, 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.
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 or 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.
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
three
months ended
March 31, 2017
and
2016
, the Company included
$0.1 million
and
$5.8 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2017
|
|
Long-term Debt
|
|
Debt Issuance Costs, Net
|
|
Long-term Debt, Net
|
8% Senior Notes
|
$
|
698,423,337
|
|
|
$
|
(8,972,661
|
)
|
|
$
|
689,450,676
|
|
Revolving Credit Facility
(1)
|
134,000,000
|
|
|
—
|
|
|
134,000,000
|
|
Total
|
$
|
832,423,337
|
|
|
$
|
(8,972,661
|
)
|
|
$
|
823,450,676
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
Long-term Debt
|
|
Debt Issuance Costs, Net
|
|
Long-term Debt, Net
|
8% Senior Notes
|
$
|
698,306,153
|
|
|
$
|
(9,681,028
|
)
|
|
$
|
688,625,125
|
|
Revolving Credit Facility
(1)
|
144,000,000
|
|
|
—
|
|
|
144,000,000
|
|
Total
|
$
|
842,306,153
|
|
|
$
|
(9,681,028
|
)
|
|
$
|
832,625,125
|
|
_____________
|
|
(1)
|
Debt issuance costs related to the Company’s revolving credit facility are recorded in “Other Noncurrent Assets, Net” on the condensed balance sheets
|
Revolving Credit Facility
In February 2012, the Company entered into an amended and restated credit agreement providing for a revolving credit facility (the “Revolving Credit Facility”), which replaced its previous revolving credit facility with a syndicated facility. The Revolving Credit Facility, which is secured by substantially all of the Company’s assets, provides for a commitment equal to the lesser of the facility amount or the borrowing base. At
March 31, 2017
, the facility amount was
$750.0 million
, the borrowing base was
$350.0 million
and there was a
$134.0 million
outstanding balance, leaving
$216.0 million
of borrowing capacity available under the facility. On May 4, 2017, the Company completed the semi-annual redetermination under the Revolving Credit Facility, with the borrowing base established at
$325.0 million
.
The Revolving Credit Facility matures on
September 30, 2018
and provides for a borrowing base subject to redetermination semi-annually each April and October and for unscheduled event-driven redeterminations. Borrowings under the Revolving Credit Facility can either be at the Alternate Base Rate (as defined in the credit agreement) plus a spread ranging from
1.0%
to
2.0%
or LIBOR borrowings at the Adjusted LIBOR Rate (as defined in the credit agreement) plus a spread ranging from
2.0%
to
3.0%
. The applicable spread at any time is dependent upon the amount of borrowings relative to the borrowing base at such time. The Company may elect, from time to time, to convert all or any part of its LIBOR loans to base rate loans or to convert all or any of the base rate loans to LIBOR loans. A commitment fee is paid on the undrawn balance based on an annual rate of either
0.375%
or
0.50%
. At
March 31, 2017
, the commitment fee was
0.375%
and the interest rate margin was
2.25%
on LIBOR loans and
1.25%
on base rate loans. At
March 31, 2017
, the Company had a borrowing base of
$350.0 million
with
$134.0 million
of LIBOR loans issued under the Revolving Credit Facility at a weighted average interest rate of
3.24%
.
The Revolving Credit Facility contains negative covenants that limit the Company’s ability, among other things, to pay any cash dividends, incur additional indebtedness, sell assets, enter into certain hedging contracts, change the nature of its business or operations, merge, consolidate, make investments, or maintain excess cash liquidity. In addition, the Company is required to maintain a current ratio (as defined in the credit agreement) of no less than
1.0
to
1.0
, a ratio of secured debt to EBITDAX (as defined in the credit agreement) of no greater than
2.5
to
1.0
and a ratio of EBITDAX (as defined in the credit agreement) to interest expense (as defined in the credit agreement) of no less than
1.5
to
1.0
. The Company was in compliance with the financial covenants of the Revolving Credit Facility at
March 31, 2017
. Effective May 4, 2017, the schedule of the minimum ratio of EBITDAX to interest expense the Company is required to maintain is as follows:
|
|
|
|
Measurement Period
|
|
Minimum ratio of EBITDAX to Interest Expense
|
12 months ended March 31, 2017
|
|
1.50 to 1.00
|
12 months ending June 30, 2017
|
|
1.50 to 1.00
|
12 months ending September 30, 2017
|
|
1.50 to 1.00
|
12 months ending December 31, 2017
|
|
1.50 to 1.00
|
12 months ending March 31, 2018
|
|
1.50 to 1.00
|
12 months ending June 30, 2018 and beyond
|
|
1.75 to 1.00
|
All of the Company’s obligations under the Revolving Credit Facility are secured by a first priority security interest in any and all assets of the Company.
8.000%
Senior Notes Due 2020
On May 18, 2012, the Company issued at par value
$300 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 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 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).
On and after June 1, 2016, the Company may redeem some or all of the Notes at redemption prices (expressed as percentages of principal amount) equal to
104%
for the twelve-month period beginning on June 1, 2016,
102%
for the twelve-month period beginning June 1, 2017 and
100%
beginning on June 1, 2018, 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
In May 2016, the Company’s shareholders approved an amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of common stock by
50%
, from
95,000,000
to
142,500,000
. As a result, the Company’s Amended and Restated Articles of Incorporation authorize the issuance of up to
147,500,000
shares. The shares are classified in
two
classes, consisting of
142,500,000
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
three
months ended
March 31, 2017
and the year ended
December 31, 2016
:
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2017
|
|
Year Ended December 31, 2016
|
Beginning Balance
|
63,259,781
|
|
|
63,120,384
|
|
Restricted Stock Grants (Note 6)
|
354,123
|
|
|
2,109,814
|
|
Other Surrenders
|
(145,946
|
)
|
|
(375,875
|
)
|
Other
|
(85,383
|
)
|
|
(1,594,542
|
)
|
Ending Balance
|
63,382,575
|
|
|
63,259,781
|
|
2017 Activity
During the
three
months ended
March 31, 2017
,
145,946
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
$0.4 million
, which is based on the market prices on the dates the shares were surrendered.
During March 2017,
85,383
shares of common stock were forfeited by our interim Chief Executive Officer and Chief Financial Officer in connection with a performance-based vesting metric that was not achieved under a restricted stock award.
Stock Repurchase Program
In May 2011, the Company’s board of directors approved a stock repurchase program to acquire up to
$150 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
months ended
March 31, 2017
and
March 31, 2016
, 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. In May 2016, the Company’s shareholders approved an amendment to the 2013 Plan to increase the number of shares available for awards under the 2013 Plan by
1.6 million
shares. As of
March 31, 2017
, there were
3,224,319
shares available for future awards under the 2013 Plan.
Restricted Stock Awards
During the
three
months ended
March 31, 2017
, the Company issued
354,123
restricted shares of common stock 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 April 2020. As of
March 31, 2017
, there was approximately
$4.9 million
of total unrecognized compensation expense related to unvested restricted stock that will be recognized over a weighted-average period of approximately
2.3
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 and activity related thereto for the
three
months ended
March 31, 2017
:
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31, 2017
|
|
Number of
Shares
|
|
Weighted-Average
Price
|
Restricted Stock Awards:
|
|
|
|
Restricted Shares Outstanding at Beginning of Period
|
1,905,104
|
|
|
$
|
4.59
|
|
Shares Granted
|
354,123
|
|
|
2.60
|
|
Lapse of Restrictions
|
(336,022
|
)
|
|
6.38
|
|
Shares Forfeited
|
(85,383
|
)
|
|
4.09
|
|
Restricted Shares Outstanding at End of Period
|
1,837,822
|
|
|
$
|
5.03
|
|
Stock Option Awards
The following table reflects the outstanding stock option awards and the activity related thereto for the
three
months ended
March 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
Stock Option Awards
(1)
|
|
Weighted-Average Exercise Price
|
|
Weighted Average Contractual Term
|
Outstanding as of 12/31/2016
|
391,872
|
|
|
$
|
3.66
|
|
|
2.9
|
Granted
|
—
|
|
|
—
|
|
|
|
Exercised
|
—
|
|
|
—
|
|
|
|
Expired or canceled
|
—
|
|
|
—
|
|
|
|
Forfeited
|
—
|
|
|
—
|
|
|
|
Outstanding of as 3/31/2017
|
391,872
|
|
|
$
|
3.66
|
|
|
2.7
|
____________
(1)
All of the stock options outstanding were vested and exercisable at the end of the period.
Performance Equity Awards
The Company has granted performance equity awards under its
2017
Long Term Incentive Program to certain officers. The awards are subject to market conditions that are based on the Company’s 2017 total shareholder return on both an absolute and relative basis. Depending on the Company’s stock price performance, on both an absolute basis and on a relative basis compared to the defined peer group, the award recipients may earn between
0%
and
150%
of their
2017
base salaries, with any such amounts expected to be settled in restricted shares of the Company’s common stock that will vest over a
three
-year service-based period beginning in 2018.
The Company used a Monte Carlo simulation model to estimate the fair value of the awards based on the expected outcome of the Company’s stock price performance, on both an absolute basis and on a relative basis compared to the defined peer group, using key valuation assumptions. The assumptions used for the Monte Carlo model to determine the fair value of the awards and associated compensation expense included a forecast period for the relevant stock price period in
2017
, a risk-free interest rate of
0.97%
and
80.0%
for the Company’s stock price volatility.
The maximum value of the performance shares issuable if all participants earned the maximum award would total
$1.3 million
. For the
three
months ended
March 31, 2017
and
2016
, the Company recorded
$9,044
and
$47,402
of compensation expense related to these performance equity awards, respectively.
NOTE 7 RELATED PARTY TRANSACTIONS
Michael Frantz, a member of the Company’s board of directors since August 2016, is the Vice President, Investments of TRT Holdings, Inc. Michael Popejoy, a member of the Company’s board of directors since January 2017, is the Senior Vice President of Energy for TRT Holdings, Inc. TRT Holdings and its affiliates (collectively, “TRT”) are significant common stockholders of the Company and also a holder of the Company’s
8%
senior unsecured notes, due 2020 (the “Notes”). The Company believes TRT owned in excess of
$200 million
aggregate principal amount of the Notes at
March 31, 2017
. The principal amounts of any Notes held by TRT are included in the Company’s long-term debt balances, and the Company’s interest expense includes interest attributable to any Notes held by TRT.
All transactions involving related parties are approved or ratified by the Company’s Audit Committee.
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
$6.8 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
$6.8 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 16, 2016, Michael Reger filed a complaint against the Company in the State of Minnesota, Fourth Judicial District, alleging breach of contract and defamation in connection with the Company’s termination of Mr. Reger’s employment as chief executive officer on August 15, 2016. Mr. Reger’s complaint alleges that the Company breached his employment agreement by, among other things, purporting to terminate him for cause, removing him from the Company’s board of directors based on such termination, and denying him payments and other benefits to which he alleges that he is entitled under the employment agreement (including payments and benefits in connection with a termination without cause). Mr. Reger is seeking unspecified damages, an order reinstating him to the Company’s board of directors, and other equitable relief. Among other damages that Mr. Reger may seek, including damages for defamation, the Company expects him to seek benefits to which he alleges he should have been entitled for a termination without cause, which may have included at least
$1.6 million
in cash severance and the immediate vesting of
1,530,796
shares of restricted stock held by Mr. Reger at the time of his termination.
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 our Company, Michael Reger (our former chief executive officer), and Thomas Stoelk (our chief financial officer and interim chief executive officer) as defendants. The complaint purports to bring a federal securities class action on behalf of the 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 federal securities laws and to pursue remedies under Sections 10(a) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.
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. At
March 31, 2017
, a valuation allowance of
$334.8 million
had been provided for our net deferred tax assets based on the uncertainty regarding whether these assets may be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
The income tax provision (benefit) for the
three
months ended
March 31, 2017
and
2016
consists of the following:
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2017
|
|
2016
|
Current Income Tax Benefit
|
$
|
—
|
|
|
$
|
—
|
|
Deferred Income Tax Benefit
|
|
|
|
|
|
Federal
|
5,950,000
|
|
|
(41,820,000
|
)
|
State
|
536,000
|
|
|
(3,638,000
|
)
|
Valuation Allowance
|
(6,486,000
|
)
|
|
45,458,000
|
|
Total Income Tax 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
month periods ended
March 31, 2017
, presented above, differ from the amount that would be provided by applying the statutory U.S. federal income tax rate of
35%
to income before income taxes. The lower effective tax rate in
2017
and
2016
relates to the valuation allowance placed on the net deferred tax assets in the second quarter of 2015, in addition to state income taxes and estimated permanent differences.
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
months ended
March 31, 2017
and
2016
, 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
March 31, 2017
and
December 31, 2016
relating to unrecognized benefits.
The tax years
2016
,
2015
,
2014
,
2013
,
2012
,
2011
and
2010
remain open to examination for federal income tax purposes and by the other major taxing jurisdictions to which the Company is subject.
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 March 31, 2017 Using
|
|
Quoted Prices In Active Markets for Identical Assets
(Level 1)
|
|
Significant Other Observable Inputs
(Level 2)
|
|
Significant Unobservable Inputs
(Level 3)
|
Commodity Derivatives – Current Asset (crude oil swaps and collars)
|
$
|
—
|
|
|
$
|
3,671,684
|
|
|
$
|
—
|
|
Commodity Derivatives – Noncurrent Asset (crude oil swaps and collars)
|
—
|
|
|
2,058,303
|
|
|
—
|
|
Commodity Derivatives – Current Liabilities (crude oil swaps)
|
—
|
|
|
(408,822
|
)
|
|
—
|
|
Total
|
$
|
—
|
|
|
$
|
5,321,165
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at December 31, 2016 Using
|
|
Quoted Prices In Active Markets
for Identical Assets
(Level 1)
|
|
Significant Other Observable Inputs
(Level 2)
|
|
Significant Unobservable Inputs
(Level 3)
|
Commodity Derivatives – Current Asset (crude oil swaps)
|
$
|
—
|
|
|
$
|
4,517
|
|
|
$
|
—
|
|
Commodity Derivatives – Current Liabilities (crude oil swaps and collars)
|
|
|
(10,001,564
|
)
|
|
|
Commodity Derivatives – Noncurrent Liabilities (crude oil swaps)
|
—
|
|
|
(1,738,329
|
)
|
|
—
|
|
Total
|
$
|
—
|
|
|
$
|
(11,735,376
|
)
|
|
$
|
—
|
|
The Level 2 instruments presented in the tables above consist of commodity derivative instruments, which include crude oil swaps, collars, and swaptions (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.
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
March 31, 2017
is
$823.5 million
, which includes
$689.5 million
of senior unsecured notes including a net discount of
$1.6 million
and
$134.0 million
of borrowings under the Company’s revolving credit facility (see Note 4). The fair value of the Company’s senior unsecured notes, which are publicly traded, is
$604.3 million
at
March 31, 2017
. The Company’s revolving credit facility 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
three
months ended
March 31, 2017
were approximately
$0.1 million
.
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
three
months ended
March 31, 2017
.
NOTE 11 DERIVATIVE INSTRUMENTS AND PRICE RISK MANAGEMENT
The Company utilizes commodity swap contracts, 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.
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Three Months Ended
March 31,
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2017
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|
2016
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Cash Received (Paid) on Derivatives
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$
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(95,659
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)
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|
$
|
25,446,900
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|
Non-Cash Gain (Loss) on Derivatives
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17,056,542
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(21,983,017
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)
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Gain on Derivative Instruments, Net
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$
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16,960,883
|
|
|
$
|
3,463,883
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|
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.
The following table reflects open commodity swap contracts as of
March 31, 2017
, the associated volumes and the corresponding fixed price.
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Settlement Period
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Oil (Barrels)
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Fixed Price ($)
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Swaps-Crude Oil
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04/01/17 – 06/30/17
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180,000
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50.00
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04/01/17 – 06/30/17
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90,000
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|
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50.01
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04/01/17 – 06/30/17
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90,000
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49.99
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04/01/17 – 06/30/17
(1)
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30,000
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|
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55.20
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04/01/17 – 12/31/17
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270,000
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54.20
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04/01/17 – 12/31/17
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180,000
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53.25
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04/01/17 – 12/31/17
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275,000
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54.10
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07/01/17 – 12/31/17
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240,000
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|
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52.75
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07/01/17 – 12/31/17
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120,000
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52.75
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07/01/17 – 12/31/17
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120,000
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53.50
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07/01/17 – 12/31/17
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60,000
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54.60
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07/01/17 – 12/31/17
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120,000
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51.75
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07/01/17 – 12/31/17
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120,000
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53.75
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01/01/18 – 09/30/18
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270,000
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54.00
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01/01/18 – 09/30/18
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270,000
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54.00
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01/01/18 – 09/30/18
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273,000
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55.20
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(1)
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The Company has entered into crude oil derivative contracts that give counterparties the option to extend certain current derivative contracts for an additional six-month period. Options covering a notional volume of
10,000
barrels per month are exercisable on or about June 30, 2017. If the counterparties exercise all such options, the notional volume of the Company’s existing crude oil derivative contracts would increase by
10,000
barrels per month at an average price of
$55.20
per barrel for each month during the period July 1, 2017 through December 31, 2017.
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The following table reflects the weighted average price of open commodity swap derivative contracts as of
March 31, 2017
, by year with associated volumes.
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Year
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Volumes (Bbl)
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Weighted
Average Price ($)
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2017
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1,895,000
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52.82
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2018
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813,000
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54.40
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In addition to the open commodity swap contracts the Company has entered into costless collars. The costless collars are used to establish floor and ceiling prices on anticipated crude oil production. There were no premiums paid or received by the Company related to the costless collar agreements. The following table reflects open costless collar agreements as of
March 31, 2017
.
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Settlement Period
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Oil (Barrels)
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Floor/Ceiling Price ($)
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Basis
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04/01/17 – 12/31/17
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135,000
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$50.00/$60.00
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NYMEX
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04/01/17 – 12/31/17
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90,000
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$50.00/$60.15
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NYMEX
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01/01/18 – 12/31/18
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360,000
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$50.00/$60.25
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NYMEX
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The following table sets forth the amounts, on a gross basis, and classification of the Company’s outstanding derivative financial instruments at
March 31, 2017
and
December 31, 2016
, respectively. Certain amounts may be presented on a net basis on the condensed financial statements when such amounts are with the same counterparty and subject to a master netting arrangement.
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Type of Crude Oil Contract
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Balance Sheet Location
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March 31, 2017 Estimated Fair Value
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December 31, 2016 Estimated Fair Value
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Derivative Assets:
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Swap Contracts
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Current Assets
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$
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3,182,425
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$
|
20,962
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Costless Collar Contracts
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Current Assets
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605,184
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|
|
—
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Swap Contracts
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Noncurrent Assets
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1,362,763
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|
|
—
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Costless Collar Contracts
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Noncurrent Assets
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695,540
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|
|
—
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Total Derivative Assets
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|
|
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$
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5,845,912
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$
|
20,962
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Derivative Liabilities:
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Swap and Swaption Contracts
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Current Liabilities
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$
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(524,747
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)
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$
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(9,862,215
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)
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Costless Collar Contracts
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Current Liabilities
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—
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|
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(155,794
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)
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Swap Contracts
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Noncurrent Liabilities
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—
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(1,738,329
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)
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Total Derivative Liabilities
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$
|
(524,747
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)
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$
|
(11,756,338
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)
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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.
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Estimated Fair Value at March 31, 2017
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Gross Amounts of
Recognized Assets
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Gross Amounts Offset
in the Balance Sheet
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Net Amounts of Assets Presented
in the Balance Sheet
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Offsetting of Derivative Assets:
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Current Assets
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$
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3,787,609
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$
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(115,925
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)
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$
|
3,671,684
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Noncurrent Assets
|
2,058,303
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—
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2,058,303
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Total Derivative Assets
|
$
|
5,845,912
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|
$
|
(115,925
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)
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$
|
5,729,987
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Offsetting of Derivative Liabilities:
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Current Liabilities
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$
|
(524,747
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)
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$
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115,925
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$
|
(408,822
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)
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Noncurrent Liabilities
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—
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—
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|
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—
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Total Derivative Liabilities
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$
|
(524,747
|
)
|
|
$
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115,925
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$
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(408,822
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)
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Estimated Fair Value at December 31, 2016
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Gross Amounts of
Recognized Assets
|
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Gross Amounts Offset
in the Balance Sheet
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Net Amounts of Assets Presented
in the Balance Sheet
|
Offsetting of Derivative Assets:
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Current Assets
|
$
|
20,962
|
|
|
$
|
(16,445
|
)
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|
$
|
4,517
|
|
Non-Current Assets
|
—
|
|
|
—
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|
|
—
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|
Total Derivative Assets
|
$
|
20,962
|
|
|
$
|
(16,445
|
)
|
|
$
|
4,517
|
|
|
|
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Offsetting of Derivative Liabilities:
|
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|
Current Liabilities
|
$
|
(10,018,009
|
)
|
|
$
|
16,445
|
|
|
$
|
(10,001,564
|
)
|
Non-Current Liabilities
|
(1,738,329
|
)
|
|
—
|
|
|
(1,738,329
|
)
|
Total Derivative Liabilities
|
$
|
(11,756,338
|
)
|
|
$
|
16,445
|
|
|
$
|
(11,739,893
|
)
|
All of the Company’s outstanding derivative instruments are covered by International Swap Dealers Association Master Agreements (“ISDAs”) entered into with counterparties that are also lenders under the Company’s Revolving Credit Facility. The Company’s obligations under the derivative instruments are secured pursuant to the Revolving Credit Facility, and no additional collateral had been posted by the Company as of
March 31, 2017
. 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
March 31, 2017
and
December 31, 2016
.