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 three 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 and six month periods ended June 30, 2014 and 2013, as reported in our consolidated financial statements and notes thereto included in Item 1.
Three months ended June 30, 2014 versus three months ended June 30, 2013
— Total revenues, not including interest income, for the three months ended June 30, 2014 were $645,000 compared to $669,000 for the three months ended June 30, 2013.
Revenues from oil and gas sales for the three months ended June 30, 2014 were $645,000 compared to $669,000 for the three months ended June 30, 2013. In the three months ended June 30, 2014, revenues from oil production were $577,000, reflecting volumes of 6,037 barrels at an average price of $95.58 per barrel, while gas revenues were $68,000, reflecting volumes of 15,661 Mcf at an average price of $4.34 per Mcf. On an overall basis, these amounts reflect a decrease in production volumes of approximately 5%, resulting primarily from the continuing recovery of production in the second quarter of 2014 following a major workover of CYMRI’s largest producing oil and gas well in the first quarter of 2014, partially offset by an increase in average oil and gas prices of approximately 1%. 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 $381,000 for the three months ended June 30, 2014 versus $331,000 for the three months ended June 30, 2013. This increase was largely due to a change in the relative timing of certain expenses between these two periods.
Depreciation, depletion and amortization (“DD&A”) expense for the three months ended June 30, 2014 was $103,000 versus $121,000 for the three months ended June 30, 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 June 30, 2014 was $10,000 versus $9,000 for the three months ended June 30, 2013, essentially equivalent amounts in both periods.
Workover expenses for the three months ended June 30, 2014 were $389,000 versus $47,000 for the three months ended June 30, 2013, representing workovers on CYMRI’s and Triumph’s oil and gas properties. This increase was due to the unexpectedly high workover costs of CYMRI’s largest water injection well, which is located in the Burnell Field.
Selling, general and administrative (“SG&A”) expenses for the three months ended June 30, 2014 were $371,000 versus $281,000 for the three months ended June 30, 2013. This increase was due to non-cash stock compensation expense recorded in the second quarter of 2014 (see Note 9), partially offset by a decrease in cash expenses.
Interest income for the three months ended June 30, 2014 was less than $1,000 versus $24,000 for the three months ended June 30, 2013. This reduction resulted from the absence of interest income on long-term notes receivable which were settled in late 2013 (see Note 4).
Interest expense for the three months ended June 30, 2014 was $22,000 versus $35,000 for the three months ended June 30, 2013. This decrease was due to the decline in borrowings.
Loss on expected settlement of notes receivable was zero for the three months ended June 30, 2014 versus $286,000 for the three months ended June 30, 2013. The prior year amount reflects the expected loss on a preliminary settlement of the outstanding balance of the notes receivable issued in the 2011 sale of a former subsidiary (see Note 4).
Gain on oil and gas derivatives for the three months ended June 30, 2014 was zero versus $9,000 for the three months ended June 30, 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 5).
Income taxes were a benefit of $140,000 for the three months ended June 30, 2014 compared to $126,000 for the three months ended June 30, 2013. These benefit amounts reflected consolidated income tax rates of approximately 22% and 31%, respectively.
Six months ended June 30, 2014 versus Six months ended June 30, 2013
— Total revenues, not including interest income, for the six months ended June 30, 2014 were $1,149,000 compared to $1,434,000 for the six months ended June 30, 2013.
Revenues from oil and gas sales for the six months ended June 30, 2014 were $1,149,000 compared to $1,434,000 for the six months ended June 30, 2013. In the six months ended June 30, 2014, revenues from oil production were $1,023,000, reflecting volumes of 10,826 barrels at an average price of $94.49 per barrel, while gas revenues were $126,000, reflecting volumes of 29,503 Mcf at an average price of $4.27 per Mcf. On an overall basis, these amounts reflect a decrease in production volumes of approximately 16%, 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 5%. 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 $755,000 for the six months ended June 30, 2014 versus $734,000 for the six months ended June 30, 2013. This relatively small increase was not considered to be significant.
Depreciation, depletion and amortization (“DD&A”) expense for the six months ended June 30, 2014 was $178,000 versus $241,000 for the six months ended June 30, 2013. This decrease was due to declines in both depletion rates and production volumes.
Accretion expense on asset abandonment obligations for the six months ended June 30, 2014 was $19,000 versus $18,000 for the six months ended June 30, 2013, essentially equivalent amounts in both periods.
Workover expenses for the six months ended June 30, 2014 were $771,000 versus $89,000 for the six months ended June 30, 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 in the first quarter of 2014 and the unexpectedly high workover costs of CYMRI’s largest water injection well in the second quarter of 2014; both of these wells were located in the Burnell Field.
Selling, general and administrative (“SG&A”) expenses for the six months ended June 30, 2014 were $764,000 versus $590,000 for the six months ended June 30, 2013. This increase was due to non-cash stock compensation expense recorded in the first two quarters of 2014 (see Note 9), partially offset by a decrease in cash expenses.
Interest income for the six months ended June 30, 2014 was less than $1,000 versus $50,000 for the six months ended June 30, 2013. This reduction resulted from the absence of interest income on long-term notes receivable which were settled in late 2013 (see Note 4).
Interest expense for the six months ended June 30, 2014 was $43,000 versus $74,000 for the six months ended June 30, 2013. This decrease was due to the decline in borrowings.
Loss on expected settlement of notes receivable was zero for the six months ended June 30, 2014 versus $286,000 for the six months ended June 30, 2013. The prior year amount reflects the expected loss on a preliminary settlement of the outstanding balance of the notes receivable issued in the 2011 sale of a former subsidiary (see Note 4).
Gain on oil and gas derivatives for the six months ended June 30, 2014 was zero versus $2,000 for the six months ended June 30, 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 5).
Income taxes were a benefit of $344,000 for the six months ended June 30, 2014 compared to $172,000 for the six months ended June 30, 2013. These benefit amounts reflected consolidated income tax rates of approximately 25% and 31%, respectively.
Liquidity and Capital Resources
Operating
activities.
Net cash used in operating activities for the six months ended June 30, 2014 was $256,000 compared to net cash provided by operating activities of $7,000 for the six months ended June 30, 2013. This difference was primarily due to the comparatively higher operating loss in the first half of 2014.
Investing
activities.
Net cash used in investing activities was $164,000 for the six months ended June 30, 2014 compared to $629,000 for the six months ended June 30, 2013. The amounts in both periods largely reflect capital expenditures related to Cinco’s oil and gas properties.
Financing activities.
Net cash provided by financing activities for the six months ended June 30, 2014 was $139,000 versus $339,000 for the six months ended June 30, 2013. Proceeds of a private equity offering in June 2014 in the amount of $500,000 (see Note 7) and convertible debt issued for Cinco’s oil and gas properties in the second quarter of 2013 of $673,000 were partially offset by essentially equivalent debt payments in both periods.
As disclosed in Note 6, 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 $1,536,000 as of June 30, 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 June 30, 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 undertaking a private equity offering in an amount of up to $8 million. As disclosed in Note 7, we closed the initial tranche of this private equity offering on June 30, 2014, in the amount of $500,000. Subsequent to June 30, 2014, we have raised an additional $100,000 in this offering, however, there is no assurance that we will be able to ultimately complete the remainder of the 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 $3,351,000. 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.