ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and notes thereto included in Item 1 in this Quarterly Report on Form 10-Q. This item contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those indicated in such forward-looking statements.
Overview
Stratum Holdings, Inc. (“we”, “our” or the “Company”) is a holding company whose operations are presently focused on the domestic Exploration & Production business. In that business, our wholly-owned subsidiaries, CYMRI, L.L.C. and Triumph Energy, Inc., own working interests in approximately 60 producing oil and gas wells in Texas and Louisiana, with net production of approximately 700 MCF equivalent per day.
We seek to increase shareholder value through an approach focused on growth and transaction opportunities in the energy industry.
Through June 3, 2011, we also operated in the Canadian Energy Services business via two wholly-owned subsidiaries, Decca Consulting, Ltd. and Decca Consulting, Inc. (collectively referred to as “Decca”). On that date, we sold the outstanding capital stock of Decca to a private company for a total sales price of $4.6 million (subject to certain adjustments), payable in a combination of: (a) Cash; (b) Non-interest bearing notes, which are payable out of the post-closing collection of Decca’s accounts receivable; and (c) Interest bearing notes, payable in 48 monthly installments of principal and interest, commencing on October 1, 2011 (see Note 2).
As a result of the sale of Decca, we are treating the revenues and expenses of the Canadian Energy Services segment for the three month and nine month periods ended September 30, 2011 as discontinued operations in this report, with our domestic Exploration & Production segment being reported as continuing operations.
Results of Operations
The following discussion reflects the revenues and expenses for the three month and nine month periods ended September 30, 2012 and 2011, as reported in our consolidated financial statements and notes thereto included in Item 1.
Three months ended September 30, 2012 versus three months ended September 30, 2011
— Total revenues from continuing operations, not including interest income, for the three months ended September 30, 2012 were $710,000 compared to $739,000 for the three months ended September 30, 2011.
Revenues from CYMRI’s and Triumph’s oil and gas sales for the three months ended September 30, 2012 were $710,000 compared to $739,000 for the three months ended September 30, 2011. In the three months ended September 30, 2012, revenues from oil production were $658,000, reflecting volumes of 7,099 barrels at an average price of $92.69 per barrel, while gas revenues were $52,000, reflecting volumes of 18,580 Mcf at an average price of $2.80 per Mcf. On an overall basis, these amounts reflect a 4% decrease in average oil and gas prices while oil and gas production volumes were essentially unchanged compared to the three months ended September 30, 2011.
Lease operating expenses (“LOE”), including production taxes, were $390,000 for the three months ended September 30, 2012 versus $348,000 for the three months ended September 30, 2011, representing LOE of CYMRI’s and Triumph’s oil and gas production operations. This slight increase was due to a change in the relative timing of certain lease operating expenses between the two quarterly periods.
Depreciation, depletion and amortization (“DD&A”) expense for the three months ended September 30, 2012 was $123,000 versus $125,000 for the three months ended September 30, 2011, representing DD&A of CYMRI’s and Triumph’s oil and gas properties. This lack of variation was as expected as oil and gas production volumes were essentially unchanged between the two quarterly periods.
Workover expenses for the three months ended September 30, 2012 were $126,000 versus $37,000 for the three months ended September 30, 2011, representing workovers on CYMRI’s and Triumph’s oil and gas properties. This increase was largely experienced in CYMRI’s Kibbe Field and Triumph’s Egan Field.
Selling, general and administrative (“SG&A”) expenses from continuing operations for the three months ended September 30, 2012 were $217,000 compared to $299,000 for the three months ended September 30, 2011. This decrease was due to the elimination of certain non-recurring SG&A expenses in the current year period following the sale of Decca in June 2011 (see Note 2).
Interest income from continuing operations for the three months ended September 30, 2012 was $31,000 versus zero for the three months ended September 30, 2011. This increase resulted from interest income earned on the long-term, interest-bearing notes receivable arising from the sale of Decca in June 2011 (see Note 2).
Interest expense from continuing operations for the three months ended September 30, 2012 was $51,000 versus $78,000 for the three months ended September 30, 2011. This decrease was due to declines in interest rates as well as in outstanding borrowings.
Loss on oil and gas derivatives for the three months ended September 30, 2012 was $95,000 versus a gain of $16,000 for the three months ended September 30, 2011. This fluctuation was due to the change in fair value of CYMRI’s outstanding oil and gas derivative contracts (see Note 4).
Income taxes from continuing operations were a benefit of $88,000 for the three months ended September 30, 2012 compared to $31,000 for the three months ended September 30, 2011. These benefit amounts reflected consolidated income tax rates from continuing operations of approximately 34% and 24%, respectively.
Nine months ended September 30, 2012 versus nine months ended September 30, 2011
— Total revenues from continuing operations, not including interest income, for the nine months ended September 30, 2012 were $2,170,000 compared to $2,324,000 for the nine months ended September 30, 2011.
Revenues from CYMRI’s and Triumph’s oil and gas sales for the nine months ended September 30, 2012 were $2,170,000 compared to $2,324,000 for the nine months ended September 30, 2011. In the nine months ended September 30, 2012, revenues from oil production were $2,010,000, reflecting volumes of 20,521 barrels at an average price of $97.95 per barrel, while gas revenues were $160,000, reflecting volumes of 60,530 Mcf at an average price of $2.64 per Mcf. On an overall basis, these amounts reflect an 8% decrease in average oil and gas prices which was partially offset by an increase in production volumes of approximately 1% due to the effect of recent field workover operations.
Lease operating expenses (“LOE”), including production taxes, were $1,145,000 for the nine months ended September 30, 2012 versus $1,172,000 for the nine months ended September 30, 2011, representing LOE of CYMRI’s and Triumph’s oil and gas production operations. This relatively small decrease was not considered to be significant.
Depreciation, depletion and amortization (“DD&A”) expense for the nine months ended September 30, 2012 was $368,000 versus $371,000 for the nine months ended September 30, 2011, representing DD&A of CYMRI’s and Triumph’s oil and gas properties. This lack of variation was as expected as oil and gas production volumes and depletion rates were essentially unchanged between the two periods.
Workover expenses for the nine months ended September 30, 2012 were $598,000 versus $207,000 for the nine months ended September 30, 2011, representing workovers on CYMRI’s and Triumph’s oil and gas properties. This increase was largely experienced in CYMRI’s Kibbe Field and Triumph’s Egan Field.
Selling, general and administrative (“SG&A”) expenses from continuing operations for the nine months ended September 30, 2012 were $786,000 compared to $870,000 for the nine months ended September 30, 2011. This decrease was due to the elimination of certain non-recurring SG&A expenses in the current year period following the sale of Decca in June 2011 (see Note 2).
Interest income from continuing operations for the nine months ended September 30, 2012 was $98,000 versus zero for the nine months ended September 30, 2011. This increase resulted from interest income earned on the long-term, interest-bearing notes receivable arising from the sale of Decca in June 2011 (see Note 2).
Interest expense from continuing operations for the nine months ended September 30, 2012 was $148,000 versus $207,000 for the nine months ended September 30, 2011. This decrease was due to declines in interest rates as well as in outstanding borrowings.
Gain on oil and gas derivatives for the nine months ended September 30, 2012 was $130,000 versus $34,000 for the nine months ended September 30, 2011. This fluctuation was largely due to the change in fair value of CYMRI’s outstanding oil and gas derivative contracts (see Note 4).
Income taxes from continuing operations were a benefit of $217,000 for the nine months ended September 30, 2012 compared to $144,000 for the nine months ended September 30, 2011. These benefit amounts reflected consolidated income tax rates from continuing operations of approximately 34% and 31%, respectively.
Income from discontinued operations, net of income taxes, was zero for the nine months ended September 30, 2012 versus net income of $3,098,000 for the nine months ended September 30, 2011. As further described in Note 2, we sold the outstanding capital stock of our Canadian Energy Services subsidiary, Decca, to a private company in June 2011. The results of operations of our Canadian Energy Services business have been classified as discontinued operations in the Consolidated Statement of Operations, net of applicable income tax expense.
Liquidity and Capital Resources
Operating
activities.
Net cash used in operating activities for the nine months ended September 30, 2012 was $401,000 compared to net cash provided by operating activities of $571,000 for the nine months ended September 30, 2011. This comparative difference was primarily due to changes in operating net cash flows from our discontinued operations arising from the Decca sale (see Note 2).
Investing
activities.
Net cash provided by investing activities, after deducting capital expenditures, was $701,000 for the nine months ended September 30, 2012 compared to $1,305,000 for the nine months ended September 30, 2011. The Company generated positive cash flows from investing activities in both of these periods primarily due to the proceeds from the post-closing collection of notes receivable arising from the Decca sale (see Note 2).
Financing activities.
Net cash used in financing activities for the nine months ended September 30, 2012 was $531,000 compared to $1,642,000 for the nine months ended September 30, 2011. This relative difference in net financing cash flows was primarily due to changes in net cash flows from our discontinued operations arising from the Decca sale (see Note 2) and largely offsets the change in net operating cash flows noted above under “Operating activities.”
As disclosed in Note 5, a substantial portion of our existing long term debt is in the form of a bank credit facility secured by CYMRI/Triumph’s producing oil and gas properties. Borrowings under the bank credit agreement are subject to a borrowing base, which is periodically redetermined, based on oil and gas reserves. Such short term borrowings amounted to $2,586,000 as of September 30, 2012.
The bank credit agreement generally does not require monthly principal payments so long as outstanding borrowings are less than a declining borrowing base. As of September 30, 2012, there was no unutilized borrowing base and the maturity was scheduled on January 1, 2014. Notwithstanding this scheduled maturity, the Company has classified such borrowings as a current liability due to its inability to consistently meet certain financial covenants under the bank credit agreement. Pursuant to debt accounting rules, the Company will maintain the current liability classification until it is able to meet such financial covenants in the future.
Our ongoing capital expenditures are in the Exploration & Production segment, which can be highly capital intensive. In this business, expenditures for CYMRI/Triumph’s drilling and equipping of oil and gas wells are typically required to maintain or increase existing production levels. We normally attempt to finance these capital expenditure requirements through a combination of cash flow from operations and secured bank borrowings. We presently have relatively low capital expenditure requirements relating to CYMRI/Triumph’s oil and gas properties as evidenced by a total of only $67,000 being spent as of September 30, 2012. We believe that our capital expenditures for the remainder of 2012 can be financed largely through our traditional sources.
Going Concern
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has reported net losses from continuing operations in the last two years and presently has a working capital deficit in the amount of $3,117,000. These factors, among others, indicate that the Company may be unable to continue as a going concern for a reasonable period of time. The consolidated financial statements do not contain any adjustments to reflect the possible future effects on the classification of assets or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern.
We believe that the June 2011 sale of Decca, on the terms summarized in Note 2, has improved our financial condition. It should be noted, however, that we did not receive the full amount of the sales price in cash at closing and our realization of the remaining sales price will depend on the purchaser making scheduled payments of principal and interest to us in accordance with the terms of our installment note receivable. As disclosed in Note 2, the purchaser was delinquent in a making the scheduled note payments to us through the first quarter of 2012, although we and the purchaser reached an informal agreement in the second quarter of 2012 whereby the purchaser began making the stated monthly note payments under a delayed payment plan which would ultimately result in the total stated amount of principal and interest being paid. The purchaser continued to make the stated monthly note payments to us under the informal agreement in the third quarter of 2012. In the unexpected event that the purchaser should not continue to abide by the informal agreement, however, we intend to pursue our legal rights to enforce collection of such note. Notwithstanding this informal agreement, it is possible that we and the purchaser may mutually agree to formally restructure the terms of this note at some point in the future, although no definitive agreement has been reached in that regard.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based on consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We believe that certain accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. See our Annual Report on Form 10-K for the year ended December 31, 2011 for a further description of our critical accounting policies and estimates.