PART I
Items 1 and 2. Business and Properties
Overview
Lilis is an independent oil and gas company focused on the exploration, development, production, and acquisition of oil, natural gas and natural gas liquids, or NGLs, from properties in the Permian Basin. Our operations are focused in the Delaware Basin of the Permian in Winkler, Loving, and Reeves Counties, Texas and Lea County, New Mexico, where the production is approximately 74% crude oil and NGLs, or Liquids, a relatively high liquid production ratio compared to many of our peers. Over 90% our of revenues are generated from the sale of Liquids.
The Company is managed by a focused and experienced management team that is dedicated to rapidly increasing the Company’s production, reserves, and acreage position.
Our History
The Company was incorporated in the State of Nevada in 2007. The name of the corporation was changed to “Lilis Energy, Inc.” in December 2013, and at such time, the Company was primarily focused on the exploration, development and production of oil and natural gas properties in the Denver-Julesburg (DJ) Basin.
In June 2016, we completed a transformative merger transaction with Brushy Resources, Inc. (“Brushy Resources” or “Brushy”), which resulted in the acquisition of a substantial portion of the Company’s current assets in the Permian Basin. Given the stacked-pay opportunities and high rates of return in the Permian Basin, the Company determined that it would focus exclusively on expanding and developing its core Permian Basin assets and completed the divestiture of all of its oil and gas properties located in the DJ Basin in March 2017.
Our Business
We are a pure play Permian Basin company focused on realizing the highest returns and delineating our acreage position to increase the value of our stock for our stockholders.
Our Business Strategy
Our goal is to grow our Company and increase stockholder value by generating cash flow primarily from new production of Liquids, as well as through delineation drilling on our existing acreage.
We continue to focus on developing our existing acreage position, growing our production and reserves, and expanding our core assets in the Delaware Basin through strategic acquisitions, acreage exchanges, and organic leasing. We plan to achieve our objectives by implementing a business strategy focused on the following:
Leverage our Extensive Operational Expertise to Reduce Costs and Plan for Cash Flow Neutrality.
We actively manage the level of our development, leasing and acquisition activity in response to commodity prices, access to capital, and the performance of our wells. We recently announced our recapitalization, which allows us to better manage our assets (See "2019 Second Lien Term Loan Conversion and Borrowing Base Redetermination" and "Subsequent Events" for further information regarding our recapitalization).
As of December 31, 2018, we operated approximately 99% of our acreage position, giving us significant control over the pace of our development and allowing us to increase value through operational and cost efficiencies. We intend to obtain the highest possible returns on the capital we expend on our development projects using results from the wells we have completed and the operational expertise of our management team. We will continue to focus on operational efficiencies, including midstream costs, salt water disposal, and capital costs of our development wells in order to maximize returns to our stockholders. We have increased our operational efficiency by entering into various infrastructure transactions, and we have structured our balance sheet with the intent to achieve cash flow neutrality in 2019 and significantly reduce our leverage profile over time. Additionally, we have an active hedging program to provide certainty regarding our cash flow and protect returns from our development activity in the event of decreases in the prices received for our production.
Realizing Highest Returns and Delineating Acreage.
We plan to drill and develop our existing acreage base of approximately 28,500 gross (20,400 net) acres in the Delaware Basin, which we believe will maximize our resource potential and increase value to our stockholders. Our drilling activity during 2018 was predominantly focused on the horizontal development and delineation of our core acreage position in the Delaware Basin. We increased our net sales production volumes by 215% to 4,965 BOE/d in 2018, as compared to 2017. We averaged 8,081 net BOE/d from December 25 through December 31, 2018, achieving our 2018 year-end exit rate target of 8,000 BOE/d. Additionally, as a result of our development efforts, acreage exchanges and acquisitions, our proved reserves increased 273% from December 31, 2017, to approximately 42,707 MBOE (thousand barrels of oil equivalent) as of December 31, 2018. Our proved reserves were Liquids rich, being comprised of approximately 69% Liquids (50% oil and 19% NGLs) and 31% natural gas.
Through the continued development of our properties, we plan to de-risk our acreage position and substantially increase our Liquids production and cash flow, thereby increasing the value of our properties. Our current leasehold position in the Delaware Basin has significant stacked-pay potential, which we believe includes at least five to seven productive zones in the Wolfcamp and Bone Springs formations. We estimate that all productive zones within our properties may support approximately 1,175 future drilling locations.
Increasing our Inventory and Improving Delineation.
We plan to expand our inventory through delineation drilling of zones on our existing acreage and through acquisitions, acreage exchanges, and organic leasing. Since entering the Delaware Basin in June 2016, we have extensively grown our acreage position by over 500% from 7,200 gross (3,400 net) acres to approximately 28,500 gross (20,400 net) acres and increased our average operated working interest to approximately 76% at December 31, 2018, through various strategic acquisitions, acreage exchanges, and organic leasing, and we operate approximately 99% of our acreage. Our acquisitions to date have added over 17,000 acres which represent a multi-year inventory of approximately 1,175 identified, potential drilling locations across at least five to seven productive pay zones.
We plan to continue evaluating opportunities for strategic acquisitions, acreage exchanges, and organic leasing in our core areas of operation. We also expect that our drilling activity will grow our inventory and the identified resource potential of our Delaware Basin properties. Throughout 2018, we successfully drilled and announced our average 24-hour, 30-day initial production data on 12 wells targeting the Wolfcamp A, Wolfcamp B, Wolfcamp XY, 2nd Bone Spring, and 3rd Bone Spring formations. We believe that our current reserves represent only a small portion of the resource potential within our acreage. Our development plan for 2019 contemplates the continued delineation of our acreage both geographically and geologically and by drilling and completing wells within additional prospective benches.
Utilizing our Cost-Efficient Infrastructure Solutions.
To support our operations and sales of our production, we have entered into various infrastructure and sales agreements that we believe secures cost-effective movement of our Liquids and natural gas in Texas and New Mexico.
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•
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We entered into several agreements with Salt Creek Midstream ("SCM") and its affiliates to provide crude gathering and transportation and water gathering and disposal infrastructure and services, including a crude oil transportation and sales agreement to secure pipeline capacity on a long-haul crude oil pipeline to the Gulf Coast, pursuant to which all volumes will have Gulf Coast pricing based on Magellan East Houston pricing throughout the 5-year term. We anticipate significantly lower crude transportation costs from approximately $5.15 per Bbl at December 31, 2018, to approximately $0.75 per Bbl commencing in March 2019, as a result of increased pipeline transportation of our crude oil under the gathering agreement with SCM. As a result of our infrastructure agreements, our salt water disposal costs decreased from approximately $2.50 per barrel in 2018 to approximately $0.49 per barrel in 2019.
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•
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In 2017, we entered into a long-term gas gathering and processing agreement with an affiliate of Lucid Energy Group (“Lucid”) to support our active drilling program in the Delaware Basin. Pursuant to our agreement with Lucid, there are no minimum volume commitments and all gas transported via Lucid is sent to Lucid’s 310 million cubic feet per day Red Hills Natural Gas Process Complex located in Lea County, New Mexico, where it is treated and processed then transported pursuant to transportation contracts through various long-haul pipelines with access to west coast markets, gulf coast markets, Permian markets and MidCon markets. Lucid is responsible for all capital costs in New Mexico and Texas, other than gathering lines from the wellhead to various Lucid receipt points.
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We believe that our infrastructure and sales agreements will further our operational efficiency, as well as provide us significant cost savings, advantaged crude pricing in the Gulf Coast markets, and more consistent production flowing to sales in 2019 and future years.
Our Strengths
Established Acreage Position in the Core of the Delaware Basin.
We believe we have assembled a substantial portfolio of Delaware Basin properties that offers high rate of return exploration and development opportunities. As of December 31, 2018, we held over 28,500 gross (20,400 net) acres in the core of the Delaware Basin, where we had an average operated working interest of approximately 76%. As of December 31, 2018, we operated approximately 99% of such acreage. Our acreage is geographically concentrated and highly contiguous, allowing us to capitalize on economies of scale with respect to drilling and production costs. We believe those efficiencies provide us with an advantage in competing for acquisitions, acreage exchanges, and organic leasing opportunities on and around our acreage.
Multi-year Portfolio of Drilling and Development Opportunities.
We have a significant inventory of drilling and development locations in Winkler, Loving and Reeves Counties, Texas and Lea County, New Mexico. We believe our properties form part of the core of the Delaware Basin. Based on our drilling to date and results from nearby wells, we have identified approximately 1,175 potential horizontal well locations on our acreage, including approximately 700 longer lateral locations. Our leasehold position has significant stacked-pay potential, which we believe includes at least five to seven productive zones. We believe that our inventory of drilling locations will allow us to grow our reserves and production at attractive rates of return based on current expectations for commodity prices.
High Degree of Operational Control.
We operate approximately 99% of our acreage, which gives us significant control over the pace of our development and the ability to design a more efficient and profitable drilling program to maximize recovery of oil and natural gas. Based on our drilling and production results to date and well-established offset operator activity in and around our project areas, we believe there are relatively low geologic risks and ample repeatable drilling opportunities across our core acreage.
Strengthening Financial Position and Flexibility.
We believe our financial position is strong and sufficient to fund our drilling and completion operations currently planned for 2019. In October 2018, we announced our entry into a new five-year $500 million senior secured reserve based revolving credit facility (“Revolving Credit Agreement”) with an initial borrowing base of $95 million, that refinanced our first-lien term loan with Riverstone Credit Partners, LLC. As of December 7, 2018, the borrowing base of our Revolving Credit Agreement had increased to $108 million. The Company enhanced liquidity through the Revolving Credit Agreement and through a tack-on to the outstanding Series C Preferred Stock (as hereinafter defined). Additionally, the Company converted a portion of its Second Lien Term Loan (as hereinafter defined) to a combination of preferred and common equity, which resulted in a significant paid-in-kind interest expense savings. We have a solid relationship with Värde Partners, Inc. and its affiliates, who have partnered with us since the time of the Brushy Resources transaction and provided us with access to significant capital resources and financing opportunities. The Company had increased its liquidity to $54.1 million as of year-end 2018, including $33 million in availability under its Revolving Credit Agreement and $21.1 million in cash. Additionally, we recently announced our recapitalization, which allows us to better manage our assets (See "2019 Second Lien Term Loan Conversion and Borrowing Base Redetermination" and "Subsequent Events" for further information regarding our recapitalization).
We believe our financial liquidity position provides us operational flexibility and a path toward continued growth in our oil and natural gas production, proved reserves, and cash flows.
Experienced Management Team.
We have an experienced and skilled management team with a long track record of driving growth through asset development and strategic acquisitions. We believe that our team’s operational expertise and extensive experience through various commodity price cycles position us to operate effectively and efficiently and, in turn, will help increase returns and value to our stockholders.
Oil and Natural Gas Properties
As of December 31, 2018, we owned leasehold acreage in approximately 28,500 gross (20,400 net) acres in the Delaware Basin, comprised of approximately 16,300 net acres in Winkler, Loving, and Reeves Counties, Texas and approximately 4,100 net acres in Lea County, New Mexico. Average net sales production volumes from our properties increased approximately 215% to 4,965 BOE/d in 2018 from 1,576 BOE/d in 2017. We averaged 8,081 net BOE/d from December 25 through December 31, 2018, achieving our 2018 year-end exit rate target of 8,000 BOE/d.
We currently estimate our properties include at least five to seven productive zones and hold approximately 1,175 future drilling locations across all of the productive zones within this position. Our reserve estimates include 37 horizontal PUD wells, as well as the capital costs required to develop these wells.
Reserve Data
Proved Reserves
The following table presents our estimated net proved oil and natural gas reserves as of December 31, 2018, 2017 and 2016, based on the reserve reports prepared by Cawley, Gillespie & Associates, Inc. Each reserve report has been prepared in accordance with the rules and regulations of the SEC. All of our proved reserves included in the reserve reports are located in the Delaware Basin of the Permian Basin:
Summary of Oil and Gas Reserves
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For the Year Ended December 31,
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2018
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2017
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2016
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Proved Developed Reserves
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Oil (MBbls)
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6,278
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2,531
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|
551
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NGLs (MBbls)
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2,654
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|
645
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3
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Total Liquids (MBbls)
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8,932
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3,176
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|
554
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Natural Gas (MMcf)
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27,046
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6,594
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3,872
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Total MBOE
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13,440
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4,275
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1,199
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Proved Undeveloped Reserves
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Oil (MBbls)
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14,927
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4,640
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—
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NGLs (MBbls)
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5,723
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|
960
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—
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Total Liquids (MBbls)
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20,650
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5,600
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—
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Natural Gas (MMcf)
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51,703
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9,466
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—
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Total MBOE
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29,267
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7,178
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—
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Total Proved Reserves
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Oil (MBbls)
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21,205
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7,171
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551
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NGLs (MBbls)
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8,377
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1,605
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3
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Total Liquids (MBbls)
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29,582
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8,776
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554
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Natural Gas (MMcf)
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78,749
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16,060
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3,872
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Total MBOE
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42,707
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11,453
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1,199
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Proved Undeveloped Reserves
As of December 31, 2018, we had a total of 29,267 MBOE proved undeveloped reserves. During 2018, we added 22,088 MBOE of proved undeveloped (“PUD”) reserves through the extension of proved acreage, primarily as a result of successful drilling on properties in the core of the Delaware Basin in Winkler, Loving, and Reeves Counties, Texas and Lea County, New Mexico.
The increase in our PUDs was partially offset by the reclassification of 2,470 MBOE, previously included in the year-end 2017 PUDs, to PDPs as a result of our horizontal development of our properties. Costs incurred relating to the development of PUDs were approximately $68.3 million during 2018.
Estimated future development costs relating to the development of PUDs are projected to be approximately $34.3 million in 2019, $128.0 million in 2020, $104.0 million in 2021 and $72.1 million in 2022.
Our estimates of proved undeveloped reserve quantities are limited by development drilling activity that we intend to undertake during the 2019 to 2022 timeframe. At December 31, 2018, we had no reserves that remained undeveloped for five or more years, and all PUD drilling locations are currently scheduled to be drilled within five years of their initial recording. For
additional information regarding the changes in our proved reserves, see our “Supplementary Information on Oil and Natural Gas Exploration, Development and Production Activities” to our consolidated financial statements in Item 15 of this Annual Report
Control over Reserve Estimates
Our reserve data and estimates were compiled and prepared internally and audited by our third-party independent consultants, Cawley, Gillespie & Associates, Inc. (“CG&A”), as described in more detail herein, in compliance with SEC definitions and guidance and in accordance with generally accepted petroleum engineering principles.
Internal Controls over Reserves Estimate
Our policy regarding internal controls over the recording of reserves is structured to objectively and accurately estimate our oil and gas reserve quantities and values in compliance with the regulations of the SEC. Responsibility for compliance in reserve bookings is delegated to our Chief Financial Officer with assistance from our senior geologist and a senior reservoir engineer.
Technical reviews are performed throughout the year by our senior reservoir engineer and our senior geologist and other consultants who evaluate all available geological and engineering data, under the guidance of our Chief Financial Officer. This data, in conjunction with economic data and ownership information, is used in making a determination of estimated proved reserve quantities. Chris Cantrell, our senior reservoir engineer, has overseen our reserve processes since 2016. Mr. Cantrell received a Bachelor of Science degree in Petroleum Engineering from Texas A&M University in 1995. He is a registered professional engineer licensed in the State of Texas. He has been continuously involved in evaluating oil and gas properties since 1997 and is a member of the Society of Petroleum Engineers and the American Petroleum Institute.
Our Reserves Committee, a committee of our Board of Directors, assists management and the Board with their oversight of our reserves estimation and certification process and the work of our independent reserve engineer. The members of the Reserves Committee currently consist of R. Glenn Dawson, John Johanning, and Nicholas Steinsberger. Mr. Dawson serves as the Chairman of the Reserves Committee. The Committee’s charter specifies the oversight responsibilities of the Reserves Committee, which include, without limitation, oversight of the Company’s reserve estimates and related disclosures of same by the Company; oversight of the qualifications, training, and independence of the independent reservoir petroleum engineers and other geoscientists proposed to be engaged to audit or report on the reserves of the Company; oversight of the evaluation of oil and gas producing activities and operations and acquisition opportunities; and oversight of hydrocarbon reserve and resource matters as deemed necessary or appropriate in the interest of the Company and its stockholders.
Our reserves estimates and the corresponding report from CG&A, along with the process for developing such estimates, are also reviewed by our geologist and the Audit Committee of our Board of Directors to ensure compliance with SEC disclosure and internal control requirements and to verify the independence of our third-party consultants. The Audit Committee of our Board of Directors reviews the final reserves estimate in conjunction with CG&A’s audit letter.
Third-Party Reserves Study
Our controls over reserve estimates include retaining an independent third-party consultant, CG&A, as our independent petroleum engineering consulting firm to perform a reserves audit of our reserves estimates. We provided to CG&A information about our oil and gas properties, including production information, prices and costs, and CG&A performed reserve studies using its own engineering assumptions and the economic data provided by us. All of our total calculated proved reserve value was audited by CG&A, and all of the information regarding our 2018, 2017, and 2016 reserves in this Annual Report is derived from CG&A’s reports.
CG&A is an independent petroleum engineering consulting firm that has been providing petroleum engineering consulting services for over 20 years. The individual at CG&A primarily responsible for overseeing our reserve audit is Todd Brooker, President of CG&A, who received a Bachelor of Science degree in Petroleum Engineering from the University of Texas and is a registered Professional Engineer in the State of Texas. He is also a member of the Society of Petroleum Engineers. Mr. Brooker and the other technical persons employed by CG&A engaged in the reserve study met the requirements regarding qualifications, independence, objectivity and confidentiality set forth in the Standards Pertaining to the Estimating and Auditing of Oil and Natural Gas Reserves Information promulgated by the Society of Petroleum Engineer.
Oil and natural gas reserves and the estimates of the present value of future net cash flows therefrom were determined based on prices and costs as prescribed by the SEC and Financial Accounting Standards Board (“FASB”) guidelines. Reserve calculations involve the estimate of future net recoverable reserves of oil and natural gas and the timing and amount of future net
cash flows to be received therefrom. Such estimates are not precise and are based on assumptions regarding a variety of factors, many of which are variable and uncertain. Proved reserves were estimated in accordance with guidelines established by the SEC and the FASB, which require that reserve estimates be prepared under existing economic and operating conditions with no provision for price and cost escalations except by contractual arrangements. For the years ended December 31, 2018, 2017, and 2016, we based the estimated discounted future net cash flows from proved reserves on the 12-month average oil and natural gas index prices, calculated as the un-weighted arithmetic average for the first-day-of-the-month price for each month and costs in effect on the date of the estimate, holding the prices and costs constant throughout the life of the properties.
Oil and Gas Production, Production Prices, and Production Costs
Production Volumes and Sales Prices
The following table summarizes the average volumes and realized prices of oil and natural gas produced from our properties during the periods indicated:
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For the Years Ended December 31,
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2018
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2017
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2016
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Production
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Oil (Bbls)-net production
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1,089,724
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371,993
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61,088
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Oil (per Bbl)-average realized price
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$
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53.26
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$
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47.92
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$
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39.59
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Natural gas liquids (Bbls)-net production
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246,425
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73,875
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11,355
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Natural gas liquids (per Bbl)-average realized price
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$
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28.11
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$
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22.49
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$
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15.22
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Natural Gas (Mcf)-production
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2,855,739
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776,164
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332,643
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Natural Gas (per Mcf)-average realized price
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$
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1.84
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$
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2.74
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$
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2.54
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Barrels of oil equivalent (BOE)
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1,812,106
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575,229
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127,863
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Average daily net production (BOE)
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4,965
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1,576
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350
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Average Sales Price per BOE
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$
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38.75
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$
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37.57
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$
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26.87
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Oil and Natural Gas Production Costs, Production Taxes, Depreciation, Depletion, and Amortization
The following table sets forth certain information regarding oil and natural gas production costs, production taxes, and depreciation, depletion and amortization:
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For the Years Ended December 31,
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2018
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2017
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2016
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Production costs per BOE
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$
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9.51
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$
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12.21
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$
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12.43
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Production taxes per BOE
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2.05
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2.06
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(1.30
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)
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Depreciation, depletion, and amortization per BOE
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14.00
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12.21
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12.25
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Total operating costs per BOE
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$
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25.56
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$
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26.48
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$
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23.38
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The average oil and NGL sales prices above are calculated by dividing revenue from oil sales by volume of oil sold, in barrels “Bbls.” The average natural gas sales prices above are calculated by dividing revenue from natural gas sales by the volume of natural gas sold, in thousand cubic feet “Mcf.” The total average sales price amounts are calculated by dividing total revenues by total volume sold, in BOE. The average production costs above are calculated by dividing production costs by total production in BOE.
Acreage
The following table sets forth our approximate gross and net developed and undeveloped leasehold acreage as of December 31,
2018
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Undeveloped Acreage
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Developed Acreage
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Total
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Gross
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Net
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Gross
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Net
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Gross
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Net
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Delaware Basin
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14,200
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9,000
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14,300
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11,400
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28,500
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20,400
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Undeveloped Acreage Expirations
Many of the leases comprising the undeveloped acreage set forth in the table above will expire at the end of their respective primary terms unless production from the leasehold acreage has been established prior to such date, in which event the lease will remain in effect until the cessation of production. The following table sets forth the net undeveloped acreage, as of December 31, 2018, that will expire over the next three years unless production is established within the spacing units covering the acreage or the lease is renewed or extended under continuous drilling provisions prior to the primary term expiration dates:
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2019
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2020
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2021
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Delaware Basin
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1,840
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6,197
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1,350
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We plan to maintain our undeveloped acreage by establishing production within the spacing units covering the acreage or extending or renewing the leases prior to their expiration.
Productive Wells
As of December 31, 2018, we have had 27.0 gross (24.9 net) oil wells and 11.0 gross (8.1 net) natural gas wells. A net well is our percentage ownership interest in a gross well.
Productive wells are either wells producing in commercial quantities or wells capable of commercial production, including natural gas wells awaiting pipeline connections to commence deliveries and oil wells awaiting connection to production facilities. Multiple completions in the same wellbore are counted as one well. A well is categorized under state reporting regulations as an oil well or a natural gas well based on the ratio of natural gas to oil produced when it first commenced production, and such designation may not be indicative of current production.
Drilling Activity
For the year ended December 31, 2018, we drilled 16.0 gross (13.5 net) horizontal wells in the Delaware Basin. We completed and placed on production 15.0 gross (14.3 net) horizontal wells. As of December 31, 2018, 6.0 gross (3.8 net) wells were drilled but not yet completed. All of these wells were successful, and none were a dry hole.
The following table sets forth information with respect to the number of wells completed during the periods indicated. Each of these wells was drilled in the Delaware Basin in the Permian Basin.
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Year Ended December 31,
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2018
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2017
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2016
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Gross
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Net
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Gross
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Net
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Gross
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Net
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Exploratory:
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Productive
|
9.00
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8.7
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5.0
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4.2
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—
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—
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Dry
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—
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—
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—
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—
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—
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—
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Development:
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Productive
|
6.0
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5.6
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—
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—
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—
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—
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Dry
|
—
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—
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—
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—
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—
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—
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Total:
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Productive
|
15.0
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14.3
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|
5.0
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|
4.2
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—
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—
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Dry
|
—
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|
—
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|
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—
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—
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—
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Present Activities
As of December 31,
2018
, we had 6.0 gross (3.8 net) wells in the process of drilling, completing, dewatering or shut-in awaiting infrastructure.
Title to Properties
We generally conduct a preliminary title examination prior to the acquisition of properties or leasehold interests. Prior to commencement of operations on such acreage, a thorough title examination will usually be conducted and any significant defects will be remedied before proceeding with operations. We believe the title to our leasehold properties is good, defensible and customary with practices in the oil and natural gas industry, subject to such exceptions that we believe do not materially detract from the use of such properties. Our properties are potentially subject to customary royalty and other interests, liens for current taxes, and other burdens which we be do not materially interfere with the use of or affect our carrying value of the properties. The majority of our Delaware Basin leasehold position is also subject to mortgages securing indebtedness under our credit and guarantee agreement.
With respect to our properties of which we are not the record owner, we rely on contracts with the owner or operator of the property or assignment of leases, pursuant to which, among other things, we generally have the right to have our interest placed on record.
Competitive Business Conditions
The oil and gas industry is intensely competitive, particularly with respect to acquiring prospective oil and natural gas properties. We face intense competition from a substantial number of major and independent oil and gas companies, many of which have larger technical staffs and greater financial and operational resources. These companies may be able to pay more for productive oil and natural gas properties and exploratory prospects. We also compete with other oil and gas companies to secure drilling rigs and other equipment and services necessary for the drilling, completion, production, processing and maintenance of our wells, and we could face shortages or delays in securing these services from time to time if availability is limited. In addition, we compete to hire and retain professionals, including experienced geologists, geophysicists, engineers, and other professionals and consultants. We believe the location of our acreage, our technical expertise, available technologies, our financial resources, and the experience and knowledge of our management enables us to compete effectively in our core operating areas, but we recognize that many of our competitors have greater financial and operational resources.
The oil and gas industry also faces competition from alternative fuel sources, including other fossil fuels such as coal and imported liquefied natural gas. Competitive conditions may also be affected by future new energy, climate-related, financial, and other policies, legislation, and regulations.
Marketing and Pricing
We derive our revenue and cash flow principally from the sale of oil, natural gas and NGLs. As a result, our revenues are determined, to a large degree, by prevailing prices for crude oil, natural gas and NGLs. We sell our oil and natural gas on the open market at prevailing market prices or through forward delivery contracts. Because some of our operations are located outside major markets, we are directly impacted by regional prices regardless of Henry Hub, WTI or other major market pricing. The market price for oil, natural gas and NGLs is dictated by supply and demand; consequently, we cannot accurately predict or control the price we may receive for our oil, natural gas and NGLs.
We have an active hedging program to provide certainty regarding our cash flow and to protect returns from our development activity in the event of decreases in the prices received for our production; however, hedging arrangements may expose us to risk of significant financial loss in some circumstances and may limit the benefit we would receive from increases in the prices for oil, natural gas and NGLs.
Major Customers
We sell our production to a small number of customers which is common in the oil and gas industry. The following table outlines our major customers and their percentage contribution to our total revenues for the years ended
December 31, 2018
and
2017
:
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|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
Texican Crude & Hydrocarbons
|
|
87
|
%
|
|
85
|
%
|
ETC Field Services
|
|
2
|
%
|
|
14
|
%
|
Lucid Energy
|
|
10
|
%
|
|
—
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%
|
Others below 10%
|
|
1
|
%
|
|
1
|
%
|
|
|
100
|
%
|
|
100
|
%
|
Delivery Commitments
As of December 31, 2018, we were not committed to providing a fixed quantity of oil or natural gas under any existing contracts.
Regulation of the Oil and Natural Gas Industry
General
Our oil and natural gas exploration, production, and related operations are subject to extensive federal, state and local laws and regulations. These laws and regulations, which are under continued review for amendment, include matters relating to drilling and production practices; the disposal of water from operations and the processing, handling and disposal of hazardous materials; bonding, permitting and licensing, and reporting requirements; taxation; and marketing, transportation and pricing practices.
The failure to comply with these laws and regulations could result in substantial penalties, including administrative, civil, or criminal penalties. These laws and regulations increase our cost of doing business and can potentially affect our profitability.
Regulation of Production of Oil and Natural Gas
The production of oil and natural gas is subject to regulation under a wide range of federal, state and local laws, orders and regulations. These statutes and regulations require permits for drilling operations, drilling bonds and reports concerning operations. The states in which we own and operate properties have regulations governing conservation matters, including provisions for the unitization or pooling of oil and natural gas properties, the establishment of maximum allowable rates of production from oil and natural gas wells, the regulation of well spacing or density, and plugging and abandonment of wells. The effect of these regulations is to limit the amount of oil and natural gas that we can produce from our wells and to limit the number of wells or the locations at which we can drill, although we can apply for exceptions to such regulations or to have reductions in well spacing or density. We believe we are in substantial compliance with these laws and regulations; however, should we fail to comply with these laws and regulations, we could face substantial penalties.
Environmental, Health, and Safety Regulations
Our operations are subject to stringent federal, state, and local laws and regulations relating to the protection of the environment and human health and safety (“EHS”). There are various governmental agencies, including the U.S. Environmental Protection Agency (“EPA”), the U.S. Occupational Safety and Health Administration (“OSHA”) and analogous state agencies that have the authority to enforce compliance with these laws and regulations. Environmental laws and regulations may require that permits be obtained before drilling commences or facilities are commissioned; restrict the types, quantities, and concentration of various substances that can be released into the environment in connection with drilling and production activities; govern the handling and disposal of waste material; and limit or prohibit drilling and exploitation activities on certain lands lying within wilderness, wetlands, and other protected areas, including areas containing threatened or endangered animal species.
We do not believe that our environmental risks are materially different from those of comparable companies in the oil and gas industry. We believe our present activities substantially comply, in all material respects, with existing environmental laws and regulations. Nevertheless, environmental laws may result in a curtailment of production or material increases in the cost of production, development or exploration, and may otherwise adversely affect our financial condition and results of operations. Although we maintain liability insurance coverage for liabilities from pollution, environmental risks are generally not fully insurable. We are committed to strict compliance with these regulations. During the years ended December 31, 2018 and 2017, we incurred approximately $38,000 and approximately $32,000, respectively, related to compliance with environmental laws for our oil and natural gas properties.
The following is a summary of the more significant existing and proposed environmental and occupational health and safety laws and regulations to which our business operations are or may be subject and for which compliance may have a material adverse impact on our capital expenditures, results of operations or financial position:
The Resource Conservation and Recovery Act
. The Resource Conservation and Recovery Act, as amended (“RCRA”), and the comparable state statutes, regulate the generation, transportation, treatment, storage, disposal and cleanup of hazardous and non-hazardous wastes. The RCRA imposes stringent operating requirements, and liability for failure to meet such requirements, on a person who is either a “generator” or “transporter” of hazardous waste or an “owner” or “operator” of a hazardous waste treatment, storage or disposal facility. The RCRA includes an exemption that allows certain oil and natural gas exploration and production waste to be classified as nonhazardous waste. A similar exemption is contained in many of the state counterparts to RCRA. As a result, we are not required to comply with a substantial portion of RCRA’s hazardous waste requirements. At various times in the past, proposals have been made to amend the RCRA to rescind the exemption that excludes oil and natural gas exploration and production wastes from regulation as hazardous waste. In 2016, the EPA agreed in a consent decree to review its regulation of oil and gas waste and has until March 2019 to determine whether revisions are necessary.
In the event that we fail to comply with requirements for the handling of hazardous waste, administrative, civil and criminal penalties can be imposed. We believe that we are in substantial compliance with applicable requirements related to hazardous waste handling. Repeal or modification of the RCRA oil and gas exemption, or modification of similar exemptions in applicable state statutes, would increase the volume of hazardous waste we are required to manage and dispose of and would cause us to incur potentially significant increased operating expenses.
Water Discharges.
The Federal Water Pollution Control Act (also known as the Clean Water Act), the Safe Drinking Water Act, the Oil Pollution Act and analogous state laws and regulations impose restrictions and controls on the discharge of produced waters and other oil and natural gas wastes into navigable waters of the United States, as well as state waters. Permits must be obtained to discharge pollutants into state and federal waters and to discharge pollutants into regulated waters and wetlands. Spill Prevention, Control, and Countermeasure requirements of the Clean Water Act require appropriate secondary containment loadout controls, piping controls, berms and other measures to help prevent the contamination of navigable waters in the event of a petroleum hydrocarbon spill, rupture or leak. In June 2015, the EPA and the U.S. Army Corps of Engineers jointly promulgated rules redefining the scope of waters protected under the Clean Water Act, and in October 2015, the U.S. Court of Appeals for the Sixth Circuit stayed them nationwide. The EPA and U.S. Army Corps of Engineers have resumed nationwide use of the agencies’ prior regulations defining the term “waters of the United States.” On February 28, 2017, President Trump directed the EPA to review the rules and “publish for notice and comment a proposed rule rescinding or revising the rules, as appropriate and consistent with law.” The Clean Water Act and comparable state statutes provide for civil, criminal and administrative penalties for unauthorized discharges of crude oil and other pollutants and impose liability on parties responsible for those discharges for the costs of cleaning up any environmental damage caused by the release and for natural resource damages resulting from the release.
The Oil Pollution Act of 1990 (“Oil Pollution Act”) and regulations thereunder are the primary federal law for oil spill liability. The Oil Pollution Act contains numerous requirements relating to the prevention of and response to petroleum releases into waters in the United States and imposes a variety of regulations on “responsible parties” related to the prevention of oil spills and liability for damages resulting from such spills in United States waters. The Oil Pollution Act subjects each responsible party to strict liability for oil removal costs and a variety of public and private damages, including, all containment and cleanup costs and certain other damages arising from a release, including, but not limited to, the costs of responding to a release of oil to surface waters and natural resource damages.
The Safe Drinking Water Act, as amended, establishes a regulatory framework for the underground injection of a variety of wastes, including brine produced and separated from crude oil and natural gas production, with the main goal being the protection of usable aquifers. The primary objective of injection well operating permits and requirements is to ensure the mechanical integrity of the wellbore and to prevent migration of fluids from the injection zone into underground sources of drinking water.
In response to recent seismic events near underground injection wells used for the disposal of oil and gas-related wastewaters, federal and state agencies have been investigating whether such wells have caused increased seismic activity, and some states have shut down or imposed moratoria on the use of such injection wells. In Texas, the Texas Railroad Commission (“RRC”) regulates the disposal of produced water by injection well. The RRC requires operators to obtain a permit for the operation of saltwater disposal wells and establishes minimum standards for injection well operations. The RRC has adopted permit rules for injection wells to address these seismic activity concerns within the state. These rules could impact the availability of injection wells for disposal of wastewater from our operations. Increased costs associated with the transportation and disposal of produced water, including the cost of complying with regulations concerning produced water disposal, may reduce our profitability; however, we do not believe that the costs associated with the disposal of produced water will have a material adverse effect on our operations.
Failure to comply with these regulations may result in substantial administrative, civil and criminal penalties, as well as injunctive obligations. We believe we are in material compliance with the requirements of each of these laws.
Air Pollutant Emissions
. The federal Clean Air Act (the “Clean Air Act”), and comparable state and local air pollution laws, provide a framework for national, state and local efforts to protect air quality. Our operations utilize equipment that emits air pollutants which may be subject to federal and state air pollution control laws. These laws generally require utilization of air emissions control equipment to achieve prescribed emissions limitations and ambient air quality standards, as well as operating permits for existing equipment and construction permits for new and modified equipment. In May 2016, the EPA issued a final rule regarding the criteria for aggregating multiple small surface sites into a single source for air-quality permitting purposes applicable to the oil and gas industry. This rule could cause small facilities, on an aggregate basis, to be deemed a major source, which would subject operators to more stringent air permitting processes and requirements. These laws and regulations may increase our costs of compliance, and we may face administrative, civil and criminal penalties if we fail to comply with the requirements of the federal Clean Air Act and associated state laws and regulations. We believe that we are in compliance in all material respects with the requirements of applicable federal and state air pollution control laws.
Regulation of “Greenhouse Gas” Emissions
. The EPA has adopted regulations that, among other things, establish Prevention of Significant Deterioration (“PSD”), construction, and Title V operating permit requirements for certain new and modified large stationary sources to address findings that emissions of carbon dioxide, methane and other greenhouse gases (“GHGs”) present an endangerment to public health and the environment. Facilities required to comply with PSD requirements for their GHG emissions will be required to meet “best available control technology” standards for those emissions, which will be established on a case-by-case basis. The EPA has also issued rules requiring the monitoring and reporting of GHG emissions, which include the reporting of GHG emissions from gathering and boosting systems, completions and workovers of oil wells using hydraulic fracturing, and blowdowns of natural gas transmission pipelines.
While Congress has from time to time considered legislation to reduce emissions of GHGs, there has not been significant activity in the form of adopted federal legislation to reduce GHG emissions in recent years. In the absence of such federal climate legislation, a number of state and regional cap and trade programs have emerged that typically require major sources of GHG emissions, such as electric power plants, to acquire and surrender emission allowances in return for emitting GHGs. Although it is not possible at this time to predict how legislation or new regulations that may be adopted to address GHG emissions would impact our business, any such future laws and regulations imposing reporting obligations on, or limiting emissions of GHGs from, our equipment and operations could require us to incur costs to reduce emissions of GHGs associated with our operations.
Restrictions on GHG emissions that may be imposed could adversely affect our operations and restrict or delay our ability to obtain air permits for new or modified sources, as well as increase our costs of operations.
Hydraulic Fracturing Activities
. Hydraulic fracturing is a common practice that is used to stimulate production of hydrocarbons, particularly natural gas, from tight unconventional formations. Federal and state occupational safety and health laws require us to organize and maintain information about hazardous materials used, released, or produced in our operations. Some of this information must be provided to our employees, state and local governmental authorities, and local citizens. We are also subject to the requirements and reporting framework set forth in the federal workplace standards.
Several states and local jurisdictions have adopted, or are considering adopting, regulations that could restrict or prohibit hydraulic fracturing in certain circumstances, impose more stringent operating standards and/or require the disclosure of the composition of hydraulic fracturing fluids. For example, the Texas Legislature adopted legislation requiring oil and gas operators to publicly disclose the chemicals used in the hydraulic fracturing process. The RRC adopted rules and regulations implementing this legislation that apply to all wells for which the RRC issues an initial drilling permit. The law requires that the well operator disclose the list of chemical ingredients subject to the requirements of OSHA for disclosure on an internet website and also file the list of chemicals with the RRC with the well completion report. The total volume of water used to hydraulically fracture a well must also be disclosed to the public and filed with the RRC. The RRC also adopted rules governing well casing, cementing and other standards for ensuring that hydraulic fracturing operations do not contaminate nearby water resources. Local government also may seek to adopt ordinances within their jurisdictions regulating the time, place and manner of drilling activities in general or hydraulic fracturing activities in particular or prohibit the performance of well drilling in general or hydraulic fracturing in particular.
We believe that we follow applicable standard industry practices and legal requirements for groundwater protection in our hydraulic fracturing activities; however, if new or more stringent federal, state, or local restrictions relating to the hydraulic fracturing process are adopted in areas where we operate, we could incur potentially significant added costs to comply with such requirements, experience delays or curtailment in the pursuit of exploration, development, or production activities, and perhaps
even be precluded from drilling wells. For additional information about hydraulic fracturing and related regulatory matters, see “Risk Factors-Risks Relating to the Oil and Gas Industry
.
”
Comprehensive Environmental Response, Compensation and Liability Act
. The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), also known as the “superfund law,” imposes joint and several liabilities, regardless of fault or the legality of the original conduct, on some classes of persons that are considered to have contributed to the release of a “hazardous substance” into the environment. These persons include the owner or operator of a disposal site or sites where the release occurred and companies that transport, dispose, or arrange for disposal of the hazardous substance(s) released. Persons who are or were responsible for releases of hazardous substances under CERCLA may be jointly and severally liable for the costs of cleaning up the hazardous substances and for damages to natural resources.
We generate materials in the course of our operations that may be regulated as hazardous substances. Despite the “petroleum exclusion” of CERCLA, which currently encompasses natural gas, we may handle other hazardous substances within the meaning of CERCLA, or similar state statutes, in the course of our ordinary operations. In addition, we currently own, lease, or operate numerous properties that have been used for oil and natural gas exploration, production and processing for many years and some of our properties have been operated by third parties or by previous owners or operators whose treatment and disposal of hazardous substances, wastes, or hydrocarbons was not under our control. Although we believe that we have utilized operating and waste disposal practices that were standard in the industry at the time, hazardous substances, wastes, or hydrocarbons may have been released on, under or from the properties owned or leased by us, or on, under or from other locations, including off-site locations, where such substances have been taken for disposal. These properties and the substances disposed or released on, under or from them may be subject to CERCLA, RCRA and analogous state and local laws. Under these laws, we could be required to undertake investigatory, response, or corrective measures, which could include soil and groundwater sampling, the removal of previously disposed substances and wastes, the cleanup of contaminated property, or performance of remedial plugging or pit closure operations to prevent future contamination, the costs of which could be substantial.
Endangered Species Act and Migratory Birds
. The Endangered Species Act (“ESA”) restricts activities that may affect federally identified endangered and threatened species or their habitats through the implementation of operating restrictions or a temporary, seasonal, or permanent ban in affected areas. Pursuant to the ESA, if a species is listed as threatened or endangered, restrictions may be imposed on activities adversely affecting that species’ habitat. We may conduct operations under oil and natural gas leases in areas where certain species that are listed as threatened or endangered are known to exist and where other species that potentially could be listed as threatened or endangered under the ESA may exist.
The U.S. Fish and Wildlife Service may designate critical habitat and suitable habitat areas that it believes are necessary for survival of a threatened or endangered species. A critical habitat or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil and natural gas development. Similar protections are offered to migratory birds under the Migratory Bird Treaty Act. The identification or designation of previously unprotected species as threatened or endangered in areas where underlying property operations are conducted could cause us to incur increased costs arising from species protection measures or could result in limitations on our exploration and production activities that could have an adverse impact on our ability to develop and produce reserves. If we were to have a portion of our leases designated as critical or suitable habitat, it could adversely impact the value of our leases.
OSHA
. We are subject to the requirements of the OSHA and comparable state statutes whose purpose is to protect the health and safety of workers. In addition, the OSHA hazard communication standard, the Emergency Planning and Community Right-to-Know Act and comparable state statutes and regulations require that we organize and/or disclose information about hazardous materials used or produced in our operations and that this information be provided to employees, state and local governmental authorities and citizens. We believe that we are in substantial compliance with all applicable laws and regulations relating to worker health and safety.
State Laws
. There are numerous state laws and regulations in the states where we operate that relate to the environmental aspects of our business. Some of those laws and regulations are discussed above. They relate to, among other things, requirements to remediate spills of deleterious substances associated with oil and gas activities, the conduct of salt water disposal operations, and the methods of plugging and abandonment of oil and gas wells which have been unproductive. Numerous state laws and regulations also relate to air and water quality. We believe that we are in substantial compliance with all state laws governing environmental matters and all permitting requirements; however, in the event that we fail to comply with such laws, we may face substantial penalties and incur significant costs.
Natural Gas Sales and Transportation
Historically, federal legislation and regulatory controls have affected the price of the natural gas we produce and the manner in which we market our production. The Federal Energy Regulatory Commission, or FERC, has jurisdiction over the transportation and sale for resale of natural gas in interstate commerce by natural gas companies.
Under the Energy Policy Act of 2005, FERC has substantial enforcement authority to prohibit the manipulation of natural gas markets and enforce its rules and orders, including the ability to assess substantial civil penalties. FERC also regulates interstate natural gas transportation rates and service conditions and establishes the terms under which we may use interstate natural gas pipeline capacity, which affects the marketing of natural gas that we produce, as well as the revenues we receive for sales of our natural gas and release of our natural gas pipeline capacity. FERC has also promulgated a series of orders, regulations and rules to foster competition in the business of transporting and marketing gas. Today, interstate pipeline companies are required to provide nondiscriminatory transportation services to producers, marketers and other shippers, regardless of whether such shippers are affiliated with an interstate pipeline company.
Under FERC’s current regulatory regime, transmission services are provided on an open-access, non-discriminatory basis at cost-based rates or negotiated rates. Gathering service, which occurs upstream of jurisdictional transmission services, is regulated by the states onshore and in state waters. Although its policy is still in flux, FERC has in the past reclassified certain jurisdictional transmission facilities as non-jurisdictional gathering facilities, which has the tendency to increase our costs of transporting natural gas to point-of-sale locations.
Additionally, we are required to comply with anti-market manipulation laws and regulations promulgated by FERC and the Commodity Future Trading Commission with regard to our physical purchases and sales of energy commodities and any related hedging activities, and if we fail to comply, we could be subject to penalties and potential third-party damage claims.
Oil Sales and Transportation
Sales of crude oil, condensate and NGLs are not currently regulated and are made at negotiated prices. Our crude oil sales are affected by the availability, terms and cost of transportation.
The transportation of oil in common carrier pipelines is subject to rate regulation. FERC regulates interstate oil pipeline transportation rates under the Interstate Commerce Act and intrastate oil pipeline transportation rates are subject to regulation by state regulatory commissions. The basis for intrastate oil pipeline regulation, and the degree of regulatory oversight and scrutiny given to intrastate oil pipeline rates, varies from state to state. We believe that the regulation of oil transportation rates will not affect our operations in any materially different way than such regulation will affect the operations of our competitors, as effective interstate and intrastate rates are equally applicable to all comparable shippers.
Further, interstate and intrastate common carrier oil pipelines must provide service on a non-discriminatory basis. Under this open access standard, common carriers must offer service to all shippers requesting service on the same terms and under the same rates. When oil pipelines operate at full capacity, access is governed by pro-rationing provisions set forth in the pipelines’ published tariffs. Accordingly, we believe that access to oil pipeline transportation services generally will be available to us to the same extent as to our competitors.
Federal Income Tax and State Severance Taxes
Federal income tax laws significantly affect our operations. The principal provisions that affect us are those that permit us, subject to certain limitations, to deduct as incurred, rather than to capitalize and amortize/depreciate, our domestic “intangible drilling and development costs” and to claim depletion on a portion of our domestic oil and natural gas properties based on 15% of our oil and natural gas gross income from such properties (up to an aggregate of 1,000 barrels per day of domestic crude oil and/or equivalent units of domestic natural gas).
Additionally, each state generally imposes a production or severance tax with respect to the production and sale of oil, natural gas and NGLs within its jurisdiction. Texas and New Mexico currently impose a severance tax on oil production of 4.60% and 8.39%, respectively, and a severance tax on natural gas production of 7.50% and 9.24%, respectively.
Federal Leases
Operations on federal oil and natural gas leases must comply with certain regulatory restrictions, including various non-discrimination statutes, and certain of such operations must be conducted pursuant to certain on-site security regulations and other permits issued by federal agencies. In addition, on federal lands in the United States, the Office of Natural Resources Revenue (“ONRR”) prescribes, and in some cases limits, the types of costs that are deductible transportation costs for purposes of royalty valuation of production sold off the lease, including the deduction of costs associated with marketer fees, cash out and other pipeline imbalance penalties, or long-term storage fees. The ONRR has also been engaged in a process of promulgating new rules and procedures for determining the value of crude oil produced from federal lands for purposes of calculating royalties owed to the government. We cannot predict what, if any, effect any new rule will have on our operations.
Some of our operations are conducted on federal lands pursuant to oil and gas leases administered by the Bureau of Land Management, or BLM. These leases contain relatively standardized terms and require compliance with detailed regulations and orders, which are subject to change. In addition to permits required from other regulatory agencies, lessees must obtain a permit from the BLM before drilling and comply with regulations governing, among other things, engineering and construction specifications for production facilities, safety procedures, the valuation of production and payment of royalties, the removal of facilities, and the posting of bonds to ensure that lessee obligations are met. Under certain circumstances, the BLM may require our operations on federal leases to be suspended or terminated.
Other Laws and Regulations
Various laws and regulations require permits for drilling wells and also cover spacing of wells, the prevention of waste of natural gas and oil, rates of production and other matters. The effect of these laws and regulations, as well as other regulations that could be promulgated in the jurisdictions in which we have production, could be to limit the number of wells that could be drilled on our properties and to limit the allowable production from the successful wells completed on our properties, thereby limiting our revenues.
Seasonal Nature of Business
Generally, the demand for oil and natural gas fluctuates depending on the time of year. Generally, demand for oil increases during the summer months and decreases during the winter months while natural gas decreases during the summer months and increases during the winter months. Seasonal anomalies such as mild winters or hot summers may sometimes lessen this fluctuation. Further, pipelines, utilities, local distribution companies, and industrial end users utilize oil and natural gas storage facilities and purchase some of their anticipated winter requirements during the summer, which can also lessen seasonal demand.
Operational Hazards and Insurance
The oil and natural gas business involves a variety of operating risks, including the risk of fire, explosions, blow outs, hydrogen sulfide emissions or releases, pipe failures and, in some cases, abnormally high pressure formations which could lead to environmental hazards such as oil spills, natural gas leaks and the discharge of toxic gases. If any of these should occur, we could be required to pay amounts due to injury; loss of life; damage or destruction to property, natural resources and equipment; pollution or environmental damage; regulatory investigation; and penalties and suspension of operations.
In accordance with industry practice, we maintain insurance against some, but not all, of the operating risks to which our business is exposed. We evaluate the purchase of insurance, coverage limits and deductibles on an annual basis.
Current Employees
As of December 31, 2018, we had 39 employees, all of whom were full-time employees, and we intend to continue to add personnel as our operational requirements grow. Our employees are not represented by any labor union or covered by any collective bargaining agreements.
We also retain certain independent consultants and contractors to provide various professional services, including additional land, legal, engineering, geology, environmental and tax services on a contract or fee basis as necessary for our operations.
Principal Executive Office and Corporate Offices
Our principal executive offices are in leased office space located at 1800 Bering Drive, Suite 510, Houston, Texas 77057, and our telephone number is (817) 585-9001. We also maintain offices in leased office space in Fort Worth, Texas and San Antonio, Texas.
Availability of Company Reports
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934 will be available through our Internet website at
https://www.lilisenergy.com
as soon as reasonably practical after we electronically file such material with, or furnish it to, the SEC. The information on, or that can be accessed through, our website is not incorporated by reference into this Annual Report and should not be considered part of this Annual Report.
Item 1A. Risk Factors
Investing in our shares of common stock involves significant risks, including the potential loss of all or part of your investment. These risks could materially affect our business, financial condition and results of operations and cause a decline in the market price of our common stock. You should carefully consider all of the risks described in this Annual Report, in addition to the other information contained in this Annual Report, before you make an investment in our common stock. Additional risks not presently known to us or that we currently deem immaterial may also adversely affect our business. In addition to other matters identified or described by us from time to time in filings with the SEC, there are several important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or results that are reflected from time to time in any forward-looking statement. Some of these important factors, but not necessarily all important factors include the following:
Risks Relating to Our Business
If we are unable to access additional capital, it could negatively impact our production, our income and ultimately our ability to retain our leases.
Our principal sources of liquidity historically have been equity contributions, borrowings under our credit facilities, net cash provided by operating activities, and net proceeds from the issuance of preferred stock. Our capital program may require additional financing above the level of cash generated by our operations to fund our growth. If our expected cash flow from operations decreases as a result of lower commodity prices or otherwise, our ability to expend the capital necessary to replace our proved reserves, maintain our leasehold acreage or maintain production may be limited, resulting in decreased production and proved reserves over time.
We plan to finance our capital expenditures with cash on hand, cash flow from operations and future issuances of debt and/or equity securities. Our cash flow from operations and access to capital is subject to a number of factors, including:
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our estimated proved oil and natural gas reserves;
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the amount of oil and natural gas we produce from existing wells;
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the prices at which we sell our production;
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the costs of developing and producing our oil and natural gas reserves;
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our ability to acquire, locate and produce new reserves;
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the ability and willingness of banks to lend to us; and
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our ability to access the equity and debt capital markets.
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Our operations and capital resources may not provide cash in sufficient funds to maintain planned or future levels of capital expenditures. Further, our actual capital expenditures in 2019 could exceed our capital expenditure budget. In the event our capital expenditure requirements at any time are greater than the amount of capital we have available, we could be required to seek additional sources of capital, which may include refinancing existing debt, joint venture partnerships, production payment financings, offerings of debt or equity securities or other means.
Oil, natural gas and NGL prices are highly volatile. If commodity prices experience substantial decline, our operations, financial condition, and level of expenditures for the development of our oil, natural gas and NGL reserves may be materially and adversely affected.
The prices we receive for our oil, natural gas, and NGL production heavily influence our revenue, operating results, profitability, access to capital, future rate of growth and carrying value of our properties. Oil, natural gas, and NGLs are commodities, and, therefore, their prices are subject to wide fluctuations in response to relatively minor changes in supply and demand.
Historically, the commodities markets have been volatile, and these markets will likely continue to be volatile in the future. If the prices of oil, natural gas and NGLs experience a substantial decline, our operations, financial condition and level of expenditures for the development of our oil, natural gas and NGL reserves may be materially and adversely affected. The prices we receive for our production, and the levels of our production, depend on numerous factors beyond our control, including:
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changes in global supply and demand for oil and natural gas;
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the actions of the Organization of Petroleum Exporting Countries, or OPEC;
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the price and quantity of imports of foreign oil and natural gas;
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political conditions, including embargoes, affecting oil-producing activity;
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the level of global oil and natural gas exploration and production activity;
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the level of global oil and natural gas inventories;
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technological advances affecting energy consumption; and
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the price and availability of alternative fuels.
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Our revenues, operating results, profitability and future rate of growth depend primarily upon the prices we receive for oil and, to a lesser extent, natural gas that we sell. Prices also affect the amount of cash flow available for capital expenditures and our ability to borrow money or raise additional capital. In addition, we may be required to record asset carrying value write-downs if prices fall. A significant decline in the prices of natural gas or oil could adversely affect our financial position, financial results, cash flows, access to capital and ability to grow.
Our level of indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from meeting our obligations under our indebtedness.
We entered into the Second Lien Credit Agreement in 2017 and the Revolving Credit Agreement in 2018 (hereinafter defined and described in more detail). As of December 31, 2018, $75.0 million was outstanding under our Revolving Credit Agreement and $111.6 million was outstanding under our Second Lien Credit Agreement.
We may incur additional debt, including secured indebtedness, or issue preferred stock in order to maintain adequate liquidity and develop and acquire properties to the extent desired. If we further utilize our credit facilities in the future or obtain additional financing, our level of indebtedness could affect our operations, including limiting our ability to obtain additional debt or equity financing for working capital, capital expenditures, debt service requirements, acquisitions and general corporate or other purposes. Additionally, if we increase our indebtedness, the debt service requirements of the additional indebtedness could make it more difficult for us to satisfy our financial obligations; and a substantial portion of our cash flows from operations would be dedicated to the payment of principal and interest on our indebtedness and would not be available for other purposes, including our operations, capital expenditures and future business opportunities. A higher level of indebtedness and/or preferred stock also increases the risk that we may default on our obligations.
The UK’s Financial Conduct Authority, or FCA, which regulates LIBOR, stated on July 27, 2017, that following 2021 it will no longer encourage panel banks to contribute to LIBOR, as it has done to date. Borrowings under our Revolving Credit Agreement bear interest at a floating rate of either LIBOR or a specified base rate plus a margin determined based upon the usage of the borrowing base. In the event LIBOR becomes unavailable prior to the maturity of our Revolving Credit Agreement, the rate of interest payable on our Revolving Credit Agreement may change. Uncertainty regarding the future of or changes to LIBOR or the unavailability of LIBOR could adversely affect our financial condition.
The Revolving Credit Agreement and Second Lien Credit Agreement, guaranteed and further secured by substantially all our assets, contain restrictive covenants that may limit our ability to respond to changes in market conditions or pursue business opportunities.
Our Revolving Credit Agreement and Second Lien Credit Agreement contain restrictive covenants that limit our ability to, among other things:
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incur additional indebtedness;
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create additional liens;
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incur fundamental changes;
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sell certain of our assets;
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merge or consolidate with another entity;
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pay dividends or make other distributions;
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engage in transactions with affiliates; and
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enter into certain swap agreements.
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The requirement that we comply with these provisions may have a material adverse effect on our ability to react to changes in market conditions, take advantage of business opportunities we believe to be desirable, obtain future financing, fund needed capital expenditures or withstand a continuing or future downturn in our business.
We may from time to time enter into alternative or additional debt agreements that contain restrictive covenants that may prevent us from taking actions that we believe would be in the best interest of our business, require us to sell assets or take other actions to reduce indebtedness to meet such covenants, or make it difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted.
In addition, our Revolving Credit Agreement requires us to maintain certain financial ratios. We may from time to time be out of compliance with covenants under our debt agreements, which will require us to seek waivers from our lenders. In connection with the preparation of this Form 10-K and the associated financial statements, the Company became aware, and promptly informed its Lenders, that it did not satisfy the leverage ratio covenant in the Revolving Credit Agreement, as of the fiscal quarter ended December 31, 2018. Accordingly, the Company requested that the Lenders consent to a waiver with respect to such provision. On March 1, 2019, the Company entered into that certain First Amendment and Waiver to Second Amended and Restated Credit Agreement, whereby the Lenders granted a waiver with respect to the breach of the leverage ratio covenant. If we fail to comply with these provisions or other financial and operating covenants in the Revolving Credit Agreement, we could be in default under the terms of the agreement. In the event of such default, our lenders could elect to declare all the funds borrowed thereunder to be due and payable, together with the accrued and unpaid interest, and the lenders under or Revolving Credit Agreement could elect to terminate their commitments thereunder.
Värde Partners, Inc., its portfolio companies, and its affiliates (collectively, “Värde”) beneficially own a significant portion of our common stock. Värde is not limited in their ability to compete with us, and the waiver of the corporate opportunity provisions in the certificates of designation relating to our Series C Preferred Stock and Series D Preferred Stock may allow Värde to benefit from corporate opportunities that might otherwise be available to us. As a result, conflicts of interest could arise in the future between us and Värde concerning conflicts over our operations or business opportunities.
Värde is a family of private investment funds that beneficially owns a significant portion of our common stock as a result of the conversion rights available to them under the Second Lien Credit Agreement, the Series C Preferred Stock (as hereinafter defined and described) and the Series D Preferred Stock (as hereinafter defined and described). Värde also has investments in other companies in the energy industry. The certificates of designation governing the preferences, rights and limitations of the Series C Preferred Stock and the Series D Preferred Stock provide that Värde is not restricted from owning assets or engaging in businesses that compete directly or indirectly with us. In particular, subject to the limitations of applicable law, if Värde, or any agent, shareholder, member, partner, director, officer, employee, investment manager or investment advisor of Värde who is also one of our directors or officers, becomes aware of a potential business opportunity, transaction or other matter, they will have no duty to communicate or offer that opportunity to us.
As such, Värde may become aware, from time to time, of certain business opportunities (such as acquisition opportunities) and may direct such opportunities to other businesses in which they have invested, in which case those opportunities may not be available to us or may be more expensive for us to pursue. Additionally, any actual or perceived conflicts of interest with respect to the foregoing could have an adverse impact on the trading price of our common stock. As of March 5, 2019, we converted our outstanding Second Lien Loans under our Second Lien Credit Agreement to a combination of two newly created series of preferred stock, Series E convertible preferred stock ("Series E Preferred Stock") and Series F non-convertible preferred stock ("Series F Preferred Stock"), and common stock and eliminated the conversion features
and voting rights on our existing Series C Preferred Stock and Series D Preferred Stock, reducing potential dilution of our common stockholders. Our Series E Preferred Stock is convertible and, if converted, could result in dilution to our common stockholders.
Our disclosure controls and procedures and internal controls over financial reporting may not detect errors or potential acts of fraud.
Our disclosure controls and procedures and internal controls may not prevent all possible errors and fraud. A control system, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the control
system are being met. In addition, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls are evaluated relative to their costs. Because of the inherent limitations in all control systems, no evaluation of our controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur without detection, which could have a material adverse effect on our business.
Failure to maintain an effective system of internal control over financial reporting may have an adverse effect on our stock price.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, and the rules and regulations promulgated by the SEC to implement Section 404, our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles. Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we are required to conduct an evaluation of the effectiveness of our internal control over financial reporting based on framework of internal control issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Because of its inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
Effective internal controls are necessary for us to provide reasonable assurance with respect to our financial reports and to effectively prevent fraud. If we cannot provide reasonable assurance with respect to our financial reports and effectively prevent fraud, our reputation and operating results could be harmed. Further, the complexities of our quarter-end and year-end closing processes increase the risk that a weakness in internal controls over financial reporting may go undetected. Therefore, even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements.
A material weakness in our internal control over financial reporting could adversely impact our ability to provide timely and accurate financial information. If we are unable to report financial information timely and accurately or to maintain effective disclosure controls and procedures, we could be subject to, among other things, regulatory or enforcement actions by the SEC and the NYSE American, including a delisting from the NYSE American, securities litigation, debt rating agency downgrades or rating withdrawals, any one of which could adversely affect the valuation of our common stock and could adversely affect our business prospects.
Decreases in oil and natural gas prices may require us to take write-downs of the carrying values of our oil and natural gas properties, potentially requiring earlier than anticipated debt repayment and negatively impacting the trading value of our securities.
Accounting rules require that we periodically review the carrying value of our oil and natural gas properties for possible impairment through the performance of a ceiling test. Based on specific market factors and circumstances at the time of prospective impairment reviews, and the continuing evaluation of development plans, production data, economics and other factors, we may be required to write down the carrying value of our oil and natural gas properties.
We perform the ceiling test at least quarterly and, in the event capitalized costs of the full cost pool exceed this ceiling, we would recognize an impairment expense. We did not incur an impairment expense for the year ended December 31, 2018. We recognized an impairment expense of approximately $10.5 million for the year ended December 31, 2017.
Future write-downs could occur for numerous reasons, including, but not limited to, continued reductions in oil and natural gas prices that lower the estimate of future net revenues from proved oil and natural gas reserves, revisions to reserve estimates, or from the addition of non-productive capitalized costs to the full cost pool that do not result in a corresponding increase in oil and natural gas reserves. Impairments of plugging and abandonment of wells in progress are other areas where costs may be capitalized into the full cost pool, without any corresponding increase in reserve values. As such, these situations could result in additional impairment expenses in the future. Impairment charges would not affect cash flow from operating activities but could have a material adverse effect on our net income and stockholders’ equity.
Our estimated reserves are based on many assumptions that may prove inaccurate. Any significant inaccuracies in our reserve estimates or underlying assumptions will materially affect the quantities and present value of our reserves.
Oil and natural gas reserve engineering requires subjective estimates of underground accumulations of oil and natural gas and assumptions concerning future oil and natural gas prices, production levels, and operating and development costs. As a result, estimated quantities of proved reserves and projections of future production rates and the timing of development expenditures may prove to be inaccurate. Any material inaccuracies in these reserve estimates or underlying assumptions could materially affect the quantities and present value of our reserves which could adversely affect our business, results of operations, and financial condition.
In order to prepare estimates, we must project production rates and the timing of development expenditures and analyze available geological, geophysical, production and engineering data. The extent, quality and reliability of this data can vary. The process also requires economic assumptions about matters such as oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. Although the reserve information contained herein is reviewed by independent reserve engineers, estimates of oil and natural gas reserves are inherently imprecise.
Further, the present value of future net cash flows from proved reserves may not be the current market value of estimated oil and natural gas reserves. If our reserve estimates or the underlying assumptions prove inaccurate, it could have a negative impact on our earnings and net income, as well as the trading price of our securities.
Hedging transactions may limit our potential gains or result in losses
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In order to comply with the requirements of our Revolving Credit Agreement and to manage our exposure to price risks in the marketing of our oil and natural gas, we have entered into derivative contracts that economically hedge our oil and gas price on a portion of our production. These contracts may limit our potential gains if oil and natural gas prices were to rise substantially over the price established by the contract. In addition, such transactions may expose us to the risk of financial loss in certain circumstances, including instances in which there is a change in the expected differential between the underlying price in the hedging agreement and actual prices received; our production and/or sales of oil or natural gas are less than expected; payments owed under derivative hedging contracts come due prior to receipt of the hedged month’s production revenue; or the other party to the hedging contract defaults on its contract obligations.
Hedging transactions that we have entered into, or may enter into in the future, may not adequately protect us from declines in the prices of oil and natural gas. In addition, the counterparties under our current or future derivatives contracts may fail to fulfill their contractual obligations to us.
Our identified drilling locations are scheduled to be drilled over a period of several years, making them susceptible to uncertainties that could materially alter the occurrence or timing of our drilling.
Our management has specifically identified and scheduled drilling locations as an estimation of future multi-year drilling activities on our existing acreage. These scheduled drilling locations represent a significant component of our growth strategy. Our ability to drill and develop these locations depends on a number of uncertainties, including oil and natural gas prices, the availability of capital, costs, drilling results, and regulatory approvals. Because of these uncertainties, we do not know if the potential drilling locations previously identified will ever be drilled or if we will be able to produce oil or natural gas from our potential drilling locations. As such, actual drilling activities may materially differ from those presently identified, which could adversely affect our business.
Drilling for and producing oil and natural gas is a speculative activity and involves numerous risks and substantial and uncertain costs that could adversely affect us.
Our success will depend on the success of our drilling program. There is no way to predict in advance of drilling and testing whether any particular prospect will yield oil or natural gas in sufficient quantities to recover drilling or completion costs or to be economically viable. The use of seismic data and other technologies and the study of producing fields in the same area will not enable us to know conclusively prior to drilling whether oil or natural gas will be present or, if present, whether oil or natural gas will be present in commercial quantities as such studies are merely an interpretive tool.
Drilling for oil and natural gas involves numerous risks, including the risk that no commercially productive natural gas or oil reservoirs will be discovered. The cost of drilling, completing, and operating wells is substantial and uncertain, and drilling operations may be curtailed, delayed, or canceled as a result of a variety of factors beyond our control, including:
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unexpected or adverse drilling conditions;
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elevated pressure or irregularities in geologic formations;
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equipment failures or accidents;
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adverse weather conditions;
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compliance with governmental requirements; and
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shortages or delays in the availability of drilling rigs, crews, and equipment.
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Additionally, the budgeted costs of planning, drilling, completing and operating wells are often exceeded and such costs can increase significantly due to various complications that may arise during the drilling and operating processes. If actual drilling and development costs are significantly more than the current estimated costs, we may not be able to continue operations as proposed and could be forced to modify our drilling plans. A productive well may become uneconomical if water or other deleterious substances are encountered which impair or prevent the production of oil and/or natural gas from the well. Unsuccessful drilling activities could result in a significant decline in production and revenues and materially affect our operations and financial condition by reducing available cash and resources.
Financial difficulties encountered by our oil and natural gas purchasers, third-party operators or other third parties could decrease cash flow from operations and adversely affect our exploration and development activities.
We derive essentially all of our revenues from the sale of our oil, natural gas and NGLs to unaffiliated third-party purchasers, independent marketing companies and midstream companies. Any delays in payments from such purchasers caused by their financial problems will have an immediate negative effect on our results of operations and cash flows.
Additionally, liquidity and cash flow problems encountered by our working interest co-owners or the third-party operators of our non-operated properties may prevent or delay the drilling of a well or the development of a project. Our working interest co-owners may be unwilling or unable to pay their share of the costs of projects as they become due. In the case of a working interest owner, we could be required to pay the working interest owner’s share of the project costs.
Our industry is highly competitive, which may adversely affect our operations and performance.
We operate in a highly competitive environment. In addition to capital, the principle resources necessary for the exploration and production of oil and natural gas include: leasehold prospects under which oil and natural gas reserves may be discovered; drilling rigs and related equipment to explore for such reserves; and knowledgeable personnel to conduct all phases of oil and natural gas operations. We must compete for such resources with both major oil and natural gas companies and independent operators.
Many of our competitors have financial and other resources substantially greater than ours. The capital, materials and resources needed for our operations may not be available when needed. If we are unable to access capital, material and resources when needed, we may face various consequences, including the breach of our obligations under our oil and natural gas leases and the potential loss of those leasehold interests; damage to our reputation in the oil and gas community; inability to retain personnel or attract capital; a slowdown in our operations and decline in revenue; and a decline in the market price of our common stock.
Properties that we acquire may not produce oil or natural gas as projected, and we may be unable to determine reserve potential, identify liabilities associated with the properties or obtain protection from sellers against them, which could cause us to incur losses.
One of our growth strategies is to pursue selective acquisitions of undeveloped acreage potentially containing oil and natural gas reserves. If we choose to pursue an acquisition, we will perform a review of the target properties. However, these reviews are inherently incomplete as they are based on the quality, availability and interpretation of the reviewed data and the acumen and the assumptions of the evaluation personnel. Generally, it is not feasible to review in depth every individual property, well, facility and/or file involved in an acquisition. Even a detailed review of records and properties may not reveal existing or potential problems, nor will it permit a buyer to become sufficiently familiar with the properties to assess fully their deficiencies and potential. We may not perform an inspection on every well, and environmental problems, such as groundwater contamination, are not necessarily observable even when an inspection is undertaken. Even when problems are identified, we may not be able to obtain effective contractual protection against all or part of those problems, and we may assume environmental and other risks and liabilities in connection with the acquired properties. If we acquire properties with risks or liabilities that were unknown or not assessed correctly, our financial condition, results of operations and cash flows could be adversely affected as claims are settled and cleanup costs related to the liabilities are incurred.
We may incur losses or costs as a result of title deficiencies in the properties in which we invest.
Prior to the drilling of an oil and natural gas well, it is customary practice in the oil and natural gas industry for the operator of the well to obtain a preliminary title review of the spacing unit within which the proposed oil and natural gas well is to be drilled to ensure there are no obvious deficiencies in title to the well. Frequently, as a result of such examinations, certain curative work must be done to correct deficiencies in the marketability of the title, and such curative work entails expense. Failure to cure any title defects may adversely impact our ability in the future to increase production and reserves. In the future, we may suffer a monetary loss from title defects or title failure. Additionally, unproved and unevaluated acreage has greater risk of title defects than developed acreage. If there are any title defects or defects in assignment of leasehold rights in properties in which we hold an interest or acquire, we will suffer a financial loss which could adversely affect our financial condition, results of operations and cash flows.
Our producing properties are all located in the Delaware Basin, making us vulnerable to risks associated with operating in one major geographic area.
As of December 31, 2018, all of our estimated proved reserves were located in the Delaware Basin in Winkler, Loving, and Reeves Counties, Texas and Lea County, New Mexico. As a result of this concentration, we may be disproportionately exposed to the impact of delays or interruptions of production from these wells caused by transportation capacity constraints, curtailment of production, availability of equipment, facilities, personnel or services, governmental regulation, natural disasters, adverse weather conditions, plant closures for scheduled maintenance or interruption of transportation of oil or natural gas produced from the wells in this area.
In addition, the effect of fluctuations on supply and demand may become more pronounced within specific geographic oil and natural gas producing areas, which may cause these conditions to occur with greater frequency or magnify the effect of these conditions. Due to the concentrated nature of our portfolio of properties, a number of our properties could experience any of the same conditions at the same time, resulting in a relatively greater impact on our results of operations than they might have on other companies that have a more diversified portfolio of properties. Such delays or interruptions could have a material adverse effect on our financial condition and results of operations.
We may not be the operator on all of our drilling locations, and, therefore, we will not be able to control the timing of exploration or development efforts, associated costs, or the rate of production of any non-operated assets.
Currently, we are the operator of approximately 99% of our acreage. As we carry out our exploration and development programs, we may enter into arrangements with respect to existing or future drilling locations that result in wells being operated by others. As a result, we may have limited ability to exercise influence over the operations of the drilling locations operated by our partners. Dependence on the operator could prevent us from realizing target returns for those locations. The success and timing of exploration and development activities operated by our partners will depend on a number of factors that will be largely outside of our control and may adversely affect our financial condition and results of operation.
The marketability of our production is dependent upon transportation and processing facilities and third parties over which or whom we may have no control.
The marketability of our production depends in part upon the availability, proximity and capacity of pipelines, natural gas gathering systems, rail service, and processing facilities in addition to competing oil and natural gas production available to third-party purchasers. We deliver our produced crude oil and natural gas through trucking, gathering systems and pipelines. The lack of availability of capacity on third-party systems and facilities could reduce the price offered for our production or result in the shut-in of producing wells or the delay or discontinuance of our development plans.
Although we have contractual control over the transportation of our production through firm transportation arrangements, third-party systems and facilities may be temporarily unavailable due to market conditions, mechanical issues, adverse weather conditions, work-loads, or other reasons outside of our control. Additionally, if our natural gas contains levels of hydrogen sulfide that require treatment prior to transportation, it could cause delays in the transportation and marketing of our production. Any significant changes affecting these infrastructure systems and facilities, as well as any delays in constructing new infrastructure systems and facilities, could delay our production, which could negatively impact our results of operations, cash flows, and financial condition.
The shut-in of our wells could negatively impact our production, liquidity, and, ultimately, our operations, results, and performance.
Our production depends, in part, upon our wells that are capable of commercial production not being shut-in (i.e., suspended from production). The lack of availability of capacity on third-party systems and facilities or the shut-in of an oil field’s production could result in the shut-in of our wells. As of December 31, 2018, we had 3 gross (2.60 net) wells shut-in.
The producing wells in which we have an interest occasionally experience reduced or terminated production. These curtailments can result from mechanical failures, contract terms, pipeline and processing plant interruptions, market conditions, operator priorities, and weather conditions. These curtailments can last from a few days to many months, any of which could have an adverse effect on our results of operations.
If we experience low oil production volumes due to the shut-in of our wells or other mechanical failures or interruptions, it would impact our ability to generate cash flows from operations and we could experience a reduction in our available liquidity. A decrease in our liquidity could adversely affect our ability to meet our anticipated working capital, debt service, and other liquidity needs.
Unless we find new oil and natural gas reserves to replace our actual production, our reserves and production will decline, which would materially and adversely affect our business, financial condition, and results of operations.
Producing oil and natural gas reservoirs generally are characterized by declining production rates and depletion that vary depending upon various factors, including reservoir characteristics and subsurface and surface pressures. Our future oil and natural gas reserves and production and, therefore, our cash flow and revenue are highly dependent on our success in efficiently obtaining additional reserves. We may not be able to develop, find or acquire reserves to replace our current and future production at costs or other terms acceptable to us, or at all, in which case our business, financial condition and results of operations would be materially and adversely affected.
The results of our planned exploratory and development drilling are subject to drilling and completion execution risks, and drilling results may not meet our economic expectations for reserves or production.
Unconventional operations involve utilizing drilling and completion techniques as developed by us and our service providers. Risks that we face while drilling include, but are not limited to, not reaching the desired objective due to drilling problems, not landing our wellbore in the desired drilling zone or specific target, not staying in the desired drilling zone while drilling horizontally through the formation, not running our casing the entire length of the wellbore and not being able to run tools and other equipment consistently through the horizontal wellbore. Risks that we face while completing our wells include, but are not limited to, insufficient mechanical integrity, not being able to hydraulic fracture stimulate the planned number of stages, not being able to run tools the entire length of the wellbore, improper design and engineering for the reservoir parameters, and unsuccessfully cleaning out the wellbore after completion of the final fracture stimulation stage.
The success of our drilling and completion techniques can only be developed over time as more wells are drilled and production profiles are established. If our drilling results are less than anticipated or we are unable to execute our drilling program because of capital constraints, lease expirations, access to gathering systems or otherwise, the return on our investment in these areas may not be as attractive as we anticipate and we could incur material write-downs of undeveloped properties and the value of our undeveloped acreage could decline in the future.
The unavailability or high cost of drilling rigs, equipment supplies, or personnel could adversely affect our ability to execute our exploration and development plans.
The oil and gas industry is cyclical and, from time to time, there are shortages of drilling rigs, equipment, supplies or qualified personnel. During these periods, the costs of and demand for rigs, equipment and supplies may increase substantially and their availability may be limited. In addition, the demand for, and wage rates of, qualified personnel, including drilling rig crews, may rise as the number of rigs in service increases. If drilling rigs, equipment, supplies or qualified personnel are unavailable to us due to excessive costs or demand or otherwise, our ability to execute our exploration and development plans could be materially and adversely affected and, as a result, our financial condition and results of operations could be materially and adversely affected.
Terrorist attacks aimed at energy operations could adversely affect our business.
The continued threat of terrorism and the impact of military and other government action have led and may lead to further increased volatility in prices for oil and natural gas and could affect these commodity markets or the financial markets used by us. In addition, the U.S. government has issued warnings that energy assets may be a future target of terrorist organizations. These developments have subjected oil and natural gas operations to increased risks. Any future terrorist attack on our facilities, customer facilities, the infrastructure depended upon for transportation of products, and, in some cases, those of other energy companies, could have a material adverse effect on our business.
We are exposed to operating hazards and uninsured risks.
Our oil and natural gas exploration and production activities are subject to the operating risks and hazards associated with drilling for and producing oil and natural gas, including fires, explosions and blowouts; negligence of personnel; inclement weather; equipment or pipeline failure; abnormally pressured formations; and environmental pollution. These events may result in substantial losses or costs to our Company, including losses and costs resulting from injury or loss of life; severe damage to or destruction of property, natural resources or equipment; pollution or environmental damage; clean-up responsibilities; regulatory investigations; penalties and/or suspension of operations; or fees and other expenses incurred in the prosecution or defense of litigation relating to such events.
In accordance with customary industry practices, we maintain insurance against some, but not all, of these risks. Our insurance may not be adequate to cover all losses or liabilities. We do not carry business interruption insurance, and we cannot fully insure against pollution and environmental risks. We may elect not to carry certain types of insurance if our management believes that the cost of available insurance is excessive relative to the risks presented. The occurrence of an event not fully covered by insurance could have a material adverse effect on our financial condition and results of operations. The impact of natural disasters or weather events in the areas where we operate has resulted in escalating insurance costs and less favorable coverage terms. Losses and liabilities arising from uninsured or underinsured events may have a material adverse effect on our financial condition and operations, including the loss of our total investment in a particular prospect.
A failure of technology systems, data breach or cyberattack could materially affect our operations
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Our information technology systems may be vulnerable to security breaches, including those involving cyberattacks using viruses, worms or other destructive software, process breakdowns, phishing or other malicious activities, or any combination of the foregoing. Such breaches could result in unauthorized access to information, including customer, employee, or other confidential data. We do not carry insurance against these risks, although we do invest in security technology, perform penetration tests, and design our business processes to attempt to mitigate the risk of such breaches. However, there can be no assurance that security breaches will not occur. Moreover, the development and maintenance of these measures requires continuous monitoring as technologies change and security measures evolve. We have experienced, and expect to continue to experience, cyber security threats and incidents, none of which has been material to us to date. However, a successful breach or attack could have a material negative impact on our operations or business reputation and subject us to consequences such as litigation and direct costs associated with incident response.
Information technology solution failures, network disruptions, breaches of data security and cyberattacks could disrupt our operations by causing delays, impeding processing of transactions and reporting financial results, resulting in the unintentional disclosure of customer, employee or our information, or damage to our reputation. A system failure, data security breach or cyberattack could have a material adverse effect on our financial condition, results of operations or cash flows. In the past, we have experienced data security breaches resulting from unauthorized access to our e-mail systems, which to date have not had a
material impact on our business; however, there is no assurance that such impacts will not be material in the future.
We may not be able to keep pace with technological developments in the industry.
The oil and natural gas industry is characterized by rapid and significant technological advancements and introductions of new products and services using new technologies. As others use or develop new technologies, we may be placed at a competitive disadvantage or competitive pressures may force us to implement those new technologies at substantial costs. In addition, other oil and natural gas companies may have greater financial, technical, and personnel resources that allow them to enjoy technological advantages and, in the future, may allow them to implement new technologies before we are in a position to do so. We may not be able to respond to these competitive pressures and implement new technologies on a timely basis or at an acceptable cost. If one or more of the technologies used now or in the future were to become obsolete or if we are unable to use the most advanced commercially available technology, the business, financial condition, and results of operations could be materially adversely affected.
We have limited management and staff and may be dependent upon partnering arrangements.
As of December 31, 2018, we had 39 full-time employees. We leverage the services of independent consultants and contractors to perform various professional services, including engineering, oil and natural gas well planning and supervision, and land, legal, environmental, accounting and tax services. We also pursue alliances with partners in the areas of geological and geophysical services and prospect generation, evaluation and prospect leasing.
Our dependence on third-party consultants and service providers creates a number of risks, including but not limited to, the possibility that such third parties may not be available to us as and when needed and the possibility that we may not be able to properly control the timing and quality of work conducted with respect to our projects. If we experience significant delays in obtaining the services of such third parties or poor performance by such parties, our results of operations and stock price could be materially adversely affected.
Our business may suffer with the loss of key personnel or changes to our Board of Directors.
We depend to a large extent on the services of certain key management personnel and other executive officers and key employees. These individuals have extensive experience and expertise in evaluating and analyzing producing oil and natural gas properties and drilling prospects, maximizing production from oil and natural gas properties, marketing oil and natural gas production and developing and executing financing and hedging strategies. The loss of any of these individuals could have a material adverse effect on operations. We do not maintain key-man life insurance with respect to any of our employees. Our success will be dependent on our ability to continue to employ and retain skilled technical personnel.
We have an active board of directors that meets several times throughout the year and is intimately involved in the business and the determination of various operational strategies. Members of our board of directors work closely with management to identify potential prospects, acquisitions and areas for further development. If any directors resign or become unable to continue in their present role, it may be difficult to find replacements with the same knowledge and experience and as a result, operations may be adversely affected.
We may be subject to risks in connection with acquisitions, and the integration of significant acquisitions may be difficult.
Our business strategy is based on our ability to acquire additional reserves, oil and natural gas properties, prospects and leaseholds. Significant acquisitions and other strategic transactions may involve risks, including:
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diversion of our management’s attention to evaluating, negotiating and integrating significant acquisitions and strategic transactions;
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challenge and cost of integrating acquired operations, information management and other technology systems and business cultures with those of ours while carrying on our ongoing business;
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difficulty associated with coordinating geographically separate organizations;
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challenge of attracting and retaining capable personnel associated with acquired operations; and
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failure to realize the full benefit that we expect in estimated proved reserves, production volume, cost savings from operating synergies or other benefits anticipated from an acquisition, or to realize these benefits within the expected time frame.
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The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of our business. Members of our senior management and other staff may be required to devote considerable amounts of time to the integration process, which will decrease the time they will have to manage our business. If our senior management and staff are not able to effectively manage the integration process, or if any significant business activities are interrupted as a result of the integration process, our business could suffer.
We may face difficulties in securing and operating under authorizations and permits to drill, complete or operate our wells.
The continued growth in oil and natural gas exploration in the United States has drawn intense scrutiny from environmental and community interest groups, regulatory agencies and other governmental entities. As a result, we may face significant opposition to, or increased regulation of, our operations, that may make it difficult or impossible to obtain permits and other needed authorizations to drill, complete or operate, which could result in operational delays or otherwise make oil and natural gas exploration more costly or difficult.
Our operations are substantially dependent on the availability of water. Restrictions on our ability to obtain water may have an adverse effect on our financial condition, results of operations and cash flows.
Water is an essential component of deep shale oil and natural gas production during both the drilling and hydraulic fracturing processes. Historically, we have been able to purchase water from local land owners for use in our operations. However, Texas has endured severe drought conditions over the past several years. These drought conditions have led governmental authorities to restrict the use of water subject to their jurisdiction for hydraulic fracturing to protect local water supplies. If we are unable to obtain water to use in our operations from local sources, we may be unable to produce oil and natural gas economically, which could have an adverse effect on our financial condition, results of operations and cash flows.
Legislative and regulatory initiatives related to global warming and climate change could have an adverse effect on our operations and the demand for oil and natural gas.
The EPA has determined that emissions of carbon dioxide, methane and other “greenhouse gases,” or “GHGs,” endanger public health and the environment because emissions of such gases are, according to the EPA, contributing to climatic changes. Based on these findings, the EPA, under the Clean Air Act, has adopted and implemented regulations to restrict emissions of greenhouse gases.
In addition, the U.S. Congress has from time to time considered adopting legislation to reduce GHG emissions and almost one-half of the states have already taken legal measures to reduce GHG emissions, primarily through the planned development of GHG emission inventories and/or regional GHG cap and trade programs. Most of these GHG cap and trade programs work by requiring major sources of emissions, such as electric power plants, or major producers of fuels, such as refineries and natural gas processing plants, to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve the overall GHG emission reduction goal.
The adoption of legislation or regulatory programs to reduce GHG emissions could require us to incur increased operating costs, such as costs to purchase and operate emissions control systems, to acquire emissions allowances or comply with new regulatory or reporting requirements. Any such legislation or regulatory programs could also increase the cost of consuming, and thereby reduce demand for, the oil, natural gas and NGLs we produce. Consequently, legislation and regulatory programs to reduce GHG emissions could have an adverse effect on our business.
Legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays in the completion of oil and natural gas wells.
Hydraulic fracturing is an important and common practice that is used to stimulate production of natural gas and/or oil from dense subsurface rock formations, and we routinely implement hydraulic fracturing techniques in many of our drilling and completion programs. The process is typically regulated by state oil and natural gas commissions, but the EPA, under the federal Safe Drinking Water Act (“SDWA”), has asserted federal regulatory authority over certain hydraulic fracturing activities involving diesel fuel.
At the state level, several states have adopted or are considering legal requirements that could impose more stringent permitting, disclosure and well construction requirements on hydraulic fracturing activities. Additionally, local government may seek to adopt ordinances within their jurisdictions regulating the time, place and manner of drilling activities in general or hydraulic fracturing activities in particular or prohibit the performance of well drilling in general or hydraulic fracturing in particular. If new or more stringent federal, state, or local legal restrictions relating to the hydraulic fracturing process are adopted in areas where we operate, we could incur potentially significant added costs to comply with such requirements, experience delays or curtailment in our exploration, development, or production activities, and perhaps even be precluded from drilling wells.
In addition, a number of federal agencies are analyzing, or have been requested to review, environmental issues associated with hydraulic fracturing. These types of studies, depending on their degree of pursuit and any meaningful results obtained, could spur initiatives to further regulate hydraulic fracturing under the SDWA or other regulatory mechanisms.
Current water regulation relating to hydraulic fracturing, particularly water source and groundwater regulation, could result in increased operational costs, operating restrictions and delays.
Hydraulic fracturing can require between three to five million gallons of water per horizontal well. We may face regulatory concerns in both the sourcing and the discharge of water used in hydraulic fracturing.
In order to source water from the local water supply for hydraulic fracturing we may need to pay premium rates and be subject to a lower priority if the local area becomes subject to water restrictions. We may also seek water from alternative providers supporting the hydraulic fracturing industry. If we have an insufficient water supply, we will be unable to engage in hydraulic fracturing until such supply is located.
In addition, hydraulic fracturing results in water discharges that must be treated and disposed of in accordance with applicable regulatory requirements. Environmental regulations governing the withdrawal, storage and use of surface water or groundwater necessary for hydraulic fracturing may increase operating costs and cause delays, interruptions or termination of operations, the extent of which cannot be predicted, and all of which could have an adverse effect on operations and financial performance. Our ability to remove and dispose of water will affect production, and the cost of water treatment and disposal may affect profitability. The imposition of new environmental initiatives and regulations could also include restrictions on our ability to conduct hydraulic fracturing or disposal of produced water, drilling fluids and other substances associated with the exploration, development and production of oil and natural gas.
We are subject to numerous federal, state, local and other laws and regulations that can adversely affect the cost, manner or feasibility of doing business.
Our operations are subject to extensive federal, state and local laws and regulations relating to the exploration, production and sale of oil and natural gas. Future laws or regulations, any adverse change in the interpretation of existing laws and regulations or our failure to comply with existing legal requirements may result in substantial penalties and harm to our business and could affect our results of operations and financial condition. We may be required to make large and unanticipated capital expenditures to comply with applicable laws and governmental regulations, including regulations governing land use restrictions; lease permit restrictions; drilling bonds and other financial responsibility in connection with operations, such as plugging and abandonment bonds; well spacing; unitization and pooling of properties; safety precautions; operational reporting; eminent domain and government takings; and taxation.
Our operations could be significantly delayed or curtailed and our cost of operations could significantly increase as a result of future changes in federal, state or local laws, regulatory requirements or restrictions.
We may incur substantial expenses, and potentially resulting liabilities, to ensure our operations are in compliance with environmental laws and regulations
.
Our oil and natural gas operations are subject to stringent federal, state and local laws and regulations relating to environmental protection, including laws and regulations relating to the release and disposal of materials into the environment. These laws and regulations, among other things, require a permit to be obtained before drilling or facility mobilization and commissioning, or injection or disposal commences; limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas; and impose substantial liabilities for pollution resulting from our operations.
Changes in environmental laws and regulations occur frequently and any changes that result in more stringent or costly waste handling, storage, transport, disposal or cleanup requirements could require us to make significant expenditures to reach and maintain compliance and may otherwise have a material adverse effect on our industry in general and on our own results of operations, competitive position or financial condition. Under these environmental laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination regardless of whether we were responsible for the release or contamination or if our operations met previous standards in the industry at the time they were performed.
Risks Relating to Our Securities
The market price of our common stock may be volatile, which may depress the market price of our securities and result in substantial losses to investors if they are unable to sell their securities at or above their purchase price.
The market price of our securities may fluctuate substantially for the foreseeable future, primarily due to a number of factors, including:
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our status as a company with a limited operating history and limited revenues to date, which may make risk-averse investors more inclined to sell their shares on the market more quickly and at greater discounts than would be the case with the shares of a seasoned issuer in the event of negative news or lack of progress;
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announcements of technological innovations or new products by us or our existing or future competitors;
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the timing and development of our products;
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general and industry-specific economic conditions;
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actual or anticipated fluctuations in our operating results;
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actions by our stockholders;
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changes in our cash flow from operations or earnings estimates;
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changes in market valuations of similar companies;
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our capital commitments;
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the sale or attempted sale or a large amount of common stock into the market; and
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the loss of any of our key management personnel.
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Many of these factors are beyond our control and may decrease the market price of our common stock, regardless of our operating performance.
We may issue shares of our preferred stock with greater rights than our common stock.
Our articles of incorporation authorize our board of directors to issue one or more series of preferred stock and set the terms of the preferred stock without seeking any further approval from our stockholders. Any preferred stock that is issued may rank ahead of our common stock, in terms of dividends, liquidation rights and voting rights. We currently have two series of preferred stock issued and outstanding, which ranks senior to our common stock with respect to dividends and rights on the liquidation, dissolution or winding up of the Company, amongst other preferences and rights.
There may be future dilution of our common stock.
We have a significant amount of derivative securities outstanding, which upon exercise or conversion, would result in substantial dilution of our common stock. To the extent outstanding restricted stock units, warrants or options to purchase our common stock under our 2016 Omnibus Incentive Plan or our 2012 Equity Incentive Plan are exercised, the price vesting triggers under the performance shares granted to our executive officers are satisfied, or additional shares of restricted stock are issued to our employees, holders of our common stock will experience dilution. Furthermore, the sale of additional equity or convertible debt securities could result in further dilution to our existing stockholders and cause the price of our outstanding securities to decline.
We do not expect to pay dividends on our common stock.
We have never paid dividends with respect to our common stock, and we do not expect to pay any dividends, in cash or otherwise, in the foreseeable future. We intend to retain any earnings for use in our business. In addition, our credit facilities and preferred stock prohibit us from paying any dividends. In the future, we may agree to further restrictions. Any return to stockholders will therefore be limited to the appreciation of their stock.
Securities analysts may not initiate coverage of our shares or may issue negative reports, which may adversely affect the trading price of the shares.
Securities analysts may not provide research reports on our Company. If securities analysts do not cover our Company, the lack of coverage may adversely affect the trading price of our shares. The trading market for our shares will rely in part on the research and reports that securities analysts publish about us and our business. If one or more of the analysts who cover our Company downgrades our shares, the trading price of our shares may decline. If one or more of these analysts ceases to cover our Company, we could lose visibility in the market, which, in turn, could also cause the trading price of our shares to decline. Further, because of our small market capitalization, it may be difficult for us to attract securities analysts to cover our Company, which could significantly and adversely affect the trading price of our shares.
Anti-takeover effects of certain provisions of Nevada state law hinder a potential takeover of our Company.
The existence of certain provisions under Nevada law could delay or prevent a change in control of the Company, which could adversely affect the price of our common stock. Additionally, Nevada law imposes certain restrictions on mergers and other business combinations between us and any holder of 10% or more of our outstanding common stock.
Item 1B. Unresolved Staff Comments
As a smaller reporting company, we are not required to provide disclosure pursuant to this Item.
Item 3. Legal Proceedings
We may from time to time be involved in various legal actions arising in the normal course of business. However, we do not believe there is any currently pending litigation that could have, individually or in the aggregate, a material adverse effect on our results of operations or financial condition.
Item 4. Mine Safety Disclosures
Not applicable.
Notes to Consolidated Financial Statements
NOTE 1 – Organization and Business
Lilis Energy, Inc. (“Lilis”, “Lilis Energy” or the “Company”) was incorporated in the State of Nevada and is listed and traded on the American New York Stock Exchange. The Company is an independent oil and natural gas company focused on the acquisition, development, and production of conventional and unconventional oil and natural gas properties in the core of the Delaware Basin in Winkler, Loving, and Reeves Counties, Texas and Lea County, New Mexico.
NOTE 2 – Basis of Presentation and Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries which includes Brushy Resources, ImPetro Operating, LLC (“ImPetro Operating”), ImPetro Resources, LLC (“ImPetro”), Lilis Operating Company, LLC (“Lilis Operating”), and Hurricane Resources LLC (“Hurricane”). All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The accompanying consolidated financial statements are prepared in conformity with GAAP which requires the Company to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities; disclosure of contingent assets and liabilities at the date of the financial statements, the reported amounts of revenues and expenses during the reporting period; and the quantities and values of proved oil, natural gas and natural gas liquid (“NGL”) reserves used in calculating depletion and assessing impairment of its oil and natural gas properties. The most significant estimates pertain to the evaluation of unproved properties for impairment, proved oil and natural gas reserves and related cash flow estimates used in the depletion and impairment of oil and natural gas properties; the timing and amount of transfers of our unevaluated properties into our amortizable full cost pool; the fair value of embedded derivatives and commodity derivative contracts, accrued oil and natural gas revenues and expenses, valuation of options and warrants, and the allocation of general administrative expenses. Actual results could differ significantly from these estimates.
Reclassifications
Certain reclassifications have been made to the prior year financial statements to conform to the
2018
presentation. These reclassifications have no effect on the Company’s previously reported results of operations, shareholders’ equity or cash flows.
In the preparation of the year-end consolidated financial statements, the Company identified an error in the classification of
$15.0 million
of cash received under the SCM agreement discussed in Note 10. Such receipts should have been reflected in investing activities instead of operating activities for the nine months ended September 30, 2018. The classification has been corrected in the consolidated statement of cash flows for the year ended December 31, 2018.
Cash and Cash Equivalents
Cash and cash equivalents include highly liquid instruments with an original maturity of three months or less are stated at cost, which approximates fair value.
Accounts Receivable
The Company has accounts receivable from joint interest owners of properties operated by the Company. The Company typically has the right to withhold future revenue disbursements to recover any non-payment of related joint interest billings. Management routinely assesses accounts receivable amounts to determine their collectability and accrues an allowance for uncollectible receivables when, based on the judgment of management, it is probable that a receivable will not be collected. The Company records actual and estimated oil and natural gas revenue receivable from third parties at its net revenue interest. In addition, the Company has receivables derived from sales of certain oil and natural gas production which are collateral under the Company’s credit agreements.
Fair Value of Financial Instruments
As of
December 31, 2018
and
2017
, the carrying value of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, revenue payable and advances from joint interest partners approximates fair value due to the short-term nature of such items. The carrying value of the Company’s secured debt is carried at cost which approximates the fair value of the debt as the related interest rates approximates interest rates currently available to the Company.
Oil and Natural Gas Properties
The Company uses the full cost method of accounting for oil and natural gas operations. Under this method, costs related to the exploration, non-production related development and acquisition of oil and natural gas reserves are capitalized. Such costs include land acquisition costs, geological and geophysical expenses, carrying charges on non-producing properties, costs of drilling, developing and completing productive wells, and any other costs directly related to acquisition and exploration activities. Proceeds from property sales are generally applied as a credit against capitalized exploration and development costs, 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 proved reserves.
Depletion of exploration and development costs and depreciation of wells and tangible production assets is computed using the units-of-production method based upon estimated proved oil and natural gas reserves. Costs included in the depletion base to be amortized include (a) all proved capitalized costs including capitalized asset retirement costs net of estimated salvage values, less accumulated depletion, and (b) estimated future development cost to be incurred in developing proved reserves, that are not otherwise included in capitalized costs.
Under the full cost method of accounting, capitalized oil and natural gas property costs less accumulated depletion (net of deferred income taxes) may not exceed an amount equal to the sum of the present value, discounted at
10%
, of estimated future net revenues from proved oil and natural gas reserves and the cost of unproved properties not subject to amortization (without regard to estimates of fair value), or estimated fair value, if lower, of unproved properties that are not subject to amortization. Should capitalized costs exceed this ceiling, an impairment expense is recognized.
The present value of estimated future net cash flows was computed by applying a flat oil price to forecast revenues from estimated future production of proved oil and natural gas reserves as of period-end, less estimated future expenditures to be incurred in developing and producing the proved reserves (assuming the continuation of existing economic conditions), less any applicable future taxes. For the year ended
December 31, 2018
, the ceiling value of the Company’s reserves was calculated based upon SEC pricing of
$65.56
per barrel for oil and
$3.10
per MMBtu for natural gas.
The costs of unproved oil and gas properties are excluded from amortization until the properties are evaluated. Costs are transferred into the amortization base on an ongoing basis as the properties are evaluated and proved oil and natural gas reserves are established or if impairment is determined. Unproved oil and gas properties are assessed periodically, at least annually, to determine whether impairment had occurred. The assessment considers the following factors, among others: intent to drill, remaining lease term, geological and geophysical evaluations, drilling results and activity, the assignment of proved reserves, the economic viability of development if proved reserves were assigned and other current market conditions. During any period in which these factors indicate an impairment, the cumulative drilling 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 were then subject to amortization.
Wells in Progress
Wells in progress connotes wells that are currently in the process of being drilled or completed or otherwise under evaluation as to their potential to produce oil and natural gas reserves in commercial quantities. Such wells continue to be classified as wells in progress and withheld from the depletion calculation and the ceiling test until such time as either proved reserves can be assigned, or the wells are otherwise abandoned. Upon either the assignment of proved reserves or abandonment, the costs for these wells are then transferred to the full cost pool and become subject to both depletion and the ceiling test calculations in accordance with full cost accounting under Rule 4-10 of Regulation S-X of the Securities Exchange Act of 1934, as amended.
Capitalized Interest
For significant oil and natural gas investments in unproved properties, and significant exploration and development projects that have not commenced production, interest is capitalized as part of the historical cost of developing and constructing assets. Capitalized interest is determined by multiplying the Company’s weighted-average borrowing cost on debt by the average amount of qualifying costs incurred. Once an asset subject to interest capitalization is completed and placed in service, the associated capitalized interest is expensed through depreciation or impairment. As of
December 31, 2018
, there were no significant exploratory
projects on unproved properties and none of the development projects exceeded the interest capitalization qualifying asset limit. As a result, no interest was capitalized as of
December 31, 2018
and
2017
.
Other Property and Equipment
Property and equipment include vehicles, office equipment and furniture which are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. The estimated useful lives of property and equipment range from
three
to
seven
years. The Company recorded approximately
$0.01 million
and
$0.04 million
of depreciation for the years ended
December 31, 2018
and
2017
, respectively.
Accrued Liabilities
As of
December 31, 2018
and
2017
, the Company’s accrued liabilities consisted of the following:
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December 31,
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2018
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2017
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(in thousands)
|
Accrued bonuses
|
$
|
2,300
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|
|
$
|
3,000
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|
Accrued drilling costs
|
7,850
|
|
|
3,615
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|
Accrued production expenses
|
2,926
|
|
|
182
|
|
Other accrued liabilities
|
1,718
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|
|
837
|
|
Total accrued liabilities
|
$
|
14,794
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|
|
$
|
7,634
|
|
Asset Retirement Obligation
s
The Company incurs retirement obligations for certain assets at the time they are placed in service. The fair values of these obligations are recorded as liabilities on a discounted basis. The costs associated with these liabilities are capitalized as part of the related assets and depreciated. Over time, the liabilities are accreted for the change in their present value. For purposes of depletion, the Company includes estimated dismantlement and abandonment cost, net of salvage values, associated with future development activities that have not yet been capitalized as asset retirement obligations. Asset retirement obligations incurred are classified as Level 3 (unobservable inputs) fair value measurements.
Revenue Recognition
Revenue is recognized when control passes to the purchaser which generally occurs when production is transferred to the purchaser. The Company measures revenue as the amount of consideration it expects to receive in exchange for the commodities transferred. All of the Company’s revenues from contracts with customers represent products transferred at a point in time as control is transferred to the customer.
The Company records revenue based on consideration specified in its contracts with its customers. The amounts collected on behalf of third parties are recorded in revenue payable. The Company recognizes revenue in the amount that reflects the consideration it expects to receive in exchange for transferring control of those goods to the customer. The contract consideration in the Company’s variable price contracts is typically allocated to specific performance obligations in the contract according to the price stated in the contract. Payment is generally received one or two months after the sale has occurred.
Stock based Compensation
The Company applies a fair value method of accounting for stock based compensation, which requires recognition in the financial statements of the cost of services received in exchange for equity awards. For equity awards, compensation expense is based on the fair value on the grant date or modification date and is recognized in the Company’s financial statements over the vesting period. The Company utilizes the Black-Scholes Merton option-pricing model to measure the fair value of stock options based on several criteria, including but not limited to, the valuation model used and associated input factors, such as expected term of the award, stock price volatility, risk free interest rate, dividend rate. These inputs are subjective and are determined using management’s judgment. If differences arise between the assumptions used in determining stock based compensation expense and the actual factors, which become known over time, the Company may change the input factors used in determining future stock based compensation expense. The Company recognizes forfeitures as and when the stock awards are forfeited.
The Company accounts for warrant grants to nonemployees whereby the fair values of such warrants are determined using the option pricing model at the earlier of the date at which the nonemployee’s performance is complete or a performance commitment is reached.
Income Taxes
The Company uses the asset and liability method in accounting for income taxes. Deferred tax assets and liabilities are recognized for temporary differences between financial statement carrying amounts and the tax bases of assets and liabilities and are measured using the tax rates expected to be in effect when the differences reverse. Deferred tax assets are also recognized for operating loss and tax credit carry forwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is used to reduce deferred tax assets when uncertainty exists regarding their realization.
The Company recognizes its tax benefits 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 settlement. A liability for “unrecognized tax benefits” is recorded for any tax benefits claimed that do not meet these recognition and measurement standards. As of
December 31, 2018
and
2017
, the Company has determined that no liability is required to be recognized.
The Company’s policy is to recognize any interest and penalties related to unrecognized tax benefits in income tax expense. No interest or penalties were required to be accrued at
December 31, 2018
and
2017
. Further, the Company does not expect that the total amount of unrecognized tax benefits will significantly increase or decrease during the next 12 months.
Concentration of Credit Risk
The Company operates a substantial portion of its oil and natural gas properties. As the operator of a property, the Company makes full payment for costs associated with the property and seeks reimbursement from the other joint interest owners in the property for their portion of those costs. When warranted, prepayments are required from joint interest owners for drilling and completion projects. Joint interest owners consist primarily of independent oil and natural gas producers whose ability to reimburse the Company could be negatively impacted by adverse market conditions.
The purchasers of the Company’s oil, natural gas and NGL production consist primarily of independent marketers, major oil and gas companies, refiners and gas pipeline companies. Credit evaluations are performed on the Company’s purchasers of its production and their financial condition is monitored on an ongoing basis. Based on those evaluations and monitoring, the Company may obtain letters of credit or parental guarantees from some purchasers.
All of the Company’s oil and natural gas derivative transactions are carried out in the over-the-counter market and are not typically subject to margin-deposit requirements. The use of derivative transactions involves the risk that the counterparties will be unable to meet the financial terms of such transactions. The Company monitors the credit ratings of its derivative counterparties on an ongoing basis. If a counterparty were to default on its obligations to the Company under the derivative contracts or seek bankruptcy protection, it could have a material adverse effect on its ability to fund planned activities and could result in a larger percentage of our future production being subject to commodity price volatility. In addition, in poor economic environments and tight financial markets, the risk of a counterparty default is heightened and fewer counterparties may participate in derivative transactions, which could result in greater concentration of exposure to any one counterparty or a larger percentage of the Company’s future production being subject to commodity price changes.
Major Customers
During the years ended
December 31, 2018
and
2017
, the Company’s major customers relative to total revenue consisted of the following:
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Year Ended December 31,
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2018
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2017
|
Texican Crude & Hydrocarbon, LLC
|
87
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%
|
|
85
|
%
|
ETC Field Services LLC
|
2
|
%
|
|
14
|
%
|
Lucid Energy
|
10
|
%
|
|
—
|
%
|
All others
|
1
|
%
|
|
1
|
%
|
|
100
|
%
|
|
100
|
%
|
Due to availability of other purchasers, we do not believe the loss of any single oil or natural gas customer would have a material adverse effect on our results of operations.
Derivative Instruments
All derivative instruments are recorded on the consolidated balance sheet at fair value as either an asset or a liability with changes in fair value recognized currently in earnings. Although derivative instruments are used by the Company to manage the price risk attributable to its expected oil and natural gas production, those derivative instruments have not been designated as accounting hedges under the accounting guidance. All of our derivatives are accounted for as mark-to-market activities. Under ASC Topic 815, “Derivatives and Hedging,” these instruments are recorded on the consolidated balance sheets at fair value as either short term or long-term assets or liabilities based on their anticipated settlement date. The Company nets derivative assets and liabilities by commodity for counterparties where a legal right to such offset exists. Changes in the derivatives’ fair values are recognized in current earnings since the Company has elected not to designate its current derivative contracts as cash flow hedges for accounting purposes.
The Company has recognized certain conversion features within its Second Lien Term Loan as embedded derivatives that have been bifurcated from the Second Lien Term Loan, as defined in Note 8, and accounted for separately from the debt.
Recently Adopted Accounting Standards
The Company adopted Accounting Standard Update (ASU) No. 2016-02, Leases (Topic 842) on January 1, 2019. This ASU establishes significant changes to accounting for leases which include recognizing a lease liability and a right-of-use (ROU) asset for all leases, with terms exceeding 12 months on the Company’s Consolidated Balance Sheet. Expenses related to operating leases will continue to be recognized in the Company’s Consolidated Statements of Operations that are similar to current lease accounting guidance. The Company adopted this ASU using the modified retrospective approach and elected a package of practical expedients which allows the Company to avoid reassessing contracts that commenced prior to adoption and were correctly classified under existing lease accounting guidance. The Company will apply the transition requirements at the January 1, 2019 effective date. This approach allows for a cumulative effect adjustment in the period of adoption and prior periods will not be restated.
Policy elections permitted under this ASU that have been made by the Company include (a) not recognizing on the balance sheet leases with terms that are less than twelve months, (b) for agreements that contain both lease and non-lease components, combining these components together and accounting for them as a single lease, (c) the package of practical expedients, which allows the Company to avoid reassessing contracts that commenced prior to adoption and were correctly classified under ASC 840.
In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842) Land Easement Practical Expedient for Transition to Topic 842. This ASU provides an optional transition practical expedient to not evaluate under Topic 842 (discussed above) existing or expired land easements that were not previously accounted for as leases under the current lease guidance in Topic 840. An entity that elects this practical expedient should evaluate new or modified land easements under Topic 842 beginning at the date that the entity adopts Topic 842. Under the full cost method of accounting, we capitalize to oil and gas properties all property acquisition, exploration, and development costs, which include the costs of land easements. We plan to elect this practical expedient and continue to apply our current accounting policy to account for land easements that existed before our adoption of Topic 842 and will evaluate new or modified land easements under Topic 842 upon our adoption of Topic 842.
The Company has also made changes to its accounting systems, business and control processes to facilitate compliance with accounting and reporting requirements. Based on leases assessed and identified at January 1, 2019, the Company estimates the impact to its Consolidated Balance Sheet would be approximately between the range of
$6.7 million
and
$8.2 million
and does not expect a material impact on its Consolidated Statements of Operations or Consolidated Statement of Cash Flows
.
On January 1, 2018, the Company adopted the new accounting standard, Accounting Standards Codification, ASC 606
, Revenue from Contracts with Customers
and all the related amendments (the “New Revenue Standard”) using the modified retrospective method. In accordance with the modified retrospective method, comparative information is not restated and continues to be reported under the accounting standards in effect for those periods. The cumulative effect of initially adopting the New Revenue Standard, if any, is recorded as an adjustment to the opening balance of retained earnings. The Company’s revenue from customers is derived from production and sales of crude oil, natural gas and NGLs and recognized when control is transferred to the customer. As operator, the Company may market production on behalf of joint interest partners and various royalty owners. Under the terms of our joint operating agreements, the Company does not take control of the production attributable to our joint interest partners and the various royalty owners. Consequently, the Company recognizes revenues only for its share of the production, see Note 6. In accordance with the New Revenue Standard requirements, the impact of adoption on the Company’s consolidated statements of operations and consolidated balance sheets was as follows:
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|
|
|
|
|
|
|
|
|
|
|
|
|
As Reported
|
|
Balances without Adoption of ASC 606
|
|
Increase (Decrease)
|
Year Ended December 31, 2018
|
(in thousands)
|
Consolidated Statements of Operations:
|
|
|
|
|
|
Revenues
|
$
|
70,216
|
|
|
$
|
70,321
|
|
|
$
|
(105
|
)
|
Operating expenses
|
(3,392
|
)
|
|
(3,497
|
)
|
|
105
|
|
|
|
|
|
|
|
As of December 31, 2018
|
|
|
|
|
|
Consolidated Balance Sheets:
|
|
|
|
|
|
Accounts receivable
|
$
|
17,363
|
|
|
$
|
17,468
|
|
|
$
|
(105
|
)
|
Accrued liabilities
|
14,793
|
|
|
14,898
|
|
|
(105
|
)
|
As shown in this comparison table, there is no impact on the net loss from the New Revenue Standard adoption and, therefore, no adjustment to the opening balance of accumulated deficit. Prior to the adoption of the New Revenue Standard, the revenue line included the value of our natural gas gatherer’s contractual volume retainage fee, with an offsetting cost included in the gathering, processing and marketing costs line. In accordance with the New Revenue Standard, the Company will only recognize revenues for its share of the production, resulting in the removal of the retainage fee approximating
$105,000
from both revenues and operating expenses during the year ended December 31, 2018.
On July 13, 2017, the Financial Accounting Standards Board (“FASB”) issued a two-part ASU, ASU 2017-11, (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Redeemable Noncontrolling Interests with a Scope Exception (ASU 2017-11). Part I of ASU 2017-11 simplifies the accounting for certain financial instruments with down round features by requiring companies to disregard the down round feature when assessing whether the instrument is indexed to its own stock, for purposes of determining liability or equity classification. Companies that provide earnings per share (EPS) data will adjust their basic EPS calculation for the effect of the feature when triggered (that is, when the exercise price of the related equity-linked financial instrument is adjusted downward because of the down round feature) and will also recognize the effect of the trigger within equity. Part II of ASU 2017-11 is not applicable to the Company since it addresses concerns relating to an indefinite deferral available to private companies with mandatorily redeemable financial instruments and certain noncontrolling interests. The provisions of ASU 2017-11 related to down rounds are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted for all organizations. The Company elected to adopt ASU 2017-11 on January 1, 2018. The Company’s SOS Warrant Liability (as described in Note 7) was accounted for as a derivative instrument solely because of its down round feature. The outstanding SOS Warrants of
$0.2 million
as of the date of adoption were reclassified to equity and the Company no longer recognize any gain or loss based on the fair value of the SOS Warrants. The cumulative effect of the adoption was not material. The SOS Warrants expired on June 23, 2018. No other derivatives instruments were affected by the adoption of ASU 2017-11.
On June 20, 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting, which supersedes most of the prior accounting guidance on nonemployee share-based payments, and instead aligns it with existing guidance on employee share-based payments in Topic 718. As a result, nonemployee share-based payment transactions will be measured by estimating the fair value of the equity instruments that an entity is obligated to issue and the measurement date will be consistent with the measurement date for employee share-based payment awards (i.e., grant date for equity-classified awards).
Probability is to be considered on nonemployee awards with performance conditions. The classification will continue to be subject to the requirements of Topic 718, Compensation - Stock Compensation, although cost recognition of nonemployee awards will remain unchanged. The amendments become effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606. The Company elected to early adopt the ASC 2018-07 during the quarter ended September 30, 2018. As a result, during the year ended December 31, 2018, there was no material impact on non-employee share-based compensation.
On January 5, 2017, the FASB issued ASU 2017-01 Business Combinations (Topic 805): Clarifying the Definition of a Business (ASU 2017-01), which clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. ASU 2017-01 introduces a screen for determining when assets acquired are not a business and clarifies that a business must include, at a minimum, an input and a substantive process that contribute to an output to be considered a business. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company adopted ASU 2017-01 on January 1, 2018. During year ended December 31, 2018, the Company completed multiple acquisitions which were assessed in accordance with the new standard (see Note 4).
On January 1, 2018, the Company retroactively adopted ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force). This ASU requires the statements of cash flows to present the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents are now included with cash and cash equivalents when reconciling the beginning of period and end of period amounts presented on the statements of cash flows. The retrospective application of this new accounting guidance did not have a material impact in the Company’s accompanying consolidated statement of cash flows for the year ended December 31, 2017. For the year ended December 31, 2018, there was no restricted cash.
NOTE 3 - OIL AND NATURAL GAS PROPERTIES
The following table set forth a summary of oil and natural gas property costs (net of divestitures) at
December 31, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
Oil and natural gas properties:
|
(In thousands)
|
Proved
|
$
|
358,858
|
|
|
$
|
141,717
|
|
Unproved
|
169,863
|
|
|
101,771
|
|
Total oil and natural gas properties
|
528,721
|
|
|
243,488
|
|
Accumulated depletion, depreciation and amortization
|
(98,342
|
)
|
|
(73,183
|
)
|
Oil and natural gas properties, net
|
$
|
430,379
|
|
|
$
|
170,305
|
|
The following table set forth a summary of costs withheld from amortization as of December 31, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year of Acquisition
|
|
Total
|
|
2018
|
|
2017
|
|
2016
|
Unamortized costs:
|
(in thousands)
|
Unproved leasehold costs
|
$
|
168,302
|
|
|
$
|
92,505
|
|
|
$
|
52,744
|
|
|
$
|
23,053
|
|
Exploratory costs
|
1,561
|
|
|
1,561
|
|
|
—
|
|
|
—
|
|
Total
|
$
|
169,863
|
|
|
$
|
94,066
|
|
|
$
|
52,744
|
|
|
$
|
23,053
|
|
For the year ended December 31, 2018,
$11.1 million
of unproved property costs were transferred to proved properties due to defective titles in certain leases. There were no such transfers of unproved properties to proved properties for the year ended December 31, 2017.
Depreciation, depletion and amortization expense related to full cost pool was approximately
$25.4 million
and
$7.0 million
for the years ended
December 31, 2018
, and
2017
, respectively.
NOTE 4 - ACQUISITIONS AND DIVESTITURES
Southwest Royalties Acquisition
On October 16, 2018, Lilis completed an acquisition of approximately
568.5
net acres in Winkler county in Texas from Southwest Royalties LLC (the “Southwest Royalties Acquisition”) for total consideration of approximately
$17.0 million
. The Company recorded
$12.6 million
of the total consideration to the full cost pool associated with acquired working interests in proved properties and
$4.5 million
to unproved acreage cost. The Southwest Royalties Acquisition was accounted for as a business combination. Therefore, the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated acquisition date fair values available at closing. Transaction costs associated for this acquisition were immaterial and were expensed in the Consolidated Statements for Operations during the year ended December 31, 2018. Revenues and operating expenses associated with the proved properties were insignificant to the December 31, 2018 Consolidated Statements of Operations.
The following table presents the final allocation of the purchase price to the assets acquired and liabilities assumed as of the acquisition date:
|
|
|
|
|
|
As of October 16, 2018
|
|
(In thousands)
|
Fair value of net assets:
|
|
Proved oil and natural gas properties
|
$
|
12,562
|
|
Unproved oil and natural gas properties
|
4,542
|
|
Total assets acquired
|
17,104
|
|
Asset retirement obligations assumed
|
(65
|
)
|
Fair value of net assets acquired
|
$
|
17,039
|
|
Ameredev Leasehold Acreage Exchange Transaction
On August 1, 2018, the Company entered into a Leasehold Exchange Agreement (the “Ameredev Exchange Agreement”) with Ameredev II, LLC (“Ameredev”) to exchange certain leasehold interests located in Lea County, New Mexico owned by the Company for certain leasehold interests owned by Ameredev also located in Lea County, New Mexico. The Ameredev Exchange Agreement closed on September 14, 2018, and required the Company pay Ameredev
$12,500
for each net mineral acre received in excess of the Company’s net mineral acres traded to Ameredev. The Company’s payment for excess net mineral acres was
$0.7 million
. In connection with the Ameredev Exchange Agreement, the Company assumed the working interests in
four
wells pursuant to which Ameredev advanced the Company
$6.5 million
for the estimated costs of the four wells. At the closing of the exchange transaction, the Company refunded the
$6.5 million
to Ameredev. The
four
wells are located in Lea County, New Mexico and operated by the Company. Total proceeds paid to Ameredev was approximately
$7.2 million
. Substantially, all the assets acquired were unproved oil and natural gas properties. As a result, the acquisition was accounted for as an asset acquisition and was recorded as an adjustment to the full cost pool. Transaction costs associated for this acquisition were immaterial.
Felix Holdings Leasehold Acreage Exchange Transaction
On June 4, 2018, the Company entered into a Leasehold Exchange Agreement (the “Felix Exchange Agreement”) with Felix Energy Holdings II, LLC (“Felix”) to exchange certain leasehold interest located in Loving and Winkler Counties in Texas owned by the Company for certain leasehold interest located in the same counties owned by Felix. The Agreement closed on August 14, 2018, with an effective date of May 1, 2018. In addition to the Felix leasehold interests, the Company acquired certain working interests in two wells operated by the Company in Winkler County, Texas. The Company paid Felix for the well costs incurred by Felix to drill and complete the two wells, less any revenues paid to Felix. The final settlement was a payment of
$0.4 million
which was recorded as an adjustment to the full cost pool. Transaction costs associated for this acquisition were immaterial.
Anadarko Acquisition
On May 3, 2018, the Company completed the acquisition of certain leasehold interests and other oil and natural gas assets in Loving and Winkler Counties, Texas from Anadarko for cash consideration of
$7.1 million
. The acquisition includes substantially all unproved leaseholds and an insignificant amount of non-consent proved producing oil and natural gas properties. As a result,
the transaction is accounted for as an asset acquisition using the fair value of
$7.1 million
. Transaction costs associated for this acquisition were immaterial.
VPD Acquisition
On February 28, 2018, the Company completed the acquisition of certain leasehold interests and other oil and natural gas assets in Loving and Winkler Counties, Texas from VPD Texas, L.P. (“VPD”) for cash consideration of
$10.7 million
(the “VPD Acquisition”). Substantially all of the assets acquired were unproved oil and natural gas properties, thus the acquisition was accounted for as an asset acquisition. Total cash consideration recorded for the VPD acquisition was approximately
$11.1 million
including
$0.5 million
of related acquisition costs. VPD is an affiliate of Värde Partners, Inc. (“Värde”). Värde participated as lead lender in the Company’s Second Lien Term Loan (as defined below in Note 9) transaction in 2017 and as investor of the Company’s Series C Preferred Stock transaction in January 2018. As a result, the VPD Acquisition is considered a related party transaction. See Note 11 -
Related Party Transactions.
In connection with the above VPD Acquisition and pursuant to Article XVI.3(b) of the Joint Operating Agreement dated February 28, 2018 (the “JOA”) entered into between VPD and ImPetro Operating, LLC (“Operator”), a subsidiary of the Company, the Company has committed to the following drilling commitments:
|
|
•
|
drill and complete
two
horizontal wells (“Initial Commitment Wells”) no later than December 31, 2018; and
|
|
|
•
|
drill and complete at least
two
additional horizontal wells (“Subsequent Commitment Wells”) that target the Wolfcamp A/B Formation no later than December 31, 2019.
|
The Company has a one-time option to extend the deadline by an additional 75 days by providing written notice to VPD of such election on or before August 31, 2018, in the case of the Initial Commitment Wells, and August 31, 2019, in the case of the Subsequent Commitment Wells.
As of December 31, 2018, the Company has spud the first two Initial Commitment Wells and executed an Amendment to the JOA to extend the drilling and completion deadline of the two Initial Commitment Wells to May 1, 2019.
OEP Acquisition
On January 30, 2018, the Company entered into a Purchase and Sale Agreement (the “Purchase and Sale Agreement”) by and between the Company and OneEnergy Partners Operating, LLC (“OEP”), pursuant to which the Company agreed to purchase from OEP, and OEP agreed to sell to the Company, certain oil and natural gas properties and related assets for a purchase price of
$70 million
, subject to customary purchase price adjustments (the “OEP Acquisition”). The properties acquired by the Company pursuant to the Purchase and Sale Agreement consist of leasehold acreage in the Delaware Basin in Lea County, New Mexico. On March 15, 2018, the Company completed the OEP Acquisition whereby the Company paid
$40 million
in cash and issued
6,940,722
shares of the Company’s common stock valued at approximately
$24.9 million
for a total purchase price of approximately
$64.9 million
, before acquisition costs and customary purchase price adjustments. The value of the shares issued was determined using the closing price of the Company’s stock on the date of closing. Transaction costs associated for this acquisition were
$1.1 million
.
Substantially, all the assets acquired in the OEP Acquisition were unproved oil and natural gas property. As a result the OEP acquisition was accounted for as an asset purchase of proved properties and unproved properties using relative fair value of the assets acquired. The proved producing properties were valued based on internal estimates of future production using strip pricing and the present value discounted at
10%
. Unproved properties acquired were valued using a market approach.
KEW Acquisition
As of December 31, 2017, the Company completed the acquisition of unproved acreage in Winkler County, Texas from KEW Drilling, a Delaware limited partnership (“KEW”), for cash consideration of
$48.9 million
plus
$0.8 million
of related acquisition costs. Substantially, all the assets acquired in the KEW acquisition were unproved oil and natural gas properties. As a result, the acquisition was accounted for as an asset acquisition using the relative fair value, which was the total cash consideration of approximately
$49.7 million
.
DJ Basin Properties Divestiture
On March 31, 2017, the Company entered into a purchase and sale agreement with Nanke Energy LLC for the divestiture of all of its oil and natural gas properties located in the Denver-Julesburg Basin (the “DJ Basin”) for consideration of
$2 million
,
subject to customary post-closing purchase price adjustments. The sale of the Company’s DJ Basin assets did not significantly alter the relationship between capitalized costs and proved reserves, and as such, all proceeds were recorded as adjustments to the Company’s full cost pool with no gain or loss recognized. The DJ Basin assets were sold to an entity owned by the Company’s former chief financial officer and therefore the divestiture is considered a related party transaction. See Note 11 -
Related Party Transactions
. The net proceeds of
$1.08 million
received on March 31, 2017 included an offset against
$0.7 million
of severance pay and
$0.22 million
of net sales adjustments due to the purchaser. In addition, the Company received
$0.2 million
in proceeds from the sale of non-operated properties sold in 2017.
NOTE 5 - ASSET RETIREMENT OBLIGATIONS (ARO)
The Company’s ARO represent the present value of the estimated cash flows expected to be incurred to plug, abandon and remediate producing properties, excluding salvage values, at the end of their productive lives in accordance with applicable laws. Revisions in estimated liabilities during the period relate primarily to changes in estimates of asset retirement costs. Revisions in estimated liabilities can also include, but are not limited to, revisions of estimated inflation rates, changes in property lives and expected timing of settlement.
The following table summarizes the changes in the Company’s ARO:
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
(In thousands)
|
ARO, beginning of period
|
$
|
952
|
|
|
$
|
1,257
|
|
Additional liabilities incurred
|
374
|
|
|
20
|
|
Accretion expense
|
85
|
|
|
82
|
|
Liabilities settled
|
(87
|
)
|
|
(288
|
)
|
Revision in estimates (1)
|
1,120
|
|
|
(119
|
)
|
ARO, end of period
|
2,444
|
|
|
952
|
|
Less: current portion of ARO (2)
|
(11
|
)
|
|
(226
|
)
|
ARO, non-current
|
$
|
2,433
|
|
|
$
|
726
|
|
|
|
(1)
|
The significant increase in revision of estimates of
$1.1 million
for the year ended December 31, 2018 was primarily attributed to increases in plugging and abandonment cost estimates by approximately
$50,000
per well.
|
(2) The current portion of ARO is included in accrued liabilities in the consolidated balance sheets.
NOTE 6 - REVENUE
Revenue is recognized when control passes to the purchaser which generally occurs when production is transferred to the purchaser. The Company measures revenue as the amount of consideration it expects to receive in exchange for the commodities transferred. All of the Company’s revenues from contracts with customers represent products transferred at a point in time as control is transferred to the customer.
The Company records revenue based on consideration specified in its contracts with its customers. The amounts collected on behalf of third parties are recorded in revenue payable. The Company recognizes revenue in the amount that reflects the consideration it expects to receive in exchange for transferring control of those goods to the customer. The contract consideration in the Company’s variable price contracts is typically allocated to specific performance obligations in the contract according to the price stated in the contract. Payment is generally received one or two months after the sale has occurred.
Crude oil revenues
Crude oil from our operated properties is produced and stored in field tanks. The Company recognizes crude oil revenue when control passes to the purchaser. The Company’s crude oil is currently sold under a single short-term contract. The purchaser’s commitment includes all quantities of crude oil from the leases that are covered by the contract, with no quantity-based restrictions or variable terms. Pricing is based on posted indexes for crude oil of similar quality, less a fees deduction that is subject to
negotiation. As of the most recent contract amendments, the negotiable fees deduction was
$5.25
per barrel from June 1, 2018 through July 31, 2018, then
$5.15
per barrel from August 1, 2018 through February 28, 2019, continuing on a month-to-month basis thereafter unless renegotiated or canceled upon 30 days’ notice. The posted index prices change monthly based on the average of daily index price points for each sales month.
Natural gas and NGL revenues
Natural gas is produced and transported via pipelines to gas processing facilities. NGLs are extracted from the natural gas at the processing facilities and processed natural gas and NGLs are marketed and sold separately on the Company’s behalf after processing. All of our operated natural gas production is sold under one of three natural gas contracts which are long-term in nature; however, one of these natural gas contracts includes 30-day cancellation provisions, and the Company therefore classifies such contract as short-term. The processor’s commitment to sell on the Company’s behalf includes all quantities of natural gas and NGL produced from specific wellbores or dedicated acreage as defined in the contract, with no quantity-based restrictions or variable terms. The gas contracts are generally market based pricing less adjustments for transportation and processing fees. A portion of natural gas delivered to the processing plants is used as fuel at the processing plant without reimbursement. The Company recognizes revenue for natural gas and NGLs when control passes at the tailgate of the processing plant.
Gathering, processing and transportation
Natural gas must be transported to a gas processing plant facility for treatment and to extract NGLs, then the final residue gas and liquid products are marketed for sale to end users at the tailgate of the plant. As a result of these activities, the Company incurs costs that are contractually passed to it from the gatherer per customary industry practice. Such costs include fees for gathering the gas and moving it from wellhead to plant inlet, plant electricity usage, inlet compression, carbon dioxide and hydrogen sulfide treatments, processing tax, fuel usage, and marketing at the tailgate. Gathering, processing and transportation costs are presented as operating expenses in the Company’s condensed consolidated statement of operations.
Imbalances
Natural gas imbalances occur when the Company sells more or less than its entitled ownership percentage of total natural gas production. Any amount received in excess of its share is treated as a liability. If the Company receives less than its entitled share, the underproduction is recorded as a receivable. The Company did not have any significant natural gas imbalance positions as of December 31, 2018 and December 31, 2017.
Contract balances and prior period performance obligations
The Company is entitled to payment from purchasers once its performance obligations have been satisfied upon delivery of the product, at which point payment is unconditional, and the Company records these invoiced amounts as accounts receivable
in its condensed consolidated balance sheets. To the extent actual volumes and prices of oil and natural gas are unavailable for a given reporting period because of timing or information not received from third parties, the expected sales volumes and prices for those properties are estimated and also recorded as accounts receivable in the accompanying condensed consolidated balance sheets. In this scenario, payment is unconditional, as the Company has satisfied its performance obligations through delivery of the relevant product. As a result, the Company has concluded that its product sales do not give rise to contract assets or liabilities under the New Revenue Standard.
The Company records revenue in the month production is delivered to the purchaser. However, settlement statements for certain oil, natural gas and NGL sales may not be received for 30 to 60 days after the date production is delivered, and as a result, the Company is required to estimate the amount of production that was delivered to the customer and the price that will be received for the sale of the product. Additionally, to the extent actual volumes and prices of oil, natural gas and NGLs are unavailable for a given reporting period because of timing or information not received from third-party purchasers, the expected sales volumes and prices for those barrels of oil, cubic feet of gas and gallons of NGL are also estimated. The Company records the differences between its estimates and the actual amounts received for product sales in the month that payment is received from the purchaser. The Company has existing internal controls in place for its estimation process, and any identified differences between its revenue estimates and actual revenue received historically have not been significant.
Significant judgments
The Company engages in various types of transactions in which midstream entities process its gas and subsequently market resulting NGLs and residue gas to third-party customers on the Company’s behalf per gas purchase contracts. These types of transactions require judgment to determine whether the Company is the principal or the agent in the contract and, as a result,
whether revenues are recorded gross or net. The Company maintains control of the natural gas and NGLs during processing and consider itself the principal in these arrangements.
Practical expedients
A significant number of the Company’s product sales are short-term in nature with contract term of one year or less. For those contracts, the Company has utilized the practical expedient in the New Revenue Standard that exempts the Company from disclosure of the transaction price allocated to remaining performance obligations if the performance obligation is part of a Contract that has an original expected duration of one year or less. For the Company’s product sales that have contract terms less than one year, the Company has utilized the practical expedient in the New Revenue Standard that states that it is not required to disclose the transaction price allocated to remaining performance obligations if the variable consideration is allocated entirely to a wholly unsatisfied performance obligation. Under these sales contracts, each unit of product represents a separate performance obligation; therefore, future volumes are wholly unsatisfied and disclosure of the transaction price allocated to remaining performance obligations is not required. The following table disaggregates the Company’s revenue by contract type (
in thousands
):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term contracts
|
|
Long-term contracts
|
|
Total
|
Year Ended December 31, 2018
|
(in thousands)
|
Crude Oil
|
$
|
58,042
|
|
|
$
|
—
|
|
|
$
|
58,042
|
|
Natural Gas
|
1,045
|
|
|
4,201
|
|
|
5,246
|
|
NGLs
|
1,381
|
|
|
5,547
|
|
|
6,928
|
|
Gathering, processing and transportation
|
(676
|
)
|
|
(2,716
|
)
|
|
(3,392
|
)
|
Customer Credit Risk
Our principal exposure to credit risk is through receivables from the sale of our oil and natural gas production of approximately
$8.2 million
at December 31, 2018, and through actual and accrued receivables from our joint interest partners of approximately
$11.4 million
at December 31, 2018. We are subject to credit risk due to the concentration of our oil and natural gas receivables with our most significant customers. We do not require our customers to post collateral, and the inability of our significant customers to meet their obligations to us or their insolvency or liquidation may adversely affect our financial results.
NOTE 7 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company measures fair value of its financial assets on a three-tier value hierarchy, which prioritizes the inputs, used in the valuation methodologies in measuring fair value:
|
|
|
●
|
Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
|
●
|
Level 2 - Other inputs that are directly or indirectly observable in the marketplace.
|
●
|
Level 3 - Unobservable inputs which are supported by little or no market activity.
|
The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The determination of the fair values of our derivative contracts incorporates various factors, which include not only the impact of our non-performance risk on our liabilities but also the credit standing of the counterparties involved. We utilize counterparty rate of default values to assess the impact of non- performance risk when evaluating both our liabilities to, and receivables from, counterparties.
Recurring Fair Value Measurements
The financial instruments measured at fair value on a recurring basis consist of the following:
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2018
|
|
2017
|
Derivative assets (liabilities):
|
|
|
|
Derivative assets - current
|
$
|
2,551
|
|
|
$
|
—
|
|
Derivative assets - non-current (1)
|
1,822
|
|
|
—
|
|
Derivative liabilities - current
|
(515
|
)
|
|
(853
|
)
|
Derivative liabilities - non-current (2)
|
(4,699
|
)
|
|
(72,937
|
)
|
Total derivative liabilities, net
|
$
|
(841
|
)
|
|
$
|
(73,790
|
)
|
(1) The non-current derivative assets are included in other assets in the consolidated balance sheets.
(2) Includes
$2.0 million
of embedded derivatives associated with Second Lien Loans and
$2.7 million
associated with commodity derivatives.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement Classification
|
|
|
|
Quoted Prices in
Active Markets for
Identical Assets or
Liabilities
(Level 1)
|
|
Significant Other
Observable Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Total
|
|
(in thousands)
|
As of December 31, 2018
|
|
|
|
|
|
|
|
|
|
|
|
Oil and natural gas derivative instruments:
|
|
|
|
|
|
|
|
Oil and natural gas derivative swap contracts
|
$
|
—
|
|
|
$
|
(2,923
|
)
|
|
$
|
—
|
|
|
$
|
(2,923
|
)
|
Oil and natural gas derivative collar contracts
|
—
|
|
|
4,047
|
|
|
—
|
|
|
4,047
|
|
Embedded derivative instruments:
|
|
|
|
|
|
|
|
Second Lien Term Loan conversion features
|
—
|
|
|
—
|
|
|
(1,965
|
)
|
|
(1,965
|
)
|
Total
|
$
|
—
|
|
|
$
|
1,124
|
|
|
$
|
(1,965
|
)
|
|
$
|
(841
|
)
|
|
|
|
|
|
|
|
|
As of December 31, 2017
|
|
|
|
|
|
|
|
Oil and natural gas derivative instruments:
|
|
|
|
|
|
|
|
Oil and natural gas derivative swap contracts
|
$
|
—
|
|
|
$
|
(706
|
)
|
|
$
|
—
|
|
|
$
|
(706
|
)
|
Oil and natural gas derivative collar contracts
|
—
|
|
|
(147
|
)
|
|
—
|
|
|
(147
|
)
|
Equity instruments:
|
|
|
|
|
|
|
|
Warrant liabilities
|
—
|
|
|
—
|
|
|
(223
|
)
|
|
(223
|
)
|
Embedded derivative instruments:
|
|
|
|
|
|
|
|
Second Lien Term Loan conversion features
|
—
|
|
|
—
|
|
|
(72,714
|
)
|
|
(72,714
|
)
|
Total
|
$
|
—
|
|
|
$
|
(853
|
)
|
|
$
|
(72,937
|
)
|
|
$
|
(73,790
|
)
|
Derivative assets and liabilities include unsettled amounts related to commodity derivative positions, including swaps and collars as of December 31, 2018 and 2017. The fair values of the Company’s derivatives are based on third-party pricing models which utilize inputs that are either readily in the public market which can be corroborated from active markets of broker quotes. Swaps and collars generally have observable inputs and these instruments are classified as Level 2.
The Company’s derivative liabilities also include embedded derivatives associated with the Second Lien Term Loan (as defined below) and warrants associated with notes payable. These instruments have fewer observable inputs from objective sources and are therefore measured using Level 3 inputs as follows:
Second Lien Term Loan Conversion Features:
Under the terms of the Company’s second lien credit agreement, dated as of April 26, 2017, by and among the Company, certain subsidiaries of the Company, as guarantors (the “Guarantors”), Wilmington Trust, National Association, as administrative agent (the “Agent”), and the lenders party thereto (the “Lenders”), including Värde as lead lender (the “Lead Lender”), as amended (the “Second Lien Credit Agreement”), the Lead Lender has the option to convert
70%
of the principal amount of each tranche of the Second Lien Term Loan (the “Second Lien Term Loan”) under the Second Lien Credit Agreement, together with accrued paid-in-kind interest and the make-whole premium on such principal amount (together the “Conversion Sum”) into shares of common stock. The make-whole premium is the cash amount representing the excess of (a) the present value at such repayment, prepayment or acceleration date or the date the obligations otherwise become due and payable in full of (1) the sum of the principal amount repaid, prepaid or accelerated
plus
(2) the interest accruing on such principal amount from the date of such repayment, prepayment or acceleration through the maturity date (excluding accrued but unpaid paid-in-kind interest to the date of such repayment, prepayment or acceleration), such present value to be computed using a discount rate equal to the Treasury Rate plus 50 basis points discounted to the repayment, prepayment or acceleration date on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months), over (b) the principal amount of the Second Lien Term Loan repaid, prepaid or accelerated. The number of shares of common stock issued will be based on the division of
70%
of the Conversion Sum by the conversion price then in effect.
The Company also has the option to cause the Second Lien Term Loan to convert if, at the time of exercise of the Company’s conversion option, the closing price of the Company’s common stock has been at least
150%
of the Conversion Price (as defined in Note 9) then in effect for at least
20
of the
30
immediately preceding trading days. The features of the make-whole premium in the Second Lien Term Loan require the conversion features to be recorded as embedded derivatives and bifurcated from its host contracts, the Second Lien Term Loan, and accounted for separately from the debt. The conversion features contained in the Second Lien Term Loan are recorded as a derivative liability at fair value each reporting period based upon values determined through the use of discounted lattice models of the Second Lien Term Loan under the Second Lien Credit Agreement. Change in fair value is accounted for in the consolidated statement operations. On October 10, 2018, the Company executed Amendment No. 6 to the Second Lien Credit Agreement for an exchange transaction of approximately
$68.3 million
claim amount of its Second Lien Term Loan for a combination of
5,952,763
shares of the Company’s common stock representing a claim value of
$29.0 million
and issuance of
100,000
shares of Series D Preferred Stock representing a claim value of
$39.3 million
. As a result of the exchange transaction, the fair value of the remaining embedded derivative liability decreased by
$12.4 million
as of October 10, 2018. The Company recorded an unrealized gain of
$58.3 million
and an unrealized loss of
$7.1 million
on the change in fair value of derivative liabilities associated with the Second Lien Term Loan conversion features for the years ended December 31, 2018 and 2017, respectively.
The fair value of the holder conversion features was determined using a binomial lattice model based on certain assumptions including (i) the Company’s stock price, (ii) risk-free rate, (iii) expected volatility, (iv) the Company’s implied credit rating, and (v) the implied credit yield of the Loan.
The following table sets forth a reconciliation of changes in the fair value of the Company’s financial assets and liabilities classified as Level 3 in the fair value hierarchy, except for the commodity derivatives classified as Level 2 as disclosed in Note 8, as of
December 31, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second Lien Term
Loan Conversion
Features
|
|
Warrant
Liabilities
|
|
Total
|
|
(in thousands)
|
Balance at January 1, 2018
|
$
|
(72,714
|
)
|
|
$
|
(223
|
)
|
|
$
|
(72,937
|
)
|
Transferred to equity
|
—
|
|
|
223
|
|
|
223
|
|
Fair value of the converted portion of the embedded derivatives associated with the Second Lien Term Loan
|
12,406
|
|
|
—
|
|
|
12,406
|
|
Change in fair value of derivative liabilities
|
58,343
|
|
|
—
|
|
|
58,343
|
|
Balance at December 31, 2018
|
$
|
(1,965
|
)
|
|
$
|
—
|
|
|
$
|
(1,965
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second Lien Term
Loan Conversion
Features
|
|
Warrant
Liabilities
|
|
Total
|
|
(in thousands)
|
Balance at January 1, 2017
|
$
|
—
|
|
|
$
|
(1,400
|
)
|
|
$
|
(1,400
|
)
|
Issuance
|
(65,647
|
)
|
|
—
|
|
|
(65,647
|
)
|
Cashless exercise of warrants
|
—
|
|
|
370
|
|
|
370
|
|
Change in fair value of derivative liabilities
|
(7,067
|
)
|
|
807
|
|
|
(6,260
|
)
|
Balance at December 31, 2017
|
$
|
(72,714
|
)
|
|
$
|
(223
|
)
|
|
$
|
(72,937
|
)
|
NOTE 8 - DERIVATIVE INSTRUMENTS
As discussed in Notes 7 and 9, the Second Lien Term Loan contains conversion features that are exercisable at the option of the Lead Lender or the Company. The conversion features have been identified as embedded derivatives which (i) contain economic characteristics that are not clearly and closely related to the host contract, the Second Lien Term Loan, and (ii) separate, stand-alone instruments with similar terms would qualify as derivative instruments. As such, the conversion features were bifurcated and accounted for separately from the Second Lien Term Loan. The conversion features are recorded at fair value for each reporting period with changes in fair value included in the consolidated statement of operations for the years ended December 31, 2018 and 2017. The Company recorded derivative liabilities associated with the Second Lien Term Loan at an original fair value of approximately
$65.6 million
at issuance. On October 10, 2018, the Company executed Amendment No. 6 to the Second Lien Credit Agreement for an exchange transaction of approximately
$68.3 million
claim amount of its Second Lien Term Loan for a combination of
5,952,763
shares of the Company’s common stock representing a claim value of approximately
$29.0 million
and issuance of
100,000
shares of Series D Preferred Stock representing a claim value of approximately
$39.3 million
. As a result of the exchange transaction, the fair value of the embedded derivative liability decreased by
$12.4 million
as of October 10, 2018. The Company recorded an unrealized gain of
$58.3 million
and an unrealized loss of
$7.1 million
on the change in fair value of derivative liabilities associated with the Second Lien Term Loan conversion features for the years ended December 31, 2018 and 2017, respectively. As of December 31, 2018 and 2017, the derivative liabilities associated with the Second Lien Term Loan were approximately
$2.0 million
and approximately
$72.7 million
, respectively.
To reduce the impact of fluctuations in oil and natural gas prices on the Company’s revenues, or to protect the economics of property acquisitions, the Company periodically enters into derivative contracts with respect to a portion of its projected oil and natural gas production through various transactions that fix or modify the future prices to be realized. The derivative contracts may include fixed-for-floating price swaps (whereby, on the settlement date, the Company will receive or pay an amount based on the difference between a pre-determined fixed price and a variable market price for a notional quantity of production), put options (whereby the Company pays a cash premium in order to establish a fixed floor price for a notional quantity of production
and, on the settlement date, receives the excess, if any, of the fixed price floor over a variable market price), and costless collars (whereby, on the settlement date, the Company receives the excess, if any, of a variable market price over a fixed floor price up to a fixed ceiling price for a notional quantity of production).
These hedging activities, which are governed by the terms of our Second Lien Credit Agreement, are intended to support oil and natural gas prices at targeted levels and manage exposure to oil and natural gas price fluctuations. It is our policy to enter into derivative contracts only with counterparties that are creditworthy and competitive market makers. All of our derivatives are with non-lender counterparties and are designated as unsecured. Certain of our derivative counterparties may require the posting of cash collateral under certain conditions. It is never the Company’s intention to enter into derivative contracts for speculative trading purposes.
All of our derivatives are accounted for as mark-to-market activities. Under ASC Topic 815, “Derivatives and Hedging,” these instruments are recorded on the consolidated balance sheets at fair value as either short term or long-term assets or liabilities based on their anticipated settlement date. The Company nets derivative assets and liabilities by commodity for counterparties where a legal right to such offset exists. Changes in the derivatives’ fair values are recognized in current earnings since the Company has elected not to designate its current derivative contracts as cash flow hedges for accounting purposes.
The following table presents the Company’s derivative positions as of
December 31, 2018
with respect to future production:
|
|
|
|
|
|
|
|
|
|
2019
|
|
2020
|
Oil positions:
|
|
|
|
Oil swaps (NYMEX WTI):
|
|
|
|
Hedged Volume (Bbls)
|
—
|
|
|
277,685
|
|
Average price ($ per Bbl)
|
$
|
—
|
|
|
$
|
56.21
|
|
|
|
|
|
Basis swaps (NYMEX WTI):
|
|
|
|
Hedged Volume (Bbls)
|
909,500
|
|
|
547,500
|
|
Average price ($ per Bbl)
|
$
|
(6.85
|
)
|
|
$
|
(5.62
|
)
|
|
|
|
|
Put Options (NYMEX WTI):
|
|
|
|
Hedged Volume (Bbls)
|
1,095,000
|
|
|
—
|
|
Average price ($ per Bbl)
|
$
|
50.41
|
|
|
$
|
—
|
|
|
|
|
|
Call Options (NYMEX WTI):
|
|
|
|
Hedged Volume (Bbls)
|
638,000
|
|
|
—
|
|
Average price ($ per Bbl)
|
$
|
69.76
|
|
|
$
|
—
|
|
|
|
|
|
Natural gas positions:
|
|
|
|
Gas swaps (NYMEX Henry Hub):
|
|
|
|
Hedged Volume (MMBtu)
|
906,238
|
|
|
714,134
|
|
Average price ($ per MMBtu)
|
$
|
2.75
|
|
|
$
|
2.54
|
|
|
|
|
|
Put Options (NYMEX Henry Hub):
|
|
|
|
Hedged Volume (MMBtu)
|
392,481
|
|
|
144,130
|
|
Average price ($ per MMBtu)
|
$
|
3.05
|
|
|
$
|
2.80
|
|
|
|
|
|
Call Options (NYMEX Henry Hub):
|
|
|
|
Hedged Volume (MMBtu)
|
392,481
|
|
|
144,130
|
|
Average price ($ per MMBtu)
|
$
|
3.58
|
|
|
$
|
3.06
|
|
|
|
|
|
For the years ended December 31, 2018 and 2017, the effect of the commodity derivative activity on the Company’s Consolidated Statements of Operations was as follows:
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
(In thousands)
|
Unrealized gain (loss) on unsettled derivatives
|
$
|
1,977
|
|
|
$
|
(853
|
)
|
Net settlement paid on derivative contracts
|
(2,742
|
)
|
|
(96
|
)
|
Net settlement receivable (payable) on derivative contracts
|
820
|
|
|
(114
|
)
|
Net gain (loss) on commodity derivatives
|
$
|
55
|
|
|
$
|
(1,063
|
)
|
The Company’s derivatives are presented on a net basis under fair value of derivative instruments on the consolidated balance sheets. The following information summarizes the gross fair values of derivative instruments, presenting the impact of offsetting the derivative assets and liabilities on the Company’s consolidated balance sheets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2018
|
|
Gross Amount of
Recognized Assets
and Liabilities
|
|
Gross Amounts
Offset in the
Consolidated
Balance Sheets (1)
|
|
Net Amounts
Presented in the
Consolidated
Balance Sheets
|
|
(in thousands)
|
Offsetting Derivative Assets:
|
|
|
|
|
|
Current assets
|
$
|
4,122
|
|
|
$
|
(1,571
|
)
|
|
$
|
2,551
|
|
Long-term assets
|
1,854
|
|
|
(32
|
)
|
|
1,822
|
|
Total assets
|
$
|
5,976
|
|
|
$
|
(1,603
|
)
|
|
$
|
4,373
|
|
Offsetting Derivative Liabilities:
|
|
|
|
|
|
Current liabilities
|
$
|
(2,086
|
)
|
|
$
|
1,571
|
|
|
$
|
(515
|
)
|
Long-term commodity derivative liabilities
|
(2,766
|
)
|
|
32
|
|
|
(2,734
|
)
|
Long-term embedded derivative liabilities
|
(1,965
|
)
|
|
—
|
|
|
(1,965
|
)
|
Total liabilities
|
$
|
(6,817
|
)
|
|
$
|
1,603
|
|
|
$
|
(5,214
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2017
|
|
Gross Amount of
Recognized Assets
and Liabilities
|
|
Gross Amounts
Offset in the
Consolidated
Balance Sheets (1)
|
|
Net Amounts
Presented in the
Consolidated
Balance Sheets
|
|
(in thousands)
|
Offsetting Derivative Assets:
|
|
|
|
|
|
Current asset
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Long-term asset
|
—
|
|
|
—
|
|
|
—
|
|
Total asset
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Offsetting Derivative Liabilities:
|
|
|
|
|
|
Current liabilities
|
$
|
(853
|
)
|
|
$
|
—
|
|
|
$
|
(853
|
)
|
Long-term commodity derivative liabilities
|
—
|
|
|
—
|
|
|
—
|
|
Long-term embedded derivative liabilities
|
(72,937
|
)
|
|
—
|
|
|
(72,937
|
)
|
Total liabilities
|
$
|
(73,790
|
)
|
|
$
|
—
|
|
|
$
|
(73,790
|
)
|
(1) This column represents the impact of offsetting commodity derivative assets and liabilities with all counterparties where the Company has the contractual rights and intends to net settle.
NOTE 9 - LONG-TERM DEBT
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
2018
|
|
2017
|
|
(In thousands)
|
6% bridge loans associated with the amended First Lien Term Loan, due 2019, net of debt issuance costs
|
$
|
—
|
|
|
$
|
30,363
|
|
8.25% Second Lien Term Loan, due 2021, net of debt issuance costs and debt discount
|
82,804
|
|
|
96,431
|
|
Revolving Credit Agreement, due April 2021
|
75,000
|
|
|
—
|
|
Other notes payable, due 2018 and 2019
|
—
|
|
|
1,011
|
|
Total long-term debt
|
$
|
157,804
|
|
|
$
|
127,805
|
|
Less: current portion
|
—
|
|
|
(11
|
)
|
Total long-term debt, net of current portion
|
$
|
157,804
|
|
|
$
|
127,794
|
|
Total principal amount of debt maturities related to borrowings for the
five
years ending December 31, 2023 include
$175.0 million
in 2021. There will be
no
minimum payments due in 2019, 2020, 2022 and 2023.
As of
December 31, 2018
and
2017
, the carrying amounts of the Second Lien Term Loan were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal
Amount
|
|
Paid-in-
kind
Interest
|
|
Unamortized
Debt
Issuance
Costs & Debt
Discount
|
|
Carrying
Amount
|
|
(in thousands)
|
As of December 31, 2018
|
|
|
|
|
|
|
|
Revolving Credit Agreement, due April 2021
|
$
|
75,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
75,000
|
|
Second Lien Term Loan, due April 2021
|
100,000
|
|
|
11,641
|
|
|
(28,837
|
)
|
|
82,804
|
|
Total:
|
$
|
175,000
|
|
|
$
|
11,641
|
|
|
$
|
(28,837
|
)
|
|
$
|
157,804
|
|
|
|
|
|
|
|
|
|
As of December 31, 2017
|
|
|
|
|
|
|
|
Bridge loans associated with the amended First Lien Term Loan, due September 2019
|
$
|
30,000
|
|
|
$
|
807
|
|
|
$
|
(444
|
)
|
|
$
|
30,363
|
|
Second Lien Term Loan, due April 2021
|
150,000
|
|
|
5,752
|
|
|
(59,321
|
)
|
|
96,431
|
|
Total:
|
$
|
180,000
|
|
|
$
|
6,559
|
|
|
$
|
(59,765
|
)
|
|
$
|
126,794
|
|
Revolving Credit Agreement
On October 10, 2018, Lilis entered into a
five
-year,
$500.0 million
senior secured revolving credit agreement by and among the Company, as borrower, certain subsidiaries of the Company, as guarantors (the “Guarantors”), BMO Harris Bank, N.A., as administrative agent, and the lenders party thereto. The Revolving Credit Agreement provides for a senior secured reserve based revolving credit facility with an initial borrowing base of
$95.0 million
. The borrowing base is subject to semiannual re-determinations in May and November of each year. On December 7, 2018, the Company’s borrowing base under the Revolving Credit Agreement was increased to
$108 million
as a result of its regularly scheduled fall redetermination process.
Borrowings under the Revolving Credit Agreement bear interest at a floating rate of either LIBOR or a specified base rate plus a margin determined based upon the usage of the borrowing base. The Company is required to pay a commitment fee of
0.5%
per annum on any unused portion of the borrowing base. The Company’s obligations under the Revolving Credit Agreement are secured by first priority liens on substantially all of the Company’s and the Guarantors’ assets and are unconditionally guaranteed by each of the Guarantors.
The Company borrowed
$60.0 million
under the Revolving Credit Agreement at closing, leaving
$35.0 million
initially available for future borrowing. The Company used the initial borrowings to repay in full and retire the Company’s previously existing
$50.0 million
Riverstone First Lien Credit Agreement (the credit agreement for which was amended and restated by the Revolving Credit Agreement), including accrued interest and a prepayment premium, and to pay transaction expenses. Future borrowings may be used to fund working capital requirements, including for the acquisition, exploration and development of oil and gas properties, and for general corporate purposes. The Revolving Credit Agreement also provides for issuance of letters of credit in an aggregate amount up to
$5.0 million
. As of December 31, 2018, the outstanding balance under the Revolving Credit Agreement was
$75.0 million
.
The Company capitalizes certain direct costs associated with the issuance of the Revolving Credit Agreement and amortizes such costs over the term of the debt instrument. The deferred financing costs related to the Revolving Credit Agreement are classified in assets. For the year ended December 31, 2018, the Company amortized debt issuance costs associated with revolving credit agreements of
$2.2 million
. For the year ended December 31, 2017, the Company had no revolving credit agreements. As of December 31, 2018, the Company has
$0.5 million
and
$1.7 million
of unamortized deferred financing costs in other current assets and non-current assets, respectively.
The Revolving Credit Agreement matures on the earlier of the fifth anniversary of the closing date and the date that is
180
days prior to the maturity date of the Company’s Second Lien Credit Agreement (as defined below). Borrowings under the Revolving Credit Agreement are subject to mandatory repayment with the net proceeds of certain asset sales and debt incurrences or if a borrowing base deficiency occurs. The Company also may voluntarily repay borrowings from time to time and, subject to the borrowing base limitation and other customary conditions, may reborrow amounts that are voluntarily repaid. Mandatory and voluntary repayments generally will be made without premium or penalty.
The Revolving Credit Agreement contains certain customary representations and warranties and affirmative and negative covenants, including covenants relating to: maintenance of books and records, financial reporting and notification, compliance with laws, maintenance of properties and insurance; and limitations on incurrence of indebtedness, liens, fundamental changes, international operations, asset sales, certain debt payments and amendments, restrictive agreements, investments, dividends and other restricted payments and hedging. It also requires the Company to maintain a ratio of Total Debt to EBITDAX of not more than
4.00
to 1.00 and a ratio of current assets to current liabilities of not less than
1.00
to 1.00 (each as defined in the Revolving Credit Agreement). On October 10, 2018, the Company entered into the Revolving Credit Agreement pursuant to which BMO Harris Bank N.A., SunTrust Bank, Capital One, N.A., and Credit Suisse AG, Cayman Islands Branch, (collectively, the “Lenders”) have made certain credit available to and on behalf of the Company. In connection with the preparation of these financial statements, the Company informed its Lenders, that it did not satisfy the leverage ratio covenant in Section 9.01(a) of the Revolving Credit Agreement, as of the fiscal quarter ended December 31, 2018. Accordingly, the Company recevied the Lenders consent to a waiver with respect to such provision on March 1, 2019.
The Revolving Credit Agreement also provides for events of default, including failure to pay any principal, interest or other amounts when due, failure to perform or observe covenants, cross-default on certain outstanding debt obligations, inaccuracy of representations and warranties, certain ERISA events, change of control, the security documents or guaranty ceasing to be effective, and bankruptcy or insolvency events, subject to customary cure periods. Amounts owed by the Company under the Revolving Credit Agreement could be accelerated and become immediately due and payable following the occurrence an event of default.
The Revolving Credit Agreement also provides for the Company to have and maintain Swap Agreements in respect of crude oil and natural gas, on not less than 50% of the projected production from the Proved Reserves classified as "Developed Producing Reserves" attributable to the oil and natural gas properties of the Company as reflected in the most recently delivered reserve report for a period through at least 24 months after the end of each applicable quarter.
First Amendment and Waiver to Second Amended and Restated Credit Agreement
On March 1, 2019, the Company executed the First Amendment and Waiver (the "First Amendment") to Second Amended and Restated Credit Agreement whereby the Majority Lenders consent to waiver of the December 31, 2018 Leverage Ratio of Total Debt to EBITDAX of not more than
4.00
to 1.00. The First Amendment has become effective as the following terms have been met:
•
The Effective Date, March 5, 2019, shall have occurred.
•
The Second Lien Term Loan discharge transaction shall have occurred, or shall occur, substantially contemporaneously with the occurrence of the Borrowing Base and Amendment Effective Date. See Note 20 Subsequent Events.
•
As of the Borrowing Base and Amendment Effective Date, after giving effect to this Agreement, (a) the representations and warranties of each Loan Party set forth in the Credit Agreement and in each other Loan Document shall be true and correct in all material respects (unless already qualified by materiality in which case such applicable representation and warranty shall be true and correct), except to the extent such representations and warranties expressly relate to an earlier date, in which case they shall be true and correct in all material respects (unless already qualified by materiality in which case such applicable representation and warranty shall be true and correct) as of such earlier date, (b) no Default, Event of Default or Borrowing Base Deficiency has occurred and is continuing. The Administrative Agent shall have received a certificate from a Responsible Officer of the Company certifying as to the matters set forth in this provision.
Second Lien Credit Agreement
On April 26, 2017, the Company entered into the Second Lien Credit Agreement comprised of convertible loans in an aggregate initial principal amount of up to
$125.0 million
in two tranches. The first tranche consists of an
$80.0 million
term loan (the “Second Lien Term Loan”), which was fully drawn and funded on April 26, 2017. The second tranche consists of up to
$45.0 million
in delayed-draw term loans (the “Delayed Draw Term Loan” and, together with the Second Lien Term Loan, the “Second Lien Loans”) was funded. Each tranche of the Second Lien Loans will bear interest at a rate per annum of
8.25%
, compounded quarterly in arrears and payable only in-kind by increasing the principal amount of the loan by the amount of the interest due on each interest payment date.
On October 3, 2017, the Company, certain subsidiaries of the Company, as guarantors (the “Guarantors”), Wilmington Trust, National Association, as administrative agent and the lenders party thereto, entered into the first amendment to the Second Lien Credit Agreement (“Amendment No. 1 to the Second Lien Credit Agreement”). The purpose of Amendment No. 1 to the Second Lien Credit Agreement is to waive certain conditions precedent to the drawing of the Delayed Draw Term Loan under the Second Lien Credit Agreement and to provide for the funding of such Delayed Draw Term Loan upon the signing of the lease acquisition agreement with KEW Drilling, a Delaware limited partnership. The Company borrowed the full
$45.0 million
of the availability under the Delayed Draw Term Loan on October 4, 2017.
On October 19, 2017, the Company entered into a second amendment to the Second Lien Credit Agreement (“Amendment No. 2 to the Second Lien Credit Agreement”), by and among the Company, the Guarantors, the Agent and the Lenders, including the Lead Lender. Amendment No. 2 to the Second Lien Credit Agreement permitted the Company to incur the Incremental Bridge Loan under the First Lien Credit Agreement.
On November 10, 2017, the Company entered into a third amendment to the Second Lien Credit Agreement (“Amendment No. 3 to the Second Lien Credit Agreement”), by and among the Company, the Guarantors, the Agent and the Lenders, including the Lead Lender. Amendment No. 3 to the Second Lien Credit Agreement increased by
$25.0 million
the amount of delayed draw term loans available for borrowing under the Second Lien Credit Agreement. The additional
$25.0 million
of Delayed Draw Term Loan was drawn on November 10, 2017. The
$25.0 million
of proceeds from these loans may be used to fund oil and natural gas property acquisitions, subject to certain limitations, to fund drilling and completion costs or for other general corporate purposes.
The Second Lien Loans are secured by second priority liens on substantially all of the Company’s and the Guarantors’ assets, including their oil and natural gas properties located in the Delaware Basin, and all of the obligations thereunder are unconditionally guaranteed by each of the Guarantors. The Second Lien Loans matures on April 26, 2021. The Second Lien Loans are subject to mandatory prepayment with the net proceeds of certain asset sales, casualty events and debt incurrences, subject to the right of the Company to reinvest the net proceeds of asset sales and casualty events within
180
days and, in the case of asset sales and casualty events, prepayment of the Incremental Bridge Loan. The Company may not voluntarily prepay the Second Lien Loans prior to March 31, 2019 except (a) in connection with a Change of Control (as defined in the Second Lien Credit Agreement) or (b) if the closing price of our common stock on the principal exchange on which it is traded has been equal to or greater than
110%
of the Conversion Price (as defined below) for at least
20
of the
30
trading days immediately preceding the prepayment.
The Company will be required to pay a make-whole premium in connection with any mandatory or voluntary prepayment of the Second Lien Loans.
Each tranche of the Second Lien Loans are separately convertible at any time, in full and not in part, at the option of the Lead Lender, as follows:
|
|
•
|
70%
of the principal amount of each tranche of Second Lien Loans, together with accrued and unpaid interest and the make-whole premium on such principal amount (the “Conversion Sum”), will convert into a number of newly issued shares of common stock determined by dividing the total of such principal amount, accrued and unpaid interest and make-whole premium by
$5.50
(subject to certain customary adjustments, the “Conversion Price”); and
|
|
|
•
|
30%
of the principal amount of the Conversion Sum will convert on a dollar for dollar basis into a new term loan (the “Take Back Loans”).
|
The terms of the Take Back Loans will be substantially the same as the terms of the Second Lien Loans, except that the Take Back Loans will not be convertible and will bear interest payable in cash at a rate of LIBOR plus
9%
(subject to a
1%
LIBOR floor).
Additionally, the Company will have the option to convert the Second Lien Loans, in whole or in part, into shares of common stock at any time or from time to time if, at the time of exercise of the Company’s conversion option, the closing price of the common stock on the principal exchange on which it is traded has been at least
150%
of the Conversion Price then in effect for at least
20
of the
30
immediately preceding trading days. Conversion at the Company’s option will occur on the same terms as conversion at the Lender’s option.
Second Lien Amendment
On October 10, 2018, the Company entered into a sixth amendment to the Second Lien Credit Agreement (“Amendment No. 6 to the Second Lien Credit Agreement”), dated April 26, 2017, by and among the Company, the Guarantors, Wilmington Trust, National Association, as administrative agent, and the lenders party thereto, including Värde Partners, Inc., as lead lender. Among other matters, the Amendment No. 6 to the Second Lien Credit Agreement amended the Second Lien Credit Agreement to permit the Company to enter into and incur indebtedness under the Revolving Credit Agreement and to provide for the reduction in the principal amount of the Second Lien Term Loans under the Second Lien Credit Agreement pursuant to the Transaction Agreement (as defined and described below).
Transaction Agreement
On October 10, 2018, the Company entered into a Transaction Agreement (the “Transaction Agreement”) by and among the Company and the Värde Parties, pursuant to which the Company agreed to:
|
|
•
|
issue to the Värde Parties (i) an aggregate of
5,952,763
shares of the Company’s common stock, par value
$0.0001
per share, which includes
5,802,763
shares of common stock at an exchange price of
$5.00
per share of common stock plus an additional
150,000
shares of common stock, and (ii)
39,254
shares of a newly created series of preferred stock of the Company, designated as “Series D
8.25%
Convertible Participating Preferred Stock” (the “Series D Preferred Stock”), as consideration for the reduction by approximately
$56.3 million
of the outstanding principal amount of the Second Lien Term Loan under the Second Lien Credit Agreement, together with accrued and unpaid interest and the make-whole amount thereon totaling approximately
$11.9 million
;
|
|
|
•
|
issue and sell to the Värde Parties
25,000
shares of a newly created subseries of the Company’s Series C
9.75%
Convertible Participating Preferred Stock, designated as “Series C-2
9.75%
Convertible Participating Preferred Stock” (the
“
Series C-2 Preferred Stock”), for a purchase price of
$1,000
per share, or an aggregate of
$25.0 million
.
|
The reduction of the
$56.3 million
of the outstanding principal amount of the Second Lien Term Loan including the accrued and unpaid interest and the make-whole amount totaling approximately
$11.9 million
resulted in the recognition of a loss of
$12.3 million
on early extinguishment of debt in the Company's Consolidated Statement of Operations during the year ended December 31, 2018.
Closing of the issuance of the shares of common stock and Series D Preferred Stock and the issuance and sale of the shares of Series C-2 Preferred Stock pursuant to the Transaction Agreement occurred on October 10, 2018. The Series D Preferred Stock and the Series C-2 Preferred Stock are recorded at fair value of
$39.9 million
and
$25.0 million
, respectively, as mezzanine equity as of December 31, 2018.
As discussed in Note 7,
Fair Value of Financial Instruments,
above and Note 8,
Derivatives,
above, the Company separately accounts for the embedded conversion features as a derivative instrument in accordance with accounting guidance relating to recording embedded derivatives at fair value. The initial fair value of the embedded derivatives is recorded as a debt discount to the Second Lien Term Loan. The debt discount is amortized over the term of the Second Lien Term Loan using the effective interest method.
Riverstone First Lien Credit Agreement
On January 30, 2018, the Company entered into an Amended and Restated Senior Secured Term Loan Credit Agreement (the “Riverstone First Lien Credit Agreement”), by and among the Company, the subsidiaries of the Company party thereto as guarantors, Riverstone Credit Management LLC, as administrative agent and collateral agent, and the lenders party thereto. Effective at closing under the Riverstone First Lien Credit Agreement, which occurred on January 31, 2018, the Riverstone First Lien Credit Agreement amended and restated the Company’s First Lien Credit Agreement, which was entered into by the Company on September 29, 2016, and subsequently amended on April 26, 2017, July 25, 2017, and October 19, 2017 (the “First Lien Credit Agreement”).
Pursuant to the Riverstone First Lien Credit Agreement, the lenders thereunder agreed to make term loans to the Company in the aggregate principal amount of
$50.0 million
(Riverstone First Lien Loans”), all of which were funded in full at closing at an original issue discount of
1.0%
of the principal amount. The Riverstone First Lien Credit Agreement provides the potential for additional term loans of up to
$30 million
, as requested by the Company and subject to certain conditions, which additional loans were uncommitted at closing. The Company used approximately
$31.5 million
of the proceeds of the Riverstone First Lien Loans to repay in full its obligations under and retire the First Lien Credit Agreement during the first quarter of 2018. The Riverstone First Lien Credit Agreement was subsequently paid and settled on October 10, 2018 for a total of
$57.0 million
which included principal, accrued PIK interest and prepayment penalties. The repayment of the Riverstone First Lien Credit Agreement resulted in a write-off of
$1.9 million
of unamortized debt issuance costs and the recognition of an
$8.1 million
loss in early extinguishment of debt, due primarily to prepayment penalties and write off of unamortized debt issuance costs, in the Company's Consolidated Statement of Operations during the year ended December 31, 2018.
SOS Note
On June 30, 2016, pursuant to the merger agreement with Brushy and as a condition of the fourth amendment to such merger agreement, the Company was required to make a cash payment of
$500,000
to SOS, and also executed a subordinated promissory note with SOS, for
$1.0 million
, at an interest rate of
6%
per annum which matures on June 30, 2019. In conjunction with the cash payment and the note, the Company also issued
200,000
warrants at an exercise price of
$25.00
. The Company accounted for the cost of warrants of
$0.2 million
as part of the Brushy merger transaction costs during the year ended December 31, 2016. The SOS note was fully paid on January 22, 2018.
Interest Expense
The components of interest expense are as follows:
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
(in thousands)
|
Interest on bridge loans associated with First Lien Term Loan
|
$
|
728
|
|
|
$
|
1,774
|
|
Interest on Revolving Credit Agreements
|
2,242
|
|
|
—
|
|
Interest on Notes Payable
|
5
|
|
|
53
|
|
Paid-in-kind interest on First Lien Term Loan and Second Lien Term Loan
|
12,213
|
|
|
6,559
|
|
Amortization of debt financing costs on Second Lien Term Loan and Revolving Credit Agreement
|
3,241
|
|
|
1,886
|
|
Amortization of discount on Second Lien Term Loan
|
14,398
|
|
|
8,485
|
|
Total:
|
$
|
32,827
|
|
|
$
|
18,757
|
|
NOTE 10 - LONG-TERM DEFERRED REVENUE AND OTHER LIABILITIES
SCM Water LLC’s Option to Exercise Purchase of Salt Water Disposal Assets
In July 2018, the Company entered into a water gathering and disposal agreement with SCM Water, LLC (“SCM Water”). The water gathering project will complement the Company’s existing water disposal infrastructure, and the Company has reserved the right to recycle its produced water. SCM Water will commence, upon receipt of regulatory approval, to build out new gathering and disposal infrastructure to all of the Company’s current and future well locations in Lea County, New Mexico, and Winkler County, Texas. All future capital expenditures will be fully funded by SCM Water and will be designed to accommodate all water produced by the Company’s operations. The Company will act as contract operator of SCM Water’s salt water disposal (“SWD Wells”). The Company has sold to SCM Water an option to acquire the Company’s existing water infrastructure, a system which is comprised of approximately
14
miles of pipeline and
one
SWD well for cash consideration upon closing, with additional payments based on reaching certain milestones.
The Company is actively working on permitting additional SWD locations to facilitate the exercise of the option. The Company anticipates that the majority of its water will eventually be disposed through the future SCM Water system at a competitive gathering rate under the agreement. Total cash consideration for the water gathering and disposal infrastructure is
$20.0 million
. On July 25, 2018, the Company received an upfront non-refundable payment of
$10.0 million
for the option to acquire its existing water infrastructure for the firm transportation and pricing for crude oil and
$5.0 million
for a prefunded drilling bonus. Additionally, the Company received
$2.5 million
on October 1, 2018 for the right-of-way/easement bonus and would receive an additional
$2.5 million
upon hitting the target of
40,000
barrels per day of produced water. As of December 31, 2018, the Company recorded the
$17.5 million
as deferred revenue until such time as SCM Water exercises its option to acquire the Company’s salt water disposal infrastructure.
Crude Oil Gathering Agreement and Option Agreement
On May 21, 2018, the Company entered into a crude oil gathering agreement and option agreement with Salt Creek Midstream, LLC (“SCM”). The crude oil gathering agreement (the “Gathering Agreement”) enables SCM to (i) design, engineer, and construct a gathering system which will provide gathering services for the Company’s crude oil and (ii) gather the Company’s crude oil on the gathering system in certain production areas located in Winkler and Loving Counties, Texas and Lea County, New Mexico. Construction of the gathering system has commenced and is expected to be completed in November 2018. The Gathering Agreement has a term of
12
years that automatically renews on a year to year basis until terminated by either party. SCM and the Company also entered into an option agreement (the “Option Agreement”) whereby the Company granted an option to SCM to provide certain midstream services related to natural gas in Winkler and Loving Counties, Texas and Lea County, New Mexico, subject to the expiration and terms of the Company’s existing gas agreement. The Option Agreement has a term commencing May 21, 2018 and terminating January 1, 2027, pursuant to its one-time option. As consideration for this option, the Company received a one-time of payment
$35.0 million
which was recorded in long-term deferred revenue.
NOTE 11 - RELATED PARTY TRANSACTIONS
During the years ended
December 31, 2018
and
2017
, the Company has engaged in the following transactions with related parties:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
Related Party
|
|
Transactions
|
|
2018
|
|
2017
|
|
|
|
|
($ in thousands)
|
Brennan Short (former Chief Operating Officer)
|
|
Consulting fees paid to MMZ Consulting, Inc. (“MMZ”) which is owned by Mr. Short. Mr. Short is the sole member of MMZ.
|
|
$
|
—
|
|
|
$
|
204
|
|
|
|
Total:
|
|
$
|
—
|
|
|
$
|
204
|
|
Kevin Nanke (former Chief Financial Officer)
|
|
Purchased the DJ Basin properties from the Company through Nanke Energy, LLC
|
|
$
|
—
|
|
|
$
|
2,000
|
|
|
|
Total:
|
|
$
|
—
|
|
|
$
|
2,000
|
|
Värde Partners, Inc. (“Värde”) (1)
|
|
The Company acquired oil and natural gas interests from VPD, an affiliate of Värde
|
|
$
|
10,705
|
|
|
$
|
—
|
|
|
|
ImPetro Operating, LLC, a wholly-owned subsidiary of the Company is the operator for two of VPD's producing wells and VPD reimbursed the Company for operating overhead charges.
|
|
44
|
|
|
—
|
|
|
|
Receivable balance outstanding as of December 31, 2018 for operating costs associated with the VPD's producing wells
|
|
1,843
|
|
|
—
|
|
|
|
Total:
|
|
$
|
12,592
|
|
|
$
|
—
|
|
(1) Värde is the lead lender in the Company’s Second Lien Loans (see Note 9 –
Long-term Debt)
and also participated in the issuances of the Preferred Stock in January and October 2018 (see Note 13 –
Mezzanine Preferred Stock).
NOTE 12 - INCOME TAXES
The income tax provision (benefit) for the years ended
December 31, 2018
and
2017
consisted of the following:
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2018
|
|
2017
|
|
(in thousands)
|
U.S. Federal:
|
|
|
|
|
|
Current
|
$
|
—
|
|
|
$
|
—
|
|
Deferred
|
(7,496
|
)
|
|
32,579
|
|
State and local:
|
|
|
|
Current
|
—
|
|
|
—
|
|
Deferred
|
509
|
|
|
1,059
|
|
|
(6,987
|
)
|
|
33,638
|
|
Change in valuation allowance
|
6,987
|
|
|
(33,638
|
)
|
Income tax provision
|
$
|
—
|
|
|
$
|
—
|
|
The tax effects of temporary differences that give rise to the Company’s deferred tax asset as of
December 31, 2018
and
2017
consisted of the following:
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2018
|
|
2017
|
|
(In thousands)
|
Deferred tax assets:
|
|
|
|
Net operating loss carry-forward
|
$
|
27,568
|
|
|
$
|
15,653
|
|
Share based compensation
|
808
|
|
|
784
|
|
Abandonment obligation
|
541
|
|
|
212
|
|
Derivative instruments
|
—
|
|
|
191
|
|
Deferred revenue
|
11,630
|
|
|
—
|
|
Interest expense
|
3,804
|
|
|
—
|
|
Accrued liabilities and other
|
85
|
|
|
52
|
|
Total deferred tax asset
|
44,436
|
|
|
16,892
|
|
Valuation allowance
|
(23,611
|
)
|
|
(16,624
|
)
|
Deferred tax asset, net of valuation allowance
|
$
|
20,825
|
|
|
$
|
268
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
Derivative instruments
|
249
|
|
|
—
|
|
Oil and natural gas properties and equipment
|
20,576
|
|
|
268
|
|
Total deferred tax liability
|
20,825
|
|
|
268
|
|
Net deferred tax asset (liability)
|
$
|
—
|
|
|
$
|
—
|
|
Reconciliation of the Company’s effective tax rate to the expected U.S. federal tax rate is:
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
Effective federal tax rate
|
21.00
|
%
|
|
34.00
|
%
|
State tax rate, net of federal benefit
|
2.06
|
%
|
|
1.11
|
%
|
Effect of the Tax Cuts and Jobs Act
|
—
|
%
|
|
-11.22
|
%
|
Change in fair value derivative liability
|
295.70
|
%
|
|
-2.59
|
%
|
Debt discount amortization
|
-72.97
|
%
|
|
-3.51
|
%
|
Share based compensation differences and forfeitures
|
—
|
%
|
|
0.91
|
%
|
Change in rate
|
-6.40
|
%
|
|
-0.05
|
%
|
Other permanent differences
|
-5.69
|
%
|
|
-4.61
|
%
|
NOL true-up - §382 limitation
|
-5.51
|
%
|
|
-47.22
|
%
|
Loss from early debt extinguishment
|
-59.01
|
%
|
|
—
|
%
|
Other
|
-0.56
|
%
|
|
-6.47
|
%
|
Valuation allowance
|
-168.62
|
%
|
|
39.65
|
%
|
Net
|
—
|
%
|
|
—
|
%
|
As of
December 31, 2018
and 2017, the Company had net operating loss carry-forwards for federal income tax purposes of approximately
$127.5 million
and
$70.1 million
respectively, available to offset future taxable income. To the extent not utilized, federal net operating loss carry-forwards incurred prior to January, 1 2018 of $
67.4 million
will expire beginning in 2028 through 2038. Federal net operating loss carryforwards incurred after December 31, 2017 of
$70.1 million
have no expiration and can only be used to offset
80%
of taxable income when utilized. A Section 382 analysis resulted in a true-up of the Company’s net operating losses subject to limitation under Section 382 due to a change in ownership from
$118.6 million
to
$9.1 million
as of December, 31 2016 on the basis the net operating losses could never be utliized under the limitation. The net operating loss of $
127.5 million
is subject to Section 382 limitations of utilization due to ownership changes of more than 50% which occurred in the current and prior tax years. The Company is currently in the process of determining the effect of the current change in ownership on the net operating loss carryforwards, including the analysis of net unrealized built-in-gains that will ultimately effect the overall limitation. The conclusion of the additional analysis under Section 382 will have no effect on the Company’s effective income tax rate or the amount of the present valuation allowance position.
In assessing the need for a valuation allowance on the Company’s deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon whether future book income is sufficient to reverse existing temporary differences that give rise to deferred tax assets, as well as whether future taxable income is sufficient to utilize net operating loss and credit carryforwards. Assessing the need for, or the sufficiency of, a valuation allowance requires the evaluation of all available evidence, both positive and negative. Negative evidence considered by management includes cumulative book and tax losses in recent years, no taxable income in available carryback years, and no tax planning strategies contemplated to realize the valued deferred tax assets.
As of December 31, 2018, and 2017, management assessed the available positive and negative evidence to estimate if sufficient future taxable income would be generated to use the Company’s deferred tax assets and determined that it is not more-likely-than-not that the deferred tax assets would be realized in the near future. Therefore, the Company recorded a full valuation allowance of approximately
$23.6 million
and
$16.6 million
on its deferred tax assets as of December 31, 2018 and 2017, respectively.
The New Tax Cuts and Jobs Act (the “Act”) was signed into law on December 22, 2017. The Act makes broad and complex changes to the U.S. tax code applicable to certain items in 2017 as well as those applicable to 2018 and subsequent years.
ASC 740
Income Taxes
("ASC 740") requires the recognition of the tax effects of the Act for annual periods that include December 22, 2017. At December 31, 2017, the Company made reasonable estimates of the effects on its existing deferred tax balances. The Company remeasured certain federal deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally twenty one percent. The amount recognized related to the remeasurement of its federal deferred tax balance was
$9.5 million
, which was subject to a valuation allowance at December 31, 2017.
The Company will continue to analyze the Act and future IRS regulations, refine its calculations, gain a more thorough understanding of how individual states are implementing this new law and evaluate other provisions of the tax reform. This further analysis could potentially affect the measurement of deferred tax balances or potentially give rise to new deferred tax amounts.
NOTE 13 - MEZZANINE PREFERRED STOCK
Series C Preferred Stock
On January 30, 2018, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) by and among the Company and certain private funds affiliated with Värde (the “Purchasers”), pursuant to which the Company agreed to issue and sell to the Purchasers, and the Purchasers agreed to purchase from the Company,
100,000
shares of a newly created series of preferred stock of the Company, designated as “Series C
9.75%
Convertible Participating Preferred Stock” (the “Series C Preferred Stock”), for a purchase price of
$1,000
per share, or an aggregate of
$100.0 million
. The terms of the Series C Preferred Stock were set forth in the Certificate of Designation for the Series C Preferred Stock (the “Amended and Restated Certificate of Designation”) filed by the Company with the Secretary of State of the State of Nevada on January 31, 2018. Closing of the issuance and sale of the shares of Series C Preferred Stock pursuant to the Securities Purchase Agreement occurred on January 31, 2018.
Series C Preferred Stock Tack-On and Series D Preferred Stock
On April 26, 2017, the Company entered into the Second Lien Credit Agreement (as defined above in Note 9 - Long Term Debt) under which Värde is the lead lender, and certain private funds affiliated with Värde are lenders). On October 10, 2018, the Company entered into a Transaction Agreement (the “Transaction Agreement”), by and among the Company and certain private funds affiliated with Värde Partners, Inc. (the “Värde Parties”), pursuant to which the Company (i) exchanged approximately
$68.3 million
of the loans under its Second Lien Credit Agreement for a combination of a Series D Preferred Stock and Common Stock (as such terms are hereinafter defined) and (ii) agreed to a tack-on issuance and sale to Värde Parties of a new subseries of Series C Preferred Stock. Specifically, pursuant to the Transaction Agreement, the Company agreed to:
|
|
•
|
issue to the Värde Parties (i) an aggregate of
5,952,763
shares of the Company’s common stock, par value
$0.0001
per share (the “Common Stock”), which includes
5,802,763
shares of Common Stock at an exchange price of
$5.00
per share of Common Stock plus an additional
150,000
shares of Common Stock, and (ii)
39,254
shares of a newly created series of preferred stock of the Company, designated as “Series D
8.25%
Convertible Participating Preferred Stock” (the “Series D Preferred Stock”), as consideration for the reduction by approximately
$56.3 million
of the outstanding principal amount of the Second Lien Term Loan under the Second Lien Credit Agreement, together with accrued and unpaid interest and the make-whole amount thereon totaling approximately
$11.9 million
;
|
|
|
•
|
issue and sell to the Värde Parties
25,000
shares of a newly created subseries of the Company’s Series C
9.75%
Convertible Participating Preferred Stock, designated as “Series C-2
9.75%
Convertible Participating Preferred Stock” (the “Series C-2 Preferred Stock”), for a purchase price of
$1,000
per share, or an aggregate of
$25 million
.
|
Pursuant to an Amended and Restated Certificate of Designation of Preferences, Rights and Limitations of Series C-1 9.75% Convertible Participating Preferred Stock and Series C-2 9.75% Convertible Participating Preferred Stock (the “Series C Certificate of Designation”), filed by the Company with the Secretary of State of Nevada on October 10, 2018, the outstanding
100,000
shares of the Company’s Series C 9.75% Convertible Participating Preferred Stock were re-designated as “Series C-1
9.75%
Convertible Participating Preferred Stock” (the “Series C-1 Preferred Stock” and, together with the Series C-2 Preferred Stock, the “Series C Preferred Stock”). The Series C Preferred Stock and the Series D Preferred Stock are referred to collectively as the “Preferred Stock.” No other terms or conditions of the Series C Preferred Stock were modified.
The terms of the Series D Preferred Stock are set forth in a Certificate of Designation of Preferences, Rights and Limitations of Series D Convertible Participating Preferred Stock (the “Series D Certificate of Designation” and, together with the Series C Certificate of Designation, the “Certificates of Designation”) filed by the Company with the Secretary of State of the State of Nevada on October 10, 2018.
Closing of the issuance of the shares of Common Stock and Series D Preferred Stock and the issuance and sale of the shares of Series C-2 Preferred Stock pursuant to the Transaction Agreement occurred on October 10, 2018. The Company intends to use the net proceeds from the sale of the shares of Series C-2 Preferred Stock for general corporate purposes, including the acquisition, exploration and development of oil and natural gas properties.
As of December 31, 2018, the Company accounted the Series C-1 Preferred Stock, Series C-2 Preferred Stock and the Series D Preferred Stock at its fair value plus cumulative PIK dividends, net of transaction costs under mezzanine equity in the consolidated balance sheet - see components of the Series C-1Preferred Stock, Series C-2 Preferred Stock and Series D Preferred Stock summarized in the table below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Series C-1 Preferred Shares
|
|
Series C-1 Preferred Stock
|
|
Number of Series C-2 Preferred Shares
|
|
Series C-2 Preferred Stock
|
|
Number of Series D Preferred Shares
|
|
Series D Preferred Stock
|
|
Total
|
|
(In thousands, except shares)
|
Balance, January 1, 2018
|
—
|
|
|
$
|
—
|
|
|
—
|
|
|
$
|
—
|
|
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Issuance of Preferred Stock
|
100,000
|
|
|
100,000
|
|
|
25,000
|
|
|
25,000
|
|
|
39,254
|
|
|
39,919
|
|
|
164,919
|
|
Transaction costs (1)
|
—
|
|
|
(2,494
|
)
|
|
—
|
|
|
(87
|
)
|
|
—
|
|
|
—
|
|
|
(2,581
|
)
|
Net Proceeds
|
100,000
|
|
|
97,506
|
|
|
25,000
|
|
|
24,913
|
|
|
39,254
|
|
|
39,919
|
|
|
162,338
|
|
Paid-in-kind dividends
|
—
|
|
|
9,268
|
|
|
—
|
|
|
609
|
|
|
—
|
|
|
810
|
|
|
10,687
|
|
Balance, December 31, 2018
|
100,000
|
|
|
$
|
106,774
|
|
|
25,000
|
|
|
$
|
25,522
|
|
|
39,254
|
|
|
$
|
40,729
|
|
|
$
|
173,025
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stated value per share
|
|
|
$
|
1,093
|
|
|
|
|
$
|
256
|
|
|
|
|
$
|
407
|
|
|
|
(1) Transaction costs incurred for the issuance of Series D Preferred Shares are included in the accounting for loss on the early extinguishment of debt associated with the Transaction Agreement dated October 10, 2018 on the reduction of the Second Lien Term Loan as disclosed in Note 9 Long-Term Debt.
There was no mezzanine equity as of December 31, 2017.
Material Terms of the Series C Preferred Stock and Series D Preferred Stock
The following is a description of the material terms of the Preferred Stock in the Securities Purchase Agreement.
Ranking.
The Series D Preferred Stock ranks senior to the Series C Preferred Stock, and the Series C Preferred Stock ranks senior to the Common Stock with respect to dividends and rights on the liquidation, dissolution or winding up of the Company.
Stated Value.
Each series of the Preferred Stock has a per share stated value of
$1,000
, subject to increase in connection with the payment of dividends in kind (the “Stated Value”).
Dividends.
Holders of shares of Preferred Stock are entitled to receive cumulative preferential dividends, payable and compounded quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, commencing April 1, 2018, at an annual rate of
9.75%
of the Stated Value for the Series C Preferred Stock and
8.25%
of the Stated Value for the Series D Preferred stock until April 26, 2021, after which the annual dividend rate will increase to
12.00%
if paid in full in cash or
15.00%
if not paid in full in cash. Dividends are payable, at the Company’s option, (i) in cash, (ii) in kind by increasing the Stated Value by the amount per share of the dividend, or (iii) in a combination thereof. In addition to these preferential dividends, holders of the Preferred Stock will be entitled to participate in any dividends paid on the Common Stock on an as-converted basis. As of December 31, 2018, the Company accrued a cumulative balance of
$10.7 million
of PIK dividends for the Preferred Stock as presented in the above table.
Optional Redemption
. The Company has the right to redeem the Series C Preferred Stock, in whole or in part, at any time (subject to certain limitations on partial redemptions), at a price per share equal to (i) the Stated Value then in effect multiplied by (a)
120%
if redeemed during 2018, (b)
125%
if redeemed during 2019 or (c)
130%
if redeemed after 2019, plus (ii) accrued and unpaid dividends thereon and any other amounts payable by the Company in respect thereof (the “Series C Optional Redemption Amount”). The Company has the right to redeem the Series D Preferred Stock, in whole or in part at any time (subject to certain limitations on partial redemptions), at a price per share equal to (i) the Stated Value then in effect multiplied by
117.5%
, plus (ii) accrued and unpaid dividends thereon and any other amounts payable by the Company in respect thereof (the “Series D optional Redemption Amount”). Each Series of the Preferred Stock is perpetual and is not mandatorily redeemable at the option of the holders, except upon the occurrence of a Change of Control (as defined in the Certificates of Designation) as described below.
Conversion.
Each share of Series C Preferred Stock is convertible at any time at the option of the holder into a number of shares of Common Stock equal to (i) the applicable Series C Optional Redemption Amount divided by (ii) a conversion price of
$6.15
, subject to adjustment (the “Series C Conversion Price”). Each share of Series D Preferred Stock is convertible at any time at the option of the holder into a number of shares of Common Stock equal to (i) the Series D Optional Redemption Amount divided by (ii) a conversion price of
$5.50
, subject to adjustment (the "Series D Conversion Price" and, together with the Series C Conversion Price, the “Conversion Prices”). The Conversion Prices will be subject to proportionate adjustment in connection with stock splits and combinations, dividends paid in stock and similar events affecting the outstanding Common Stock. Additionally, the Conversion Prices will be adjusted, based on a broad-based weighted average formula, if the Company issues, or is deemed to issue, additional shares of Common Stock for consideration per share that is less than the lesser of (i)
$5.25
and (ii) the applicable Conversion Price then in effect, subject to certain exceptions and to the applicable Share Cap (as defined below).
The Company has the right to force the conversion of any or all of the outstanding shares of Preferred Stock if (i) the volume-weighted average price per share of the Common Stock on the principal exchange on which it is then traded has been at least
140%
of the applicable Conversion Price then in effect for at least
20
of the
30
consecutive trading days immediately preceding the exercise by the Company of the forced conversion right and (ii) certain trading and other conditions are satisfied.
To comply with rules of the NYSE American (on which the Common Stock is traded), the Certificates of Designation provide that the number of shares of Common Stock issuable on conversion of a share of Preferred Stock may not exceed (i) in the case of the Series C-1 Preferred Stock (a) the Stated Value divided by (b)
$4.42
(which was the closing price of the Common Stock on the NYSE American on January 30, 2018) (the “C-1 Share Cap”) or (ii) in the case of the Series C-2 Preferred Stock and the Series D Preferred Stock (a) the Stated Value divided by (b)
$4.41
(which was the closing price of the Common Stock on the NYSE American on October 9, 2018) (together with the C-1 Share Cap, the “Share Caps”), in each case prior to the receipt of shareholder approval of the issuance of shares of Common Stock.
Change of Control.
Upon the occurrence of a Change of Control (as defined in the Certificates of Designation), each holder of shares of Preferred Stock will have the option to:
|
|
•
|
cause the Company to redeem all of such holder’s shares of Preferred Stock for cash in an amount per share equal to (i) the applicable Optional Redemption Amount plus (ii)
2.5%
of the Stated Value, in each case as in effect immediately prior to the Change of Control;
|
|
|
•
|
convert all of such holder’s shares of Preferred Stock into the number of shares of Common Stock into which such shares are convertible immediately prior to the Change of Control; or
|
|
|
•
|
continue to hold such holder’s shares of Preferred Stock, subject to any adjustments to the applicable Conversion Price or the number and kind of securities or other property issuable upon conversion resulting from the Change of Control and to the Company’s or its successor’s optional redemption rights described above.
|
Liquidation Preference
. Upon any liquidation, dissolution or winding up of the Company:
|
|
•
|
holders of shares of Series D Preferred Stock will be entitled to receive, prior to any distributions on the Series C Preferred Stock, the Common Stock or other capital stock of the Company ranking junior to the Series D Preferred Stock, an amount per share of Series D Preferred Stock equal to the greater of (i) the Series D Optional Redemption Amount then in effect
|
and (ii) the amount such holder would receive in respect of the number of shares of Common Stock into which such shares of Series D Preferred Stock is then convertible; and
|
|
•
|
holders of shares of Series C Preferred Stock will be entitled to receive, prior to any distributions on the Common Stock or other capital stock of the Company ranking junior to the Series C Preferred Stock, an amount per share of Series C Preferred Stock equal to the greater of (i) the applicable Series C Optional Redemption Amount then in effect and (ii) the amount such holder would receive in respect to the number of shares of common stock into which a share of Series C Preferred Stock is then convertible.
|
Voting Rights
. In addition to the Board designation rights described in the Certificate of Designation, holders of shares of Preferred Stock will be entitled to vote with the holders of shares of Common Stock, as a single class, on all matters submitted for a vote of holders of shares of Common Stock. When voting together with the Common Stock, each share of Preferred Stock will entitle the holder to a number of votes equal to (i) the applicable Stated Value as of the applicable record date or other determination date divided by (ii) (a) in the case of Series C-1 Preferred Stock,
$4.42
(the closing price of the Common Stock on the NYSE American on January 30, 2018), and (b) in the case of Series C-2 Preferred Stock and Series D Preferred Stock,
$4.41
(the closing price of the Common Stock on the NYSE American on October 9, 2018).
NOTE 14 - STOCKHOLDERS’ EQUITY
Issuance of Common Stock
On October 10, 2018, in conjunction with the consideration for the reduction of the outstanding principal amount of the term loan under the Second Credit Agreement as disclosed in Note 9 - Long-term Debts, the Company issued an aggregate of
5,952,763
shares of the Company’s common stock, par value
$0.0001
per share which includes
5,802,763
shares of common stock at an exchange price of
$5.00
per share of common stock plus an additional
150,000
shares of common stock.
Common Stock Repurchase
In March 2018, the Company entered into a share-repurchase agreement (the “SRA”) with an investment brokerage company (“Broker”) to repurchase
$1.0 million
of the Company’s common stock as part of the Share Repurchase Plan (the “Plan”). Under the terms of the SRA, the Company paid cash directly to the Broker and received delivery of shares of the Company’s common stock. All of the shares acquired by the Company under the SRA are recorded as treasury stock. For the nine months ended December 31, 2018 the Company purchased
253,598
shares of the Company’s common stock for approximately
$1.0 million
.
Authorized Shares of Common Stock
On May 2, 2017, the Board of Directors authorized the amendment of the Company’s certificate of incorporation to increase the number of authorized shares of common stock by
50 million
from the prior level of
100 million
. This amendment was also approved by the Company’s stockholders on July 13, 2017. There was no change in the stated par value of the shares as a result of this amendment.
Private Placement
On February 28, 2017, the Company entered into a Securities Subscription Agreement (the “Subscription Agreement”) with certain institutional and accredited investors in connection with a private placement (the “March 2017 Private Placement”) to sell
5.2 million
units, consisting of approximately
5.2 million
shares of common stock and warrants to purchase approximately an additional
2.6 million
shares of common stock. Each unit consisted of one share of common stock and a warrant to purchase
0.50
shares of common stock, at a price per unit of
$3.85
. Each warrant has an exercise price of
$4.50
and may be subject to redemption by the Company, upon prior written notice, if the price of the Company’s common stock closes at or above
$6.30
for
twenty
trading days during a consecutive
thirty
trading day period. As of December 31, 2017, the Company received aggregate gross proceeds of
$20.0 million
and issued
5,194,821
shares of common stock and warrants to purchase
2,597,420
shares of common stock.
Warrants
The following table provides a summary of warrant activity as of
December 31, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
Warrants
|
|
Weighted-
Average
Exercise
Price
|
Outstanding at January 1, 2017
|
15,915,511
|
|
|
$
|
3.34
|
|
Warrants issued in connection with private placement
|
2,597,420
|
|
|
4.50
|
|
Warrants issued to Heartland
|
160,714
|
|
|
3.50
|
|
Exercised
|
(6,144,176
|
)
|
|
(0.30
|
)
|
Forfeited or expired
|
(646,669
|
)
|
|
(25.70
|
)
|
Outstanding at December 31, 2017
|
11,882,800
|
|
|
$
|
3.34
|
|
Exercised
|
(3,975,957
|
)
|
|
2.21
|
|
Forfeited or expired
|
(2,889,514
|
)
|
|
3.35
|
|
Outstanding at December 31, 2018
|
5,017,329
|
|
|
$
|
3.83
|
|
The outstanding warrants at December 31, 2018 will expire as follows:
|
|
|
|
|
Year
|
|
Warrants
|
2019
|
|
2,263,267
|
|
2020
|
|
174,642
|
|
2021
|
|
—
|
|
2022
|
|
2,579,420
|
|
|
|
5,017,329
|
|
|
|
|
NOTE 15 - STOCK BASED AND OTHER COMPENSATION
On April 20, 2016, the Company’s Board and the Compensation Committee of the Board approved the Company’s 2016 Omnibus Incentive Plan (the “2016 Plan”). On November 3, 2016 the Company’s stockholders voted to increase number of shares of common stock authorized for issuance under the 2016 Plan to
10 million
. At the 2017 Annual Meeting of Stockholders of the Company held on July 13, 2017, the Company’s stockholders approved the second amendment to its 2016 Plan to increase the number of shares of common stock available for grant under the 2016 Plan from
10 million
to
13 million
shares. As of
December 31, 2018
,
6.7 million
shares of the
13 million
shares of the Company’s common stock authorized for awards under the 2016 Plan remained available for future issuances. The Company generally issues new shares to satisfy awards under employee stock based payment plans.
The following table sets forth the stock based compensation expense recognized during the years ended December 31, 2018 and 2017 and the unamortized portion of the stock based compensation expense and weighted average amortization period of the remaining vesting period at December 31, 2018 and 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
(in thousands)
|
Stock
Options
|
|
Restricted
Stock
|
|
Total
|
|
Stock
Options
|
|
Restricted
Stock
|
|
Total
|
Stock based compensation expense
|
$
|
2,158
|
|
|
$
|
6,842
|
|
|
$
|
9,000
|
|
|
$
|
7,255
|
|
|
$
|
14,283
|
|
|
$
|
21,538
|
|
Unamortized stock based compensation costs
|
$
|
487
|
|
|
$
|
3,501
|
|
|
$
|
3,988
|
|
|
$
|
4,267
|
|
|
$
|
8,669
|
|
|
$
|
12,936
|
|
Weighted average amortization period remaining (years)
|
0.3
|
|
|
0.5
|
|
|
|
|
0.7
|
|
|
0.8
|
|
|
|
Summary of non-cash compensation in the Statement of Changes in Stockholders’ Equity:
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2018
|
|
2017
|
|
(In thousands)
|
Common stock issued for directors’ fees
|
$
|
1,182
|
|
|
$
|
959
|
|
Stock based compensation for issuance of stock options
|
1,933
|
|
|
7,255
|
|
Stock based compensation for issuance of restricted stock
|
4,372
|
|
|
13,227
|
|
Common stock issued for professional services
|
1,513
|
|
|
97
|
|
Total non-cash compensation in the Statement of Changes in Stockholders’ Equity
|
$
|
9,000
|
|
|
$
|
21,538
|
|
Restricted Stock
Employees may be granted restricted stock in the form of restricted stock awards or restricted stock units. Restricted stock is subject to forfeiture restrictions and cannot be sold, transferred, or disposed of during the restriction period. The holders of restricted stock awards have the same rights as a stockholder of the Company with respect to such shares, including the right to vote and receive dividends or other distributions paid with respect to the shares. A restricted stock unit is equivalent to a restricted stock award except that unit holders do not have the right to vote.
Restricted stock vests over service periods ranging from the date of grant generally up to two or three years.
A summary of restricted stock grant activity pursuant to the 2016 Plan for the years ended
December 31, 2018
and
2017
is presented below:
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
Weighted
Average Grant
Date Price
|
Outstanding at January 1, 2017
|
1,068,305
|
|
|
$
|
—
|
|
Granted
|
4,266,345
|
|
|
1.54
|
|
Vested and issued
|
(2,162,915
|
)
|
|
(1.75
|
)
|
Forfeited or canceled
|
(696,469
|
)
|
|
—
|
|
Outstanding at December 31, 2017
|
2,475,266
|
|
|
$
|
4.22
|
|
Granted
|
1,194,944
|
|
|
4.59
|
|
Vested and issued
|
(1,436,146
|
)
|
|
(2.38
|
)
|
Forfeited or canceled
|
(1,280,480
|
)
|
|
(4.44
|
)
|
Outstanding at December 31, 2018
|
953,584
|
|
|
$
|
4.85
|
|
A summary of restricted stock unit grant activity pursuant to the 2012 Plan for the years ended
December 31, 2018
and
2017
is presented below. The Company no longer grants any awards under the 2012 Plan.
|
|
|
|
|
|
|
|
|
|
Number of
Shares
|
|
Weighted
Average Grant
Date Price
|
Outstanding at January 1, 2017
|
186,900
|
|
|
$
|
12.29
|
|
Granted
|
—
|
|
|
—
|
|
Vested and issued
|
(150,419
|
)
|
|
(18.75
|
)
|
Forfeited
|
(26,482
|
)
|
|
(16.15
|
)
|
Outstanding at December 31, 2017
|
9,999
|
|
|
6.57
|
|
Granted
|
—
|
|
|
—
|
|
Vested and issued
|
(9,999
|
)
|
|
(6.57
|
)
|
Forfeited
|
—
|
|
|
—
|
|
Outstanding at December 31, 2018
|
$
|
—
|
|
|
$
|
—
|
|
Stock Options
Employees may be granted incentive stock options to purchase shares of the Company’s common stock with an exercise price equal to, or greater than, the fair market value of the Company’s common stock on the date of grant. These stock options generally vest over
two
years from the date of grant and
terminate at the earlier of the date of exercise or ten years from the date of grant.
During the years ended
December 31, 2018
and 2017, the Company received cash proceeds of approximately
$2.6 million
and approximately
$0.5 million
, respectively, from the exercise of vested stock options.
The fair value of stock option awards is determined using the Black-Sholes-Merton option-pricing model based on several assumptions. These assumptions are based on management’s best estimate at the time of grant. The Company used the following weighted average of each assumption based on the grants in each fiscal year:
|
|
|
|
|
|
|
|
2018
|
|
2017
|
Expected Term in Years
|
6
|
|
|
2
|
|
Expected Volatility
|
66
|
%
|
|
101
|
%
|
Expected Dividends
|
—
|
%
|
|
—
|
%
|
Risk-Free Interest Rate
|
2.67
|
%
|
|
1.38
|
%
|
The Company estimates expected volatility based on an analysis of its historical stock prices since the initial public offering date in 2007. The Company estimates the expected term of its option awards based on the vesting period. The Company uses this method to provide a reasonable basis for estimating its expected term due to the lack of sufficient historical employee exercise data on stock option awards.
A summary of stock option activity for the years ended
December 31, 2018
and
2017
is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options Outstanding and Exercisable
|
|
Number
of Options
|
|
Weighted
Average
Exercise
Price
|
|
Number
of Options
Vested/
Exercisable
|
|
Weighted
Average
Remaining
Contractual Life
(Years)
|
Outstanding at December 31, 2016
|
5,956,833
|
|
|
$
|
2.04
|
|
|
2,208,757
|
|
|
9.6
|
Granted
|
3,260,000
|
|
|
4.74
|
|
|
|
|
|
Exercised
|
(304,896
|
)
|
|
(2.01
|
)
|
|
|
|
|
Forfeited or canceled
|
(1,606,937
|
)
|
|
(3.06
|
)
|
|
|
|
|
Outstanding at December 31, 2017
|
7,305,000
|
|
|
3.74
|
|
|
3,534,484
|
|
|
8.9
|
Granted
|
352,500
|
|
|
4.07
|
|
|
|
|
|
Exercised
|
(1,024,877
|
)
|
|
(2.67
|
)
|
|
|
|
|
Forfeited or canceled
|
(1,601,045
|
)
|
|
(4.20
|
)
|
|
|
|
|
Outstanding at December 31, 2018
|
5,031,578
|
|
|
$
|
3.81
|
|
|
5,035,317
|
|
|
7.9
|
During the year ended December 31, 2018, options to purchase
352,500
shares of the Company’s common stock were granted under the 2016 Plan. The weighted average fair value of these options was
$4.07
. During the year ended December 31, 2018, the Company received
$2.6 million
from the exercise of vested stock options.
The outstanding options had
no
intrinsic value at December 31, 2018. The outstanding options had an intrinsic value of approximately
$10.1 million
at December 31,
2017
.
NOTE 16 - SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes information on non-cash investing and financing activities for the years ended
December 31, 2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
(in thousands)
|
Non-cash investing and financing activities excluded from the statement of cash flows:
|
|
|
|
Conversion of Series B Preferred Stock and accrued dividends to common stock
|
$
|
—
|
|
|
$
|
14,865
|
|
Fair value of warrants issued for financing costs and debt discount
|
—
|
|
|
1,031
|
|
Common stock issued for acquisition of oil and natural gas properties
|
24,778
|
|
|
—
|
|
Common stock issued for commitment fees associated with Private Placement
|
—
|
|
|
250
|
|
Cashless exercise of warrants and stock options
|
359
|
|
|
370
|
|
Accrued drilling costs
|
7,850
|
|
|
3,615
|
|
Change in asset retirement obligation
|
1,495
|
|
|
99
|
|
Issuance of common stock for drilling services
|
—
|
|
|
97
|
|
Issuance of common stock and preferred stock for debt conversion
|
64,504
|
|
|
—
|
|
Reduction of fair value for converted embedded derivatives
|
12,406
|
|
|
—
|
|
Accrued PIK dividends on Series C-1, C-2 and D Preferred Stock
|
10,687
|
|
|
—
|
|
Transfer of warrant derivative instruments to equity
|
223
|
|
|
—
|
|
NOTE 17 - LOSS PER COMMON SHARE
The following table shows the computation of basic and diluted net loss per share for the years ended December 31, 2018 and 2017
:
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2018
|
|
2017
|
|
(in thousands)
|
Net loss
|
$
|
(4,143
|
)
|
|
$
|
(80,082
|
)
|
Dividends on Series C-1, C-2 and D convertible preferred stock
|
(10,687
|
)
|
|
—
|
|
Dividends on redeemable preferred stock
|
—
|
|
|
(122
|
)
|
Dividend and deemed dividends on Series B convertible preferred stock
|
—
|
|
|
(4,635
|
)
|
Net loss attributable to common stockholders
|
$
|
(14,830
|
)
|
|
$
|
(84,839
|
)
|
|
|
|
|
Weighted average common shares outstanding - basic
|
62,854,214
|
|
|
42,428,148
|
|
|
|
|
|
Net loss per common share - basic
|
$
|
(0.24
|
)
|
|
$
|
(2.00
|
)
|
|
|
|
|
Numerator for diluted loss per share:
|
|
|
|
Net loss attributable to common stockholders
|
$
|
(14,830
|
)
|
|
$
|
(84,839
|
)
|
Add: interest expense on convertible Second Lien Loans
|
13,429
|
|
|
—
|
|
Less: fair value change of embedded derivatives associated with Second Lien Loans
|
(35,471
|
)
|
|
—
|
|
Net loss attributable to common stockholders
|
$
|
(36,872
|
)
|
|
$
|
(84,839
|
)
|
|
|
|
|
Denominator for diluted net loss per share:
|
|
|
|
Weighted average number of common shares outstanding - basic
|
62,854,214
|
|
|
42,428,148
|
|
Dilution effect of if-converted Second Lien Loans (1)
|
15,597,127
|
|
|
—
|
|
Weighted average number of common shares outstanding - diluted
|
78,451,341
|
|
|
42,428,148
|
|
|
|
|
|
Net loss per share - diluted:
|
|
|
|
Net loss per common shares (diluted)
|
$
|
(0.47
|
)
|
|
$
|
(2.00
|
)
|
|
|
(1)
|
The Company excluded the following shares from the diluted loss per share calculations because they are anti-dilutive at December 31, 2018 and 2017:
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
2018
|
|
2017
|
Stock Options
|
|
5,031,578
|
|
|
7,305,000
|
|
Restricted Stock Units
|
|
—
|
|
|
9,999
|
|
Stock Purchase Warrants
|
|
5,017,329
|
|
|
11,882,800
|
|
If-converted Second Lien Term Loans
|
|
—
|
|
|
24,202,016
|
|
If-converted Series C-1 9.75% Convertible Participating Preferred Stock
|
|
21,309,234
|
|
|
—
|
|
If-converted Series C-2 9.75% Convertible Participating Preferred Stock
|
|
4,986,382
|
|
|
—
|
|
If-converted Series D 8.25% Convertible Participating Preferred Stock
|
|
8,543,670
|
|
|
—
|
|
Total
|
|
44,888,193
|
|
|
43,399,815
|
|
NOTE 18 - SEGMENT INFORMATION
Operating segments are defined as components of an entity that engage in activities from which it may earn revenues and incur expenses for which separate operational financial information is available and are regularly evaluated by the chief operating decision maker for the purposes of allocating resources and assessing performance. The Company currently has only
one
reportable operating segment, which is oil and natural gas development, exploration and production for which the Company has a single management team that allocates capital resources to maximize profitability and measures financial performance as a single entity.
NOTE 19 - COMMITMENTS AND CONTINGENCIES
Firm Oil Takeaway and Pricing Agreement
On July 25, 2018, the Company executed a
five
-year agreement to secure firm takeaway pipeline capacity and pricing on a long-haul pipeline to the Gulf Coast commencing July 1, 2019. The agreement guarantees
6,000
Bbl/d of firm capacity on a long-haul pipeline to Corpus Christi at a specified price, beginning July 1, 2019 through June 30, 2020, and
5,000
Bbl/d from July 1, 2020 through June 30, 2024. We will have firm takeaway and firm pricing commencing July 1, 2019, and the ability to increase capacity subject to availability by SCM. Further, SCM has agreed to purchase the crude from us at a specified Magellan East Houston price with a fixed “differential basis,” providing price relief versus current market conditions.
Environmental and Governmental Regulation
At
December 31, 2018
, there were no known environmental or regulatory matters which are reasonably expected to result in a material liability to the Company. Many aspects of the oil and natural gas industry are extensively regulated by federal, state, and local governments in all areas in which the Company has operations. Regulations govern such things as drilling permits, environmental protection and air emissions/pollution control, spacing of wells, the unitization and pooling of properties, reports concerning operations, land use, and various other matters including taxation. Oil and natural gas industry legislation and administrative regulations are periodically changed for a variety of political, economic, and other reasons. As of
December 31, 2018
, the Company had not been fined or cited for any violations of governmental regulations that would have a material adverse effect upon the financial condition of the Company.
Legal Proceedings
The Company may from time to time be involved in various legal actions arising in the normal course of business. In the opinion of management, the Company’s liability, if any, in these pending actions would not have a material adverse effect on the financial position of the Company. The Company’s general and administrative expenses would include amounts incurred to resolve claims made against the Company.
The Company believes there is no litigation pending that could have, individually or in the aggregate, a material adverse effect on its results of operations or financial condition.
Operating Leases
The Company has only the office spaces in both Houston, Texas, and Fort Worth, Texas, with minimum lease payments with commitments that have initial or remaining lease terms in excess of one year as of December 31, 2018, comprising
$0.2 million
in 2019,
$0.1 million
in 2020 and less than
$0.1 million
in 2021. The Company recognizes rent expense on a straight-line basis over the noncancelable lease term. The leases for office space in Houston, Texas, and Fort Worth, Texas, expire in August 2021 and January 2020, respectively. There were no other noncancelable leases during the year ended December 31, 2018. For the years ended December 31, 2018 and 2017, the Company recognized rent expense of
$0.6 million
, respectively.
NOTE 20 - SUBSEQUENT EVENTS
First Amendment and Waiver to Revolving Credit Agreement
On March 1, 2019, the Company entered into a First Amendment and Waiver (the “First Amendment”) to the Revolving Credit Agreement. Among other matters, the First Amendment provided for an acceleration of the scheduled May 2019 redetermination of the borrowing base under the Revolving Credit Agreement. The redetermination became effective on March 5, 2019 upon closing of the transactions contemplated by the 2019 Transaction Agreement (as defined below), including the satisfaction in full, as described below, of the Second Lien Loans under the Second Lien Credit Agreement. As so redetermined, the borrowing base is
$125 million
until the next redetermination date, reflecting an increase of
$17 million
from the previously in effect borrowing base of
$108 million
. As amended by the First Amendment, the Revolving Credit Agreement provides that the next scheduled borrowing base redetermination will occur on or about July 1, 2019. Thereafter, scheduled redeterminations of the borrowing base will occur semi-annually on or about May 1 and November 1 of each year, beginning November 1, 2019.
In connection with the satisfaction in full of the Second Lien Loans and the termination of the Second Lien Credit Agreement, the First Amendment also amended the maturity date provisions of the Revolving Credit Agreement to eliminate any springing maturity under the Revolving Credit Agreement tied to the maturity of the Second Lien Credit Agreement, resulting in a fixed maturity date under the Revolving Credit Agreement of October 10, 2023.
As disclosed in Note 9 - Long-Term Debt, the First Amendment also included a limited waiver of compliance by the Company with the leverage ratio covenant in the Revolving Credit Agreement as of December 31, 2018. The First Amendment also effected certain other ministerial and conforming amendments to the Revolving Credit Agreement related to the transactions contemplated by the 2019 Transaction Agreement and required payment by the Company to lenders of customary fees.
2019 Transaction Agreement
On March 5, 2019, the Company entered into a Transaction Agreement (the “2019 Transaction Agreement”) by and among the Company and the Värde Parties. Pursuant to the Transaction Agreement and a related payoff letter, the Company agreed to issue to the Värde Parties shares of two new series of its preferred stock and shares of its Common Stock, as consideration for the termination of the Second Lien Credit Agreement and the satisfaction in full, in lieu of repayment in cash, of all the Second Lien Loans under the Second Lien Credit Agreement. Specifically, in exchange for satisfaction of the outstanding principal amount of the Second Lien Loans, accrued and unpaid interest thereon and the make-whole amount totaling approximately
$133.6 million
(the “Second Lien Exchange Amount”), the Company agreed to issue to the Värde Parties an aggregate of:
|
|
•
|
55,000
shares of a newly created series of preferred stock of the Company, designated as “Series F
9.00%
Participating Preferred Stock” (the “Series F Preferred Stock”), corresponding to
$55 million
of the Second Lien Exchange Amount based on the aggregate initial Stated Value of the shares of Series F Preferred Stock;
|
|
|
•
|
60,000
shares of a newly created series of preferred stock of the Company, designated as “Series E
8.25%
Convertible Participating Preferred Stock” (the “Series E Preferred Stock”), corresponding to
$60 million
of the Second Lien Exchange Amount based on the aggregate initial Stated Value (as defined below) of the shares of Series E Preferred Stock; and
|
|
|
•
|
9,891,638
shares of Common Stock, corresponding to approximately
$18.6 million
of the Second Lien Exchange Amount, based on the closing price of the Common Stock on the NYSE American on March 4, 2019 of
$1.88
.
|
In addition, pursuant to the Transaction Agreement, the Company agreed to issue to the Värde Parties an aggregate of
7,750,000
shares of Common Stock, as consideration for the Värde Parties’ consent to the amendment of the terms of the Series D Preferred Stock and the Series C Preferred Stock (each as defined in Note 13) to, as more fully described below:
|
|
•
|
eliminate the convertibility of the Series D Preferred Stock and the Series C Preferred Stock into shares of Common Stock;
|
|
|
•
|
eliminate the right of holders of the Series D Preferred Stock and the Series C Preferred Stock to vote together with holders of Common Stock;
|
|
|
•
|
modify the rights of holders of the Series D Preferred Stock and the Series C Preferred Stock to participate with holders of Common Stock in dividends and distributions on liquidation;
|
|
|
•
|
cap the redemption premium on the Series C Preferred Stock at the current level of
25%
, instead of increasing to
30%
after December 31, 2019;
|
|
|
•
|
modify in some respects the rights of holders of the Series D Preferred Stock and the Series C Preferred Stock to appoint members of the Company’s board of directors; and
|
|
|
•
|
conform certain negative covenants to those applicable to the Series F Preferred Stock and Series E Preferred Stock.
|
Closing of the transactions contemplated by the 2019 Transaction Agreement, including the issuance of the shares of Series F Preferred Stock, Series E Preferred Stock and Common Stock, the satisfaction and termination of the Second Lien Credit Agreement and the amendment of the terms of the Series D Preferred Stock and Series C Preferred Stock occurred on March 5,
2019. References to the Series D Preferred Stock and the Series C Preferred Stock below in this Note 20 are to those series of preferred stock as so amended.
The terms of the Series F Preferred Stock are set forth in a Certificate of Designation of Preferences, Rights and Limitations of Series F
9.00%
Participating Preferred Stock filed by the Company with the Secretary of State of the State of Nevada on March 5, 2019 (the “Series F Certificate of Designation”). The terms of the Series E Preferred Stock are set forth in a Certificate of Designation of Preferences, Rights and Limitations of Series E
8.25%
Convertible Participating Preferred Stock filed by the Company with the Secretary of State of the State of Nevada on March 5, 2019 (the “Series E Certificate of Designation”). The terms of the Series D Preferred Stock are set forth in an Amended and Restated Certificate of Designation of Preferences, Rights and Limitations of Series D
8.25%
Participating Preferred Stock filed by the Company with the Secretary of State of the State of Nevada on March 5, 2019 (the “Amended and Restated Series D Certificate of Designation”). The terms of the Series C Preferred Stock are set forth in a Second Amended and Restated Certificate of Designation of Preferences, Rights and Limitations of Series C-1
9.75%
Participating Preferred Stock and Series C-2
9.75%
Participating Preferred Stock filed by the Company with the Secretary of State of the State of Nevada on March 5, 2019 (the “Second Amended and Restated Series C Certificate of Designation”) The Series F Certificate of Designation, the Series E Certificate of Designation, the Amended and Restated Series D Certificate of Designation and the Second Amended and Restated Series C Certificate of Designation are referred to collectively in this Note 20 as the “Certificates of Designation”.
The following is a description of the material terms of the Series F Preferred Stock and the Series E Preferred Stock, the material amended terms of the Series D Preferred Stock and the Series C Preferred Stock and the material terms of the 2019 Transaction Agreement. Except as otherwise noted in this Note 20, the material terms of the Series D Preferred Stock and the Series C Preferred Stock remain as in effect prior to the closing of the transactions contemplated by the 2019 Transaction Agreement as disclosed in Note 13 - Mezzanine Preferred Stock. The Series F Preferred Stock, the Series E Preferred Stock, the Series D Preferred Stock and the Series C Preferred Stock are referred to collectively in this Note 20 as the “Preferred Stock.”
Ranking
. The Series F Preferred Stock ranks senior to all of the other series of Preferred Stock, and the Series E Preferred Stock ranks senior to the Series D Preferred Stock and the Series C Preferred Stock, in each case with respect to dividends and rights on the liquidation, dissolution or winding up of the Company.
Stated Value
. The Series F Preferred Stock and the Series E Preferred Stock have an initial per share stated value of
$1,000
, subject to increase in connection with the payment of dividends in kind as described below (the “Stated Value”).
Dividends
. Holders of the Series F Preferred Stock and the Series E Preferred Stock are entitled to receive cumulative preferential dividends, payable and compounded quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, commencing April 1, 2019, at an annual rate of
9.00%
of the Stated Value for the Series F Preferred Stock and
8.25%
of the Stated Value for the Series E Preferred Stock. However, if, on any dividend payment date occurring after April 26, 2021, dividends due on such dividend payment date on the Series F Preferred Stock or the Series E Preferred Stock are not paid in full in cash, the annual dividend rate for the dividends due on such dividend payment date (but not for any future dividend payment date on which dividends are paid in full in cash) will be
10.00%
on the Series F Preferred Stock and
9.25%
on the Series E Preferred Stock. Dividends are payable, at the Company’s option, (i) in cash, (ii) in kind by increasing the Stated Value by the amount per share of the dividend or (iii) in a combination thereof. The Company expects to pay dividends in kind for the foreseeable future.
In addition to these preferential dividends, holders of each series of Preferred Stock are entitled to participate in dividends paid on the Common Stock. For holders of the Series F Preferred Stock, the Series D Preferred Stock and the Series C Preferred Stock, such participation will be based on the dividends such holders would have received if, immediately prior to the applicable record date, each outstanding share of such series of Preferred Stock had been converted into a number of shares of Common Stock equal to the applicable Optional Redemption Price (as defined below) divided by
$7.00
, subject to proportionate adjustment in connection with stock splits and combinations, dividends paid in stock and similar events affecting the outstanding Common Stock (such price, as so adjusted, the “Participation Price”) (regardless of the fact that shares of such series of Preferred Stock are not convertible into Common Stock). For holders of the Series E Preferred Stock, such participation will be based on the number of shares of Common Stock such holders would have owned if all shares of Series E Preferred Stock had been converted to Common Stock at the Conversion Rate (as defined below) then in effect.
Optional Redemption
.
The Company has the right to redeem the Series F Preferred Stock, in whole or in part at any time (subject to certain limitations on partial redemptions), at a price per share equal to (i) the Stated Value then in effect, multiplied by
115.0%
, plus (ii) accrued and unpaid dividends thereon and any other amounts payable by the Company in respect thereof (the “Series F Optional Redemption Price”).
The Series F Preferred Stock is not redeemable at the option of the holders except in connection with a Change of Control as described below and is perpetual unless redeemed in accordance with the Series F Certificate of Designation.
Subject to the limitations described below and certain additional limitations on partial redemptions, the Company has the right to redeem the Series E Preferred Stock, in whole or in part at any time, at a price per share equal to (i) the Stated Value then in effect multiplied by (A)
110%
if the optional redemption date occurs on or prior to March 5, 2020, (B)
105%
if the optional redemption date occurs after March 5, 2020 and on or prior to March 5, 2021 and (C)
100%
if the optional redemption date occurs after March 5, 2021, plus (ii) accrued and unpaid dividends thereon and any other amounts payable by the Company in respect thereof (the “Series E Optional Redemption Price”). However, for any optional redemption effected in connection with or following a Change of Control (as defined in the Series E Certificate of Designation) or any mandatory redemption in connection with a Change of Control as described below, the Series E Optional Redemption Price will be calculated under clause (C) above, regardless of when the redemption or Change of Control occurs.
The Company may not effect an optional redemption of the Series E Preferred Stock unless:
|
|
•
|
either (i) as of the optional redemption date, there are no shares of the Series F Preferred Stock outstanding or (ii) all outstanding shares of the Series F Preferred Stock are redeemed on such optional redemption date concurrently with such optional redemption of the Series E Preferred Stock in accordance with the terms of the Series F Certificate of Designation;
|
|
|
•
|
the aggregate Series E Optional Redemption Price for all shares of the Series E Preferred Stock to be redeemed pursuant to such optional redemption shall not exceed the aggregate amount of net cash proceeds received by the Company from a contemporaneous issuance of Common Stock issued for the purpose of redeeming such shares of Series E Preferred Stock; and
|
|
|
•
|
if the optional redemption date occurs prior to March 5, 2022, then (i) the VWAP for at least
20
trading days during the
30
trading day period immediately preceding the notice of the optional redemption has been at least
150%
of the Conversion Price (as defined below) then in effect, and (ii) such optional redemption shall be for all (but not less than all) then-outstanding shares of Series E Preferred Stock.
|
The Series E Preferred Stock is not redeemable at the option of the holders except in connection with a Change of Control as described below and is perpetual unless converted or redeemed in accordance with the Series E Certificate of Designation.
As amended, the redemption price payable by the Company in connection with a redemption of the Series C Preferred Stock will be a price per share equal to (i) the Stated Value (as defined in the Series C Certificate of Designation) multiplied by
125.0%
plus (ii) accrued and unpaid dividends thereon and any other amounts payable by the Company in respect thereof (the “Series C Optional Redemption Price” and, together with the Series E Optional Redemption Price, the Series F Optional Redemption Price and the Series D Optional Redemption Amount (as defined in Note 13), the respective “Optional Redemption Prices”). Prior to the amendments effected in connection with the closing under the 2019 Transaction Agreement, the percentage specified in clause (i) above would have increased to
130.0%
for a redemption of the Series C Preferred Stock effected after December 31, 2019.
Conversion
. Each share of the Series E Preferred Stock is convertible at any time at the option of the holder into a number of shares of Common Stock equal to (i) the applicable Series E Optional Redemption Price divided by (ii) the Conversion Price (as defined below) (the “Conversion Rate”). However, for purposes of determining the Conversion Rate, the Series E Optional Redemption Price will calculated on the basis applicable to an optional redemption occurring after March 5, 2021 (
i.e.
, multiplying the Stated Value by
100.0%
), regardless of the timing or circumstances of the conversion. The “Conversion Price” for the Series E Preferred Stock is
$2.50
, subject to adjustment as described below. The Conversion Price will be subject to proportionate adjustment in connection with stock splits and combinations, dividends paid in stock and similar events affecting the outstanding Common Stock. Additionally, the Conversion Price will be adjusted, based on a broad-based weighted average formula, if the Company issues, or is deemed to issue, additional shares of Common Stock for consideration per share that is less than the Conversion Price then in effect, subject to certain exceptions and to the Share Cap (as defined below).
To comply with rules of the NYSE American, the Series E Certificate of Designation provides that the number of shares of Common Stock issuable on conversion of a share of Series E Preferred Stock may not exceed (the “Share Cap”) the Stated Value divided by
$1.88
(which was the closing price of the Common Stock on the NYSE American on March 4, 2019), subject to proportionate adjustment in connection with stock splits and combinations, dividends paid in stock and similar events affecting the outstanding Common Stock (such price, as so adjusted, the “Initial Market Price”), prior to the receipt of shareholder approval of the issuance of shares of Common Stock in excess of the Share Cap upon conversion of shares of Series E Preferred Stock. The 2019 Transaction Agreement requires the Company to seek such shareholder approval at its next annual meeting of shareholders. Accordingly, the Company intends to seek such shareholder approval at its 2019 annual meeting of shareholders.
The Company does not have the right to force the conversion of shares of the Series E Preferred Stock based on the trading price of the Common Stock or otherwise.
The Series F Preferred Stock and, as amended, the Series D Preferred Stock and the Series C Preferred Stock are not convertible into Common Stock.
Change of Control
. Upon the occurrence of a Change of Control (as defined in the Certificates of Designation), each holder of shares of the Series E Preferred Stock and the Series F Preferred Stock will have the option to:
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cause the Company to redeem all of such holder’s shares of Series E Preferred Stock or Series F Preferred Stock for cash in an amount per share equal to the applicable Optional Redemption Price;
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in the case of the Series E Preferred Stock, convert all of such holder’s shares of Series E Preferred Stock into Common Stock at the Conversion Rate; or
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continue to hold such holder’s shares of Series E Preferred Stock or Series F Preferred Stock, subject to the Company’s or its successor’s optional redemption rights described above and, in the case of the Series E Preferred Stock, subject to any adjustments to the Conversion Price or the number and kind of securities or other property issuable upon conversion resulting from the Change of Control.
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Because of the elimination of the convertibility of the Series D Preferred Stock and the Series C Preferred Stock, holders of the Series D Preferred Stock and the Series C Preferred Stock no longer have the option to convert their shares of Series D Preferred Stock or Series C Preferred Stock to Common Stock in connection with a Change of Control.
Liquidation Preference
. Upon any liquidation, dissolution or winding up of the Company:
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holders of shares of Series F Preferred Stock, Series D Preferred Stock or Series C Preferred will be entitled to receive, after any distributions on the Preferred Stock ranking senior to such series of Preferred Stock (as applicable) and prior to any distributions on the Preferred Stock ranking junior to such series of Preferred Stock (as applicable), the Common Stock or other capital stock of the Company ranking junior to such series of Preferred Stock, an amount per share equal to the greater of (i) the applicable Optional Redemption Price then in effect and (ii) the proceeds the holders of Preferred Stock of such series would be entitled to receive if, immediately prior to the payment of such amount, each then-outstanding share of such series of Preferred Stock had been converted into a number of shares of Common Stock equal to the applicable Optional Redemption Price divided by the Participation Price (regardless of the fact that shares of such series of Preferred Stock are not convertible into Common Stock); and
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holders of shares of Series E Preferred Stock will be entitled to receive, after any distributions on the Series F Preferred Stock and prior to any distributions on the Series D Preferred Stock, the Series C Preferred Stock, the Common Stock or other capital stock of the Company ranking junior to the Series E Preferred Stock, an amount per share of Series E Preferred Stock equal to the greater of (i) the Series E Optional Redemption Price then in effect and (ii) the amount such holder would receive in respect of the number of shares of Common Stock into which such share of Series E Preferred Stock is then convertible.
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Board Designation Rights
. The Series F Certificate of Designation provides that holders of the Series F Preferred Stock have the right, voting separately as a class, to designate
one
member of the Company’s board of directors (the “Board”) for as long as the aggregate Stated Value of all outstanding shares of the Series F Preferred Stock is at least equal to
$13,750,000
.
The Series E Certificate of Designation provides that holders of the Series E Preferred Stock have the right, voting separately as a class, to designate
one
member of the Board for as long as the shares of Common Stock issuable on conversion of the outstanding shares of Series E Preferred Stock represent at least
5%
of the outstanding shares of Common Stock (giving effect to conversion of all outstanding shares of the Series E Preferred Stock).
The Amended and Restated Series D Certificate of Designation provides that holders of the Series D Preferred Stock will the right, voting separately as a class, to designate
one
member of the Board for as long as the aggregate Stated Value (as defined in the Amended and Restated Series D Certificate of Designation) of all outstanding shares of the Series D Preferred Stock is at least equal to
$9,813,500
.
The Second Amended and Restated Series C Certificate of Designation provides that holders of the Series C Preferred Stock have the right, voting separately as a class, to designate
two
members of the Board for so long as the aggregate Stated Value (as defined in the Second Amended and Restated Series C Certificate of Designation) of all outstanding shares of the Series C Preferred Stock is at least equal to
$31,250,000
.
The 2019 Transaction Agreement required that the Board take, and the Board has taken, all actions necessary to increase the number of directors constituting the entire Board by two directors (to total
eleven
), which vacancies created by the increase, are required to be filled by (i) the person designated by the holders of the Series F Preferred Stock and (ii) the person designated by the holders of the Series E Preferred, in each case, as and when required under the Series F Certificate of Designation or the Series E Certificate of Designation, as applicable. The 2019 Transaction Agreement provides that, effective at the closing thereunder, the three directors previously designated by the Värde Parties pursuant to their previously existing rights under the Series C Preferred Stock and the Second Lien Credit Agreement, became the directors entitled to be appointed by the holders of the Series C Preferred Stock and the holders of the Series D Preferred Stock pursuant to the Second Amended and Restated Series C Certificate of Designation and the Amended and Restated Series D Certificate of Designation.
The Transaction Agreement separately grants to the Värde Parties, for so long as the Värde Parties and their affiliates continue to beneficially own (as defined in Rule 13d-3 under the Exchange Act) shares of Common Stock (including the Common Shares) representing at least the applicable percentage of the outstanding shares of Common Stock specified in the bullet points below, the right (but not the obligation) to designate to the Board the following numbers of directors: