NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DEBTOR-IN-POSSESSION)
Note 1—Business and Organization
Extraction Oil & Gas, Inc. (the "Company" or "Extraction") is an independent oil and gas company focused on the acquisition, development and production of oil, natural gas and natural gas liquids (“NGLs”) reserves in the Rocky Mountain region, primarily in the Wattenberg Field of the Denver-Julesburg Basin (the "DJ Basin") of Colorado, as well as the construction and support of midstream assets to gather crude oil, natural gas and water production. As described in the section titled Voluntary Reorganization under Chapter 11 of the Bankruptcy Code below, during the second quarter of 2020, the Company filed for bankruptcy and, as a result, was delisted from the NASDAQ Global Select Market on June 25, 2020 and began trading on the Pink Open Market under the symbol "XOGAQ."
Voluntary Reorganization under Chapter 11 of the Bankruptcy Code
As previously disclosed, on June 14, 2020 (the “Petition Date”), Extraction and its wholly owned subsidiaries (collectively, the “Debtors”), filed voluntary petitions for relief under chapter 11 ("Chapter 11") of title 11 of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). The Debtor's Chapter 11 cases (the “Chapter 11 Cases”) are being jointly administered under the caption In re Extraction Oil & Gas., et al. Case No. 20-11548 (CSS).
The Debtors continue to operate their businesses and manage their properties as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. The Debtors continue to operate as an ongoing business in accordance with the previously approved Bankruptcy Court orders.
The commencement of a voluntary proceeding in bankruptcy constituted an immediate event of default under the Credit Agreement (as defined in Note 6—Long-Term Debt) and the indentures governing the Company’s Senior Notes (as defined below), resulting in the automatic and immediate acceleration of all of the Company’s debt outstanding under the Credit Agreement and Senior Notes. Accordingly, the Company has classified its outstanding Senior Notes debt as liabilities subject to compromise on its condensed consolidated balance sheet as of September 30, 2020. The Credit Facility (as defined in Note 6—Long-Term Debt) was not classified as liabilities subject to compromise because it is fully secured and is expected to be unimpaired. Please refer to Note 4—Liabilities Subject to Compromise for more information. Pursuant to the Bankruptcy Code and as described in Note 6—Long-Term Debt, the filing of the Chapter 11 Cases automatically stayed most actions against the Debtors, including most actions to collect indebtedness incurred prior to the Petition Date or to exercise control over the Debtors’ property.
Restructuring Support Agreement
As previously disclosed, on June 14, 2020, the Company entered into a Restructuring Support Agreement (the “RSA”) with (i) significant holders of its 7.375% senior unsecured notes due 2024 (the “2024 Senior Notes”) issued pursuant to that certain indenture, dated as of August 1, 2017, by and among Extraction, as issuer, certain guarantors party thereto and Wilmington Savings Fund Society, FSB, as trustee (such trustee, “WSFS” and such indenture, the “2024 Senior Notes Indenture”) and (ii) significant holders (such holders, together with the foregoing significant holders under the 2024 Senior Notes, the “Consenting Stakeholders”) of its 5.625% senior unsecured notes due 2026 (the “2026 Senior Notes” and, together with the 2024 Senior Notes, the “Senior Notes”) issued pursuant to that certain indenture, dated as of January 25, 2018, by and among Extraction, the subsidiary guarantors party thereto and WSFS, as trustee (the “2026 Senior Notes Indenture” and, together with the 2024 Senior Notes Indenture, the “Senior Notes Indentures”). The RSA contemplates a financial restructuring of the existing indebtedness of, and equity interests in, the Company to be effectuated through a joint Chapter 11 plan of reorganization (as amended or modified, the “Restructuring Plan”).
Restructuring Plan, Disclosure Statement, and Backstop Commitment Agreement
On July 30, 2020, the Debtors filed a proposed Restructuring Plan and related Disclosure Statement describing the Restructuring Plan and the solicitation of votes to approve the same from certain of the Debtors’ creditors with respect to the Chapter 11 Cases (as amended or modified, the “Disclosure Statement”). Subsequently on October 22,
2020 and November 5, 2020, the Debtors filed first and second amendments, respectively, to the Disclosure Statement. The hearing to consider approval of the Disclosure Statement was held on November 6, 2020. On November 6, 2020, the Bankruptcy Court approved the adequacy of the Disclosure Statement and the Debtors commenced solicitation process to receive votes on the Restructuring Plan. Pursuant to the terms of the Restructuring Plan and as described in the Disclosure Statement, the Debtors will also commence a rights offering, which has been backstopped by certain holders of the Senior Notes. On November 6, 2020, the Bankruptcy Court approved the Backstop Commitment Agreement, which provides a commitment of $200 million. The hearing on the confirmation of the Restructuring Plan has been scheduled to be held on or before December 21, 2020.
The Restructuring Plan contemplates, among other things, the following:
•holders of claims under the Amended and Restated Credit Agreement, dated as of August 16, 2017, by and among Extraction, the subsidiary guarantors party thereto, the lenders from time to time thereto, and Wells Fargo Bank, National Association, as administrative agent (as may be amended, restated, supplemented, or otherwise modified from time to time, the “Credit Agreement”), except to the extent that a Holder of an Allowed Revolving Credit Agreement Claim and the Debtors against which such Allowed Revolving Credit Agreement Claim is asserted agree to a less favorable treatment for such Holder, in full and final satisfaction, settlement, release, and discharge of and in exchange for each Allowed Revolving Credit Agreement Claim, each Holder of such Allowed Revolving Credit Agreement Claim shall receive, either:
◦(i) if such Holder elects to participate in the Exit RBL Facility on a pro rata basis, determined on a ratable basis with respect to its percentage of the Obligations (as defined in the Revolving Credit Agreement) under the Revolving Credit Agreement, such Holder of an Allowed Revolving Credit Agreement Claim shall become an Exit RBL Facility Lender in accordance with the terms of the Exit RBL Facility Documents; or
◦(ii) if such Holder does not elect to participate in the Exit RBL Facility as provided above (including by not making any election with respect to the Exit RBL Facility on the ballot), its Pro Rata Share of the Exit Term Loans.
•holders of claims under the Senior Notes Indentures (“Senior Notes Claims”) shall receive, in full and final satisfaction, compromise, settlement, release, and discharge of, and in exchange for such Allowed Senior Notes Claim, its Pro Rata share of (A) the Claims Equity Allocation and (B) the Senior Noteholder Subscription Rights;
•holders of trade claims shall receive, in full and final satisfaction, compromise, settlement, release, and discharge of, and in exchange for such Allowed Trade Claim, payment in full of such Allowed Trade Claim on the Effective Date or otherwise in the ordinary course of the Debtors’ business;
•holders of claims arising from non-funded debt general unsecured obligations shall receive, in full and final satisfaction, compromise, settlement, release, and discharge of, and in exchange for such Allowed General Unsecured Claim, its Pro Rata share of the Claims Equity Allocation;
•each Existing Preferred Interest in the Company shall be canceled, released, and extinguished, and will be of no further force or effect, and each Holder of an Allowed Existing Preferred Interest shall receive, in full and final satisfaction, compromise, settlement, release, and discharge of, and in exchange for such Existing Preferred Interest, its Pro Rata share of (A) 50% of the Existing Interests Equity Allocation, (B) the Existing Preferred Interest Subscription Rights, (C) 50% of the Tranche A Warrants, and (D) 50% of the Tranche B Warrants;
•each Existing Common Interest in the Company shall be canceled, released, and extinguished, and will be of no further force or effect, and each Holder of an Allowed Existing Common Interest shall receive, in full and final satisfaction, compromise, settlement, release, and discharge of, and in exchange for such Existing Common Interest its Pro Rata share of (A) 50% of the Existing Interests Equity Allocation, (B) the Existing Common Interest Subscription Rights, (C) 50% of the Tranche A Warrants, and (D) 50% of the Tranche B Warrants;
•holders of claims arising from the DIP Credit Facility (as defined in Note 6—Long-Term Debt) receiving cash or such other consideration as the DIP Lenders (as defined in Note 6—Long-Term Debt) agree in their sole discretion;
•cash payment in full of all administrative expense claims, priority tax claims, other priority claims, and other secured claims or other such treatment rendering such claims unimpaired, including reinstatement pursuant to section 1124 of the Bankruptcy Code or delivery of the collateral securing any such secured claim and payment of any interest required under section 506(b) of the Bankruptcy Code; and
•the Restructuring Plan will provide for the establishment of a post-emergence management incentive plan to be adopted by the New Board (the “Management Incentive Plan”), which may include (a) restricted stock units, options, New Common Shares, or other rights exercisable, exchangeable, or convertible into New Common Shares representing up to 10% of the New Common Shares on a fully diluted and fully distributed basis (the “MIP Equity”) and (b) other terms and conditions customary for similar type equity plans.
Information contained in the Restructuring Plan and the Disclosure Statement is subject to change, whether as a result of amendments or supplements to the Restructuring Plan or Disclosure Statement, third-party actions, or otherwise, and should not be relied upon by any party. There is no guarantee the Restructuring Plan can be implemented and the Restructuring Plan approved.
The information presented in this section is not a solicitation to accept or reject the Restructuring Plan. Any such solicitation will be made pursuant to and in accordance with the Disclosure Statement and applicable law, including orders of the Bankruptcy Court. Capitalized terms used but not specifically defined in this section have the meanings specified for such terms in the Restructuring Plan and Disclosure Statement, as applicable.
Tax Attributes and Net Operating Loss Carryforwards
The Company has substantial tax net operating loss carryforwards and other tax attributes. Under the U.S. Internal Revenue Code of 1986, as amended (the “Code”), our ability to use these net operating losses and other tax attributes may be limited if the Company experiences an “ownership change”, as determined under Section 382 of the Code. Accordingly, on July 13, 2020, the Company obtained a final order from the Bankruptcy Court that is intended to prevent an ownership change during the pendency of the Chapter 11 Cases and therefore protect the Company's ability to use its tax attributes by imposing certain notice procedures and transfer restrictions on the trading of the Company’s existing common stock and preferred stock.
In general, the order applies to any person or entity that, directly or indirectly, beneficially owns (or would beneficially own as a result of a proposed transfer) at least 4.5% of the Company’s common stock or preferred stock. Such persons are required to notify the Company and the Bankruptcy Court before effecting a transaction involving the Company's common stock or preferred stock, and the Company has the right to seek an injunction to prevent the transaction if it might adversely affect the Company's ability to use its tax attributes. The order also requires any person or entity that, directly or indirectly, beneficially owns at least 50% of the Company’s common stock or preferred stock to notify the Company and the Bankruptcy Court prior to claiming any deduction for worthlessness of the Company's common stock or preferred stock for a tax year ending before the Company’s emergence from chapter 11 protection and the Company has the right to seek an injunction to prevent the transaction if it might adversely affect the Company's ability to use its tax attributes.
Any purchase, sale or other transfer of, or any claim of a deduction for worthlessness with respect to, the Company's common stock or preferred stock in violation of the restrictions of the order is null and void ab initio as an act in violation of a Bankruptcy Court order and would therefore confer no rights on a proposed transferee or such holder, as applicable.
Ability to Continue as a Going Concern
The condensed consolidated financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets and satisfaction of liabilities and commitments in the normal course of business. The condensed consolidated financial statements do not reflect any adjustments that might result if the Company is unable to continue as a going concern.
As discussed above, the filing of the Chapter 11 Cases constituted an event of default under the Company’s outstanding debt agreements, which resulted in the automatic and immediate acceleration of all of the Company’s debt outstanding under the Credit Agreement and Senior Notes. The Company projects that it will not have sufficient cash on hand or available liquidity to repay such debt. These conditions and events raise substantial doubt about the Company’s ability to continue as a going concern.
The Company’s ability to continue as a going concern is contingent upon, among other things, its ability to, subject to the Bankruptcy Court’s approval, implement the Restructuring Plan, successfully emerge from the Chapter 11 Cases and generate sufficient liquidity from the Restructuring to meet its obligations and operating needs. As a result of risks and uncertainties related to (i) the Company’s ability to obtain requisite support for the Restructuring Plan from various stakeholders, and (ii) the effects of disruption from the Chapter 11 Cases making it more difficult to maintain business, financing and operational relationships, the Company has concluded that management’s plans do not alleviate substantial doubt regarding the Company’s ability to continue as a going concern.
The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of this uncertainty.
Deconsolidation of Elevation Midstream, LLC
Elevation Midstream, LLC ("Elevation"), a Delaware limited liability company, is focused on the construction and operation of gathering systems and facilities to serve the development of acreage in the Company’s Hawkeye and Southwest Wattenberg areas. Midstream assets of Elevation are represented as the gathering systems and facilities line item within the condensed consolidated balance sheets for any periods ended on or prior to December 31, 2019.
During the first quarter of 2020, Elevation's then non-controlling interest owner, which owned 100% of Elevation's preferred stock, per contractual agreement, expanded Elevation's then five member board of managers by four seats and filled them with managers of their choosing (the "Board Expansion"). Because Extraction had the right to appoint only three of the managers of Elevation before and after Board Expansion, Extraction determined the Company had lost voting control of Elevation, and on March 16, 2020 deconsolidated Elevation and began accounting for the entity as an equity method investment. Though Extraction determined control of Elevation was lost under the voting interest model of consolidation, the Company also determined significant influence was not lost due to (1) Extraction owning 100% of the common stock, (2) Extraction appointing three of the nine managers of Elevation and (3) Extraction's continuing involvement in the day-to-day operation of Elevation through a management services agreement. Because Extraction also determined the Company is not the primary beneficiary, Elevation Midstream, LLC is not a variable interest entity.
Extraction elected the fair value option to remeasure the Elevation equity method investment and determined it had no fair value. The Company recorded a $73.1 million loss on deconsolidation of the investment in the condensed consolidated statements of operations for the three months ended March 31, 2020. Also during the three months ended March 31, 2020, Elevation determined certain gathering systems and facilities were impaired by $50.3 million as a result of the abandonment of certain projects. In accordance with Accounting Standards Codification ("ASC") Topic 323-10-35-20: Investments—equity method and joint ventures, Extraction discontinued applying the equity method investment for Elevation as the impairment charge would have reduced the investment below zero.
On May 1, 2020, Elevation's board of managers issued 1,530,000,000 common units at a price of $0.01 per unit to certain of Elevation's members other than Extraction (the "Capital Raise"). The Capital Raise caused Extraction's ownership of Elevation to be diluted to less than 0.01%. As a result of the Capital Raise, beginning in May 2020 Extraction began accounting for Elevation under the cost method of accounting. The Company reserves all rights related to actions taken by Elevation’s board of managers.
Note 2—Basis of Presentation, Significant Accounting Policies and Recent Accounting Pronouncements
Basis of Presentation
The unaudited condensed consolidated financial statements include the accounts of the Company, including its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The financial statements included herein were prepared from the records of the Company in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the Securities and Exchange Commission rules and regulation for interim financial reporting. In the opinion of management, all adjustments, consisting primarily of normal recurring accruals that are considered necessary for a fair statement of the
unaudited condensed consolidated financial information, have been included. However, operating results for the period presented are not necessarily indicative of the results that may be expected for a full year. Interim condensed consolidated financial statements and the year-end balance sheets do not include all of the information and notes required by GAAP for audited annual consolidated financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (“Annual Report”).
Significant Accounting Policies
The significant accounting policies followed by the Company are set forth in Note 2 to the Company’s consolidated financial statements in its Annual Report and are supplemented by the notes to the unaudited condensed consolidated financial statements in this report.
Beginning after the Petition Date, the Company has applied ASC Topic 852 — Reorganizations in preparing the condensed consolidated financial statements. ASC 852 requires the financial statements, for periods subsequent to the Chapter 11 Cases' filing date, to distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Accordingly, certain expenses incurred during the bankruptcy proceedings, including unamortized debt issuance costs associated with debt classified as liabilities subject to compromise, are recorded as reorganization items. In addition, pre-petition obligations that may be impacted by the chapter 11 process have been classified on the condensed consolidated balance sheets as liabilities subject to compromise. These liabilities are reported at the amounts the Company anticipates will be allowed by the Bankruptcy Court, even if they may be settled for lesser amounts. See below for more information regarding reorganization items.
GAAP requires certain additional reporting for financial statements prepared between the Petition Date and the date that the Company emerges from bankruptcy, including:
•Reclassification of pre-petition liabilities that are unsecured, under-secured or where it cannot be determined that the liabilities are fully secured to a separate line item in the condensed consolidated balance sheets called liabilities subject to compromise; and
•Segregation of reorganization items as a separate line in the condensed consolidated statements of operations outside of income from continuing operations.
Debtor-In-Possession
The Debtors are currently operating as debtors in possession in accordance with the applicable provisions of the Bankruptcy Code. The Bankruptcy Court has approved motions filed by the Debtors that were designed primarily to mitigate the impact of the Chapter 11 Cases on the Company’s operations, customers and employees. As a result, the Company is able to conduct normal business activities and pay all associated obligations for the period following its bankruptcy filing in the ordinary course of business and is authorized to pay and has paid certain pre-petition obligations, including, among other things, for employee wages and benefits and certain goods and services provided. During the Chapter 11 Cases, transactions outside the ordinary course of business require prior approval of the Bankruptcy Court.
Automatic Stay
Subject to certain specific exceptions under the Bankruptcy Code, the Chapter 11 Cases automatically stayed most judicial or administrative actions against the Debtors and efforts by creditors to collect on or otherwise exercise rights or remedies with respect to pre-petition claims. Absent an order from the Bankruptcy Court, substantially all of the Debtors’ pre-petition liabilities are subject to settlement under the Bankruptcy Code.
Executory Contracts
Subject to certain exceptions, under the Bankruptcy Code, the Debtors may assume, assign, or reject certain executory contracts and unexpired leases subject to the approval of the Bankruptcy Court and certain other conditions. Generally, the rejection of an executory contract or unexpired lease is treated as a pre-petition breach of such executory contract or unexpired lease and, subject to certain exceptions, relieves the Debtors from performing their future obligations under such executory contract or unexpired lease but entitles the contract counterparty or lessor to a pre-petition general unsecured claim for damages caused by such deemed breach. Generally, the assumption of an executory contract or unexpired lease requires the Debtors to cure existing monetary defaults under such executory contract or unexpired lease and provide adequate assurance of future performance.
Potential Claims
The Debtors have filed with the Bankruptcy Court schedules and statements setting forth, among other things, the assets and liabilities of each of the Debtors, subject to the assumptions filed in connection therewith. These schedules and statements may be subject to further amendment or modification after filing. Certain holders of pre-petition claims that are not governmental units were required to file proofs of claim by the bar date of August 14, 2020. As of November 2, 2020, the Debtors' have received approximately 2,545 proofs of claim, primarily representing general unsecured claims, for an amount of approximately $6.7 billion. These claims will be reconciled to amounts recorded in liabilities subject to compromise in the condensed consolidated balance sheet. Differences in amounts recorded and claims filed by creditors will be investigated and resolved, including through the filing of objections with the Bankruptcy Court, where appropriate. The Company may ask the Bankruptcy Court to disallow claims that the Company believes are duplicative, have been later amended or superseded, are without merit, are overstated or should be disallowed for other reasons. In addition, as a result of this process, the Company may identify additional liabilities that will need to be recorded or reclassified to liabilities subject to compromise. In light of the substantial number of claims filed, and expected to be filed, the claims resolution process may take considerable time to complete and likely will continue after the Debtors emerge from bankruptcy.
Financial Statement Classification of Liabilities Subject to Compromise
The accompanying condensed consolidated balance sheets as of September 30, 2020 includes amounts classified as liabilities subject to compromise, which represent liabilities the Company anticipates will be allowed as claims in the Chapter 11 Cases. These amounts represent the Debtors’ current estimate of known or potential obligations to be resolved in connection with the Chapter 11 Cases, and may differ from actual future settlement amounts paid. Differences between liabilities estimated and claims filed, or to be filed, will be investigated and resolved in connection with the claims resolution process. The Company will continue to evaluate these liabilities throughout the chapter 11 process and adjust amounts as necessary. Such adjustments may be material. Please refer to Note 4—Liabilities Subject to Compromise for more information.
Reorganization Items, Net
The Debtors, have incurred and will continue to incur significant costs associated with the reorganization, primarily from damages for rejected or settled contracts and legal and professional fees. The amount of these costs, which since the Petition Date, are being expensed as incurred, are expected to significantly affect the Company’s results of operations. In accordance with applicable guidance, costs associated with the bankruptcy proceedings have been recorded as reorganization items within the Company's accompanying condensed consolidated statements of operations for the three and nine months ended September 30, 2020. Please refer to Note 5—Reorganization Items, Net for more information.
Revenue — Contract Balances
The Company had a certain revenue contract with an initial term beginning on November 1, 2016 and continuing until October 31, 2020 after which the contract was to begin an automatic month-to-month renewal unless terminated by either party giving notice at least six months prior to the effective termination date but in no event could either party give such notice earlier than November 1, 2020. Based on the accounting treatment pursuant to ASC 606 — Revenue from Contracts with Customers, the contract term would end on April 30, 2021 because it could be terminated by either party with no penalty effective as of such date. The contract term impacted the amount of consideration that could be included in the transaction price. The Company recognizes revenue and invoices customers once its performance obligations have been satisfied. When it becomes probable that the Company will not meet its performance obligations, the transaction price allocated to the performance obligation is constrained in the amount of the estimated unmet performance obligation and recognized as a reduction to revenue in the period in which the transaction price changes. On June 12, 2020, the Company and the counterparty to the contract mutually cancelled the contract effective June 30, 2020. As a result of the cancellation, for the three months ended September 30, 2020, no revenue was recorded as a reduction in the transaction price resulting from unsatisfied performance obligations in the period. For the nine months ended September 30, 2020, $12.3 million was recorded as a reduction in the transaction price resulting from unsatisfied performance obligations in the period. For the three and nine months ended September 30, 2019, the Company allocated $22.2 million to a satisfied performance obligation recognized within oil sales. As a result of the contract termination, the Company incurred an early termination fee of $13.2 million recorded in other operating expenses for the nine months ended September 30, 2020. This amount was settled during the third quarter of 2020, and there are no remaining amounts due to the counterparty.
Other Operating Expenses
Other operating expenses were $9.8 million and $75.5 million for the three and nine months ended September 30, 2020, respectively. There were no other operating expenses for the three and nine months ended September 30, 2019. The amounts in the current year are made up of the following:
•$46.8 million loss contingency from an alleged breach in contract stemming from a purported failure to complete the pipeline extensions connecting certain wells to the Badger central gathering facility prior to April 1, 2020. Please see Note 14—Commitments and Contingencies for further details.
•$2.9 million of accrued interest related to the aforementioned alleged breach in contract recorded in the third quarter of 2020.
•$13.2 million early termination penalty for the revenue contract terminated in June 2020. Please see the section Revenue — Contract Balance immediately above for further details.
•$7.5 million charge to income for expenses related to workforce reductions in February and May 2020.
•$2.4 million charge to income for expenses related to certain drilling rig standby charges during the second quarter of 2020.
•$2.4 million charge to income for interest expense on unpaid production taxes recorded in the third quarter of 2020.
•$0.3 million charge to income for other legal accruals recorded in the third quarter of 2020.
Impairment of Oil and Gas Properties
For the three months ended September 30, 2020 the Company recognized no impairment expense on its proved oil and gas properties, but for the nine months ended September 30, 2020 the Company recognized $1.6 million related to impairment of assets in its northern field. For the three months ended September 30, 2019, the Company recognized no impairment expense on its proved oil and gas properties, but for the nine months ended September 30, 2019, the Company recognized $11.2 million related to impairment of assets in its northern field. The fair value did not exceed the Company's carrying amount associated with its proved oil and gas properties in its northern field. For the three and nine months ended September 30, 2020 and 2019, the Company did not have any proved property impairment in its Core DJ Basin field.
Of the Company's $9.8 million in exploration and abandonment expenses for the three months ended September 30, 2020, $9.5 million was lease abandonment expense. Of the Company's $184.9 million in exploration and abandonment expenses for the nine months ended September 30, 2020, $179.0 million was lease abandonment expense. Unproved oil and gas properties consist of costs to acquire unevaluated leases as well as costs to acquire unproved reserves. The Company evaluates significant unproved oil and gas properties for impairment based on remaining lease term, drilling results, reservoir performance, seismic interpretation or future plans to develop acreage. When successful wells are drilled on undeveloped leaseholds, unproved property costs are reclassified to proved properties and depleted on a unit-of-production basis. Impairment expense and lease extension payments for unproved properties are reported in exploration and abandonment expenses in the condensed consolidated statements of operations.
Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-13, Financial Instruments—Credit Losses. In May 2019, ASU No. 2016-13 was subsequently amended by ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses and ASU No. 2019-05, Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief. ASU No. 2016-13, as amended, affects trade receivables, financial assets and certain other instruments that are not measured at fair value through net income. This ASU replaced the incurred loss approach with an expected loss model for instruments measured at amortized cost and was effective for financial statements issued for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. ASU No. 2016-13 will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The Company adopted this ASU on January 1, 2020, and the adoption did not have a material impact on the condensed consolidated financial statements and related disclosures.
In August 2018, the FASB issued ASU No. 2018-13, which removes or modifies current fair value disclosures and adds additional disclosures. The update to the guidance is the result of the FASB's test of the principles developed in its disclosure effectiveness project, which is designed to improve the effectiveness of disclosures in the notes to the financial statements. The disclosures that have been removed or modified may be applied immediately with retrospective application. For public entities, the new guidance was effective for fiscal years beginning after December 15, 2019, including interim reporting periods within that reporting period. The Company adopted this ASU on January 1, 2020, and the adoption did not have a material impact on the condensed consolidated financial statements and related disclosures.
In August 2018, the FASB issued ASU No. 2018-15, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal-use software license. For public entities, the guidance is effective for fiscal years beginning after December 15, 2019, including interim reporting periods within that reporting period. The Company adopted this ASU on January 1, 2020 which did not have a material impact on the condensed consolidated financial statements and related disclosures as capitalized costs for internal-use software were not material as of September 30, 2020.
Other than as disclosed above or in the Company’s Annual Report, there are no other accounting standards applicable to the Company as of September 30, 2020 and through the date of this filing that would have a material effect on the Company’s unaudited condensed consolidated financial statements and related disclosures that have been issued but not yet adopted by the Company.
Note 3—Divestitures
February 2020 Divestiture
In February 2020, the Company completed the sale of certain non-operated producing properties for aggregate sales proceeds of approximately $12.2 million, subject to customary purchase price adjustments. No gain or loss was recognized for the February 2020 Divestiture. The Company continues to explore divestitures as part of our ongoing initiative to divest non-strategic assets.
December 2019 Divestiture
In December 2019, the Company completed the sale of certain non-operated producing properties for aggregate sales proceeds of approximately $10.0 million, subject to customary purchase price adjustments. No gain or loss was recognized for the December 2019 Divestiture.
August 2019 Divestiture
In August 2019, the Company completed the sale of certain non-operated producing properties for aggregate sales proceeds of approximately $22.0 million, subject to customary purchase price adjustments. No gain or loss was recognized for the August 2019 Divestiture.
March 2019 Divestiture
In March 2019, the Company completed the sale of its interests in approximately 5,000 net acres of leasehold and producing properties for aggregate sales proceeds of approximately $22.4 million. The effective date for the March 2019 Divestiture was July 1, 2018 with purchase price adjustments calculated as of the closing date of $5.9 million, resulting in net proceeds of $16.5 million. No gain or loss was recognized for the March 2019 Divestiture.
Note 4—Liabilities Subject to Compromise
The Company’s liabilities subject to compromise consisted of the following (in thousands):
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September 30,
2020
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Accounts payable and accrued liabilities
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$
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93,526
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Revenue payable
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63,841
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Production taxes payable - current
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155,894
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Production taxes payable - non-current
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22,405
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Asset retirement obligations - current
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18,306
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Asset retirement obligations - non-current
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71,798
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Accrued interest on debt subject to compromise
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31,676
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2024 Senior Notes due May 15, 2024
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400,000
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2026 Senior Notes due February 1, 2026
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700,189
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Deferred liability
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16,813
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Deferred tax liability
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2,200
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Damages for rejected and settled contracts
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494,398
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Other liabilities
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38,400
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Total liabilities subject to compromise
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$
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2,109,446
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As discussed in Note 1—Business and Organization — Voluntary Reorganization under Chapter 11 of the Bankruptcy Code, since the Petition Date, the Company has been operating as debtor-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with provisions of the Bankruptcy Code. On the accompanying condensed consolidated balance sheets, the line item liabilities subject to compromise reflects the expected allowed amount of the prepetition claims that are not fully secured and that have at least a possibility of not being repaid at the full claim amount. Determination of the value at which liabilities will ultimately be settled cannot be made until the Bankruptcy Court approves the Restructuring Plan. In addition, the manner by which those liabilities are settled will ultimately be determined by the aforementioned Restructuring Plan and could include settlement in cash, Company equity or a combination. Liabilities subject to compromise includes amounts related to the rejection of various executory contracts and unexpired leases. Additional amounts may be included in liabilities subject to compromise in future periods if additional executory contracts and unexpired leases are rejected. The Company will continue to evaluate the amount and classification of its prepetition liabilities. Any additional liabilities that are subject to compromise will be recognized accordingly, and the aggregate amount of liabilities subject to compromise may change.
Note 5— Reorganization Items, Net
The Company’s reorganization items, net consisted of the following (in thousands):
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For the Three Months Ending
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For the Nine Months Ending
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September 30,
2020
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September 30,
2020
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Professional fees
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$
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23,469
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|
|
$
|
25,819
|
|
|
Professional services fees
|
—
|
|
|
2,200
|
|
|
Trustee fees
|
356
|
|
|
471
|
|
|
Damages for rejected and settled contracts
|
478,370
|
|
|
486,104
|
|
|
DIP Credit Facility fees
|
—
|
|
|
1,251
|
|
|
Write-off of debt issuance costs
|
272
|
|
|
13,541
|
|
|
Court approved vendor settlements
|
(1,394)
|
|
|
(1,394)
|
|
|
Total reorganization items, net
|
$
|
501,073
|
|
|
$
|
527,992
|
|
We have incurred and will continue to incur significant expenses, gains and losses associated with the reorganization, primarily adjustments for allowable claims related to executory contracts approved for rejection by the Bankruptcy Court, negotiated settlements on executory contracts, the write-off of unamortized debt issuance costs and professional fees incurred subsequent to the Chapter 11 filings for the restructuring process. The amount of these items, which are being incurred in reorganization items, net within our accompanying unaudited condensed consolidated statements of operations, are expected to significantly affect our results of operations. In future periods, we may also incur adjustments for allowable claims related to our legal proceedings and executory contracts approved for rejection by the Bankruptcy Court.
As of September 30, 2020, $505.4 million of reorganization costs, net consisting of professional fees, trustee fees and damages for rejected contracts are accrued and unpaid and are presented in either accounts payable and accrued liabilities or liabilities subject to compromise on the condensed consolidated balance sheets. The write-off of the Senior Notes debt issuance costs are included in reorganization items, net as the Company believes the underlying debt instruments will be impacted by the Chapter 11 Cases. The write-off of the Senior Notes debt issuance costs is a non-cash reorganization item. For the three and nine months ended September 30, 2020, the Company had cash charges related to reorganization items, net of $6.7 million and $10.5 million, respectively.
Note 6—Long-Term Debt
The Company’s long-term debt consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
2020
|
|
December 31,
2019
|
|
DIP Credit Facility
|
$
|
110,000
|
|
|
$
|
—
|
|
|
Credit Facility due August 16, 2022 (or an earlier time as set forth in the Credit Facility)
|
453,746
|
|
|
470,000
|
|
|
2024 Senior Notes due May 15, 2024
|
400,000
|
|
|
400,000
|
|
|
2026 Senior Notes due February 1, 2026
|
700,189
|
|
|
700,189
|
|
|
Total principal
|
1,663,935
|
|
|
1,570,189
|
|
|
Unamortized debt issuance costs on Senior Notes (1)
|
—
|
|
|
(14,412)
|
|
|
Total debt, prior to reclassification to liabilities subject to compromise
|
1,663,935
|
|
|
1,555,777
|
|
|
Less amounts reclassified to liabilities subject to compromise (2)
|
(1,100,189)
|
|
|
—
|
|
|
Total debt not subject to compromise (3)
|
563,746
|
|
|
1,555,777
|
|
|
Less current portion of long-term debt (4)
|
(563,746)
|
|
|
—
|
|
|
Total long-term debt
|
$
|
—
|
|
|
$
|
1,555,777
|
|
(1) As a result of the Chapter 11 Cases and the adoption of ASC 852, the Company wrote off all unamortized debt issuance cost balances to reorganization items, net in the condensed consolidated statements of operations during the nine months ended September 30, 2020.
(2) Debt subject to compromise includes the principal balances of the Company’s Senior Notes, which are unsecured claims in the Chapter 11 Cases and where the payments are stayed.
(3) Debt not subject to compromise includes all borrowings outstanding under the Credit Facility and DIP Credit Facility which are fully secured claims in the Chapter 11 Cases and are expected to be unimpaired.
(4) Due to uncertainties regarding the outcome of the Chapter 11 Cases, the Company has classified the borrowings outstanding under the Credit Facility and DIP Credit Facility as current liabilities on the condensed consolidated balance sheets as of September 30, 2020.
Chapter 11 Cases and Effect of Automatic Stay
On June 14, 2020, the Company filed for relief under Chapter 11 of the Bankruptcy Code. The commencement of a voluntary proceeding in bankruptcy constituted an immediate event of default under the Credit Agreement and the indentures governing the Company’s Senior Notes, resulting in the automatic and immediate acceleration of all of the Company’s outstanding debt under the Credit Agreement and Senior Notes. In conjunction with the filing of the Chapter 11 Cases, the Company did not make the $14.8 million interest payment on the Company’s 2024 Senior Notes (as defined below) due on May 15, 2020. Any efforts to enforce payment obligations related to the acceleration of the Company’s debt have been automatically stayed as a result of the filing of the Chapter 11 Cases, and the creditors’ rights of enforcement are subject to the applicable provisions of the Bankruptcy Code. Please refer to Note 1—Business and Organization — Ability to Continue as a Going Concern for more information on the Chapter 11 Cases.
Debtor-in-Possession Financing
On June 16, 2020, in connection with the filing of the Chapter 11 Cases, the Debtors entered into a debtor-in-possession credit agreement on the terms set forth in a Superpriority Senior Secured Debtor-in-Possession Credit Agreement (the “DIP Credit Agreement”), by and among the Company, as borrower, the Company’s subsidiaries party thereto, as guarantors, the lenders party thereto (the “DIP Lenders”), and Wells Fargo Bank, National Association, as DIP agent and issuing lender, pursuant to which, having been granted the approval of the Bankruptcy Court, the DIP Lenders agree to provide the Company with a superpriority senior secured debtor-in-possession credit facility (as amended, the “DIP Credit Facility”) with loans in an aggregate principal amount not to exceed $50.0 million that, among other things, will be used to finance the ongoing general corporate needs of the Debtors during the course of the Chapter 11 Cases. In addition to the $50.0 million of incremental loans, the DIP Credit Facility included $75.0 million in Credit Facility loans rolled over into the DIP Credit Facility during July 2020, for a total facility size of $125.0 million.
The maturity date of the DIP Credit Agreement is the earliest of (i) December 14, 2020, or the date that is six (6) months after the filing of the Chapter 11 Cases; provided, that such date may be extended to March 14, 2021 with the prior written approval of certain of the DIP Lenders; (ii) the consummation of a sale of all or substantially all of the assets of the Debtors; (iii) the effective date of a plan of reorganization or liquidation in the Chapter 11 Cases; (iv) the entry of an order by the Bankruptcy Court dismissing any of the Chapter 11 Cases or converting such Chapter 11 Cases to a case under chapter 7 of title 11 of the United States Bankruptcy Code; and (v) the date of termination of the DIP Lenders’ commitments and the acceleration of any outstanding extensions of credit, in each case, under the DIP Credit
Agreement and in accordance with the interim and final orders entered by the Bankruptcy Court concerning the DIP Credit Agreement. Furthermore, the DIP Credit Facility's interest rate varies similar to the Company's Credit Agreement and was a LIBOR loan with a base interest rate of 1.00% and spread of 5.75% as of September 30, 2020.
The DIP Credit Agreement contains a requirement that the Company provide, on a monthly basis, a rolling thirteen-week operating budget and cash flow forecast (the “Approved Budget”) and not vary from the Approved Budget, subject to a Permitted Variance (defined below). The Approved Budget is, subject to certain exceptions, tested on a weekly basis to measure any variance, on an aggregate basis, for all disbursements made in the prior four-week period. The disbursements actually made in such prior four week period compared to the budgeted aggregate disbursements for such four week period reflected in the most recently delivered Approved Budget may not vary by more than 10% (or a greater amount, to the extent agreed upon by the DIP Agent) (such variance, a “Permitted Variance”). As of September 30, 2020, the Company was in compliance with the covenants under the DIP Credit Facility.
The DIP Credit Agreement contains events of default customary to debtor-in-possession financings, including events related to the Chapter 11 Cases, the occurrence of which could result in the acceleration of the Debtors’ obligation to repay the outstanding indebtedness under the DIP Credit Agreement. The Debtors’ obligations under the DIP Credit Agreement will be secured by a security interest in, and lien on, substantially all present and after acquired property (whether tangible, intangible, real, personal or mixed) of the Debtors and will be guaranteed by all of the Company’s restricted subsidiaries.
On July 20, 2020, the Company, together with its subsidiaries party thereto, certain of the DIP Lenders and Wells Fargo Bank, National Association entered into an amendment to the DIP Credit Agreement to, among other things: (i) extend certain Milestones in the DIP Credit Agreement, (ii) modify the limitation on the amount of undrawn New Money Interim Loans and New Money Final Loans in any borrowing so that the amount permitted to be drawn in accordance with the Approved Budget gives effect to the Permitted Variance, (iii) provide for customary prohibitions against unreasonable withholding of approvals with respect to the Approved Budget and the Restructuring Plan on the part of the DIP Lenders and the DIP Agent, and (iv) reaffirm the Debtors’ liens, guaranties and representations and warranties under the DIP Credit Agreement.
On November 2, 2020, the Company, together with its subsidiaries party thereto, certain of the DIP Lenders and Wells Fargo Bank, National Association entered into a second amendment to the DIP Credit Agreement to, among other things: (i) extend certain “Milestones,” as defined in the DIP Credit Agreement, (ii) extend the “Scheduled Maturity Date,” as defined in the DIP Credit Agreement, to January 31, 2021 and (iii) provide that the Scheduled Maturity Date may be further extended, at the request of the Company, to a date that is on or before March 14, 2021 with the prior written consent of the Majority Lenders, as defined in the DIP Credit Agreement.
As of September 30, 2020, the Company's DIP Credit Facility borrowings were $35.0 million and $75.0 million had been rolled over from the Credit Facility for a total outstanding balance of $110.0 million. The DIP Credit Facility is classified as a current liability on the condensed consolidated balance sheets as of September 30, 2020 as it is fully secured and expected to be unimpaired. On July 20, 2020, the Bankruptcy Court entered the final order approving the DIP Credit Agreement and associated DIP Credit Facility (the “Final DIP Order”) and $52.5 million was rolled over from the Credit Agreement into the DIP Credit Facility. On July 27, 2020, the Company drew an additional $20.0 million on the DIP Credit Facility leaving $15.0 million of availability on the facility. However, this availability could be restricted by a minimum liquidity covenant of $10.0 million from unrestricted cash and DIP Credit Facility availability.
Credit Agreement
In August 2017, the Company entered into an amendment and restatement of its existing credit facility to provide aggregate commitments of $1.5 billion with a syndicate of banks, which is subject to a borrowing base (as amended, the "Credit Facility"). The Credit Facility matures on the earlier of (a) August 16, 2022, (b) April 15, 2021, if (and only if) (i) the Series A Preferred Stock have not been converted into common equity or redeemed prior to April 15, 2021 (the Company can redeem the Series A Preferred Stock at any time), and (ii) prior to April 15, 2021, the maturity date of the Series A Preferred Stock has not been extended to a date that is no earlier than six months after August 16, 2022 or (c) the earlier termination in whole of the commitments under the Credit Facility. No principal payments are generally required until the Credit Facility matures or in the event that the borrowing base falls below the outstanding balance.
The amount available to be borrowed under the Company’s Credit Facility is subject to a borrowing base that is redetermined semiannually on each May 1 and November 1, and will depend on the volumes of the Company’s proved oil and gas reserves, commodity prices, estimated cash flows from these reserves and other information deemed relevant by the administrative agent under the Company’s Credit Facility. Additionally, the undrawn balance may be constrained by the Company's quantitative covenants under the Credit Facility, including the current ratio and ratio of consolidated debt less cash balances to its consolidated EBITDAX, at the next required quarterly compliance date.
On April 27, 2020, the lenders under the Credit Facility provided notice to the Company that they had completed the redetermination scheduled to occur on May 1, 2020, and via this redetermination, the borrowing base had been reduced from $950.0 million to $650.0 million. Following this redetermination, the Company had outstanding borrowings of $600.5 million and had standby letters of credit of $49.5 million, which reduce the availability of the undrawn borrowing base.
The commencement of the Chapter 11 Cases constituted a termination event with respect to the Company’s derivative instruments, which permits the counterparties to such derivative instruments to terminate their outstanding hedges. Such termination events are not stayed under the Bankruptcy Code. During June 2020, certain of the lenders under the Credit Agreement elected to terminate their International Swaps and Derivatives Association master agreements and outstanding hedges with the Company for aggregate settlement proceeds of $96.1 million. The proceeds from these terminations were applied to the outstanding borrowings under the Credit Facility.
As is described in the Debtor-in-Possession Financing section above, $22.5 million rolled from the Credit Facility to the DIP Credit Facility on June 16, 2020 and an additional $52.5 million rolled on July 20, 2020 upon court approval of the Final DIP Order. As of September 30, 2020, the Credit Facility had a drawn balance of $453.7 million classified as a current liability on the condensed consolidated balance sheet. During the third quarter, due to the cancellation of a certain revenue contract discussed in Note 2—Basis of Presentation, Significant Accounting Policies and Recent Accounting Pronouncements — Revenue — Contract Balances, $24.3 million was drawn on a $40.0 million letter of credit secured by the Company's Credit Facility. As of the date of this filing, and excluding any undrawn amounts under letters of credit, the available amount to be borrowed under the Credit Facility was zero.
Principal amounts borrowed on the Credit Facility will be payable on the maturity date. The Company can repay any amounts borrowed prior to the maturity date without any premium or penalty other than customary LIBOR breakage costs. Prior to the filing of the Chapter 11 Cases, amounts repaid under the Credit Facility could be re-borrowed from time to time, subject to the terms of the facility.
Interest on the Credit Facility is payable at one of the following two variable rates as selected by the Company: a base rate based on the Prime Rate or the Eurodollar rate, based on LIBOR. Either rate is adjusted upward by an applicable margin, based on the utilization percentage of the facility as outlined in the pricing grid below. Additionally, the Credit Facility provides for a commitment fee of 0.375% to 0.50%, depending on borrowing base usage. Due to the bankruptcy filing on June 14, 2020, a default penalty of an additional 2.00% went into effect and increased the Credit Agreement interest rates above those interest rates shown in the grid below. The grid below shows the Base Rate Margin and Eurodollar Margin depending on the applicable Borrowing Base Utilization Percentage (as defined in the Credit Agreement) as of the date of this filing:
Borrowing Base Utilization Grid
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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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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eurodollar
|
|
Base Rate
|
|
Commitment
|
|
Borrowing Base Utilization Percentage
|
|
Utilization
|
|
Margin
|
|
Margin
|
|
Fee Rate
|
|
Level 1
|
|
<25%
|
|
1.50
|
%
|
|
0.50
|
%
|
|
0.38
|
%
|
|
Level 2
|
|
≥
|
25%
|
<
|
50%
|
|
1.75
|
%
|
|
0.75
|
%
|
|
0.38
|
%
|
|
Level 3
|
|
≥
|
50%
|
<
|
75%
|
|
2.00
|
%
|
|
1.00
|
%
|
|
0.50
|
%
|
|
Level 4
|
|
≥
|
75%
|
<
|
90%
|
|
2.25
|
%
|
|
1.25
|
%
|
|
0.50
|
%
|
|
Level 5
|
|
≥90%
|
|
2.50
|
%
|
|
1.50
|
%
|
|
0.50
|
%
|
The Credit Agreement contains representations, warranties, covenants, conditions and defaults customary for transactions of this type, including but not limited to: (i) limitations on liens and incurrence of debt covenants;
(ii) limitations on dividends, distributions, redemptions and restricted payments covenants; (iii) limitations on investments, loans and advances covenants; and (iv) limitations on the sale of property, mergers, consolidations and other similar transactions covenants. Additionally, the Credit Agreement limits the Company entering into hedges in excess of 85% of its anticipated production volumes.
The Credit Agreement also contains financial covenants requiring the Company to comply on the last day of each quarter with a current ratio of its restricted subsidiaries’ current assets (includes availability under the revolving Credit Facility and unrestricted cash and excludes derivative assets) to its restricted subsidiaries’ current liabilities (excludes obligations under the revolving Credit Facility, senior notes and certain derivative liabilities), of not less than 1.0 to 1.0 and to maintain, on the last day of each quarter, a ratio of its restricted subsidiaries’ debt less cash balances to its restricted subsidiaries EBITDAX (EBITDAX is defined as net income adjusted for interest expense, income tax expense/benefit, DD&A, exploration and abandonment expenses as well as certain non-recurring cash and non-cash charges and income (such as stock-based compensation expense, unrealized gains/losses on commodity derivatives and impairment of long-lived assets and goodwill), subject to pro forma adjustments for non-ordinary course acquisitions and divestitures) for the four fiscal quarter periods most recently ended, of not greater than 4.0 to 1.0 as of the last day of such fiscal quarter.
The acceleration of the obligations under the Credit Agreement as of June 14, 2020 resulted in a cross-default and acceleration of the maturity of the Company’s other outstanding long-term debt. The Credit Facility is classified as a current liability on the condensed consolidated balance sheets as of September 30, 2020 as it is fully secured and expected to be unimpaired.
Any borrowings under the Credit Facility are collateralized by substantially all of the assets of the Company and certain of its subsidiaries, including oil and gas properties, personal property and the equity interests of those subsidiaries of the Company. The Company has entered into oil and natural gas hedging transactions with several counterparties that are also lenders under the Credit Facility. The Company’s obligations under these hedging contracts are secured by the collateral securing the Credit Facility. Elevation is an unrestricted subsidiary, which is no longer consolidated or controlled by the Company, and the assets and credit of Elevation are not available to satisfy the debts and other obligations of the Company or its other subsidiaries.
2024 Senior Notes
In August 2017, the Company issued at par $400.0 million principal amount of 7.375% Senior Notes due May 15, 2024 (the "2024 Senior Notes" and the offering, the "2024 Senior Notes Offering"). The 2024 Senior Notes bear an annual interest rate of 7.375%. The interest on the 2024 Senior Notes is payable on May 15 and November 15 of each year which commenced on November 15, 2017. The Company received net proceeds of approximately $392.6 million after deducting fees.
The Company's 2024 Senior Notes are its senior unsecured obligations and rank equally in right of payment with all of its other senior indebtedness and senior to any of its subordinated indebtedness. The Company's 2024 Senior Notes are fully and unconditionally guaranteed on a senior unsecured basis by certain of the Company's current subsidiaries and by certain future restricted subsidiaries that guarantees its indebtedness under a Credit Facility (the "2024 Senior Notes Guarantors"). The 2024 Senior Notes are effectively subordinated to all of the Company's secured indebtedness (including all borrowings and other obligations under its Credit Facility) to the extent of the value of the collateral securing such indebtedness, and structurally subordinated in right of payment to all existing and future indebtedness and other liabilities (including trade payables) of any of its future subsidiaries that do not guarantee the 2024 Senior Notes.
The 2024 Senior Notes also contain affirmative and negative covenants that, among other things, limit the Company's and the 2024 Senior Notes Guarantors' ability to make investments; declare or pay any dividend or make any other payment to holders of the Company’s or any of its 2024 Senior Notes Guarantors’ equity interests; repurchase or redeem any equity interests of the Company; repurchase or redeem subordinated indebtedness; incur additional indebtedness or issue preferred stock; create liens; sell assets; enter into agreements that restrict dividends or other payments by restricted subsidiaries; consolidate, merge or transfer all or substantially all of the assets of the Company; engage in transactions with the Company's affiliates; engage in any business other than the oil and gas business; and create unrestricted subsidiaries. The indenture governing the 2024 Senior Notes also contains customary events of
default. Upon the occurrence of events of default arising from certain events of bankruptcy or insolvency, the 2024 Senior Notes shall become due and payable immediately without any declaration or other act of the trustee or the holders of the 2024 Senior Notes.
The filing of the Chapter 11 Cases resulted in an event of default under and acceleration of the maturity of the Company’s 2024 Senior Notes.
2026 Senior Notes
In January 2018, the Company issued at par $750.0 million principal amount of 5.625% Senior Notes due February 1, 2026 (the "2026 Senior Notes" and together with the 2024 Senior Notes, the "Senior Notes" and the offering of the 2026 Senior Notes, the "2026 Senior Notes Offering"). The 2026 Senior Notes bear an annual interest rate of 5.625%. The interest on the 2026 Senior Notes is payable on February 1 and August 1 of each year commencing on August 1, 2018. The Company received net proceeds of approximately $737.9 million after deducting fees.
The Company's 2026 Senior Notes are the Company's senior unsecured obligations and rank equally in right of payment with all of the Company's other senior indebtedness and senior to any of the Company's subordinated indebtedness. The Company's 2026 Senior Notes are fully and unconditionally guaranteed on a senior unsecured basis by certain of the Company's current subsidiaries and by certain future restricted subsidiaries that guarantee the Company's indebtedness under a Credit Facility (the "2026 Senior Notes Guarantors"). The 2026 Senior Notes are effectively subordinated to all of the Company's secured indebtedness (including all borrowings and other obligations under its Credit Facility) to the extent of the value of the collateral securing such indebtedness, and structurally subordinated in right of payment to all existing and future indebtedness and other liabilities (including trade payables) of certain of the Company's future restricted subsidiaries that do not guarantee the 2026 Senior Notes.
The 2026 Senior Notes also contain affirmative and negative covenants that, among other things, limit the Company's and the 2026 Senior Notes Guarantors' ability to make investments; declare or pay any dividend or make any other payment to holders of the Company's or any of its 2026 Senior Notes Guarantors' equity interests; repurchase or redeem any equity interests of the Company; repurchase or redeem subordinated indebtedness; incur additional indebtedness or issue preferred stock; create liens; sell assets; enter into agreements that restrict dividends or other payments by restricted subsidiaries; consolidate, merge or transfer all or substantially all of the assets of the Company; engage in transactions with the Company’s affiliates; engage in any business other than the oil and gas business; and create unrestricted subsidiaries. The indenture governing the 2026 Senior Notes also contains customary events of default. Upon the occurrence of events of default arising from certain events of bankruptcy or insolvency, the 2026 Senior Notes shall become due and payable immediately without any declaration or other act of the trustee or the holders of the 2026 Senior Notes.
The filing of the Chapter 11 Cases resulted in an event of default under and acceleration of the maturity of the Company’s 2026 Senior Notes.
Debt Issuance Costs
Debt issuance costs include origination, legal and other fees incurred in connection with the Company’s Credit Facility and Senior Notes. As of September 30, 2020, the Company had debt issuance costs, net of accumulated amortization, of $0.5 million related to its Credit Facility which has been reflected on the Company's condensed consolidated balance sheets within the line item other non-current assets. As a result of the bankruptcy, the Company wrote-off $13.5 million in unamortized debt issuance costs on the 2024 and 2026 Senior Notes to reorganization items, net in the condensed consolidated statements of operations. For the three months ended September 30, 2020 and 2019, the Company recorded amortization expense related to the debt issuance costs of $0.2 million and $1.0 million, respectively. For the nine months ended September 30, 2020 and 2019, the Company recorded amortization expense related to the debt issuance costs of $3.3 million and $3.8 million, respectively.
Interest Incurred on Long-Term Debt
For the three and nine months ended September 30, 2020, the Company incurred interest expense on long-term debt of $8.1 million and $50.6 million, respectively, as compared to $23.8 million and $66.9 million, respectively, for the three and nine months ended September 30, 2019. Absent the automatic stay, interest expense for the three and nine months ended September 30, 2020 would have been $24.6 million and $69.2 million, respectively. For the three and nine months ended September 30, 2020, the Company capitalized interest expense on long term debt of $0.9 million and $4.9 million, respectively, as compared to $1.6 million and $5.4 million, respectively, for the three and nine months ended September 30, 2019, which has been reflected in the Company’s condensed consolidated financial statements.
Senior Note Repurchase Program
On January 4, 2019, the Board of Directors authorized a program to repurchase up to $100.0 million of the Company’s Senior Notes (the “Senior Notes Repurchase Program”). The Company’s Senior Notes Repurchase Program is subject to restrictions under the Credit Facility and does not obligate it to acquire any specific nominal amount of Senior Notes. For the three and nine months ended September 30, 2020, the Company did not repurchase any Senior Notes. As a result of the Chapter 11 Cases, the authorization to repurchase Senior Notes is no longer applicable. For the three months ended September 30, 2019, the Company did not repurchase 2026 Senior Notes. For the nine months ended September 30, 2019, the Company repurchased a nominal value of $49.8 million for $39.3 million in connection with the Senior Notes Repurchase Program. Interest expense for the nine months ended September 30, 2019 contained a $10.5 million gain on debt repurchase related to the Company's Senior Notes Repurchase Program. For the three months ended September 30, 2019, this gain was zero.
Note 7—Commodity Derivative Instruments
The Company has entered into commodity derivative instruments, as described below. The Company has utilized swaps, put options and call options to reduce the effect of price changes on a portion of the Company’s future oil and natural gas production.
A swap has an established fixed price. When the settlement price is below the fixed price, the counterparty pays the Company an amount equal to the difference between the settlement price and the fixed price multiplied by the hedged contract volume. When the settlement price is above the fixed price, the Company pays its counterparty an amount equal to the difference between the settlement price and the fixed price multiplied by the hedged contract volume.
A put option has an established floor price. The buyer of the put option pays the seller a premium to enter into the put option. When the settlement price is below the floor price, the seller pays the buyer an amount equal to the difference between the settlement price and the strike price multiplied by the hedged contract volume. When the settlement price is above the floor price, the put option expires worthless. Some of the Company’s purchased put options have deferred premiums. For the deferred premium puts, the Company agrees to pay a premium to the counterparty at the time of settlement.
A call option has an established ceiling price. The buyer of the call option pays the seller a premium to enter into the call option. When the settlement price is above the ceiling price, the seller pays the buyer an amount equal to the difference between the settlement price and the strike price multiplied by the hedged contract volume. When the settlement price is below the ceiling price, the call option expires worthless.
The Company combines swaps, purchased put options, purchased call options, sold put options and sold call options in order to achieve various hedging strategies. Some examples of the Company’s hedging strategies are collars which include purchased put options and sold call options, three-way collars which include purchased put options, sold put options and sold call options, and enhanced swaps, which include either sold put options or sold call options with the associated premiums rolled into an enhanced fixed price swap. The Company has historically relied on commodity derivative contracts to mitigate its exposure to lower commodity prices.
The objective of the Company’s use of commodity derivative instruments is to achieve more predictable cash flows in an environment of volatile oil and natural gas prices and to manage its exposure to commodity price risk. While
the use of these commodity derivative instruments limits the downside risk of adverse price movements, such use may also limit the Company’s ability to benefit from favorable price movements. The Company may, from time to time, add incremental derivatives to hedge additional production, restructure existing derivative contracts or enter into new transactions to modify the terms of current contracts in order to realize the current value of the Company’s existing positions. The Company does not enter into derivative contracts for speculative purposes.
To reduce the impact of fluctuations in oil and natural gas prices on the Company's revenues, the Company has periodically entered into commodity derivative contracts with respect to certain of its oil and natural gas production through various transactions that limit the downside of future prices received. The Company plans to continue its practice of entering into such transactions to reduce the impact of commodity price volatility on its cash flow from operations. Future transactions may include price swaps whereby the Company will receive a fixed price for its production and pay a variable market price to the contract counterparty. Additionally, the Company may enter into collars, whereby it receives the excess, if any, of the fixed floor over the floating rate or pay the excess, if any, of the floating rate over the fixed ceiling price. These hedging activities are intended to support oil and natural gas prices at targeted levels and to manage the Company's exposure to oil and natural gas price fluctuations.
The use of derivatives involves the risk that the counterparties to such instruments will be unable to meet the financial terms of such contracts. The Company’s derivative contracts are currently with two counterparties, both of which are lenders under the Credit Agreement and the DIP Credit Facility. The Company has netting arrangements with the counterparty that provide for the offset of payables against receivables from separate derivative arrangements with the counterparties in the event of contract termination. The derivative contracts may be terminated by a non-defaulting party in the event of default by one of the parties to the agreement. There is no credit risk related contingent features or circumstances in which the features could be triggered in derivative instruments that are in a net liability position at the end of the reporting period.
Effect of Chapter 11 Cases
The commencement of the Chapter 11 Cases constituted a termination event with respect to the Company’s derivative instruments, which permits the counterparties to such derivative instruments to terminate their outstanding hedges. Such termination events are not stayed under the Bankruptcy Code. During June 2020, certain of the lenders under the Credit Agreement elected to terminate their International Swaps and Derivatives Association master agreements and outstanding hedges with the Company for aggregate settlement proceeds of $96.1 million. The proceeds from these terminations were applied to the outstanding borrowings under the Credit Facility. After the June 2020 terminations, the remaining active contracts consisted of the items shown in the table immediately below.
The Company’s open commodity derivative contracts by quarter as of September 30, 2020 are summarized below:
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|
|
|
|
12/31/2020
|
|
3/31/2021
|
|
6/30/2021
|
|
NYMEX WTI Crude Swaps:
|
|
|
|
|
|
|
Notional volume (Bbl)
|
1,875,000
|
|
|
750,000
|
|
|
450,000
|
|
|
Weighted average fixed price ($/Bbl)
|
$
|
47.59
|
|
|
$
|
60.07
|
|
|
$
|
60.07
|
|
|
NYMEX WTI Crude Purchased Puts:
|
|
|
|
|
|
|
Notional volume (Bbl)
|
—
|
|
|
150,000
|
|
|
150,000
|
|
|
Weighted average purchased put price ($/Bbl)
|
$
|
—
|
|
|
$
|
55.04
|
|
|
$
|
55.04
|
|
|
NYMEX WTI Crude Sold Calls:
|
|
|
|
|
|
|
Notional volume (Bbl)
|
—
|
|
|
150,000
|
|
|
150,000
|
|
|
Weighted average sold call price ($/Bbl)
|
$
|
—
|
|
|
$
|
65.00
|
|
|
$
|
65.00
|
|
|
NYMEX WTI Crude Sold Puts:
|
|
|
|
|
|
|
Notional volume (Bbl)
|
—
|
|
|
900,000
|
|
|
600,000
|
|
|
Weighted average sold put price ($/Bbl)
|
$
|
—
|
|
|
$
|
43.92
|
|
|
$
|
43.88
|
|
|
NYMEX HH Natural Gas Swaps:
|
|
|
|
|
|
|
Notional volume (MMBtu)
|
9,000,000
|
|
|
—
|
|
|
—
|
|
|
Weighted average fixed price ($/MMBtu)
|
$
|
2.53
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
CIG Basis Swaps
|
|
|
|
|
|
|
Notional volume (MMBtu)
|
3,000,000
|
|
|
—
|
|
|
—
|
|
|
Weighted average fixed basis price ($/MMBtu)
|
$
|
(0.40)
|
|
|
$
|
—
|
|
|
$
|
—
|
|
The following tables detail the fair value of the Company’s derivative instruments, including the gross amounts and adjustments made to net the derivative instruments for the presentation in the condensed consolidated balance sheets (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2020
|
|
Location on Balance Sheet
|
|
Gross Amounts of Recognized Assets and Liabilities
|
|
Gross Amounts Offsets in the Balance Sheet(1)
|
|
Net Amounts of Assets and Liabilities Presented in the Balance Sheet
|
|
Gross Amounts not Offset in the Balance Sheet(2)
|
|
Net Amounts(3)
|
|
Current assets
|
|
$
|
40,595
|
|
|
$
|
(7,970)
|
|
|
$
|
32,625
|
|
|
$
|
—
|
|
|
$
|
32,625
|
|
|
Non-current assets
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Current liabilities
|
|
(8,646)
|
|
|
7,970
|
|
|
(676)
|
|
|
—
|
|
|
(676)
|
|
|
Non-current liabilities
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2019
|
|
Location on Balance Sheet
|
|
Gross Amounts of Recognized Assets and Liabilities
|
|
Gross Amounts Offsets in the Balance Sheet(1)
|
|
Net Amounts of Assets and Liabilities Presented in the Balance Sheet
|
|
Gross Amounts not Offset in the Balance Sheet(2)
|
|
Net Amounts(3)
|
|
Current assets
|
|
$
|
48,605
|
|
|
$
|
(31,051)
|
|
|
$
|
17,554
|
|
|
$
|
—
|
|
|
$
|
30,783
|
|
|
Non-current assets
|
|
38,034
|
|
|
(24,805)
|
|
|
13,229
|
|
|
—
|
|
|
—
|
|
|
Current liabilities
|
|
(33,049)
|
|
|
31,051
|
|
|
(1,998)
|
|
|
—
|
|
|
(2,106)
|
|
|
Non-current liabilities
|
|
(24,913)
|
|
|
24,805
|
|
|
(108)
|
|
|
—
|
|
|
—
|
|
(1)Agreements are in place that allow for the financial right of offset for derivative assets and derivative liabilities at settlement or in the event of a default under the agreements.
(2)Netting for balance sheet presentation is performed by current and non-current classification. This adjustment represents amounts subject to an enforceable master netting arrangement, which are not netted on the condensed consolidated balance sheets. There are no amounts of related financial collateral received or pledged.
(3)Net amounts are not split by current and non-current. All counterparties in a net asset position are shown in the current asset line, and all counterparties in a net liability position are shown in the current liability line item.
The table below sets forth the commodity derivatives gain (loss) for the three and nine months ended September 30, 2020 and 2019 (in thousands). Commodity derivatives gain (loss) are included under the other income (expense) line item in the condensed consolidated statements of operations.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended September 30,
|
|
For the Nine Months Ended September 30,
|
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
|
Commodity derivatives gain (loss)
|
$
|
(9,673)
|
|
|
$
|
87,956
|
|
|
$
|
184,041
|
|
|
$
|
39,383
|
|
Note 8—Asset Retirement Obligations
The Company follows accounting for asset retirement obligations in accordance with ASC 410 — Asset Retirement and Environmental Obligations, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it was incurred if a reasonable estimate of fair value could be made. The Company’s asset retirement obligations primarily represent the estimated present value of the amounts expected to be incurred to plug, abandon and remediate producing and shut-in wells at the end of their productive lives in accordance with applicable local, state and federal laws, and applicable lease terms. The Company determines the estimated fair value of its asset retirement obligations by calculating the present value of estimated cash flows related to plugging and abandonment liabilities. The significant inputs used to calculate such liabilities include estimates of costs to be incurred, the Company’s credit adjusted discount rates, inflation rates and estimated dates of abandonment. The asset retirement liability is accreted to its present value each period and the capitalized asset retirement costs are depleted with proved oil and gas properties using the unit of production method. Asset retirement obligations are currently presented in the line item liabilities subject to compromise on the condensed consolidated balance sheets.
The following table summarizes the activities of the Company’s asset retirement obligations for the period indicated (in thousands):
|
|
|
|
|
|
|
|
|
For the Nine Months Ended September 30, 2020
|
|
Balance beginning of period
|
$
|
95,908
|
|
|
Liabilities incurred or acquired
|
332
|
|
|
Liabilities settled
|
(18,975)
|
|
|
Revisions in estimated cash flows
|
7,861
|
|
|
Accretion expense
|
4,978
|
|
|
Balance end of period
|
$
|
90,104
|
|
Note 9—Fair Value Measurements
ASC 820, Fair Value Measurement and Disclosure, establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions of what market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of the inputs as follows:
•Level 1: Quoted prices are available in active markets for identical assets or liabilities;
•Level 2: Quoted prices in active markets for similar assets and liabilities that are observable for the asset or liability;
•Level 3: Unobservable pricing inputs that are generally less observable from objective sources, such as discounted cash flow models or valuations.
The financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels. There were no transfers between levels during any periods presented below.
The following table presents the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2020 and December 31, 2019 by level within the fair value hierarchy (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement at September 30, 2020
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Financial Assets:
|
|
|
|
|
|
|
|
|
Commodity derivative assets
|
$
|
—
|
|
|
$
|
32,625
|
|
|
$
|
—
|
|
|
$
|
32,625
|
|
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
Commodity derivative liabilities
|
$
|
—
|
|
|
$
|
676
|
|
|
$
|
—
|
|
|
$
|
676
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurement at December 31, 2019
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Financial Assets:
|
|
|
|
|
|
|
|
|
Commodity derivative assets
|
$
|
—
|
|
|
$
|
30,783
|
|
|
$
|
—
|
|
|
$
|
30,783
|
|
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
Commodity derivative liabilities
|
$
|
—
|
|
|
$
|
2,106
|
|
|
$
|
—
|
|
|
$
|
2,106
|
|
The following methods and assumptions were used to estimate the fair value of the assets and liabilities in the tables above:
Commodity Derivative Instruments
The Company determines its estimate of the fair value of derivative instruments using a market based approach that takes into account several factors, including quoted market prices in active markets, implied market volatility factors, quotes from third parties, the credit rating of each counterparty, and the Company's own credit rating. In consideration of counterparty credit risk, the Company assessed the possibility of whether each counterparty to the derivative would default by failing to make any contractually required payments. Additionally, the Company considers that it is of substantial credit quality and has the financial resources and willingness to meet its potential repayment obligations associated with the derivative transactions. Derivative instruments utilized by the Company consist of swaps, put options and, call options. The oil and natural gas derivative markets are highly active. Although the Company’s derivative instruments are valued using public indices, the instruments themselves are traded with third party counterparties and are not openly traded on an exchange. As such, the Company has classified these instruments as Level 2.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, commodity derivative instruments (discussed above) and long-term debt. As of September 30, 2020, the Senior Notes were reclassified to liabilities subject to compromise. The carrying values of cash and cash equivalents,
accounts receivable and accounts payable are representative of their fair values due to their short-term maturities. The carrying amounts of the Company’s Credit Facility and DIP Credit Facility approximated fair value as it bears interest at variable rates over the term of the loan. The fair values of the 2024 Senior Notes and 2026 Senior Notes were derived from available market data. As such, the Company has classified the 2024 Senior Notes and 2026 Senior Notes as Level 2. Please refer to Note 6—Long-Term Debt for further information. The Company’s policy is to recognize transfers between levels at the end of the period. This disclosure (in thousands) does not impact the Company's financial position, results of operations or cash flows.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2020
|
|
At December 31, 2019
|
|
|
Carrying Amount
|
|
Fair Value
|
|
Carrying Amount
|
|
Fair Value
|
|
Credit Facility
|
$
|
453,746
|
|
|
$
|
453,746
|
|
|
$
|
470,000
|
|
|
$
|
470,000
|
|
|
DIP Credit Facility
|
$
|
110,000
|
|
|
$
|
110,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
2024 Senior Notes(1)
|
$
|
400,000
|
|
|
$
|
102,500
|
|
|
$
|
394,824
|
|
|
$
|
250,000
|
|
|
2026 Senior Notes(2)
|
$
|
700,189
|
|
|
$
|
178,548
|
|
|
$
|
690,953
|
|
|
$
|
420,113
|
|
(1)The carrying amount of the 2024 Senior Notes includes no unamortized debt issuance costs as of September 30, 2020 and $5.2 million as of December 31, 2019.
(2)The carrying amount of the 2026 Senior Notes includes no unamortized debt issuance costs as of September 30, 2020 and $9.2 million as of December 31, 2019.
Non-Recurring Fair Value Measurements
The Company applies the provisions of the fair value measurement standard on a non-recurring basis to its non-financial assets and liabilities, including proved property. These assets and liabilities are not measured at fair value on a recurring basis, but are subject to fair value adjustments when facts and circumstances arise that indicate a need for remeasurement.
The Company utilizes fair value on a non-recurring basis to review its proved oil and gas properties for potential impairment when events and circumstances indicate, and at least annually, a possible decline in the recoverability of the carrying value of such property. The Company uses an income approach analysis based on the net discounted future cash flows of producing property. The future cash flows are based on management’s estimates for the future. Unobservable inputs include estimates of oil and gas production, as the case may be, from the Company’s reserve reports, commodity prices based on the sales contract terms and forward price curves, operating and development costs and a discount rate based on a market-based weighted average cost of capital (all of which are Level 3 inputs within the fair value hierarchy). For the nine months ended September 30, 2020 and 2019, the Company recognized $1.6 million and $11.2 million, respectively in impairment expense on its proved oil and gas properties related to impairment of assets in its northern field. For the three months ended September 30, 2020 and 2019, the Company recognized no impairment expense on its proved oil and gas properties related to impairment of assets in its northern field.
Note 10—Income Taxes
The Company computes an estimated annual effective tax rate (“AETR”) each quarter based on the current and forecasted operating results. The income tax expense or benefit associated with the interim period is computed using the most recent estimated AETR applied to the year-to-date ordinary income or loss, plus the tax effect of any significant or infrequently occurring items recorded during the interim period. The computation of the estimated AETR at each interim period requires certain estimates and significant judgements including, but not limited to, the expected operating income (loss) for the year, projections of the proportion of income earned and taxed in various jurisdictions, permanent differences and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision for income taxes may change as new events occur, more experience is obtained, and additional information becomes known or as the tax environment changes.
The effective combined U.S. federal and state income tax rate for the nine months ended September 30, 2020 and 2019 was (0.27)% and (5.7)%, respectively. The effective rate for the nine months ended September 30, 2020 and 2019 differs from the amount that would be provided by applying the statutory U.S. federal income tax rate of 21% to
pre-tax income due to (i) the effect of a full valuation allowance in effect at September 30, 2020 and (ii) the effects of state taxes, permanent taxable differences, and income attributable to non-controlling interest for the nine months ended September 30, 2019. Before accounting for a naked credit deferred tax liability, net tax expense for the three months ended September 30, 2020 was reduced to zero due to the valuation allowance. The naked credit deferred tax liability results in tax expense of $2.2 million for the nine months ended September 30, 2020.
The Company considers whether some portion, or all, of the deferred tax assets (“DTAs”) will be realized based on a more likely than not standard of judgment. The ultimate realization of DTAs is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. At December 31, 2019, the Company had a valuation allowance totaling $246.1 million against its DTAs resulting from prior year cumulative financial losses, oil and gas impairments, and significant net operating losses for U.S. federal and state income tax. The Company assesses the appropriateness of its valuation allowance on a quarterly basis. As of September 30, 2020, there was no change in the Company’s assessment of the realizability of its DTAs, except for a naked credit deferred tax liability.
On July 13, 2020 the Bankruptcy Court entered a final order approving certain procedures (including notice requirements) that certain shareholders and potential shareholders must comply with regarding transfers of, or declarations of worthlessness with respect to, the Company’s common stock and preferred stock, as well as certain obligations with respect to notifying the Company with respect to current share ownership, each of which are intended to preserve the Company’s ability to use its net operating losses to offset possible future U.S. taxable income by reducing the likelihood of an ownership change under Section 382 of the Code during the pendency of the Chapter 11 Cases.
Note 11—Stock-Based Compensation
Extraction Long Term Incentive Plan
In October 2016, the Company’s board of directors adopted the Extraction Oil & Gas, Inc. 2016 Long Term Incentive Plan (the “2016 Plan” or “LTIP”), pursuant to which employees, consultants and directors of the Company and its affiliates performing services for the Company are eligible to receive awards. The 2016 Plan provides for the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, bonus stock, dividend equivalents, other stock-based awards, substitute awards, annual incentive awards and performance awards intended to align the interests of participants with those of stockholders. In May 2019, the Company's stockholders approved the amendment and restatement of the Company's 2016 Long Term Incentive Plan. The amended and restated 2016 Long Term Incentive Plan provides a total reserve of 32.2 million shares of common stock for issuance pursuant to awards under the LTIP. Extraction has granted awards under the LTIP to certain directors, officers and employees, including stock options, restricted stock units, performance stock awards, performance stock units, performance cash awards and cash awards.
Restricted Stock Units
Restricted stock units granted under the LTIP (“RSUs”) generally vest over either a one or three-year service period, with 100% vesting in year one or 25%, 25% and 50% of the units vesting in year one, two and three, respectively. Grant date fair value was determined based on the value of Extraction’s common stock pursuant to the terms of the LTIP. The Company assumed a forfeiture rate of zero as part of the grant date estimate of compensation cost.
The Company recorded $1.0 million and $3.4 million of stock-based compensation costs related to RSUs for the three and nine months ended September 30, 2020, respectively, as compared to $6.6 million and $20.6 million for the three and nine months ended September 30, 2019, respectively. These costs were included in the condensed consolidated statements of operations within the general and administrative expenses line item. As of September 30, 2020, there was $4.1 million of total unrecognized compensation cost related to the unvested RSUs granted to certain directors, officers and employees that is expected to be recognized over a weighted average period of 1.2 years.
The following table summarizes the RSU activity from January 1, 2020 through September 30, 2020 and provides information for RSUs outstanding at the dates indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Shares
|
|
Weighted Average Grant Date
Fair Value
|
|
Non-vested RSUs at January 1, 2020
|
2,635,765
|
|
|
$
|
8.32
|
|
|
Granted
|
1,409,765
|
|
|
$
|
0.75
|
|
|
Forfeited
|
(1,845,164)
|
|
|
$
|
2.99
|
|
|
Vested
|
(995,805)
|
|
|
$
|
9.03
|
|
|
Non-vested RSUs at September 30, 2020
|
1,204,561
|
|
|
$
|
7.05
|
|
Performance Stock Awards
The Company granted performance stock awards ("PSAs") to certain executives under the LTIP in October 2017, March 2018, April 2019 and March 2020. The number of shares of the Company's common stock that may be issued to settle these various PSAs ranges from zero to two times the number of PSAs awarded. PSA's that settle in cash are presented as liability awards. Generally, the shares issued for PSAs are determined based on the satisfaction of a time-based vesting schedule and a weighting of one or more of the following: (i) absolute total stockholder return ("ATSR"), (ii) relative total stockholder return ("RTSR"), as compared to the Company's peer group and (iii) cash return on capital invested ("CROCI") or return on invested capital ("ROIC") measured over a three-year period and vest in their entirety at the end of the three-year measurement period. Any PSAs that have not vested at the end of the applicable measurement period are forfeited. The vesting criterion that is associated with the RTSR is based on a comparison of the Company's total shareholder return for the measurement period compared to that of a group of peer companies for the same measurement period. As the ATSR and RTSR vesting criteria are linked to the Company's share price, they each are considered a market condition for purposes of calculating the grant-date fair value of the awards. The vesting criterion that is associated with the CROCI and ROIC are considered a performance condition for purposes of calculating the grant-date fair value of the awards.
The fair value of the PSAs was measured at the grant date with a stochastic process method using a Monte Carlo simulation. A stochastic process is a mathematically defined equation that can create a series of outcomes over time. Those outcomes are not deterministic in nature, which means that by iterating the equations multiple times, different results will be obtained for those iterations. In the case of the Company's PSAs, the Company cannot predict with certainty the path its stock price or the stock prices of its peer will take over the performance period. By using a stochastic simulation, the Company can create multiple prospective stock pathways, statistically analyze these simulations, and ultimately make inferences regarding the most likely path the stock price will take. As such, because future stock prices are stochastic, or probabilistic with some direction in nature, the stochastic method, specifically the Monte Carlo Model, is deemed an appropriate method by which to determine the fair value of the PSAs. Significant assumptions used in this simulation include the Company's expected volatility, risk-free interest rate based on U.S. Treasury yield curve rates with maturities consistent with the measurement period as well as the volatilities for each of the Company's peers.
The Company recorded $0.9 million and $1.0 million of stock-based compensation costs related to PSAs for the three and nine months ended September 30, 2020, respectively, as compared to $0.7 million and $6.8 million of stock-based compensation costs related to PSAs for the three and nine months ended September 30, 2019, respectively. These costs were included in the condensed consolidated statements of operations within the general and administrative expenses line item. As of September 30, 2020, there was $1.8 million of total unrecognized compensation cost related to the unvested PSAs granted to certain executives that is expected to be recognized over a weighted average period of 0.5 years.
The following table summarizes the PSA activity from January 1, 2020 through September 30, 2020 and provides information for PSAs outstanding at the dates indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Shares (1)
|
|
Weighted Average Grant Date
Fair Value
|
|
Non-vested PSAs at January 1, 2020
|
2,863,190
|
|
|
$
|
7.72
|
|
|
Granted
|
5,952,700
|
|
|
$
|
0.29
|
|
|
Forfeited(2)
|
(5,881,200)
|
|
|
$
|
(0.29)
|
|
|
Vested
|
—
|
|
|
$
|
—
|
|
|
Non-vested PSAs at September 30, 2020
|
2,934,690
|
|
|
$
|
8.18
|
|
(1)The number of awards assumes that the associated maximum vesting condition is met at the target amount. The final number of shares of the Company's common stock issued may vary depending on the performance multiplier, which ranges from zero to one for the 2017 and 2018 grants and ranges from zero to two for the 2019 and 2020 grants, depending on the level of satisfaction of the vesting condition.
(2)The Company approved retention agreements on June 12, 2020 with certain executives and senior managers. These retention agreements, are subject to repayment upon a resignation without “good reason” or termination of employment for “cause” before specified dates and events. As a condition to participating in the revised compensation program, the equity compensation awards granted in 2020 were cancelled.
Stock Options
Expense on the stock options is recognized on a straight-line basis over the service period of the award less awards forfeited. The fair value of the stock options was measured at the grant date using the Black-Scholes valuation model. The Company utilizes the "simplified" method to estimate the expected term of the stock options granted as there is limited historical exercise data available in estimating the expected term of the stock options. Expected volatility is based on the volatility of the historical stock prices of the Company’s peer group. The risk-free rates are based on the yields of U.S. Treasury instruments with comparable terms. A dividend yield and forfeiture rate of zero were assumed. Stock options granted under the LTIP vest ratably over three years and are exercisable immediately upon vesting through the tenth anniversary of the grant date. To fulfill options exercised, the Company will issue new shares.
The Company recorded no stock-based compensation costs related to stock options for the three and nine months ended September 30, 2020, as compared to $4.0 million and $11.5 million for the three and nine months ended September 30, 2019, respectively. These costs were included in the condensed consolidated statements of operations within the general and administrative expenses line item. As of September 30, 2020, there are no remaining unrecognized compensation costs related to the stock options granted to certain executives.
There was no stock option activity from January 1, 2020 through September 30, 2020. However, as of September 30, 2020, there was approximately 5.2 million outstanding and exercisable stock options with a weighted-average exercise price of $18.50.
Incentive Restricted Stock Units
Officers of the Company contributed 2.7 million shares of common stock to Extraction Employee Incentive, LLC (“Employee Incentive”), which is owned solely by certain officers of the Company. Employee Incentive issued restricted stock units (“Incentive RSUs”) to certain employees. Incentive RSUs vested over a three year service period, with 25%, 25% and 50% of the units vesting in year one, two and three, respectively. On July 17, 2017, the partners of Employee Incentive amended the vesting schedule in which 25% vested immediately and the remaining Incentive RSUs vest 25%, 25% and 25% each six months thereafter, over the remaining 18-month service period. Grant date fair value was determined based on the value of the Company's common stock on the date of issuance. The Company assumed a forfeiture rate of zero as part of the grant date estimate of compensation cost.
The Company recorded no stock-based compensation costs related to Incentive RSUs for the three and nine months ended September 30, 2020. The Company recorded no stock-based compensation costs related to Incentive RSUs for the three months ended September 30, 2019. The Company recorded $0.8 million of stock-based compensation costs related to Incentive RSUs for the nine months ended September 30, 2019. These costs were included in the condensed consolidated statements of operations within the general and administrative expenses line item. As of September 30, 2020, there are no remaining unrecognized compensation costs related to the Incentive RSUs granted to certain employees.
Note 12—Equity
Series A Preferred Stock
The holders of our Series A Preferred Stock (the "Series A Preferred Holders") are entitled to receive a cash dividend of 5.875% per year, payable quarterly in arrears, and the Company has the ability to pay such quarterly dividends in kind at a dividend rate of 10% per year (decreased proportionately to the extent such quarterly dividends are partially paid in cash). The Company has paid the quarterly dividends in kind from the fourth quarter of 2019 until the filing of the Chapter 11 Cases. Because certain provisions within the RSA and the DIP Credit Agreement restrict the Company's ability to declare a dividend, the Company has not made any dividend payments on the Series A Preferred Stock since the commencement of the Chapter 11 Cases. The Series A Preferred Stock is convertible into shares of our common stock at the election of the Series A Preferred Holders at a conversion ratio per share of Series A Preferred Stock of 61.9195. Until the three-year anniversary of the closing of the IPO, the Company could elect to convert the Series A Preferred Stock at a conversion ratio per share of Series A Preferred Stock of 61.9195, but only if the closing price of our common stock had traded at or above a certain premium to our initial offering price, such premium to decrease with time. On October 15, 2019, the three year anniversary had passed for the Series A Preferred Stock to convert into our common stock. Prior to the commencement of the Chapter 11 Cases, the Company could have redeemed the Series A Preferred Stock for the liquidation preference, which was $198.7 million on June 14, 2020. In certain situations, including a change of control, the Series A Preferred Stock may be redeemed for cash in an amount equal to the greater of (i) 135% of the liquidation preference of the Series A Preferred Stock and (ii) a 17.5% annualized internal rate of return on the liquidation preference of the Series A Preferred Stock. The Series A Preferred Stock matures on October 15, 2021, at which time they are mandatorily redeemable for cash at the liquidation preference to the extent there are legally available funds to do so. For more information, see the Company’s Annual Report.
Elevation Common Units
On May 1, 2020, Elevation's board of managers issued 1,530,000,000 common units at a price of $0.01 per unit to certain of Elevation's members other than Extraction through the Capital Raise. The Capital Raise caused Extraction's ownership of Elevation to be diluted to less than 0.01%. As a result of the Capital Raise, beginning in May 2020 Extraction began accounting for Elevation under the cost method of accounting. The Company reserves all rights related to actions taken by Elevation’s board of managers.
Elevation Preferred Units
In July 2018 and July 2019, respectively, Elevation sold 150,000 and 100,000 of Elevation Preferred Units at a price of $990 per unit to a third party (the "Purchaser"). The aggregate liquidation preference when the units were sold was $150.0 million and $100.0 million, respectively. These Preferred Units represent the noncontrolling interest presented on the condensed consolidated balance sheets, condensed consolidated statements of operations and condensed consolidated statements of changes in stockholders' equity and noncontrolling interest for periods ended on or prior to December 31, 2019. As part of the July 2018 transaction, the Company committed to Elevation that it would drill at least 425 qualifying wells in the acreage dedicated to Elevation by December 31, 2023, subject to reductions if Elevation does not invest the full amount of capital as initially anticipated. Pursuant to the Fourth Amendment to the Elevation Gathering Agreements between Elevation and Extraction, this drilling commitment would be eliminated, if and only if all Elevation Preferred Units have been redeemed in full or are otherwise no longer outstanding. Please see Note 14—Commitments and Contingencies — Elevation Gathering Agreements for further details.
Upon deconsolidation of Elevation Midstream, LLC as discussed in Note 1—Business and Organization -Deconsolidation of Elevation Midstream, LLC, the $270.5 million Elevation preferred unit balance in the noncontrolling interest line item of the condensed consolidated balance sheets as of March 31, 2020 was removed. The amount
comprises the line item effects of deconsolidation of Elevation Midstream, LLC on the condensed consolidated statements of changes in stockholders' equity and noncontrolling interest as of March 31, 2020.
During the twenty-eight months following the July 3, 2018 Preferred Unit closing date, Elevation is required to pay the Purchaser a quarterly commitment fee payable in cash or in kind of 1.0% per annum on any undrawn amounts of such additional $250.0 million commitment. For the three months ended September 30, 2020, due to the deconsolidation of Elevation during the first quarter of 2020, the Company's condensed consolidated statements excluded all commitment fees paid-in-kind from the Preferred Unit commitment fees and dividends paid-in-kind line item in the condensed consolidated statements of changes in stockholders' equity and noncontrolling interest. For the three months ended September 30, 2019, Elevation recognized $0.7 million of commitment fees paid-in-kind. For the nine months ended September 30, 2020 and 2019, respectively, Elevation recognized $0.6 million and $2.4 million of commitment fees paid-in-kind.
The Elevation Preferred Units entitle the Purchaser to receive quarterly dividends at a rate of 8.0% per annum. The Dividend is currently payable solely in cash. For the three months ended September 30, 2020, due to the deconsolidation of Elevation during the first quarter of 2020, the Company's condensed consolidated statements excluded all dividends paid-in-kind from the Preferred Unit commitment fees and dividends paid-in-kind line item in the condensed consolidated statements of changes in stockholders' equity and noncontrolling interest. For the three months ended September 30, 2019, Elevation recognized $5.2 million of dividends paid-in-kind. For the nine months ended September 30, 2020 and 2019, respectively, Elevation recognized $5.5 million and $11.5 million of dividends paid-in-kind.
Note 13—Earnings (Loss) Per Share
Basic earnings per share (“EPS”) includes no dilution and is computed by dividing net income (loss) available to common shareholders by the weighted average number of shares outstanding during the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings of the Company.
The Company uses the “if-converted” method to determine potential dilutive effects of the Company’s outstanding Series A Preferred Stock and the treasury method to determine the potential dilutive effects of outstanding restricted stock awards and stock options. The basic weighted average shares outstanding calculation is based on the actual days in which the shares were outstanding for the three and nine months ended September 30, 2020 and 2019.
The components of basic and diluted EPS were as follows (in thousands, except per share data):
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For the Three Months Ended September 30,
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For the Nine Months Ended September 30,
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2020
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2019
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2020
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2019
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Basic and Diluted Income (Loss) Per Share
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Net income (loss)
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$
|
(540,607)
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$
|
33,924
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$
|
(823,504)
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$
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(16,664)
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Less: Noncontrolling interest
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—
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(5,776)
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|
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(6,160)
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(13,849)
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Less: Adjustment to reflect Series A Preferred Stock dividends
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—
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|
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(2,721)
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|
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(8,749)
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(8,164)
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Less: Adjustment to reflect accretion of Series A Preferred Stock discount
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(1,865)
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(1,682)
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(5,452)
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(4,915)
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Adjusted net income (loss) available to common shareholders, basic and diluted
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$
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(542,472)
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$
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23,745
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$
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(843,865)
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$
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(43,592)
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Denominator:
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Weighted average common shares outstanding, basic and diluted (1) (2)
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138,348
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137,789
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138,080
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155,847
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Income (Loss) Per Common Share
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Basic and diluted
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$
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(3.92)
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$
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0.17
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$
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(6.11)
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$
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(0.28)
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(1)For the three and nine months ended September 30, 2020, 6,448,989 potentially dilutive shares, including restricted stock awards and stock options outstanding, were not included in the calculation above, as they had an anti-dilutive effect on EPS. Additionally, 11,472,445 common shares associated with the assumed conversion of Series A Preferred Stock were also excluded, as they would have had an anti-dilutive effect on EPS.
(2)For the three and nine months ended September 30, 2019, 8,956,812 potentially dilutive shares, including restricted stock awards and stock options outstanding, were not included in the calculation above, as they had an anti-dilutive effect on EPS. Additionally, 11,472,445 common shares associated with the assumed conversion of Series A Preferred Stock were also excluded, as they would have had an anti-dilutive effect on EPS.
Note 14—Commitments and Contingencies
Chapter 11 Cases
On June 14, 2020, the Company filed the Chapter 11 Cases seeking relief under the Bankruptcy Code. The Company continues to operate its business and manage its properties in the ordinary course of business pursuant to the applicable provisions of the Bankruptcy Code. In addition, commencement of the Chapter 11 Cases automatically stayed all of the proceedings and actions against the Company (other than regulatory enforcement matters), including those noted below. Please refer to Note 1—Business and Organization for more information on the Chapter 11 Cases.
General
As is customary in the oil and gas industry, the Company may at times have commitments in place to reserve or earn certain acreage positions or wells. If the Company does not meet such commitments, the acreage positions or wells may be lost, or the Company may be required to pay damages if certain performance conditions are not met.
Leases
The Company has entered into operating leases for certain office facilities, compressors and office equipment. In connection with the Chapter 11 Cases, the Company filed a motion to reject its drilling rig contracts effective June 14, 2020. For one of the contracts, the rejection resulted in the removal of the lease liability and net right-of-use asset in the amount of $6.7 million from the condensed consolidated balance sheets. Maturities of operating lease liabilities associated with right-of-use assets and including imputed interest were as follows (in thousands):
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As of September 30,
2020
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As of December 31,
2019
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2020 - remaining
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$
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836
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2020
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$
|
19,040
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2021
|
|
3,045
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|
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2021
|
|
5,247
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2022
|
|
2,670
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|
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2022
|
|
2,211
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|
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2023
|
|
2,450
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|
|
2023
|
|
2,246
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|
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2024
|
|
2,301
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2024
|
|
2,301
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Thereafter
|
|
8,273
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Thereafter
|
|
8,273
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Total lease payments
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19,575
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|
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Total lease payments
|
|
39,318
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|
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Less imputed interest (1)
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|
(2,347)
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Less imputed interest (1)
|
|
(4,735)
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Present value of lease liabilities (2)
|
|
$
|
17,228
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Present value of lease liabilities (2)
|
|
$
|
34,583
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|
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(1) Calculated using the estimated interest rate for each lease.
(2) Of the total present value of lease liabilities as of September 30, 2020 and December 31, 2019, $3.2 million and $17.4 million, respectively, were recorded in accounts payable and accrued liabilities and $14.0 million and $17.2 million, respectively, were recorded in other non-current liabilities on the condensed consolidated balance sheets.
Drilling Rigs
As of September 30, 2020, the Company was not subject to commitments on any drilling rigs. As part of Chapter 11, the Company filed a motion to reject its drilling rig contract. As such, the Company recorded $6.7 million in liabilities subject to compromise on the condensed consolidated balance sheets as of September 30, 2020 and in reorganization items, net on the condensed consolidated statements of operations.
Delivery Commitments
As part of the Chapter 11 Cases, the Company is currently in the process of renegotiating certain contracts terms which include minimum volume commitments. If mutual terms cannot be reached, the Company under Chapter 11 may file a motion to reject the contract.
On November 2, 2020, the Bankruptcy Court ruled in favor of the Company rejecting several midstream contracts. As a result of these rejected contracts, the Company accrued $405.2 million within liabilities subject to compromise on the condensed consolidated balance sheets as of September 30, 2020 and in reorganization items, net on the condensed consolidated statements of operations for the three and nine months ended September 30, 2020.
The Company was subject to a firm transportation agreement that commenced in November 2016 and had a ten-year term with a monthly minimum delivery commitment of 45,000 Bbl/d in year one, 55,800 Bbl/d in year two, 61,800 Bbl/d in years three through seven and 58,000 Bbl/d in years eight through ten. Until June 2020, these were obligations of the Company’s oil marketer, which reverted back to the Company when the oil marketing contract terminated in June 2020. In May 2017, the Company amended its agreement with its oil marketer that required it to sell all of its crude oil from an area of mutual interest in exchange for a make-whole provision that allowed the Company to satisfy any minimum volume commitment deficiencies incurred by its oil marketer with future barrels of crude oil in excess of their minimum volume commitment during the contract term. In May 2019, the Company extended the term of this agreement through October 31, 2020 subject to an evergreen provision thereafter where either party can provide a six month notice of termination beginning November 1, 2020. Due to the contract termination date, the amount of consideration recognized in revenue is reduced. Please see Note 2—Basis of Presentation, Significant Accounting Policies and Recent Accounting Pronouncements — Revenue — Contract Balances. On June 12, 2020, the Company and the transportation contract counterparty mutually terminated its contract with the Company's oil marketer effective June 30, 2020. The Company had posted a letter of credit for this agreement in the amount of $40.0 million and, as of September 30, 2020, the counterparty had drawn $24.3 million on the letter of credit.
After termination of the aforementioned contract with the oil marketer, the Company had a long-term crude oil delivery commitment agreement that commenced on July 1, 2020. As of September 30, 2020, the Company's long-term
crude oil delivery commitment had a monthly minimum delivery commitment of 61,800 Bbl/d through October 2023 and then would reduce to 58,000 Bbl/d through October 2026. The Company was required to pay a shortfall fee for any volume deficiencies under these commitments. On November 2, 2020, the Bankruptcy Court ruled in favor of the Company rejecting this contract with an effective date as of June 14, 2020, and, therefore, the Company has no remaining minimum delivery commitments under this transportation contract. The counterparty to this contract has indicated that it plans on appealing the ruling approving of the rejection of the contract.
The Company had two long-term crude oil gathering commitments with two unconsolidated subsidiaries in which the Company has a de minimis minority ownership interest. Please see Note 1—Business and Organization for information related to the deconsolidation of Elevation Midstream, LLC. The first agreement commenced in November 2016 and had a term of ten years with a minimum volume commitment of an average of 9,167 Bbl/d in year one, 17,967 Bbl/d in year two, 18,800 Bbl/d for years three through five and 10,000 Bbl/d for years six through ten. The Company may have been required to pay a shortfall fee for any volume deficiencies under this commitment. The second agreement commenced in October 2019 and had a term of ten years for an average of 3,200 Bbl/d in year one, 8,000 Bbl/d in year two, 14,000 Bbl/d in year three, 16,000 Bbl/d in years four through eight, 12,000 Bbl/d in year nine and 10,000 Bbl/d in year ten. On November 2, 2020, the Bankruptcy Court ruled in favor of the Company rejecting both of these crude oil gathering contracts with an effective date as of June 14, 2020, and, therefore, the Company has no remaining minimum delivery commitments. The counterparties to these contracts have indicated that they plan on appealing the ruling approving of the rejection of these contracts.
In February 2019, the Company entered into two long-term gas gathering and processing agreements with third-party midstream providers. One of the agreements additionally includes a long-term NGL sales commitment for take-in-kind NGLs from other processing agreements. The first agreement commenced in November 2019 and has a term of twenty years with a minimum volume commitment of 251 Bcf to be delivered within the first seven years. The annual commitments over seven years are to be delivered on an average 85,000 Mcf/d in year one, 125,000 Mcf/d in year two, 140,000 Mcf/d in year three, 118,000 Mcf/d in year four, 98,000 Mcf/d in year five, 70,000 Mcf/d in year six and 52,000 Mcf/d in year seven. The aggregate remaining amount of estimated payments under this agreement is approximately $281.5 million. The second agreement commenced on January 2020 and has a term of ten years with an annual minimum volume commitment of 13.0 Bcf in years one through ten. The second agreement also includes a commitment to sell take-in-kind NGLs of 4,000 Bbl/d in year one and 7,500 Bbl/d in years two through seven with the ability to roll up to a 10% shortfall in a given month to the subsequent month.
The summary of these minimum volume commitments as of September 30, 2020, was as follows:
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Oil (MBbl)
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Gas (MMcf)
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Total (MBOE)
|
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2020 - remaining
|
2,466
|
|
|
10,260
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|
|
4,176
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|
|
2021
|
9,797
|
|
|
46,540
|
|
|
17,554
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|
|
2022
|
8,944
|
|
|
49,758
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|
|
17,237
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|
|
2023
|
9,490
|
|
|
41,850
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|
|
16,465
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|
|
2024
|
9,516
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|
|
34,160
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|
|
15,209
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Thereafter
|
29,860
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|
|
40,260
|
|
|
36,570
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Total
|
70,073
|
|
|
222,828
|
|
|
107,211
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|
In collaboration with several other producers and a midstream provider, on December 15, 2016 and August 7, 2017, the Company agreed to participate in expansions of natural gas gathering and processing capacity in the DJ Basin. The plan includes two new processing plants as well as the expansion of related gathering systems. The first plant commenced operations in August 2018 and the second plant commenced operations in July 2019. The Company’s share of these commitments will require an incremental 51.5 and 20.6 MMcf per day, respectively, over a baseline volume of 65 MMcf per day to be delivered after the plants' in-service dates for a period of seven years thereafter. The Company may be required to pay a shortfall fee for any incremental volume deficiency under these commitments. These contractual obligations can be reduced by the Company’s proportionate share of the collective volumes delivered to the plants by other third-party incremental volumes available to the midstream provider at the new facilities that are in excess of the total commitments. The Company is also required for the first three years of each contract to guarantee a certain target profit margin on these volumes sold.
In July 2019, the Company entered into three long-term contracts to supply 125,000 dekatherms of residue gas per day for five years to a transportation company. The aggregate remaining amount of estimated commitment assuming no production is $27.5 million. The Company has posted a letter of credit for this agreement in the amount of $8.7 million.
The Company is considering rejecting certain midstream contracts with minimum volume commitments as part of the Chapter 11 Cases. The aggregate amount of estimated remaining payments under agreements that have not been rejected is $309.0 million.
Elevation Gathering Agreements
In July 2018, the Company entered into three long-term gathering agreements (the "Elevation Gathering Agreements") for gas, crude oil and produced water with Elevation. Under the agreements, the Company agreed to drill 100 wells in Broomfield and 325 wells in Hawkeye by December 31, 2023 if both facilities are to be built, subject to adjustments if less capital is spent. Elevation has alleged that if the Company fails to complete the wells by the applicable commitment deadline, then it would be in breach of the agreement and Elevation could attempt to assert damages against Extraction and its affiliates. During the first quarter of 2020, Elevation postponed indefinitely further development of gathering systems and facilities that were to be constructed to service the Company's acreage in Hawkeye and another project in the Southwest Wattenberg area. Due to the decision to not complete the Hawkeye facilities and based on the amount of capital invested, Elevation has asserted that the drilling commitment now consists of 297 wells in the Broomfield area of operations with a deadline of December 31, 2022.
In April 2019, the Elevation Gathering Agreements were amended to provide for, among other amendments, the inclusion of additional gathering facilities that would produce into Elevation’s Badger facility. Pursuant to this amendment, Elevation has asserted that the additional gathering facilities were required to be completed by April 1, 2020 or, within 30 days of such date, Elevation could assert that Extraction must make a payment to Elevation in the amount of 135% of all costs incurred by Elevation as of such date for the development and construction of such additional gathering facilities. As of September 30, 2020, the costs incurred by Elevation for these additional gathering facilities totaled $34.9 million. The Company did not cause the completion of these additional gathering facilities by April 1, 2020, and Elevation has alleged that Extraction is in breach of the Elevation Gathering Agreements. On April 2, 2020, Elevation demanded payment of $46.8 million due to an alleged breach in contract stemming from a purported failure to complete the pipeline extensions connecting certain wells to the Badger central gathering facility prior to April 1, 2020. While the Company disputes that these amounts are due to Elevation, under ASC Topic 450 - Contingencies, the Company recorded the amount in liabilities subject to compromise on the condensed consolidated balance sheet as of September 30, 2020 and in other operating expenses on the condensed consolidated statements of operations.
In December 2019, the Elevation Gathering Agreements were further amended to provide Elevation additional connection fees that are consistent with market terms (the "Connect Fees"). In the fourth quarter of 2019, the Company incurred and paid $19.5 million for Connect Fees pursuant to the Elevation Gathering Agreements, and in the first quarter of 2020 the Company incurred and paid $23.5 million. The Company does not expect to incur additional Connect Fees for the year ending December 31, 2020.
In March 2020, the Elevation Gathering Agreements were further amended to reset all gathering rates and eliminate existing minimum drilling commitment. This amendment will not become effective until after all Elevation Preferred Units have been redeemed in full or are otherwise no longer outstanding.
In November 2020, the Company and Elevation reached an agreement in principle regarding amendments to the gathering agreements and the settlement of outstanding claims. The Company anticipates finalizing the settlement in the fourth quarter of 2020, pending Bankruptcy Court approval. As part of the settlement, the Company will pay Elevation $38.4 million in cash over 24 months following the Company’s emergence from chapter 11 and both parties agreed Elevation will be allowed to submit an unsecured claim $80.0 million with the Bankruptcy Court. The agreement would also release certain areas from future dedication, provide a reduction in gathering fees, a reduction in the number of wells subject to the drilling commitment, and an extended term in order to satisfy the drilling commitment. The Company had previously accrued $46.8 million as discussed above and $2.9 million of accrued interest. Therefore, during the third quarter of 2020, the Company accrued $68.7 million within liabilities subject to compromise on the condensed
consolidated balance sheets as of September 30, 2020 and in reorganization items, net on the condensed consolidated statements of operations for the three and nine months ended September 30, 2020.