10-Q 1 c993-20190630x10q.htm 10-Q mcf_Current_Folio_10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2019 

OR

 

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

Commission file number 001-16317 

 

CONTANGO OIL & GAS COMPANY

(Exact name of registrant as specified in its charter)

 

TEXAS

 

95-4079863

 

 

 

(State or other jurisdiction of
incorporation or organization)

 

(IRS Employer
Identification No.)

 

 

 

717 TEXAS AVENUE, SUITE 2900

HOUSTON, TEXAS

 

77002

(Address of principal executive offices)

 

(Zip Code)

 

(713) 236-7400

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, Par Value $0.04 per share

MCF

NYSE American

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

Accelerated filer

Non-accelerated filer

 

Smaller reporting company

Emerging growth company

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes      No  

 

The total number of shares of common stock, par value $0.04 per share, outstanding as of August 5, 2019 was 34,434,406.

 

 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE SIX MONTHS ENDED JUNE 30, 2019

 

TABLE OF CONTENTS

 

 

 

 

 

 

 

 

    

    

   

Page

 

PART I—FINANCIAL INFORMATION 

 

 

 

 

 

 

 

Item 1. 

 

Consolidated Financial Statements

 

 

 

 

 

Consolidated Balance Sheets (unaudited) as of June 30, 2019 and December 31, 2018

 

3

 

 

 

Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2019 and 2018

 

4

 

 

 

Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2019 and 2018

 

5

 

 

 

Consolidated Statement of Shareholders’ Equity (unaudited) for the six months ended June 30, 2019 and 2018

 

6

 

 

 

Notes to the Consolidated Financial Statements (unaudited)

 

8

 

Item 2. 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

23

 

Item 3. 

 

Quantitative and Qualitative Disclosures about Market Risk

 

35

 

Item 4. 

 

Controls and Procedures

 

35

 

 

 

 

 

 

 

PART II—OTHER INFORMATION 

 

 

 

 

 

 

 

Item 1. 

 

Legal Proceedings

 

36

 

Item 1A. 

 

Risk Factors

 

36

 

Item 2. 

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

37

 

Item 3. 

 

Defaults upon Senior Securities

 

37

 

Item 4. 

 

Mine Safety Disclosures

 

38

 

Item 5. 

 

Other Information

 

38

 

Item 6. 

 

Exhibits

 

38

 

 

All references in this Quarterly Report on Form 10-Q to the “Company”, “Contango”, “we”, “us” or “our” are to Contango Oil & Gas Company and its subsidiaries.

2

Item 1. Consolidated Financial Statements

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except shares)

 

 

 

 

 

 

 

 

 

 

 

June 30, 

 

December 31, 

 

 

    

2019

    

2018

  

 

 

 

 

 

 

(unaudited)

 

CURRENT ASSETS:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

 —

 

$

 —

 

Accounts receivable, net

 

 

10,147

 

 

11,531

 

Prepaid expenses

 

 

1,005

 

 

1,303

 

Current derivative asset

 

 

2,149

 

 

4,600

 

Other current assets

 

 

391

 

 

 —

 

Total current assets

 

 

13,692

 

 

17,434

 

PROPERTY, PLANT AND EQUIPMENT:

 

 

 

 

 

 

 

Natural gas and oil properties, successful efforts method of accounting:

 

 

 

 

 

 

 

Proved properties

 

 

1,098,773

 

 

1,095,417

 

Unproved properties

 

 

44,003

 

 

34,612

 

Other property and equipment

 

 

1,331

 

 

1,314

 

Accumulated depreciation, depletion and amortization

 

 

(912,347)

 

 

(898,169)

 

Total property, plant and equipment, net

 

 

231,760

 

 

233,174

 

OTHER NON-CURRENT ASSETS:

 

 

 

 

 

 

 

Investments in affiliates

 

 

6,480

 

 

5,743

 

Long-term derivative asset

 

 

244

 

 

 —

 

Deferred tax asset

 

 

 —

 

 

424

 

Other non-current assets

 

 

480

 

 

357

 

Total other non-current assets

 

 

7,204

 

 

6,524

 

TOTAL ASSETS

 

$

252,656

 

$

257,132

 

 

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

47,966

 

$

39,506

 

Current derivative liability

 

 

292

 

 

422

 

Current asset retirement obligations

 

 

826

 

 

1,329

 

Current portion of long-term debt

 

 

60,000

 

 

60,000

 

Total current liabilities

 

 

109,084

 

 

101,257

 

NON-CURRENT LIABILITIES:

 

 

 

 

 

 

 

Long-term debt

 

 

 —

 

 

 —

 

Asset retirement obligations

 

 

11,725

 

 

12,168

 

Other long-term liabilities

 

 

3,677

 

 

3,318

 

Total non-current liabilities

 

 

15,402

 

 

15,486

 

Total liabilities

 

 

124,486

 

 

116,743

 

COMMITMENTS AND CONTINGENCIES (NOTE 12)

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY:

 

 

 

 

 

 

 

Common stock, $0.04 par value, 100 million shares authorized, 39,967,341 shares issued and 34,442,843 shares outstanding at June 30, 2019, 39,617,442 shares issued and 34,158,492 shares outstanding at December 31, 2018

 

 

1,587

 

 

1,573

 

Additional paid-in capital

 

 

341,563

 

 

339,981

 

Treasury shares at cost (5,524,498 shares at June 30, 2019 and 5,458,950 shares at December 31, 2018)

 

 

(129,266)

 

 

(129,030)

 

Retained deficit

 

 

(85,714)

 

 

(72,135)

 

Total shareholders’ equity

 

 

128,170

 

 

140,389

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

 

$

252,656

 

$

257,132

 

 

The accompanying notes are an integral part of these consolidated financial statements 

3

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 

 

June 30, 

 

 

    

2019

    

2018

 

2019

    

2018

 

 

 

(unaudited)

 

(unaudited)

 

REVENUES:

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil and condensate sales

 

$

7,439

 

$

9,607

 

$

13,845

 

$

18,418

 

Natural gas sales

 

 

3,857

 

 

5,848

 

 

9,499

 

 

14,457

 

Natural gas liquids sales

 

 

1,466

 

 

2,993

 

 

3,429

 

 

6,010

 

Total revenues

 

 

12,762

 

 

18,448

 

 

26,773

 

 

38,885

 

EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

5,694

 

 

6,478

 

 

10,886

 

 

13,405

 

Exploration expenses

 

 

249

 

 

394

 

 

473

 

 

863

 

Depreciation, depletion and amortization

 

 

7,573

 

 

9,498

 

 

15,129

 

 

19,983

 

Impairment and abandonment of oil and gas properties

 

 

1,247

 

 

777

 

 

1,834

 

 

4,104

 

General and administrative expenses

 

 

4,456

 

 

5,354

 

 

9,461

 

 

12,080

 

Total expenses

 

 

19,219

 

 

22,501

 

 

37,783

 

 

50,435

 

OTHER INCOME (EXPENSE):

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (loss) from investment in affiliates, net of income taxes

 

 

427

 

 

(475)

 

 

457

 

 

232

 

Gain from sale of assets

 

 

421

 

 

1,370

 

 

409

 

 

10,817

 

Interest expense

 

 

(1,079)

 

 

(1,262)

 

 

(2,171)

 

 

(2,671)

 

Gain (loss) on derivatives, net

 

 

2,065

 

 

(2,610)

 

 

(813)

 

 

(3,642)

 

Other income

 

 

89

 

 

 3

 

 

 3

 

 

882

 

Total other income (expense)

 

 

1,923

 

 

(2,974)

 

 

(2,115)

 

 

5,618

 

NET LOSS BEFORE INCOME TAXES

 

 

(4,534)

 

 

(7,027)

 

 

(13,125)

 

 

(5,932)

 

Income tax provision

 

 

(427)

 

 

(151)

 

 

(454)

 

 

(309)

 

NET LOSS

 

$

(4,961)

 

$

(7,178)

 

$

(13,579)

 

$

(6,241)

 

NET LOSS PER SHARE:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.15)

 

$

(0.29)

 

$

(0.40)

 

$

(0.25)

 

Diluted

 

$

(0.15)

 

$

(0.29)

 

$

(0.40)

 

$

(0.25)

 

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

33,909

 

 

24,933

 

 

33,840

 

 

24,863

 

Diluted

 

 

33,909

 

 

24,933

 

 

33,840

 

 

24,863

 

 

The accompanying notes are an integral part of these consolidated financial statements 

4

 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

June 30, 

 

 

    

2019

    

2018

 

 

 

 

 

 

 

 

 

 

 

(unaudited)

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net loss

 

$

(13,579)

 

$

(6,241)

 

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation, depletion and amortization

 

 

15,129

 

 

19,983

 

Impairment of natural gas and oil properties

 

 

1,079

 

 

3,890

 

Deferred income taxes

 

 

424

 

 

 —

 

Gain on sale of assets

 

 

(409)

 

 

(10,817)

 

Gain from investment in affiliates

 

 

(457)

 

 

(232)

 

Stock-based compensation

 

 

1,637

 

 

3,008

 

Unrealized loss on derivative instruments

 

 

2,078

 

 

2,311

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Decrease in accounts receivable & other receivables

 

 

1,530

 

 

2,132

 

Decrease in prepaids

 

 

298

 

 

352

 

Increase (decrease) in accounts payable & advances from joint owners

 

 

8,592

 

 

(2,027)

 

Decrease in other accrued liabilities

 

 

(350)

 

 

(2,618)

 

Increase in income taxes receivable, net

 

 

(424)

 

 

 —

 

Increase (decrease) in income taxes payable, net

 

 

(258)

 

 

229

 

Other

 

 

(392)

 

 

3,293

 

Net cash provided by operating activities

 

$

14,898

 

$

13,263

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Natural gas and oil exploration and development expenditures

 

$

(14,604)

 

$

(30,077)

 

Additions to furniture & equipment

 

 

(17)

 

 

 —

 

Sale of oil & gas properties

 

 

 —

 

 

21,562

 

Net cash used in investing activities

 

$

(14,621)

 

$

(8,515)

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Borrowings under credit facility

 

$

73,548

 

$

130,677

 

Repayments under credit facility

 

 

(73,548)

 

 

(135,230)

 

Net costs from equity offering

 

 

(41)

 

 

 —

 

Purchase of treasury stock

 

 

(236)

 

 

(195)

 

Net cash used in financing activities

 

$

(277)

 

$

(4,748)

 

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

$

 —

 

$

 —

 

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

 

 —

 

 

 —

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

 —

 

$

 —

 

 

The accompanying notes are an integral part of these consolidated financial statements 

5

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

For the six months ended June 30, 2019

(in thousands, except number of shares)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Total

 

 

 

Common Stock

 

Paid-in

 

Treasury

 

Retained

 

Shareholders’

 

 

    

Shares

    

Amount

    

Capital

    

Stock

    

Deficit

    

Equity

 

 

 

(unaudited)

 

Balance at December 31, 2018

 

34,158,492

 

$

1,573

 

$

339,981

 

$

(129,030)

 

$

(72,135)

 

$

140,389

 

Equity offering costs

 

 —

 

 

 —

 

 

(86)

 

 

 —

 

 

 —

 

 

(86)

 

Treasury shares at cost

 

(49,415)

 

 

 —

 

 

 —

 

 

(186)

 

 

 —

 

 

(186)

 

Restricted shares activity

 

307,650

 

 

12

 

 

(12)

 

 

 —

 

 

 —

 

 

 —

 

Stock-based compensation

 

 —

 

 

 —

 

 

1,052

 

 

 —

 

 

 —

 

 

1,052

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(8,618)

 

 

(8,618)

 

Balance at March 31, 2019

 

34,416,727

 

$

1,585

 

$

340,935

 

$

(129,216)

 

$

(80,753)

 

$

132,551

 

Equity offering costs

 

 —

 

 

 —

 

 

45

 

 

 —

 

 

 —

 

 

45

 

Treasury shares at cost

 

(16,133)

 

 

 —

 

 

 —

 

 

(50)

 

 

 —

 

 

(50)

 

Restricted shares activity

 

42,249

 

 

 2

 

 

(2)

 

 

 —

 

 

 —

 

 

 —

 

Stock-based compensation

 

 —

 

 

 —

 

 

585

 

 

 —

 

 

 —

 

 

585

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(4,961)

 

 

(4,961)

 

Balance at June 30, 2019

 

34,442,843

 

$

1,587

 

$

341,563

 

$

(129,266)

 

$

(85,714)

 

$

128,170

 

 

The accompanying notes are an integral part of these consolidated financial statements 

 

 

 

 

6

 

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

For the six months ended June 30, 2018

(in thousands, except number of shares)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Total

 

 

 

Common Stock

 

Paid-in

 

Treasury

 

Retained

 

Shareholders’

 

 

    

Shares

    

Amount

    

Capital

    

Stock

    

Earnings (Deficit)

    

Equity

 

 

 

(unaudited)

 

Balance at December 31, 2017

 

25,505,715

 

$

1,223

 

$

302,527

 

$

(128,583)

 

$

49,433

 

$

224,600

 

Treasury shares at cost

 

(16,032)

 

 

 —

 

 

 —

 

 

(71)

 

 

 —

 

 

(71)

 

Restricted shares activity

 

206,114

 

 

 8

 

 

(8)

 

 

 —

 

 

 —

 

 

 —

 

Stock-based compensation

 

 —

 

 

 —

 

 

1,424

 

 

 —

 

 

 —

 

 

1,424

 

Net income

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

937

 

 

937

 

Balance at March 31, 2018

 

25,695,797

 

$

1,231

 

$

303,943

 

$

(128,654)

 

$

50,370

 

$

226,890

 

Treasury shares at cost

 

(33,703)

 

 

 —

 

 

 —

 

 

(124)

 

 

 —

 

 

(124)

 

Restricted shares activity

 

77,188

 

 

 4

 

 

(4)

 

 

 —

 

 

 —

 

 

 —

 

Stock-based compensation

 

 —

 

 

 —

 

 

1,584

 

 

 —

 

 

 —

 

 

1,584

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(7,178)

 

 

(7,178)

 

Balance at June 30, 2018

 

25,739,282

 

$

1,235

 

$

305,523

 

$

(128,778)

 

$

43,192

 

$

221,172

 

 

 

The accompanying notes are an integral part of these consolidated financial statements 

 

 

 

7

CONTANGO OIL & GAS COMPANY AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Organization and Business

 

Contango Oil & Gas Company (collectively with its subsidiaries, “Contango” or the “Company”) is a Houston, Texas based, independent oil and natural gas company. The Company’s business is to maximize production and cash flow from its offshore properties in the shallow waters of the Gulf of Mexico (“GOM”) and onshore Texas and Wyoming properties and to use that cash flow to explore, develop, exploit, increase production from and acquire crude oil and natural gas properties in West Texas, the onshore Texas Gulf Coast and the Rocky Mountain regions of the United States. On June 14, 2019, following approval by the Company’s stockholders at the 2019 annual meeting of stockholders, the Company changed its state of incorporation from the State of Delaware to the State of Texas and increased the Company’s number of authorized shares of common stock from 50 million to 100 million.

 

The following table lists the Company’s primary producing areas as of June 30, 2019:

 

Location

    

Formation

Gulf of Mexico

 

Offshore Louisiana - water depths less than 300 feet

Southern Delaware Basin, Pecos County, Texas

 

Wolfcamp A and B

Madison and Grimes counties, Texas

 

Woodbine (Upper Lewisville)

Zavala and Dimmit counties, Texas

 

Buda / Eagle Ford / Georgetown

San Augustine County, Texas

 

Haynesville shale, Mid Bossier shale and James Lime formations

Other Texas Gulf Coast

 

Conventional and smaller unconventional formations

Weston County, Wyoming

 

Muddy Sandstone

Sublette County, Wyoming

 

Jonah Field (1)


(1)

Through a 37% equity investment in Exaro Energy III LLC (“Exaro”). Production associated with this investment is not included in the Company’s reported production results for all periods shown in this report.

 

Since 2016, the Company has been focused on the development of its Southern Delaware Basin acreage in Pecos County, Texas, which is expected to continue to generate positive returns in the current price environment. As of June 30, 2019, the Company was producing from twelve wells over its approximate 17,000 gross operated  (8,100 total net) acre position in this West Texas area,  prospective for the Wolfcamp A, Wolfcamp B and Second Bone Spring formations. 

 

The Company currently expects this acreage in West Texas to be the primary focus of its drilling program for the remainder of 2019. Until a sustained improvement in commodity prices occurs, the Company will commit drilling capital to West Texas, and other areas, only to fulfill leasehold commitments, preserve core acreage and, where determined appropriate to do so, expand its presence in those existing areas. The Company will continue to make balance sheet strength a priority in 2019 by limiting capital expenditures to a level that can be funded through internally generated cash flow and non-core asset sales. During this time, the Company will continue to identify opportunities for cost reductions and operating efficiencies in all areas of its operations, while also searching for new resource acquisition opportunities. Acquisition efforts will be focused on areas in which the Company can leverage its geological and operational experience and expertise to exploit identified drilling opportunities and where it can develop an inventory of additional drilling prospects that the Company believes will enable it to economically grow production and add reserves.

 

 

2. Summary of Significant Accounting Policies

 

The accounting policies followed by the Company are set forth in the notes to the Company’s audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”) filed with the Securities and Exchange Commission (“SEC”). Please refer to the notes to the financial statements included in the 2018 Form 10-K for additional details of the Company’s financial condition, results of operations and cash flows. No material items included in those notes have changed except as a result of normal transactions in the interim or as disclosed within this interim report.

 

8

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, pursuant to the rules and regulations of the SEC, including instructions to Quarterly Reports on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete annual financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of the unaudited consolidated financial statements have been included. All such adjustments are of a normal recurring nature. The consolidated financial statements should be read in conjunction with the 2018 Form 10-K. These unaudited interim consolidated results of operations for the six months ended June 30, 2019 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2019.

 

The Company’s consolidated financial statements include the accounts of Contango Oil & Gas Company and its subsidiaries, after elimination of all material intercompany balances and transactions. All wholly owned subsidiaries are consolidated. The investment in Exaro by the Company’s wholly owned subsidiary, Contaro Company, is accounted for using the equity method of accounting, and therefore, the Company does not include its share of individual operating results or production in those reported for the Company’s consolidated results of operations.

 

Liquidity and Going Concern

 

Over the past several months, the Company has been in discussions with its current lenders and other sources of capital regarding a possible refinancing and/or replacement of its Credit Facility (as defined in Note 10 – “Indebtedness”), which matures on October 1, 2019. The refinancing or replacement of the Credit Facility could be made in conjunction with an issuance of unsecured or non-priority secured debt or preferred or common equity, non-core property monetization, monetization of certain midstream and/or water handling facilities, or a combination of the foregoing. These discussions have included a possible new, replacement or extended credit facility that would be expected to provide additional borrowing capacity for future capital expenditures and acquisitions. There is no assurance, however, that such discussions will result in a refinancing of the Credit Facility on acceptable terms, if at all, or provide any specific amount of additional liquidity. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. However, the accompanying financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The accompanying financial statements do not include adjustments that might result from the outcome of the uncertainty, including any adjustments to reflect the possible future effects of the recoverability and classification of recorded asset amounts or amounts and classifications of liabilities that might be necessary should the Company be unable to continue as a going concern.

Oil and Gas Properties - Successful Efforts

The Company’s application of the successful efforts method of accounting for its natural gas and oil exploration and production activities requires judgment as to whether particular wells are developmental or exploratory, since exploratory costs and the costs related to exploratory wells that are determined to not have proved reserves must be expensed whereas developmental costs are capitalized. The results from a drilling operation can take considerable time to analyze, and the determination that commercial reserves have been discovered requires both judgment and application of industry experience. Wells may be completed that are assumed to be productive and actually deliver natural gas and oil in quantities insufficient to be economic, which may result in the abandonment of the wells at a later date. On occasion, wells are drilled which have targeted geologic structures that are both developmental and exploratory in nature, and in such instances an allocation of costs is required to properly account for the results. Delineation seismic costs incurred to select development locations within a productive natural gas and oil field are typically treated as development costs and capitalized, but often these seismic programs extend beyond the proved reserve areas, and therefore, management must estimate the portion of seismic costs to expense as exploratory. The evaluation of natural gas and oil leasehold acquisition costs included in unproved properties requires management's judgment of exploratory costs related to drilling activity in a given area. Drilling activities in an area by other companies may also effectively condemn leasehold positions.

 

Impairment of Long-Lived Assets

 

Pursuant to GAAP, when circumstances indicate that proved properties may be impaired, the Company compares expected undiscounted future cash flows on a field by field basis to the unamortized capitalized cost of the asset. If the estimated future undiscounted cash flows based on the Company’s estimate of future reserves, natural gas and oil prices,

9

operating costs and production levels from oil and natural gas reserves, are lower than the unamortized capitalized cost, then the capitalized cost is reduced to fair value. The factors used to determine fair value include, but are not limited to, estimates of proved, probable and possible reserves, future commodity prices, the timing of future production and capital expenditures and a discount rate commensurate with the risk reflective of the lives remaining for the respective oil and gas properties. Additionally, the Company may use appropriate market data to determine fair value. During the six months ended June 30, 2019, the Company recognized $0.2 million in non-cash proved property impairment related to leases in Wyoming and an onshore non-operated property in an area previously impaired due to revised reserve estimates made during the quarter ended December 31, 2018. During the six months ended June 30, 2018, the Company recognized $2.7 million in non-cash proved property impairment charges, $2.3 million of which related to its Vermilion 170 offshore property and $0.4 million of which related to non-core onshore properties due to revised reserve estimates. The Vermilion 170 offshore property was subsequently sold effective December 1, 2018

 

Unproved properties are reviewed quarterly to determine if there has been impairment of the carrying value, with any such impairment charged to expense in the period. The Company recognized non-cash impairment expense of approximately $0.4 million and approximately $0.9 million for three and six months ended June 30, 2019, respectively,  related to impairment of certain unproved properties primarily due to expiring leases. The Company recognized non-cash impairment expense of approximately $0.4 million and approximately $1.2 million for three and six months ended June 30, 2018, respectively, related to impairment of certain non-core unproved properties primarily due to expiring leases.

 

Net Loss Per Common Share 

 

Basic net loss per common share is computed by dividing the net loss attributable to common stock by the weighted average number of common shares outstanding for the period. Diluted net loss per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Potentially dilutive securities, including unexercised stock options, performance stock units and unvested restricted stock, have not been considered when their effect would be antidilutive. For the three and six months ended June 30, 2019, the Company excluded 648,170 shares or units and 561,164 shares or units, respectively, of potentially dilutive securities, as they were antidilutive. For the three and six months ended June 30, 2018, the Company excluded 1,628,321 shares or units and 1,713,673 shares or units, respectively, of potentially dilutive securities, as they were antidilutive.

 

Subsidiary Guarantees

 

Contango Oil & Gas Company, as the parent company (the “Parent Company”), has filed a registration statement on Form S-3 with the SEC to register, among other securities, debt securities that the Parent Company may issue from time to time. Any such debt securities would likely be guaranteed on a joint and several and full and unconditional basis by each of the Company’s current subsidiaries and any future subsidiaries specified in any future prospectus supplement (each a “Subsidiary Guarantor”). Each of the Subsidiary Guarantors is wholly owned by the Parent Company, either directly or indirectly. The Parent Company has no assets or operations independent of the Subsidiary Guarantors, and there are no significant restrictions upon the ability of the Subsidiary Guarantors to distribute funds to the Parent Company. The Parent Company has one wholly owned subsidiary that is inactive and not a Subsidiary Guarantor. The Parent Company’s wholly owned subsidiaries do not have restricted assets that exceed 25% of net assets as of the most recent fiscal year end that may not be transferred to the Parent Company in the form of loans, advances or cash dividends by such subsidiary without the consent of a third party.

 

 

 

Revenue Recognition

 

Adoption of ASC 606

 

As of January 1, 2018, the Company adopted Accounting Standards Codification Topic 606 – Revenue from Contracts with Customers (“ASC 606”), which supersedes the revenue recognition requirements and industry-specific guidance under Accounting Standards Codification Topic 605 – Revenue Recognition (“ASC 605”). The Company adopted ASC 606 using the modified retrospective method which allows the Company to apply the new standard to all new contracts entered into after December 31, 2017 and all existing contracts for which all (or substantially all) of the revenue has not been recognized under legacy revenue guidance prior to December 31, 2017. The Company identified no material impact on its historical revenues upon initial application of ASC 606, and as such did not recognize any cumulative catch-up effect to the opening balance of the Company’s shareholders’ equity as of January 1, 2018. ASC 606 supersedes previous revenue recognition requirements in ASC 605 and includes a five-step revenue recognition model to depict the

10

transfer of goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services.

 

Revenue from Contracts with Customers

 

Sales of oil, condensate, natural gas and natural gas liquids (“NGLs”) are recognized at the time control of the products are transferred to the customer. Based upon the Company’s current purchasers’ past experience and expertise in the market, collectability is probable, and there have not been payment issues with the Company’s purchasers over the past year or currently. Generally, the Company’s gas processing and purchase agreements indicate that the processors take control of the gas at the inlet of the plant and that control of residue gas is returned to the Company at the outlet of the plant. The midstream processing entity gathers and processes the natural gas and remits proceeds to the Company for the resulting sales of NGLs. The Company delivers oil and condensate to the purchaser at a contractually agreed-upon delivery point at which the purchaser takes custody, title and risk of loss of the product. 

 

When sales volumes exceed the Company’s entitled share, a production imbalance occurs. If production imbalance exceeds the Company’s share of the remaining estimated proved natural gas reserves for a given property, the Company records a liability. Production imbalances have not had and currently do not have a material impact on the financial statements, and this did not change with the adoption of ASC 606.

 

Transaction Price Allocated to Remaining Performance Obligations

 

Generally, the Company’s contracts have an initial term of one year or longer but continue month to month unless written notification of termination in a specified time period is provided by either party to the contract. The Company has used the practical expedient in ASC 606 which states that the Company is not required to disclose that transaction price allocated to remaining performance obligations if the variable consideration is allocated entirely to a wholly unsatisfied performance obligation. Future volumes are wholly unsatisfied, and disclosure of the transaction price allocated to remaining performance obligation is not required.

 

Contract Balances

 

The Company receives purchaser statements from the majority of its customers, but there are a few contracts where the Company prepares the invoice. Payment is unconditional upon receipt of the statement or invoice. Accordingly, the Company’s product sales contracts do not give rise to contract assets or liabilities under ASC 606. The majority of the Company’s contract pricing provisions are tied to a market index, with certain adjustments based on, among other factors, whether a well delivers to a gathering or transmission line, quality of the oil or natural gas, and supply and demand conditions. The price of these commodities fluctuates to remain competitive with supply.

 

Prior Period Performance Obligations

 

The Company records revenue in the month production is delivered to the purchaser. Settlement statements may not be received for 30 to 90 days after the date production is delivered, and therefore the Company is required to estimate the amount of production delivered to the purchaser and the price that will be received for the sale of the product. Differences between the Company’s estimates and the actual amounts received for product sales are generally recorded in the month that payment is received. Any differences between the Company’s revenue estimates and actual revenue received historically have not been significant. The Company has internal controls in place for its revenue estimation accrual process.

 

Impact of Adoption of ASC 606

 

The Company has reviewed all of its natural gas, NGLs, residue gas, condensate and crude oil sales contracts to assess the impact of the provisions of ASC 606. Based upon the Company’s review, there were no required changes to the recording of residue gas or condensate and crude oil contracts. Certain NGL and natural gas contracts would require insignificant changes to the recording of transportation, gathering and processing fees as net to revenue or as an expense. The Company concluded that these minor changes were not material to its operating results on a quantitative or qualitative basis. Therefore, there was no impact to its results of operations for the six months ended June 30, 2019. The Company has modified procedures to its existing internal controls relating to revenue by reviewing for any significant increase in sales level, primarily on gas processing or gas purchasing contracts, on a quarterly basis to monitor the significance of

11

gross revenue versus net revenue and expenses under ASC 606. As under previous revenue guidance, the Company will continue to review all new or modified revenue contracts on a quarterly basis for proper treatment.

 

Recent Accounting Pronouncements

 

In August 2018, the FASB issued ASU 2018-13 – Fair Value Measurement (“Topic 820”). The amendments in ASU 2018-13 modify the disclosure requirements on fair value measurements in Topic 820. The amendments in this update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The provisions of this update are not expected to have a material impact on the Company’s financial position or results of operations.

 

3. Acquisitions and Dispositions  

 

On March 28, 2018, the Company sold its operated Eagle Ford Shale assets located in Karnes County, Texas for a cash purchase price of $21.0 million. The Company recorded a net gain of $9.4 million, prior to final closing adjustments.

 

On May 25, 2018, the Company sold its non-operated assets located in Starr County, Texas for a cash purchase price of $0.6 million. The Company recorded a gain of $1.4 million after removal of the asset retirement obligations associated with the sold properties.

 

On June 10, 2019, the Company sold certain minor, non-core operated assets located in Lavaca and Wharton counties, Texas in exchange for the buyer’s assumption of the plugging and abandonment liabilities of the properties. The Company recorded a gain of $0.4 million after removal of the asset retirement obligations associated with the sold properties.

 

4. Fair Value Measurements

 

Pursuant to Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), the Company's determination of fair value incorporates not only the credit standing of the counterparties involved in transactions with the Company resulting in receivables on the Company's consolidated balance sheets, but also the impact of the Company's nonperformance risk on its own liabilities. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy assigns the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Level 2 measurements are inputs that are observable for assets or liabilities, either directly or indirectly, other than quoted prices included within Level 1. The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company classifies fair value balances based on the observability of those inputs.

 

The following table sets forth, by level within the fair value hierarchy, the Company’s financial assets and liabilities that were accounted for at fair value as of June 30, 2019. As required by ASC 820, a financial instrument's level within the fair value hierarchy is 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 fair value assets and liabilities and their placement within the fair value hierarchy levels. There have been no transfers between Level 1, Level 2 or Level 3.

 

Fair value information for financial assets and liabilities was as follows as of June 30, 2019 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

Fair Value Measurements Using

 

 

    

Carrying Value

    

Level 1

    

Level 2

    

Level 3

 

Derivatives

 

 

 

 

 

 

 

 

 

Commodity price contracts - assets

 

$

2,393

 

$

 —

 

$

2,393

 

$

 —

 

Commodity price contracts - liabilities

 

$

(292)

 

$

 —

 

$

(292)

 

$

 —

 

 

Derivatives listed above are recorded in “Current derivative asset or liability” and “Long-term derivative asset” on the Company’s consolidated balance sheet and include swaps and costless collars that are carried at fair value. The

12

Company records the net change in the fair value of these positions in "Gain (loss) on derivatives, net" in its consolidated statements of operations. The Company is able to value the assets and liabilities based on observable market data for similar instruments, which resulted in reporting its derivatives as Level 2. This observable data includes the forward curves for commodity prices based on quoted market prices and implied volatility factors related to changes in the forward curves. See Note 5 - "Derivative Instruments" for additional discussion of derivatives.

 

As of June 30, 2019, the Company's derivative contracts were all with major institutions with investment grade credit ratings which are believed to have minimal credit risk. As such, the Company is exposed to credit risk to the extent of nonperformance by the counterparties in the derivative contracts discussed above; however, the Company does not anticipate such nonperformance.

 

Estimates of the fair value of financial instruments are made in accordance with the requirements of Accounting Standards Codification Topic 825, Financial Instruments. The estimated fair value amounts are determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The estimated fair value of cash, accounts receivable and accounts payable approximates their carrying value due to their short-term nature. The estimated fair value of the Company's Credit Facility approximates carrying value because the facility interest rate approximates current market rates and is reset at least every quarter. See Note 10 - "Indebtedness" for further information.

 

Impairments

 

The Company tests proved oil and natural gas properties for impairment when events and circumstances indicate a decline in the recoverability of the carrying value of such properties, such as a downward revision of the reserve estimates or lower commodity prices. The Company estimates the undiscounted future cash flows expected in connection with the oil and gas properties on a field by field basis and compares such future cash flows to the unamortized capitalized costs of the properties. If the estimated future undiscounted cash flows are lower than the unamortized capitalized cost, the capitalized cost is reduced to its fair value. The factors used to determine fair value include, but are not limited to, estimates of proved, probable and possible reserves, future commodity prices, the timing of future production and capital expenditures and a discount rate commensurate with the risk reflective of the lives remaining for the respective oil and gas properties. Additionally, the Company may use appropriate market data to determine fair value. Because these significant fair value inputs are typically not observable, impairments of long-lived assets are classified as a Level 3 fair value measure.

 

Unproved properties are reviewed quarterly to determine if there has been impairment of the carrying value, with any such impairment charged to expense in the period.

 

Asset Retirement Obligations

 

The initial measurement of asset retirement obligations at fair value is calculated using discounted cash flow techniques and based on internal estimates of future retirement costs associated with oil and gas properties. The factors used to determine fair value include, but are not limited to, estimated future plugging and abandonment costs and expected lives of the related reserves. As there is no corroborating market activity to support the assumptions used, the Company has designated these liabilities as Level 3.

 

5. Derivative Instruments

 

The Company is exposed to certain risks relating to its ongoing business operations, such as commodity price risk. Derivative contracts are typically utilized to hedge the Company's exposure to price fluctuations and reduce the variability in the Company's cash flows associated with anticipated sales of future oil and natural gas production. The Company typically hedges a substantial, but varying, portion of anticipated oil and natural gas production for future periods. The Company believes that these derivative arrangements, although not free of risk, allow it to achieve a more predictable cash flow and to reduce exposure to commodity price fluctuations. However, derivative arrangements limit the benefit of increases in the prices of crude oil, natural gas and natural gas liquids sales. Moreover, because its derivative arrangements apply only to a portion of its production, the Company’s strategy provides only partial protection against declines in commodity prices. Such arrangements may expose the Company to risk of financial loss in certain circumstances. The Company continuously reevaluates its hedging programs in light of changes in production, market conditions and commodity price forecasts.

13

 

As of June 30, 2019, the Company’s natural gas and oil derivative positions consisted of swaps and costless collars.  Swaps are designed so that the Company receives or makes payments based on a differential between fixed and variable prices for crude oil and natural gas. A costless collar consists of a purchased put option and a sold call option, which establishes a minimum and maximum price, respectively, that the Company will receive for the volumes under the contract.

 

It is the Company's policy to enter into derivative contracts only with counterparties that are creditworthy institutions deemed by management as competent and competitive market makers. The Company does not post collateral, nor is it exposed to potential margin calls, under any of these contracts, as they are secured under the Credit Facility or under unsecured lines of credit with non-bank counterparties. See Note 10 – “Indebtedness” for further information regarding the Credit Facility.

 

The Company has elected not to designate any of its derivative contracts for hedge accounting. Accordingly, derivatives are carried at fair value on the consolidated balance sheets as assets or liabilities, with the changes in the fair value included in the consolidated statements of operations for the period in which the change occurs. The Company records the net change in the mark-to-market valuation of these derivative contracts, as well as all payments and receipts on settled derivative contracts, in “Gain (loss) on derivatives, net” on the consolidated statements of operations.

 

As of June 30, 2019, the following financial derivative instruments were in place (fair value in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity

    

Period

    

Derivative

    

Volume/Month

    

Price/Unit

    

Fair Value

 

Natural Gas

 

July 2019

 

Swap

 

600,000

Mmbtus

 

$

2.75

(1)

 

$

278

 

Natural Gas

 

Aug 2019 - Oct 2019

 

Swap

 

100,000

Mmbtus

 

$

2.75

(1)

 

$

136

 

Natural Gas

 

Nov 2019 - Dec 2019

 

Swap

 

500,000

Mmbtus

 

$

2.75

(1)

 

$

267

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil

 

July 2019 - Dec 2019

 

Collar

 

7,000

Bbls

 

$

50.00

-

58.00

(2)

 

$

(237)

 

Oil

 

July 2019 - Dec 2019

 

Collar

 

4,000

Bbls

 

$

52.00

-

59.45

(3)

 

$

(33)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil

 

July 2019

 

Swap

 

6,000

Bbls

 

$

66.10

(3)

 

$

46

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil

 

July 2019

 

Swap

 

12,000

Bbls

 

$

72.10

(3)

 

$

163

 

Oil

 

Aug 2019 - Oct 2019

 

Swap

 

9,000

Bbls

 

$

72.10

(3)

 

$

370

 

Oil

 

Nov 2019 - Dec 2019

 

Swap

 

12,000

Bbls

 

$

72.10

(3)

 

$

340

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil

 

July 2019 - Dec 2019

 

Swap

 

2,400

Bbls

 

$

61.72

(3)

 

$

51

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural Gas

 

Jan 2020 - March 2020

 

Swap

 

425,000

Mmbtus

 

$

2.84

(1)

 

$

225

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural Gas

 

April 2020 - July 2020

 

Swap

 

400,000

Mmbtus

 

$

2.53

(1)

 

$

167

 

Natural Gas

 

Aug 2020 - Oct 2020

 

Swap

 

40,000

Mmbtus

 

$

2.53

(1)

 

$

5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural Gas

 

Nov 2020 - Dec 2020

 

Swap

 

375,000

Mmbtus

 

$

2.70

(1)

 

$

38

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Oil

 

Jan 2020 - June 2020

 

Swap

 

22,000

Bbls

 

$

57.74

(3)

 

$

148

 

Oil

 

July 2020 - Dec 2020

 

Swap

 

15,000

Bbls

 

$

57.74

(3)

 

$

221

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total net fair value of derivative instruments

 

 

$

2,185

 


(1)    Based on Henry Hub NYMEX natural gas prices.

(2)    Based on Argus Louisiana Light Sweet crude oil prices.

(3)    Based on West Texas Intermediate crude oil prices.

 

In addition to the above financial derivative instruments, the Company also had a costless swap agreement with a Midland WTI - Cushing oil differential swap price of $0.05 per barrel of crude oil. The agreement fixes the Company’s exposure to that differential on 12,000 barrels of crude oil per month for January 2020 through June 2020 and 10,000 

14

barrels per month for July 2020 through December 2020. The fair value of this costless swap agreement was in a liability position of $84 thousand as of June 30, 2019.

 

The following summarizes the fair value of commodity derivatives outstanding on a gross and net basis as of June 30, 2019 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Gross

    

Netting (1)

    

Total

 

Assets

 

$

2,393

 

$

 —

 

$

2,393

 

Liabilities

 

$

(292)

 

$

 —

 

$

(292)

 


(1)   Represents counterparty netting under agreements governing such derivatives.

 

The following summarizes the fair value of commodity derivatives outstanding on a gross and net basis as of December 31, 2018 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

    

Gross

    

Netting (1)

    

Total

 

Assets

 

$

4,600

 

$

 —

 

$

4,600

 

Liabilities

 

$

(422)

 

$

 —

 

$

(422)

 


(1)   Represents counterparty netting under agreements governing such derivatives.

 

 

The following table summarizes the effect of derivative contracts on the consolidated statements of operations for the three and six months ended June 30, 2019 and 2018 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 

 

Six Months Ended June 30, 

 

 

    

2019

    

2018

    

2019

    

2018

 

Crude oil contracts