REVENUE FROM CONTRACTS WITH CUSTOMERS

The company’s revenue streams are reported under three segments: oil and natural gas, contract drilling, and mid-stream. This is our disaggregation of revenue and how our segment revenue is reported (as reflected in Note 14 - Industry Segment Information). Revenue from the oil and natural gas segment is derived from sales of our oil and natural gas production. Revenue from the contract drilling segment is derived by contracting with upstream companies to drill an agreed-on number of wells or provide drilling rigs and services over an agreed-on period of time. Revenue from the mid-stream segment is derived from gathering, transporting, and processing natural gas production and selling those commodities. The company sells its hydrocarbons (from the oil and natural gas and mid-stream segments) to midstream and downstream oil and gas companies.

We satisfy performance obligation for each contract as follows: for the contract drilling and mid-stream contracts, we satisfy the performance obligation over the agreed-on time period within the contracts, and for oil and natural gas contracts, we satisfy the performance obligation with each delivery of volumes. For oil and natural gas contracts, as it is more feasible, we account for these deliveries on a monthly basis. Per the contracts for all segments, customers pay for the services/goods received on a monthly basis within an agreed on number of days following the end of the month. Besides the mid-stream demand fees discussed further below, there were no other contract assets or liabilities.

Oil and Natural Gas Contracts, Revenues, Implementation Impact to Retained Earnings, and Performance Obligations

Typical types of revenue contracts signed are Oil Sales Contracts, Gas Purchase Agreements, North American Energy Standards Board (NAESB) Contracts, Gas Gathering and Processing Agreements, and revenues earned as the non-operated party with the operator serving as an agent on our behalf under our Joint Operating Agreements. Contract term can range from single month to extended term contracts spanning a decade or more; some include evergreen provisions. Revenues from sales are recognized when the customer obtains control of the company’s product. For sales to other midstream and downstream oil and gas companies, this would occur at a point in time, typically on delivery to the customer. Sales generated from our non-operated interest are recorded based on the information obtained from the operator. On adoption of the standard, no adjustment to opening retained earnings was required.

Certain costs as either a deduction from revenue or an expense is determined based on when control of the commodity transfers to the customer, which would affect our total revenue recognized, but will not affect gross profit. For example, gathering, processing and transportation costs that are included as part of the contract price with the customer upon transfer of control of the commodity are included in the transaction price, while costs incurred while we are in control of the commodity represent operating costs. The following table summarizes the impact of the adoption of ASC 606 on revenue and operating costs, as the change did not impact income from operations or net income for the three months ended March 31, 2018:



	As Reported		Adjustments due to ASC 606			Amounts without the Adoption of ASC 606
	(In thousands)
Oil and natural gas revenues	$	103,099	$	(3,169	)	$	106,268
Oil and natural gas operating costs	35,962		(3,169		)	39,131
Gross profit	$	67,137	$	—		$	67,137

Our performance obligation for all contracts is the delivery of oil and gas volumes to the customer. Typically the contract will establish a period of time (for example, a month or a year); however, each delivery can be considered separately identifiable as each delivery provides benefits to the customer on its own. For feasibility, as accounting for a monthly performance obligation is not materially different than identifying a more granular performance obligation, we conclude this performance obligation is satisfied monthly. We typically receive payment within a set number of days following the end of the month and includes payment for all deliveries in that month. Depending on contract circumstances, judgment could be required to determine when the transfer of control occurs. Generally, depending of the facts and circumstances, we consider the transfer of control of the asset in a commodity sale to occur at the point the commodity transfers to our final purchaser.

The majority of the consideration received for oil and gas sales is variable. Most of our contracts state the consideration is calculated by multiplying a variable quantity by an agreed-on index price less deductions related to gathering, transportation, fractionation, and related fuel charges. There are also instances where the consideration is quantity multiplied by a weighted average sales price. These different pricing tools can change the perception of when control transfers; however, when analyzed with other control factors, typically the accounting conclusion is the same for both pricing methods. In these instances, the variable consideration is partially constrained. In addition, all variable consideration is settled at the end of the month; therefore, whether the variability is constrained does not affect accounting for revenue under ASC 606 as the variability is known prior to each reporting period. An estimation and allocation of transaction price and future obligations are not required.

Contract Drilling Contracts, Revenues, Implementation impact to retained earnings, and Performance Obligations

The contract drilling contracts we use primarily are industry standard IADC contracts 2003 and 2013. Contract terms can range from six months to two or more years or can be based on terms to drill a specific number of wells. These allocation rules in ASC 606 are referred to as the series guidance which states that a contract may contain a single performance obligation composed of a series of distinct goods or services if 1) each distinct good or service is substantially the same and would meet the criteria to be a performance obligation satisfied over time and 2) each distinct good or service is measured using the same method as it relates to the satisfaction of the overall performance obligation. The company determined that the delivery of drilling services is within the scope of the series guidance as both criteria noted above are met. Specifically, 1) each distinct increment of service (i.e. hour available to drill) that the driller promises to transfer represents a performance obligation that would meet the criteria for recognizing revenue over time, and 2) the driller would use the same method for measuring progress toward satisfaction of the performance obligation for each distinct increment of service in the series. At inception, the total transaction price will be estimated to include any applicable fixed consideration, unconstrained variable consideration (estimated day rate mobilization and demobilization revenue, estimated operating day rate revenue to be earned over the contract term, expected bonuses (if material and can be reasonably estimated without significant reversal), and penalties (if material and can be reasonably estimated without significant reversal)). Allocation rules under the new standard will allow the company to recognize revenues associated with contract drilling contacts in materially the same manner as under the previous revenue accounting standard. A contract liability will be recorded for consideration received before the corresponding transfer of services. Such liabilities will generally only arise in relation to upfront mobilization fees which are paid in advance and are allocated/recognized over the entire performance obligation. Such balances will be amortized over the recognition period based on the same method of measure used for revenue. On adoption of the standard, no adjustment to opening retained earnings was required.

Our performance obligation for all contracts is to drill the agreed-on number of wells or drill over an agreed-on period of time as stated in the contract. Mobilization and demobilization activities associated with a drilling contract are not considered to be distinct within the context of the contract and therefore, any associated revenue is allocated to the overall performance obligation of drilling services and recognized ratably over the initial term of the related drilling contract. It typically takes from 10 to 90 days to complete drilling a well; therefore, depending on the number of wells under a contract, the contract term could be up to two years. Most of the drilling contracts are for less than one year. As the customer simultaneously received and consumes the benefits provided by the company’s performance, and the company’s performance enhances an asset that the customer controls, the performance obligation to drill the well occurs over time. We typically receive payment within a set number of days following the end of the month and includes payment for all services performed that month (calculated on an hourly basis). The company satisfies its overall performance obligation when the well included in the contract is drilled to an agreed-upon depth or by a set date.

All consideration received for contract drilling contracts is variable, excluding termination fees, which we concluded will not be applicable to our current contracts as of the reporting date. The consideration is calculated by multiplying a variable quantity (number of days/hours) by an agreed-on daily price (for the daily rate, mobilization and demobilization revenue). Other revenue items per the contract include bonus/penalty revenue, reimbursable revenue, drilling fluid rates, and early termination fees. All variable consideration is not constrained but is settled at the end of the month; therefore, whether or not the variability is constrained does not affect accounting for revenue under ASC 606 as the variability is known prior to each reporting period excluding certain bonuses/penalties which might be based on activity that occurs over the entire term of the contract. We have evaluated the mobilization and de-mobilization charges on outstanding contracts, however, the impact to the financial statements was immaterial. As of March 31, 2018, we had 32 contract drilling contracts (six long-term) for a duration of two to fourteen months.

Per the new guidance in relation to disclosures regarding remaining performance obligations, there is a practical expedient for contracts that have an original expected duration of one year or less (ASC 606-10-50-14) and for contracts where the entity can recognize revenue as invoiced (ASC 606-10-55-18). The majority of contract drilling contracts have an original term of less than one year; however, there are a few contracts with a longer duration that are not material.

Mid-stream Contracts Revenues, and Implementation impact to retained earnings, and Performance Obligations

Revenues are generated from the fees earned for gas gathering and processing services provided to a customer. Typical types of revenue contracts signed are Gas Gathering and Processing agreements. Contract terms can range from single month to extended term contracts spanning a decade or more, some include evergreen provisions. Fees for mid-stream services (gathering, transportation, processing) are performance obligations and meet the criteria of over time recognition which could be considered a series of distinct performance obligations that represents one overall performance obligation of gas gathering and processing services.

On adoption of the standard, an adjustment to opening retained earnings was made in the amount of $1.7 million ($1.3 million, net of tax). This adjustment related to the timing of revenue recognized on certain demand fees and had the following impact to the Unaudited Condensed Consolidated Balance Sheet:



	Balance at December 31, 2017		Adjustments due to ASC 606			Balance at January 1, 2018
	(In thousands)
Assets:
Other assets	$	16,230	$	10,798		$	27,028
Liabilities and shareholders' equity:
Current portion of other long-term liabilities	13,002		2,748			15,750
Other long-term liabilities	100,203		9,737			109,940
Deferred income taxes	133,477		(413		)	133,064
Retained earnings	799,402		(1,274		)	798,128

The following impact of these demand fees to the Unaudited Condensed Consolidated Balance Sheet on at March 31, 2018:



	As Reported		Adjustments due to ASC 606			Amounts without the Adoption of ASC 606
	(In thousands)
Assets:
Prepaid expenses and other	$	7,724	$	50		$	7,674
Other assets	27,470		11,397			16,073
Liabilities and shareholders' equity:
Current portion of other long-term liabilities	14,587		2,824			11,763
Other long-term liabilities	104,286		9,118			95,168
Deferred income taxes	136,600		(121		)	136,479
Retained earnings	805,993		(374		)	805,619

This adjustment related to the timing of revenue recognized on certain demand fees and had the following impact to the Unaudited Condensed Consolidated Income Statement for the three months ended March 31, 2018:



	As Reported		Adjustments due to ASC 606		Amounts without the Adoption of ASC 606
	(In thousands)
Gas gathering and processing revenues	$	56,044	$	1,192	$	54,852
Deferred income tax expense	3,607		292		3,315
Net income	7,865		900		6,965

The only fixed consideration related to mid-stream consideration is the demand fee which is calculated by multiplying an agreed-on price by a fixed number of volumes per month over a specified term in the contract.

Included below is the additional fixed revenue the company will earn over the remaining term of the contracts and excludes all variable consideration to be earned with the associated contract.



Contract	Remaining Term of Contract	April - December 2018		2019		2020			2021			2022		Total Remaining Impact to Revenue
		(In thousands)
Demand fee contracts	4-5 years	$	3,777	$	2,632	$	(3,781	)	$	(3,507	)	$	1,374	$	495

Before the implementation of ASC 606, we recognized the entire demand fee as the fee was payable the first five years after the effective date, not the entire term of the contract. However, as the demand fee does not specifically relate to a distinct performance obligation, the amount should be recognized over the life of the contract. Therefore, the demand fee already recognized for $1.7 million ($1.3 million, net of tax) was adjusted to retained earnings as of January 1, 2018, and will be recognized over the remaining term of the contract. As this amount is fixed consideration, recognition of the remaining portion will be stable. For the first three months of March 31, 2018, $1.2 million was recognized in revenue for these demand fees.

Besides the demand fee, there were no other contract assets or liabilities (see above for the balance sheet line items where they are reported.)



	March 31, 2018			January 1, 2018			Change
	(In thousands)
Contract assets	$	11,447		$	10,798		$	649
Contract liabilities	11,942			12,485			(543		)
Contract liabilities, net	$	(495	)	$	(1,687	)	$	1,192

Our performance obligations for all contracts is to gather, transport, or process an agreed-on number of volumes as stated in the contract. Typically the contract will establish a period of time over which the company will perform the mid-stream services. Certain contracts also include an agreed-on quantity (or an agreed-on minimum quantity) of volumes that the company will deliver or service. The term under mid-stream service contracts is typically five to ten years. Under service contracts, as the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs, the performance obligation to gather, transport, or process occurs over time. We typically receive payment within a set number of days following the end of the month and includes payment for all services performed that month. The company satisfies its overall performance obligation at the end of the contract term.

Most of the consideration received for mid-stream service contracts is variable. The consideration is calculated by multiplying a variable quantity (number of volumes) by an agreed-on price per MCF (commodity fee and the gathering fee). One fixed component of revenue is calculated by multiplying an agreed-on price by a certain volume commitment (MCF per day). Other revenue items may include shortfall fees. All variable consideration is settled at the end of the month; therefore, whether or not the variability is constrained does not affect accounting for revenue under ASC 606 as the variability is known before each reporting period. However, this excludes the shortfall fee as this fee could be based on a set number of volumes over the course of more than one month.

Per the new guidance related to disclosures for remaining performance obligations, there is a practical expedient for contracts that have an original expected duration of one year or less (ASC 606-10-50-14). There is also a practical expedient for “variable consideration [that] is allocated entirely to a wholly unsatisfied performance obligation… that forms part of a single performance obligation… for which the criteria in paragraph 606-10-32-40 have been met” (ASC 606-10-50-14A). As stated previously, the contract term for mid-stream services is typically longer than one year. However, based on the guidance at 606-10-32-40, we determined some of the variable payment in mid-stream service agreements specifically relates to the entity’s efforts to satisfy the performance obligation and that “allocating the variable amount entirely to the distinct good or service is consistent with the allocation objective in paragraph 606-10-32-28.” Therefore, the practical expedient relates to this variable consideration: the commodity fee and the gathering fee. The last time we received a shortfall fee was in 2016 and the amount was immaterial to total mid-stream revenues. These terms have historically been limited in our contracts.

We calculate revenue earned from the variable consideration related to mid-stream services by multiplying the number of volumes serviced times an agreed-on price. Therefore, the variable portion of this consideration is due to the change in volumes. This variability is resolved at the end of each month as the company will know the number of volumes serviced under each contract and payment is received monthly. The mid-stream gathering service contracts remaining are for a duration of less than one year to 15 years.

While long term service contracts are in place as of the reporting date, due to the variable volumes an estimation and allocation of transaction price and future obligations are not required.