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
Caprock Oil, Inc. (“we”, “our” or the “Company”) is a holding company whose operations are primarily focused on the Exploration & Production business. In that business, our two wholly-owned “legacy” subsidiaries, CYMRI, L.L.C. and Triumph Energy, Inc., maintain working interests in approximately 45 to 50 producing oil and gas wells in Texas and Louisiana, with net production of approximately 600 MCF equivalent per day.
On March 17, 2014, we completed the acquisition of Cinco NRG, LLC (“Cinco”), a private oil and gas company, which was under common control by our majority shareholder. We acquired Cinco through the issuance of a total of 46,942,538 shares of our Common Stock. Cinco was formed in April 2013 to acquire working interests in specific oil and gas properties in Texas and Alabama. At present, Cinco has a 10% non-operated working interest in a producing oil field in Texas and a 50% non-operated working interest in two exploratory prospects in Alabama. Under the accounting rules for entities under common control, we have reflected Cinco’s operations on a retroactive basis in our consolidated financial statements from the inception of Cinco in April 2013.
Results of Operations
The following discussion reflects the revenues and expenses for the three month periods ended March 31, 2014 and 2013, as reported in our consolidated financial statements and notes thereto included in Item 1.
Three months ended March 31, 2014 versus three months ended March 31, 2013
— Total revenues, not including interest income, for the three months ended March 31, 2014 were $505,000 compared to $765,000 for the three months ended March 31, 2013.
Revenues from oil and gas sales for the three months ended March 31, 2014 were $505,000 compared to $765,000 for the three months ended March 31, 2013. In the three months ended March 31, 2014, revenues from oil production were $447,000, reflecting volumes of 4,789 barrels at an average price of $93.34 per barrel, while gas revenues were $58,000, reflecting volumes of 13,842 Mcf at an average price of $4.19 per Mcf. On an overall basis, these amounts reflect a decrease in production volumes of approximately 26%, resulting primarily from a major workover of CYMRI’s largest producing oil and gas well in the first quarter of 2014, further compounded by a decrease in average oil and gas prices of approximately 11%. We anticipate that our production volumes will slowly return to normal levels following this workover while we expect continued volatility in oil and gas commodity prices in the future.
Lease operating expenses (“LOE”), including production taxes, were $374,000 for the three months ended March 31, 2014 versus $403,000 for the three months ended March 31, 2013. This decrease was largely due to a decline in production volumes in the first quarter of 2014.
Depreciation, depletion and amortization (“DD&A”) expense for the three months ended March 31, 2014 was $75,000 versus $120,000 for the three months ended March 31, 2013. This decrease was due to declines in both depletion rates and production volumes.
Accretion expense on asset abandonment obligations for the three months ended March 31, 2014 was $10,000 versus $9,000 for the three months ended March 31, 2013, essentially equivalent amounts in both periods.
Workover expenses for the three months ended March 31, 2014 were $382,000 versus $43,000 for the three months ended March 31, 2013, representing workovers on CYMRI’s and Triumph’s oil and gas properties. This increase was due to the unanticipated workover of CYMRI’s largest producing oil and gas well, which is located in the Burnell Field.
Selling, general and administrative (“SG&A”) expenses for the three months ended March 31, 2014 were $393,000 compared to $309,000 for the three months ended March 31, 2013. This increase was
primarily due to non-cash stock compensation expense recorded in the first quarter of 2014 (see Note 7).
Interest income for the three months ended March 31, 2014 was less than $1,000 versus $26,000 for the three months ended March 31, 2013. This reduction resulted from the absence of interest income on long-term notes receivable which were settled in late 2013.
Interest expense for the three months ended March 31, 2014 was $21,000 versus $39,000 for the three months ended March 31, 2013. This decrease was due to the decline in borrowings.
Loss on oil and gas derivatives for the three months ended March 31, 2014 was zero versus $7,000 for the three months ended March 31, 2013. This fluctuation was due to the change in fair value of CYMRI’s outstanding oil and gas derivative contracts which expired in late 2013 (see Note 4).
Income taxes were a benefit of $204,000 for the three months ended March 31, 2014 compared to $46,000 for the three months ended March 31, 2013. These benefit amounts reflected consolidated income tax rates of approximately 27% and 34%, respectively.
Liquidity and Capital Resources
Operating
activities.
Net cash used in operating activities for the three months ended March 31, 2014 was $15,000 compared to net cash provided by operating activities for the three months ended March 31, 2013 of $1,000. This difference was primarily due to the comparatively higher operating loss in the first quarter of 2014.
Investing
activities.
Net cash used in investing activities was $142,000 for the three months ended March 31, 2014 compared to $11,000 for the three months ended March 31, 2013. This increase largely reflects incremental capital expenditures related to Cinco’s oil and gas properties in the first quarter of 2014.
Financing activities.
Net cash used in financing activities for the three months ended March 31, 2014 was $197,000 compared to $163,000 for the three months ended March 31, 2013. This relative difference in financing cash flows was not considered to be significant.
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 $1,686,000 as of March 31, 2014. The bank credit agreement does not require monthly principal payments so long as outstanding borrowings are less than a declining borrowing base. Effective January 1, 2014, the bank credit agreement was amended to redefine the declining borrowing base and retain all other significant terms while extending the maturity for 12 months to January 1, 2015. As of March 31, 2014, the bank credit agreement will mature in less than one year.
Capital expenditures in the Exploration & Production business can be highly intensive. Expenditures for drilling and equipping of oil and gas wells are typically required to maintain or increase production levels. We normally attempt to finance such 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 our legacy oil and gas properties, however, we expect that our capital expenditures will increase significantly in the future as a result of the new oil and gas properties that we have acquired in the Cinco acquisition.
In order to provide an equity underpinning for the increased capital expenditures related to our recently acquired oil and gas properties, we are currently planning to undertake a private equity offering of our Common Stock in an amount of up to $8 million in the second quarter of 2014. However, there is no assurance that we will be able to ultimately complete such a private equity offering on terms that will be acceptable to the Company.
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 $3,311,000. 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.
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, 2013 for a further description of our critical accounting policies and estimates.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information for this Item is not required as the Registrant is a “smaller reporting company” as defined in Rule 12b-2 of the Exchange Act.
ITEM 4.
CONTROLS AND PROCEDURES
(a) Disclosure controls and procedures
As of March 31, 2014, our senior executive officer, who is also our Chief Financial Officer, evaluated the effectiveness of the design and operation of our internal controls over financial reporting which encompasses our disclosure controls and procedures. Based on this evaluation, our senior executive officer has concluded that our disclosure controls and procedures as of the end of the period covered by this Quarterly Report were not effective because of a lack of segregation of duties, as described in Item 9A. (b) of our Annual Report on Form 10-K for the year ended December 31, 2013, which we view as an integral part of our disclosure controls and procedures.
The lack of segregation of duties referenced above represents a material weakness in our internal controls over financial reporting. Notwithstanding this weakness, management believes that the consolidated financial statements included in this report fairly present, in all material respects, our consolidated financial position and results of operations as of and for the quarter ended March 31, 2014.
(b) Changes in internal controls over financial reporting
There was no change in our internal controls over financial reporting that occurred during the quarter ended March 31, 2014, that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.