NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.BASIS OF PRESENTATION
Description of Company
Gulfport Energy Corporation (the "Company" or "Gulfport") is an independent natural gas-weighted exploration and production company focused on the production of natural gas, crude oil and NGL in the United States. The Company's principal properties are located in eastern Ohio targeting the Utica and in central Oklahoma targeting the SCOOP Woodford and SCOOP Springer formations. Gulfport filed for voluntary reorganization under Chapter 11 of the Bankruptcy Code on November 13, 2020, and subsequently operated as a debtor-in-possession, in accordance with applicable provisions of the Bankruptcy Code, until its emergence on May 17, 2021. The Company refers to the post-emergence reorganized organization in the condensed financial statements and footnotes as the "Successor" for periods subsequent to May 17, 2021, and the pre-emergence organization as "Predecessor" for periods on or prior to May 17, 2021.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Gulfport were prepared in accordance with GAAP and the rules and regulations of the SEC.
This Quarterly Report on Form 10-Q (this “Form 10-Q”) relates to the financial position and periods as of and for the three months ended September 30, 2022 ("Current Successor Quarter"), as of and for the nine months ended September 30, 2022 ("Current Successor YTD Period"), May 18, 2021 through September 30, 2021 (“Prior Successor Period”), the three months ended September 30, 2021 ("Prior Successor Quarter"), and January 1, 2021 through May 17, 2021 (“Prior Predecessor YTD Period”). The Company's annual report on Form 10-K for the year ended December 31, 2021 (“2021 Form 10-K”) should be read in conjunction with this Form 10-Q. The accompanying unaudited consolidated financial statements reflect all normal recurring adjustments which, in the opinion of management, are necessary for a fair statement of our condensed consolidated financial statements and accompanying notes and include the accounts of our wholly-owned subsidiaries. Intercompany accounts and balances have been eliminated. The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern.
Voluntary Reorganization Under Chapter 11 of the Bankruptcy Code
In connection with the Company's emergence from bankruptcy and in accordance with ASC 852, the Company qualified for and applied fresh start accounting on the Emergence Date. For further information on the Company’s reorganization value and the resulting fresh start adjustments made on the Emergence Date, refer to the “Fresh Start Accounting” footnote in the notes to the consolidated financial statements in Item 8 of the Company’s 2021 Form 10-K.
Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities consisted of the following at September 30, 2022 and December 31, 2021 (in thousands): | | | | | | | | | | | |
| Successor |
| September 30, 2022 | | December 31, 2021 |
Accounts payable and other accrued liabilities | $ | 202,838 | | | $ | 143,938 | |
Revenue payable and suspense | 222,729 | | | 180,857 | |
Accrued contract rejection damages and shares held in reserve | 40,996 | | | 69,216 | |
Total accounts payable and accrued liabilities | $ | 466,563 | | | $ | 394,011 | |
Reorganization Items, Net
In the Prior Predecessor YTD Period, the Company incurred significant expenses related to its Chapter 11 filing. The amount of these items, which were incurred in reorganization items, net within the Company's accompanying consolidated
statements of operations, significantly affected the Company's statements of operations. The Company also incurred adjustments for allowable claims related to its legal proceedings and executory contracts approved for rejection by the Bankruptcy Court.
The following table summarizes the components in reorganization items, net included in the Company's consolidated statements of operations for the Current Successor YTD Period, Prior Successor Period, and Prior Predecessor YTD Period (in thousands):
| | | | | | | | | | | | | | | | | | | | |
| Successor | | | Predecessor |
| Nine Months Ended September 30, 2022 | | Period from May 18, 2021 through September 30, 2021 | | | Period from January 1, 2021 through May 17, 2021 |
Legal and professional advisory fees | $ | — | | | $ | — | | | | $ | 81,565 | |
Net gain on liabilities subject to compromise | — | | | — | | | | (575,182) | |
Fresh start adjustments, net | — | | | — | | | | 160,756 | |
Elimination of predecessor accumulated other comprehensive income | — | | | — | | | | 40,430 | |
Debt issuance costs | — | | | — | | | | 3,150 | |
Other items, net | — | | | — | | | | 22,383 | |
Reorganization items, net | $ | — | | | $ | — | | | | $ | (266,898) | |
Other, net
Other, net included in the Company's consolidated statements of operations for the Current Successor YTD period included $11.5 million related to the TC claim distribution received in February 2022 as discussed in Note 7. Supplemental Cash Flow and Non-Cash Information (in thousands) | | | | | | | | | | | | | | | | | | | | |
| Successor | | | Predecessor |
| Nine Months Ended September 30, 2022 | | Period from May 18, 2021 through September 30, 2021 | | | Period from January 1, 2021 through May 17, 2021 |
Supplemental disclosure of cash flow information: | | | | | | |
Cash paid for reorganization items, net | $ | — | | | $ | 42,202 | | | | $ | 87,199 | |
Interest payments | $ | 30,102 | | | $ | 6,465 | | | | $ | 7,272 | |
Changes in operating assets and liabilities: | | | | | | |
(Increase) decrease in accounts receivable - oil, natural gas, and natural gas liquids sales | $ | (84,674) | | | $ | (5,230) | | | | $ | (60,832) | |
(Increase) decrease in accounts receivable - joint interest and other | $ | (14,947) | | | $ | 5,536 | | | | $ | (3,005) | |
Increase (decrease) in accounts payable and accrued liabilities | $ | 65,648 | | | $ | (48,903) | | | | $ | 79,193 | |
Decrease in prepaid expenses | $ | 3,061 | | | $ | 7,231 | | | | $ | 135,471 | |
Decrease in other assets | $ | 1,352 | | | $ | 106 | | | | $ | 3,067 | |
Total changes in operating assets and liabilities | $ | (29,560) | | | $ | (41,260) | | | | $ | 153,894 | |
Supplemental disclosure of non-cash transactions: | | | | | | |
Capitalized stock-based compensation | $ | 2,141 | | | $ | 484 | | | | $ | 930 | |
Asset retirement obligation capitalized | $ | 53 | | | $ | 55 | | | | $ | 546 | |
Asset retirement obligation removed due to divestiture | $ | (7) | | | $ | — | | | | $ | — | |
Interest capitalized | $ | — | | | $ | 117 | | | | $ | — | |
| | | | | | |
Release of common stock held in reserve | $ | 28,220 | | | $ | 23,893 | | | | $ | — | |
Foreign currency translation gain on equity method investments | $ | — | | | $ | — | | | | $ | 2,570 | |
2.PROPERTY AND EQUIPMENT
The major categories of property and equipment and related accumulated DD&A and impairment as of September 30, 2022 and December 31, 2021 are as follows (in thousands):
| | | | | | | | | | | |
| Successor |
| September 30, 2022 | | December 31, 2021 |
Proved oil and natural gas properties | $ | 2,303,728 | | | $ | 1,917,833 | |
Unproved properties | 184,075 | | | 211,007 | |
Other depreciable property and equipment | 5,767 | | | 4,943 | |
Land | 386 | | | 386 | |
Total property and equipment | 2,493,956 | | | 2,134,169 | |
Accumulated DD&A and impairment | (467,485) | | | (278,341) | |
Property and equipment, net | $ | 2,026,471 | | | $ | 1,855,828 | |
Under the full cost method of accounting, the Company is required to perform a ceiling test each quarter. The test determines a limit, or ceiling, on the book value of the Company's oil and natural gas properties. At September 30, 2022, the net book value of the Company's oil and gas properties was below the calculated ceiling for the period leading up to September 30, 2022. As a result, the Company did not record an impairment of its oil and natural gas properties for the Current Successor Quarter. The Company recorded impairment of its oil and natural gas properties of $117.8 million for the Prior Successor Period. Upon the application of fresh start accounting, the value of the Company's oil and natural gas properties were determined using forward strip oil and natural gas prices as of the Emergence Date. These prices were higher than the 12-month weighted average prices used in the full cost ceiling limitation at June 30, 2021, which led to the Prior Successor Period impairment charge.
Certain general and administrative costs are capitalized to the full cost pool and represent management’s estimate of costs incurred directly related to exploration and development activities. All general and administrative costs not capitalized are charged to expense as they are incurred. Capitalized general and administrative costs were approximately $4.9 million and $5.1 million for the Current Successor Quarter and Prior Successor Quarter, respectively. Capitalized general and administrative costs were approximately $14.6 million, $7.3 million, and $8.0 million for the Current Successor YTD Period, Prior Successor Period, and Prior Predecessor YTD Period, respectively.
The Company evaluates the costs excluded from its amortization calculation at least annually. Individually insignificant unevaluated properties are grouped for evaluation and periodically transferred to evaluated properties over a timeframe consistent with their expected development schedule.
The following table summarizes the Company’s non-producing properties excluded from amortization by area as of September 30, 2022:
| | | | | |
| Successor |
| September 30, 2022 |
| (In thousands) |
Utica | $ | 151,856 | |
SCOOP | 32,219 | |
| |
Total unproved properties | $ | 184,075 | |
Asset Retirement Obligation
The following table provides a reconciliation of the Company’s asset retirement obligation for the Current Successor YTD Period (in thousands):
| | | | | | | | |
Asset retirement obligation at January 1, 2022 (Successor) | | $ | 28,264 | |
Liabilities incurred | | 53 | |
| | |
Liabilities removed due to divestitures | | (7) | |
Accretion expense | | 2,057 | |
| | |
Asset retirement obligation at September 30, 2022 | | $ | 30,367 | |
The following table provides a reconciliation of the Company’s asset retirement obligation for the Prior Predecessor YTD Period and Prior Successor Period (in thousands):
| | | | | | | | |
Asset retirement obligation at January 1, 2021 (Predecessor) | | $ | 63,566 | |
Liabilities incurred | | 546 | |
Accretion expense | | 1,229 | |
Ending balance as of May 17, 2021 (Predecessor) | | 65,341 | |
Fresh start adjustments(1) | | (46,257) | |
| | |
| | |
Asset retirement obligation at May 18, 2021 (Successor) | | 19,084 | |
Liabilities incurred | | 56 | |
Accretion expense | | 714 | |
Asset retirement obligation at September 30, 2021 | | $ | 19,854 | |
_____________________(1) The Company recorded its asset retirement obligation at fair value as of the Emergence Date.
3.DEBT
Debt consisted of the following items as of September 30, 2022 and December 31, 2021 (in thousands):
| | | | | | | | | | | |
| Successor |
| September 30, 2022 | | December 31, 2021 |
Credit Facility | $ | 179,000 | | | $ | 164,000 | |
8.000% senior unsecured notes due 2026 | 550,000 | | | 550,000 | |
Net unamortized debt issuance costs | (899) | | | (1,054) | |
Total debt, net | 728,101 | | | 712,946 | |
Less: current maturities of long-term debt | — | | | — | |
Total long-term debt, net | $ | 728,101 | | | $ | 712,946 | |
Credit Facility
On October 14, 2021, the Company entered into the Third Amended and Restated Credit Agreement with JPMorgan Chase Bank, N.A., as administrative agent, and various lender parties ("Credit Facility"). The Credit Facility provided for an aggregate maximum principal amount of up to $1.5 billion, an initial borrowing base of $850.0 million and an initial aggregate elected commitment amount of $700.0 million. The credit agreement also provides for a $175.0 million sublimit of the aggregate commitments that is available for the issuance of letters of credit. The Credit Facility matures October 14, 2025.
On May 2, 2022, the Company completed its semi-annual borrowing base redetermination and entered into the first amendment to its credit agreement (“Amendment”). The Amendment, among other things, (a) increased the borrowing base under the Credit Agreement from $850 million to $1.0 billion with the elected commitments remaining at $700 million, (b) amended certain covenants related to hedging to ease certain requirements and limitations, (c) amended the covenants governing restricted payments to (i) increase the Net Leverage Ratio allowing unlimited restricted payments from 1.00 to 1.00 to 1.25 to 1.00 and (ii) permit additional restricted payments to redeem preferred equity until December 31, 2022 provided certain leverage, no event of default or borrowing base deficiency and availability tests are met, and (d) provide for the transition from a LIBOR to a SOFR benchmark, with a 10 basis point credit spread adjustment for all tenors.
The Credit Facility bears interest at a rate equal to, at the Company’s election, either (a) SOFR benchmark plus an applicable margin that varies from 2.75% to 3.75% per annum or (b) a base rate plus an applicable margin that varies from 1.75% to 2.75% per annum, based on borrowing base utilization. The Company is required to pay a commitment fee of 0.50% per annum on the average daily unused portion of the current aggregate commitments under the Credit Facility. The Company is also required to pay customary letter of credit and fronting fees.
The borrowing base will be redetermined semiannually on or around May 1 and November 1 of each year. On October 31, 2022, the Company completed its semi-annual borrowing base redetermination as discussed in Note 13. The credit agreement requires the Company to maintain as of the last day of each fiscal quarter (i) a net funded leverage ratio of less than or equal to 3.25 to 1.00, and (ii) a current ratio of greater than or equal to 1.00 to 1.00.
The obligations under the Credit Facility, certain swap obligations and certain cash management obligations, are guaranteed by the Company and the wholly-owned domestic material subsidiaries of the Borrower (collectively, the “Guarantors” and, together with the Borrower, the “Loan Parties”) and secured by substantially all of the Loan Parties’ assets (subject to customary exceptions).
The credit agreement also contains customary affirmative and negative covenants, including, among other things, as to compliance with laws (including environmental laws and anti-corruption laws), delivery of quarterly and annual financial statements and borrowing base certificates, conduct of business, maintenance of property, maintenance of insurance, entry into certain derivatives contracts, restrictions on the incurrence of liens, indebtedness, asset dispositions, restricted payments, and other customary covenants. These covenants are subject to a number of limitations and exceptions.
As of September 30, 2022, the Company had $179.0 million outstanding borrowings under the Credit Facility, $113.2 million in letters of credit outstanding and was in compliance with all covenants under the Credit Facility.
As of September 30, 2022, the Credit Facility bore interest at a weighted average rate of 6.23%.
2026 Senior Notes
On the Emergence Date, pursuant to the terms of the Plan, the Company issued $550 million aggregate principal amount of its 8.000% senior notes due 2026. The notes are guaranteed on a senior unsecured basis by each of the Company's subsidiaries that guarantee the Credit Facility. Interest on the 2026 Senior Notes is payable semi-annually, on June 1 and December 1 of each year. The 2026 Senior Notes were issued under the Indentures, dated as of May 17, 2021, by and among the Issuer, UMB Bank, National Association, as trustee, and the Guarantors and mature on May 17, 2026.
The covenants of the 1145 Indenture (other than the payment covenant) require that the Company comply with the covenants of the 4(a)(2) Indenture, as amended. The 4(a)(2) Indenture contains covenants limiting the Issuer’s and its restricted subsidiaries’ ability to (i) incur additional debt, (ii) pay dividends or distributions in respect of certain equity interests or redeem, repurchase or retire certain equity interests or subordinated indebtedness, (iii) make certain investments, (iv) create restrictions on distributions from restricted subsidiaries, (v) engage in specified sales of assets, (vi) enter into certain transactions among affiliates, (vii) engage in certain lines of business, (viii) engage in consolidations, mergers and acquisitions, (ix) create unrestricted subsidiaries and (x) incur or create liens. These covenants contain important exceptions, limitations and qualifications. At any time that the 2026 Senior Notes are rated investment grade, certain covenants will be terminated and cease to apply.
Fair Value of Debt
At September 30, 2022, the carrying value of the outstanding debt represented by the 2026 Senior Notes was $549.1 million. Based on the quoted market prices (Level 1), the fair value of the 2026 Senior Notes was determined to be $546.3 million at September 30, 2022.
4.MEZZANINE EQUITY AND EQUITY
On the Emergence Date, the Company filed an amended and restated certificate of incorporation with the Delaware Secretary of State to provide for, among other things, (i) the authority to issue 42 million shares of common stock with a par value of $0.0001 per share and (ii) the designation of 110,000 shares of preferred stock, with a par value of $0.0001 per share and a liquidation preference of $1,000 per share ("Liquidation Preference").
Mezzanine Equity
Preferred Stock
On the Emergence Date, the Successor issued 55,000 shares of preferred stock.
Holders of preferred stock are entitled to receive cumulative quarterly dividends at a rate of 10% per annum of the Liquidation Preference with respect to cash dividends and 15% per annum of the Liquidation Preference with respect to dividends paid in kind as additional shares of preferred stock (“PIK Dividends”). Gulfport currently has the option to pay either cash or PIK dividends on a quarterly basis.
Each holder of shares of preferred stock has the right (the “Conversion Right”), at its option and at any time, to convert all or a portion of the shares of preferred stock that it holds into a number of shares of common stock equal to the quotient obtained by dividing (x) the product obtained by multiplying (i) the Liquidation Preference times (ii) an amount equal to one (1) plus the Per Share Makewhole Amount (as defined in the Preferred Terms) on the date of conversion, by (y) $14.00 per share (as may be adjusted under the Preferred Terms) (the “Conversion Price”). The shares of preferred stock outstanding at September 30, 2022 would convert to approximately 3.7 million shares of common stock if all holders of preferred stock exercised their Conversion Right.
Gulfport shall have the right, but not the obligation, to redeem all, but not less than all, of the outstanding shares of preferred stock by notice to the holders of preferred stock, at the greater of (i) the aggregate value of the preferred stock, calculated by the Current Market Price (as defined in the Preferred Terms) of the number of shares of common stock into which, subject to redemption, such preferred stock would have been converted if such shares were converted pursuant to the Conversion Right at the time of such redemption and (ii) (y) if the date of such redemption is on or prior to the three year anniversary of the Emergence Date, the sum of the Liquidation Preference plus the sum of all unpaid PIK Dividends through the three year anniversary of the Emergence Date, or (x) if the date of such redemption is after the three year anniversary of the Emergence Date, the Liquidation Preference (the “Redemption Price”).
Following the Emergence Date, if there is a Fundamental Change (as defined in the Preferred Terms), Gulfport is required to redeem all, but not less than all, of the outstanding shares of preferred stock by cash payment of the Redemption Price per share of preferred stock within three (3) business days of the occurrence of such Fundamental Change. Notwithstanding the foregoing, in the event of a redemption pursuant to the preceding sentence, if Gulfport lacks sufficient cash to redeem all outstanding shares of preferred stock, the Company is required to redeem a pro rata portion of each holder’s shares of preferred stock.
The preferred stock has no stated maturity and will remain outstanding indefinitely unless repurchased or redeemed by Gulfport or converted into common stock.
The preferred stock has been classified as mezzanine equity in the accompanying consolidated balance sheets due to the redemption features noted above.
Dividends and Conversions
During the Current Successor YTD Period, the company paid $4.1 million of cash dividends to holders of our preferred stock.
The following table summarizes activity of the Company’s preferred stock for the Current Successor YTD Period:
| | | | | | | | |
Preferred stock at December 31, 2021 | | 57,896 | |
| | |
Conversion of preferred stock | | (5,551) | |
Preferred stock at September 30, 2022 | | 52,345 | |
Equity
Common Stock
On the Emergence Date, all existing shares of the Predecessor's common stock were cancelled. The Successor issued approximately 19.8 million shares of common stock and 1.7 million shares of common stock were issued to the Disputed Claims reserve.
In January 2022 approximately 876,000 shares in the Disputed Claims reserve at December 31, 2021 were issued to certain claimants. As of September 30, 2022, approximately 62,000 shares continue to be held in the Disputed Claims reserve and may be issued upon finalization of remaining claims.
Share Repurchase Program
In November 2021 the Company's Board of Directors approved a stock repurchase program to acquire up to $100 million of its common stock and increased the authorization from $100 million to $200 million in April 2022 and from $200 million to $300 million in July 2022 ("Repurchase Program"). Purchases under the Repurchase Program may be made from time to time in open market or privately negotiated transactions, and will be subject to available liquidity, market conditions, credit agreement restrictions, applicable legal requirements, contractual obligations and other factors. The Repurchase Program does not require the Company to acquire any specific number of shares of common stock. The Company intends to purchase shares under the Repurchase Program with available funds while maintaining sufficient liquidity to fund its capital development program. The Repurchase Program is authorized to extend through June 30, 2023, and may be suspended from time to time, modified, extended or discontinued by the board of directors at any time. The following table summarizes activity under the Repurchase Program for the Current Successor Quarter and Current Successor YTD Period (number of shares and dollar value of shares purchased shown in thousands):
| | | | | | | | | | | | | | | | | | | | |
| | Total Number of Shares Purchased | | Dollar Value of Shares Purchased | | Average Price Paid Per Share |
First quarter 2022 | | 438 | | | $ | 35,512 | | | $ | 81.06 | |
Second quarter 2022 | | 1,416 | | | 127,510 | | | 90.06 | |
Third quarter 2022 | | 753 | | | 64,549 | | | 85.72 | |
Total | | 2,607 | | | $ | 227,571 | | | $ | 87.29 | |
5.STOCK-BASED COMPENSATION
On the Emergence Date, the Company's Predecessor common stock was cancelled and the Company's Successor common stock was issued. Accordingly, the Company's then existing stock-based compensation awards were also cancelled. Stock-based compensation for the Predecessor and Successor periods are not comparable.
Successor Stock-Based Compensation
As of the Emergence Date, the board of directors adopted the Incentive Plan with a share reserve equal to 2.8 million shares of common stock. The Incentive Plan provides for the grant of incentive stock options, nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, dividend equivalents and performance awards or any combination of the foregoing. The Company has granted both restricted stock units and performance vesting restricted stock units to employees and directors pursuant to the Incentive Plan, as discussed below. During the Current Successor Quarter and the Current Successor YTD Period, the Company's stock-based compensation expense was $2.4 million and $6.3 million, of which the Company capitalized $0.8 million and $2.1 million, respectively, relating to its exploration and development efforts. During the Prior Successor Quarter and the Prior Successor Period, the Company's stock-based compensation expense was $1.4 million, of which the Company capitalized $0.5 million relating to its exploration and development efforts. Stock compensation expense, net of the amounts capitalized, is included in general and administrative expenses in the accompanying consolidated statements of operations. As of September 30, 2022, the Company has awarded an aggregate of approximately 268,000 restricted stock units and approximately 191,000 performance vesting restricted stock units, net of forfeited awards, under the Incentive Plan.
The following table summarizes restricted stock unit activity for the Current Successor YTD Period:
| | | | | | | | | | | | | | | | | | | | | | | |
| Number of Unvested Restricted Stock Units | | Weighted Average Grant Date Fair Value | | Number of Unvested Performance Vesting Restricted Stock Units | | Weighted Average Grant Date Fair Value |
Unvested shares as of January 1, 2022 | 198,413 | | | $ | 66.04 | | | 153,138 | | | $ | 48.54 | |
Granted | 2,154 | | | 73.83 | | | — | | | — | |
Vested | (3,074) | | | 65.75 | | | — | | | — | |
Forfeited/canceled | (1,157) | | | 66.89 | | | — | | | — | |
Unvested shares as of March 31, 2022 | 196,336 | | | $ | 67.16 | | | 153,138 | | | $ | 48.54 | |
Granted | 76,038 | | | 97.55 | | | 37,666 | | | 66.82 | |
Vested | (10,817) | | | 63.53 | | | — | | | — | |
Forfeited/canceled | (3,752) | | | 75.70 | | | — | | | — | |
Unvested shares as of June 30, 2022 | 257,805 | | | $ | 75.37 | | | 190,804 | | | $ | 52.15 | |
Granted | — | | | — | | | — | | | — | |
Vested | (52,701) | | | 66.18 | | | — | | | — | |
Forfeited/canceled | (3,265) | | | 85.36 | | | — | | | — | |
Unvested shares as of September 30, 2022 | 201,839 | | | $ | 77.60 | | | 190,804 | | | $ | 52.15 | |
Successor Restricted Stock Units
Restricted stock units awarded under the Incentive Plan generally vest ratably over a period of 3 or 4 years in the case of employees and 4 years in the case of directors upon the recipient meeting applicable service requirements. Stock-based compensation expense is recorded ratably over the service period. The grant date fair value of restricted stock units represents the closing market price of the Company's common stock on the date of the grant. Unrecognized compensation expense as of September 30, 2022 was $14.1 million. The expense is expected to be recognized over a weighted average period of 2.38 years.
Successor Performance Vesting Restricted Stock Units
The Company has awarded performance vesting restricted stock units to certain of its executive officers under the Incentive Plan. The number of shares of common stock issued pursuant to the award will be based on a combination of (i) the Company's total shareholder return ("TSR") and (ii) the Company's relative total shareholder return ("RTSR") for the performance period. Participants will earn from 0% to 200% of the target award based on the Company's TSR and RTSR ranking compared to the TSR of the companies in the Company's designated peer group at the end of the performance period. Awards will be earned and vested over a three-year performance period, subject to earlier termination of the performance period in the event of a change in control. The grant date fair values were determined using the Monte Carlo simulation method and are being recorded ratably over the performance period.
The table below summarizes the assumptions used in the Monte Carlo simulation to determine the grant date fair value of awards granted during the Current Successor YTD Period:
| | | | | |
Grant date | April 29, 2022 |
Forecast period (years) | 3 |
Risk-free interest rates | 2.9% |
Implied equity volatility | 88.4% |
Stock price on the date of grant | $93.98 |
Unrecognized compensation expense as of September 30, 2022, related to performance vesting restricted shares was $6.5 million. The expense is expected to be recognized over a weighted average period of 1.95 years.
Predecessor Stock-Based Compensation
The Predecessor granted restricted stock units to employees and directors pursuant to the 2019 Amended and Restated Incentive Stock Plan (the "2019 Plan"). During the Prior Predecessor YTD Period, the Company’s stock-based compensation cost was $4.4 million, of which the Company capitalized $0.9 million, relating to its exploration and development efforts. Stock compensation costs, net of the amounts capitalized, are included in general and administrative expenses in the accompanying consolidated statements of operations.
The following table summarizes restricted stock unit activity for the Prior Predecessor YTD Period:
| | | | | | | | | | | | | | | | | | | | | | | |
| Number of Unvested Restricted Stock Units | | Weighted Average Grant Date Fair Value | | Number of Unvested Performance Vesting Restricted Stock Units | | Weighted Average Grant Date Fair Value |
Unvested shares as of January 1, 2021 | 1,702,513 | | | $ | 4.74 | | | 840,595 | | | $ | 4.07 | |
Granted | — | | | — | | | — | | | — | |
Vested | (227,132) | | | 8.45 | | | — | | | — | |
Forfeited/canceled | (1,475,381) | | | 4.16 | | | (840,595) | | | 4.07 | |
Unvested shares as of May 17, 2021 | — | | | $ | — | | | — | | | $ | — | |
Predecessor Restricted Stock Units
Restricted stock units awarded under the 2019 Plan generally vested over a period of one year in the case of directors and three years in the case of employees and vesting was dependent upon the recipient meeting applicable service requirements. Stock-based compensation costs are recorded ratably over the service period. The grant date fair value of restricted stock units represents the closing market price of the Company's common stock on the date of grant. All unrecognized compensation expense was recognized as of the Emergence Date.
Predecessor Performance Vesting Restricted Stock Units
The Company previously awarded performance vesting restricted stock units to certain of its executive officers under the 2019 Plan. The number of shares of common stock issued pursuant to the award was based on RTSR. RTSR is an incentive measure whereby participants will earn from 0% to 200% of the target award based on the Company’s TSR ranking compared to the TSR of the companies in the Company’s designated peer group at the end of the performance period. Awards were to be earned and vested over a performance period measured from January 1, 2019 to December 31, 2021, subject to earlier termination of the performance period in the event of a change in control. All unrecognized compensation expense was recognized as of the Emergence Date.
6.EARNINGS PER SHARE
Basic income or loss per share attributable to common stockholders is computed as (i) net income or loss less (ii) dividends paid to holders of preferred stock less (iii) net income or loss attributable to participating securities divided by (iv) weighted average basic shares outstanding. Diluted net income or loss per share attributable to common stockholders is computed as (i) basic net income or loss attributable to common stockholders plus (ii) diluted adjustments to income allocable to participating securities divided by (iii) weighted average diluted shares outstanding. The "if-converted" method is used to determine the dilutive impact for the Company's convertible preferred stock and the treasury stock method is used to determine the dilutive impact of unvested restricted stock.
There were no potential shares of common stock that were considered dilutive for the Current Successor Quarter, Current Successor YTD Period, Prior Successor Period, Prior Successor Quarter, or Prior Predecessor YTD Period. There were 3.7 million shares of potential common shares issuable due to the Company's convertible preferred stock for each of the Current Successor Quarter and Current Successor YTD Period. There were 1.2 million and 1.5 million shares of restricted stock that were considered anti-dilutive during the Current Successor Quarter and Current Successor YTD Period, respectively.
Reconciliations of the components of basic and diluted net (loss) income per common share are presented in the tables below (in thousands): | | | | | | | | | | | |
| Successor |
| Three Months Ended September 30, 2022 | | Three Months Ended September 30, 2021 |
Net loss | $ | (18,472) | | | $ | (461,313) | |
Dividends on preferred stock | (1,309) | | | (2,095) | |
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Net loss attributable to common stockholders | $ | (19,781) | | | $ | (463,408) | |
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Basic Shares | 19,635 | | | 20,598 | |
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Basic and Dilutive EPS | $ | (1.01) | | | $ | (22.50) | |
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| Successor | | | Predecessor |
| Nine Months Ended September 30, 2022 | | Period from May 18, 2021 through September 30, 2021 | | | Period from January 1, 2021 through May 17, 2021 |
Net (loss) income | $ | (253,867) | | | $ | (670,899) | | | | $ | 250,994 | |
Dividends on preferred stock | (4,136) | | | (3,126) | | | | — | |
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Net (loss) income attributable to common stockholders | $ | (258,003) | | | $ | (674,025) | | | | $ | 250,994 | |
Basic Shares | 20,514 | | | 20,507 | | | | 160,834 | |
Basic and Dilutive EPS | $ | (12.58) | | | $ | (32.87) | | | | $ | 1.56 | |
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7.COMMITMENTS AND CONTINGENCIES
Commitments
Future Firm Transportation and Gathering Agreements
The Company has contractual commitments with midstream and pipeline companies for future gathering and transportation of natural gas from the Company's producing wells to downstream markets. Under certain of these agreements, the Company has minimum daily volume commitments. The Company is also obligated under certain of these arrangements to pay a demand charge for firm capacity rights on pipeline systems regardless of the amount of pipeline capacity utilized by the Company. If the Company does not utilize the capacity, it often can release it to other counterparties, thus reducing the cost of these commitments. Working interest owners and royalty interest owners, where appropriate, will be responsible for their proportionate share of these costs. Commitments related to future firm transportation and gathering agreements are not recorded as obligations in the accompanying consolidated balance sheets; however, costs associated with utilized future firm transportation and gathering agreements are reflected in the Company's estimates of proved reserves.
A summary of these commitments at September 30, 2022 are set forth in the table below, excluding contracts in the process of being rejected as discussed in the Litigation and Regulatory Proceedings section below (in thousands):
| | | | | | | | |
Remaining 2022 | | $ | 58,483 | |
2023 | | 229,733 | |
2024 | | 220,708 | |
2025 | | 139,706 | |
2026 | | 136,235 | |
Thereafter | | 889,674 | |
Total | | $ | 1,674,539 | |
Contingencies
The Company is involved in a number of litigation and regulatory proceedings including those described below. Many of these proceedings are in early stages, and many of them seek or may seek damages and penalties, the amount of which is indeterminate. The Company's total accrued liabilities in respect of litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses after considering, among other factors, the progress of each case or proceeding, its experience and the experience of others in similar cases or proceedings, and the opinions and views of legal counsel. Significant judgment is required in making these estimates and their final liabilities may ultimately be materially different. In accordance with ASC Topic 450, Contingencies, an accrual is recorded for a material loss contingency when its occurrence is probable and damages are reasonably estimable based on the anticipated most likely outcome or the minimum amount within a range of possible outcomes.
Litigation and Regulatory Proceedings
As part of its Chapter 11 Cases and restructuring efforts, the Company filed motions to reject certain firm transportation agreements between the Company and affiliates of TC Energy Corporation ("TC") and Rover Pipeline LLC ("Rover") (jointly, the “Pending Motions to Reject”). During the third quarter of 2021, Gulfport finalized a settlement agreement with TC that was approved by the Bankruptcy Court on September 21, 2021. Pursuant to the settlement agreement, Gulfport and TC agreed that the firm transportation contracts between Gulfport and TC would be rejected without any further payment or obligation by Gulfport or TC, and TC assigned its damages claims from such rejection to Gulfport. In exchange, Gulfport agreed to make a payment of $43.8 million in cash to TC. The $43.8 million was paid to TC on October 7, 2021. Gulfport expects to receive distributions for a significant portion of such amounts through future distributions with respect to the assigned claims pursuant to the terms of the Plan that became effective in May 2021. Any future distributions will be recognized once received by Gulfport. In February 2022, Gulfport received an initial distribution of $11.5 million from the above-mentioned claim, which is included in Other, net in the accompanying consolidated statements of operations. The timing and amount of any future distributions are not certain, and the total amount received will be impacted by the bankruptcy trustee's distributions and other bankruptcy claims.
The Pending Motions to Reject were removed to the United States District Court for the Southern District of Texas (the “District Court”) by TC and Rover prior to the TC settlement. On July 13, 2022, the District Court referred the Pending Motion to Reject with respect to Rover back to the Bankruptcy Court. The Company believes that the Pending Motion to Reject with respect to Rover will be ultimately granted, and that the Company does not have any ongoing obligation pursuant to the contract; however, if the Company is not permitted to reject the Rover firm transportation contract, it could be required to post additional credit assurance and be liable for demand charges, attorneys' fees and interest.
The Company has been named as a defendant in three separate complaints, two filed by Siltstone Resources, LLC, and the third filed by the Ohio Public Works Commission (OPWC) (together, the "Complaints"). The Complaints all arise from restrictive covenants in favor of OPWC generally prohibiting any transfer and any use inconsistent with a green park space. OPWC filed crossclaims against Gulfport in the Siltstone matters alleging that the transfer of the mineral rights and the development of oil and gas on the property violated these restrictive covenants. On June 19, 2018, October 25, 2019, and March 15, 2019, each trial court in the Complaints entered judgment in favor of the Company and other defendants, finding the restrictive covenants only applied to the surface estate. OPWC appealed each judgement to the respective Ohio Courts of Appeal where the trial court decisions were reversed in favor of OPWC. The Company and certain other parties to the Complaints appealed the appellate court decisions to the Ohio Supreme Court. On February 23, 2022, the Ohio Supreme Court affirmed the first appellate decision and remanded the case back to the trial court. The other two complaints are still pending before the Ohio Supreme Court. OPWC is seeking both injunctive relief to enforce the restrictive covenants and equitable relief. Liquidated damages were successfully discharged in the Company’s Chapter 11 proceedings through May 17, 2021. The scope and consequence of any injunctive relief that may be granted is not certain, but may have an adverse impact on the Company's operations associated with the leases subject to the Complaints.
In March 2020, Robert F. Woodley, individually and on behalf of all others similarly situated, filed a federal securities class action against the Company, David M. Wood, Keri Crowell and Quentin R. Hicks in the United States District Court for the Southern District of New York. The complaint alleges that the Company made materially false and misleading statements regarding the Company’s business and operations in violation of the federal securities laws and seeks unspecified damages, the payment of reasonable attorneys’ fees, expert fees and other costs, pre-judgment and post-judgment interest, and such other and further relief that may be deemed just and proper. On January 11, 2022, the court granted Gulfport's motion to dismiss and the case was closed by the court on February 14, 2022. The plaintiffs appealed the district court ruling, and the appellate court affirmed the lower court's motion to dismiss on October 27, 2022.
The Company, along with other oil and gas companies, have been named as a defendant in J&R Passmore, LLC, individually and on behalf of all others similarly situated, in the United States District Court for the Southern District of Ohio on December 6, 2018. Plaintiffs assert their respective leases are limited to the Marcellus and Utica shale geological formations and allege that Defendants have willfully trespassed and illegally produced oil, natural gas, and other hydrocarbon products beyond these respective formations. Plaintiffs seek the full value of any production from below the Marcellus and Utica shale formations, unspecified damages from the diminution of value to their mineral estate, unspecified punitive damages, and the payment of reasonable attorney fees, legal expenses, and interest. On April 27, 2021, the Bankruptcy Court for the Southern District of Texas approved a settlement agreement in which the plaintiffs fully released the Company from all claims for amounts allegedly owed to the plaintiffs through the effective date of the Company’s Chapter 11 plan, which occurred on May 17, 2021. The plaintiffs are continuing to pursue alleged damages after May 17, 2021.
Business Operations
The Company is involved in various lawsuits and disputes incidental to its business operations, including commercial disputes, personal injury claims, royalty claims, property damage claims and contract actions.
Environmental Contingencies
The nature of the oil and gas business carries with it certain environmental risks for Gulfport and its subsidiaries. Gulfport and its subsidiaries have implemented various policies, programs, procedures, training and audits to reduce and mitigate environmental risks. The Company conducts periodic reviews, on a company-wide basis, to assess changes in their environmental risk profile. Environmental reserves are established for environmental liabilities for which economic losses are probable and reasonably estimable. The Company manages its exposure to environmental liabilities in acquisitions by using an evaluation process that seeks to identify pre-existing contamination or compliance concerns and address the potential liability. Depending on the extent of an identified environmental concern, they may, among other things, exclude a property from the transaction, require the seller to remediate the property to their satisfaction in an acquisition or agree to assume liability for the remediation of the property.
Other Matters
Based on management’s current assessment, they are of the opinion that no pending or threatened lawsuit or dispute relating to its business operations is likely to have a material adverse effect on their future consolidated financial position, results of operations or cash flows. The final resolution of such matters could exceed amounts accrued, however, and actual results could differ materially from management’s estimates.
8.DERIVATIVE INSTRUMENTS
Natural Gas, Oil and NGL Derivative Instruments
The Company seeks to mitigate risks related to unfavorable changes in natural gas, oil and NGL prices, which are subject to significant and often volatile fluctuation, by entering into over-the-counter fixed price swaps, basis swaps, collars and various types of option contracts. These contracts allow the Company to mitigate the impact of declines in future natural gas, oil and NGL prices by effectively locking in a floor price for a certain level of the Company’s production. However, these hedge contracts also limit the benefit to the Company in periods of favorable price movements.
The volume of production subject to commodity derivative instruments and the mix of the instruments are frequently evaluated and adjusted by management in response to changing market conditions. Gulfport may enter into commodity derivative contracts up to limitations set forth in its Credit Facility. The Company generally enters into commodity derivative contracts for approximately 50% to 75% of its forecasted annual production by the end of the first quarter of each fiscal year. The Company typically enters into commodity derivative contracts for the next 12 to 24 months. Gulfport does not enter into commodity derivative contracts for speculative purposes.
Fixed price swaps are settled monthly based on differences between the fixed price specified in the contract and the referenced settlement price. When the referenced settlement price is less than the price specified in the contract, the Company receives an amount from the counterparty based on the price difference multiplied by the volume. Similarly, when the referenced settlement price exceeds the price specified in the contract, the Company pays the counterparty an amount based on the price difference multiplied by the volume. The prices contained in these fixed price swaps are based on the NYMEX Henry Hub for natural gas, the NYMEX WTI for oil and Mont Belvieu for propane.
The Company does not currently have any commodity derivative transactions that have margin requirements or collateral provisions that would require payments prior to the scheduled settlement dates. The Company's commodity derivative contract counterparties are typically financial institutions and energy trading firms with investment-grade credit ratings. Gulfport routinely monitors and manages its exposure to counterparty risk by requiring specific minimum credit standards for all counterparties, actively monitoring counterparties' public credit ratings and avoiding the concentration of credit exposure by transacting with multiple counterparties. The Company has master netting agreements with some counterparties that allow the offsetting of receivables and payables in a default situation.
Below is a summary of the Company’s open fixed price swap positions as of September 30, 2022.
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| Index | | Daily Volume | | Weighted Average Price |
Natural Gas | | | (MMBtu/d) | | ($/MMBtu) |
Remaining 2022 | NYMEX Henry Hub | | 270,000 | | | $ | 2.96 | |
2023 | NYMEX Henry Hub | | 165,014 | | | $ | 3.64 | |
2024 | NYMEX Henry Hub | | 54,973 | | | $ | 3.98 | |
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Oil | | | (Bbl/d) | | ($/Bbl) |
Remaining 2022 | NYMEX WTI | | 3,000 | | | $ | 66.03 | |
2023 | NYMEX WTI | | 3,000 | | | $ | 74.47 | |
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NGL | | | (Bbl/d) | | ($/Bbl) |
Remaining 2022 | Mont Belvieu C3 | | 4,000 | | | $ | 36.62 | |
2023 | Mont Belvieu C3 | | 3,000 | | | $ | 38.07 | |
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The Company entered into costless collars based off the NYMEX WTI and Henry Hub oil and natural gas indices. Each two-way price collar has a set floor and ceiling price for the hedged production. If the applicable monthly price indices are outside of the ranges set by the floor and ceiling prices in the various collars, the Company will cash-settle the difference with the hedge counterparty. Below is a summary of the Company's costless collar positions as of September 30, 2022.
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| Index | | Daily Volume | | Weighted Average Floor Price | | Weighted Average Ceiling Price |
Natural Gas | | | (MMBtu/d) | | ($/MMBtu) | | ($/MMBtu) |
Remaining 2022 | NYMEX Henry Hub | | 389,500 | | | $ | 2.54 | | | $ | 2.96 | |
2023 | NYMEX Henry Hub | | 285,000 | | | $ | 2.93 | | | $ | 4.78 | |
2024 | NYMEX Henry Hub | | 80,000 | | | $ | 3.63 | | | $ | 7.02 | |
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Oil | | | (Bbl/d) | | ($/Bbl) | | ($/Bbl) |
Remaining 2022 | NYMEX WTI | | 1,500 | | | $ | 55.00 | | | $ | 60.00 | |
In the third quarter of 2019, the Company sold call options in exchange for a premium, and used the associated premiums received to enhance the fixed price for a portion of the fixed price natural gas swaps primarily for 2020. Each short call option has an established ceiling price. When the referenced settlement price is above the price ceiling established by these short call options, the Company pays its counterparty an amount equal to the difference between the referenced settlement price and the price ceiling multiplied by the hedged contract volumes. No payment is due from either party if the referenced settlement price is below the price ceiling. Below is a summary of the Company's open sold call option positions as of September 30, 2022.
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| Index | | Daily Volume | | Weighted Average Price |
Natural Gas | | | (MMBtu/d) | | ($/MMBtu) |
Remaining 2022 | NYMEX Henry Hub | | 152,675 | | | $ | 2.90 | |
2023 | NYMEX Henry Hub | | 407,925 | | | $ | 2.90 | |
2024 | NYMEX Henry Hub | | 202,000 | | | $ | 3.33 | |
2025 | NYMEX Henry Hub | | 33,315 | | | $ | 4.65 | |
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In addition, the Company entered into natural gas basis swap positions. As of September 30, 2022, the Company had the following natural gas swap positions open:
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| Gulfport Pays | | Gulfport Receives | | Daily Volume | | Weighted Average Fixed Spread |
Natural Gas | | | | | (MMBtu/d) | | ($/MMBtu) |
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2023 | Rex Zone 3 | | NYMEX Plus Fixed Spread | | 40,000 | | | $ | (0.21) | |
Balance Sheet Presentation
The Company reports the fair value of derivative instruments on the consolidated balance sheets as derivative instruments under current assets, noncurrent assets, current liabilities and noncurrent liabilities on a gross basis. The Company determines the current and noncurrent classification based on the timing of expected future cash flows of individual trades. The following table presents the fair value of the Company’s derivative instruments on a gross basis at September 30, 2022 and December 31, 2021 (in thousands):
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| Successor |
| September 30, 2022 | | December 31, 2021 |
| | | |
Short-term derivative asset | $ | 53,342 | | | $ | 4,695 | |
Long-term derivative asset | 24,335 | | | 18,664 | |
Short-term derivative liability | (817,384) | | | (240,735) | |
Long-term derivative liability | (299,150) | | | (184,580) | |
Total commodity derivative position | $ | (1,038,857) | | | $ | (401,956) | |
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Gains and Losses
The following tables present the gain and loss recognized in net loss on natural gas, oil and NGL derivatives in the accompanying consolidated statements of operations for the Current Successor Quarter, Current Successor YTD Period, Prior Successor Quarter, Prior Successor Period, and Prior Predecessor YTD Period (in thousands):
| | | | | | | | | | | |
| Net loss on derivative instruments |
| Successor |
| Three Months Ended September 30, 2022 | | Three Months Ended September 30, 2021 |
Natural gas derivatives - fair value losses | $ | (161,532) | | | $ | (517,799) | |
Natural gas derivatives - settlement losses | (354,084) | | | (82,566) | |
Total losses on natural gas derivatives | (515,616) | | | (600,365) | |
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Oil derivatives - fair value gains (losses) | 33,545 | | | (1,590) | |
Oil derivatives - settlement losses | (9,035) | | | (4,336) | |
Total gains (losses) on oil and condensate derivatives | 24,510 | | | (5,926) | |
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NGL derivatives - fair value gains (losses) | 19,043 | | | (10,201) | |
NGL derivatives - settlement losses | (2,832) | | | (5,984) | |
Total gains (losses) on NGL derivatives | 16,211 | | | (16,185) | |
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Total losses on natural gas, oil and NGL derivatives | $ | (474,895) | | | $ | (622,476) | |
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| Net loss on derivative instruments |
| Successor | | | Predecessor |
| Nine Months Ended September 30, 2022 | | Period from May 18, 2021 through September 30, 2021 | | | Period from January 1, 2021 through May 17, 2021 |
Natural gas derivatives - fair value losses | $ | (659,193) | | | $ | (638,063) | | | | $ | (123,080) | |
Natural gas derivatives - settlement losses | (754,177) | | | (89,255) | | | | (3,362) | |
Total losses on natural gas derivatives | (1,413,370) | | | (727,318) | | | | (126,442) | |
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Oil derivatives - fair value gains (losses) | 8,076 | | | (6,947) | | | | (6,126) | |
Oil derivatives - settlement losses | (31,460) | | | (4,336) | | | | — | |
Total losses on oil and condensate derivatives | (23,384) | | | (11,283) | | | | (6,126) | |
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NGL derivatives - fair value gains (losses) | 14,216 | | | (17,549) | | | | (4,671) | |
NGL derivatives - settlement losses | (13,779) | | | (5,984) | | | | — | |
Total gains (losses) on NGL derivatives | 437 | | | (23,533) | | | | (4,671) | |
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Total losses on natural gas, oil and NGL derivatives | $ | (1,436,317) | | | $ | (762,134) | | | | $ | (137,239) | |
Offsetting of Derivative Assets and Liabilities
As noted above, the Company records the fair value of derivative instruments on a gross basis. The following tables present the gross amounts of recognized derivative assets and liabilities in the consolidated balance sheets and the amounts that are subject to offsetting under master netting arrangements with counterparties, all at fair value (in thousands):
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| Successor |
| As of September 30, 2022 |
| Gross Assets (Liabilities) | | Gross Amounts | | |
| Presented in the | | Subject to Master | | Net |
| Consolidated Balance Sheets | | Netting Agreements | | Amount |
Derivative assets | $ | 77,677 | | | $ | (72,718) | | | $ | 4,959 | |
Derivative liabilities | $ | (1,116,533) | | | $ | 72,718 | | | $ | (1,043,815) | |
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| Successor |
| As of December 31, 2021 |
| Gross Assets (Liabilities) | | Gross Amounts | | |
| Presented in the | | Subject to Master | | Net |
| Consolidated Balance Sheets | | Netting Agreements | | Amount |
Derivative assets | $ | 23,359 | | | $ | (20,265) | | | $ | 3,094 | |
Derivative liabilities | $ | (425,315) | | | $ | 20,265 | | | $ | (405,050) | |
Concentration of Credit Risk
By using derivative instruments that are not traded on an exchange, the Company is exposed to the credit risk of its counterparties. Credit risk is the risk of loss from counterparties not performing under the terms of the derivative instrument. When the fair value of a derivative instrument is positive, the counterparty is expected to owe the Company, which creates credit risk. To minimize the credit risk in derivative instruments, it is the Company’s policy to enter into derivative contracts only with counterparties that are creditworthy financial institutions deemed by management as competent and competitive market makers. The Company’s derivative contracts are spread between multiple counterparties to lessen its exposure to any individual counterparty. Additionally, the Company uses master netting agreements to minimize credit risk exposure. The
creditworthiness of the Company’s counterparties is subject to periodic review. None of the Company’s derivative instrument contracts contain credit-risk related contingent features. Other than as provided by the Company’s revolving credit facility, the Company is not required to provide credit support or collateral to any of its counterparties under its derivative instruments, nor are the counterparties required to provide credit support to the Company.
9.FAIR VALUE MEASUREMENTS
The Company records certain financial and non-financial assets and liabilities on the balance sheet at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. Market or observable inputs are the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. Fair value measurements are classified and disclosed in one of the following categories:
Level 1 – Quoted prices (unadjusted) in active markets for identical assets and liabilities that the Company has the ability to access at the measurement date.
Level 2 – Quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 – Significant inputs to the valuation model are unobservable.
Valuation techniques that maximize the use of observable inputs are favored. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the placement of assets and liabilities within the levels of the fair value hierarchy. Reclassifications of fair value between Level 1, Level 2 and Level 3 of the fair value hierarchy, if applicable, are made at the end of each quarter.
Financial assets and liabilities
The following tables summarize the Company’s financial and non-financial assets and liabilities by valuation level as of September 30, 2022 and December 31, 2021 (in thousands):
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| Successor |
| September 30, 2022 |
| Level 1 | | Level 2 | | Level 3 |
Assets: | | | | | |
Derivative instruments | $ | — | | | $ | 77,677 | | | $ | — | |
Contingent consideration arrangement | — | | | — | | | 4,900 | |
Total assets | $ | — | | | $ | 77,677 | | | $ | 4,900 | |
Liabilities: | | | | | |
Derivative instruments | $ | — | | | $ | 1,116,533 | | | $ | — | |
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| Successor |
| December 31, 2021 |
| Level 1 | | Level 2 | | Level 3 |
Assets: | | | | | |
Derivative instruments | $ | — | | | $ | 23,359 | | | $ | — | |
Contingent consideration arrangement | — | | | — | | | 5,800 | |
Total assets | $ | — | | | $ | 23,359 | | | $ | 5,800 | |
Liabilities: | | | | | |
Derivative instruments | $ | — | | | $ | 425,315 | | | $ | — | |
The Company estimates the fair value of all derivative instruments using industry-standard models that consider various assumptions, including current market and contractual prices for the underlying instruments, implied volatility, time value, nonperformance risk, as well as other relevant economic measures. Substantially all of these inputs are observable in the marketplace throughout the full term of the instrument and can be supported by observable data. The Company adjusted the fair value of its derivative instruments as a fresh start adjustment at the Emergence Date as a result of changes in the Company's credit adjustment to reflect its new credit standing at emergence.
The Company's SCOOP water infrastructure sale, which closed in the first quarter of 2020, included a contingent consideration arrangement. As of September 30, 2022, the fair value of the contingent consideration was $4.9 million, of which $0.6 million is included in prepaid expenses and other assets and $4.3 million is included in other assets in the accompanying consolidated balance sheets. The fair value of the contingent consideration arrangement is calculated using discounted cash flow techniques and is based on internal estimates of the Company's future development program and water production levels. Given the unobservable nature of the inputs, the fair value measurement of the contingent consideration arrangement is deemed to use Level 3 inputs. The Company has elected the fair value option for this contingent consideration arrangement and, therefore, records changes in fair value in earnings. The Company recognized losses of $0.3 million and $1.2 million for the Current Successor Quarter and Prior Successor Quarter, respectively, with respect to this contingent consideration arrangement. The Company recognized losses of $0.4 million, $0.1 million and a nominal gain for the Current Successor YTD Period, Prior Successor Period, and Prior Predecessor YTD Period, respectively, with respect to this contingent consideration arrangement. These fair value changes are included in other expense (income) in the accompanying consolidated statements of operations.
Non-financial assets and liabilities
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. Given the unobservable nature of the inputs, including plugging costs and reserve lives, the initial measurement of the asset retirement obligation liability is deemed to use Level 3 inputs. See Note 2 for further discussion of the Company’s asset retirement obligations. Fair value of other financial instruments
The carrying amounts on the accompanying consolidated balance sheet for cash and cash equivalents, accounts receivable, and accounts payable and accrued liabilities are carried at cost, which approximates market value due to their short-term nature. Long-term debt related to the Company's Credit Facility is carried at cost, which approximates market value based on the borrowing rates currently available to the Company with similar terms and maturities.
10.REVENUE FROM CONTRACTS WITH CUSTOMERS
Revenue Recognition
The Company’s revenues are primarily derived from the sale of natural gas, oil, condensate and NGL. These sales are recognized in the period that the performance obligations are satisfied. The Company generally considers the delivery of each unit (MMBtu or Bbl) to be separately identifiable and represents a distinct performance obligation that is satisfied at the time control of the product is transferred to the customer. Revenue is measured based on consideration specified in the contract with the customer, and excludes any amounts collected on behalf of third parties. These contracts typically include variable consideration that is based on pricing tied to market indices and volumes delivered in the current month. As such, this market pricing may be constrained (i.e., not estimable) at the inception of the contract but will be recognized based on the applicable market pricing, which will be known upon transfer of the goods to the customer. The payment date is usually within 30 days of the end of the calendar month in which the commodity is delivered.
Gathering, processing and compression fees attributable to gas processing, as well as any transportation fees, including firm transportation fees, incurred to deliver the product to the purchaser, are presented as transportation, gathering, processing and compression expense in the accompanying consolidated statements of operations.
Transaction Price Allocated to Remaining Performance Obligations
A significant number of the Company's product sales are short-term in nature generally through evergreen contracts with contract terms of one year or less. These contracts typically renew automatically under the same provisions. For those contracts, the Company has utilized the practical expedient allowed in the revenue accounting standard that exempts the Company from disclosure of the transaction price allocated to remaining performance obligations if the performance obligation is part of a contract that has an original expected duration of one year or less.
For product sales that have a contract term greater than one year, the Company has utilized the practical expedient that exempts the Company from disclosure of the transaction price allocated to remaining performance obligations if the variable consideration is allocated entirely to a wholly unsatisfied performance obligation. Under these sales contracts, each unit of product generally represents a separate performance obligation; therefore, future volumes are wholly unsatisfied and disclosure of the transaction price allocated to remaining performance obligations is not required. Currently, the Company's product sales that have a contractual term greater than one year have no long-term fixed consideration.
Contract Balances
Receivables from contracts with customers are recorded when the right to consideration becomes unconditional, generally when control of the product has been transferred to the customer. Receivables from contracts with customers were $317.5 million and $232.9 million as of September 30, 2022 and December 31, 2021, respectively, and are reported in accounts receivable - oil, natural gas, and natural gas liquids sales on the consolidated balance sheets. The Company currently has no assets or liabilities related to its revenue contracts, including no upfront or rights to deficiency payments.
Prior-Period Performance Obligations
The Company records revenue in the month production is delivered to the purchaser. However, settlement statements for certain sales may be received for 30 to 90 days after the date production is delivered, and as a result, the Company is required to estimate the amount of production that was delivered to the purchaser and the price that will be received for the sale of the product. The differences between the estimates and the actual amounts for product sales is recorded in the month that payment is received from the purchaser. For each of the periods presented, revenue recognized in the reporting periods related to performance obligations satisfied in prior reporting periods was not material.
11.LEASES
Nature of Leases
The Company has operating leases on certain equipment with remaining lease durations in excess of one year. The Company recognizes a right-of-use asset and lease liability on the balance sheet for all leases with lease terms of greater than one year. Short-term leases that have an initial term of one year or less are not capitalized.
The Company has entered into contracts for drilling rigs with varying terms with third parties to ensure operational continuity, cost control and rig availability in its operations. The Company has concluded its drilling rig contracts are operating leases as the assets are identifiable and the Company has the right to control the identified assets. However, at September 30, 2022, the Company did not have any active long-term drilling rig contracts in place.
The Company rents office space for its corporate headquarters, field locations and certain other equipment from third parties, which expire at various dates through 2026. These agreements are typically structured with non-cancelable terms of one to five years. The Company has determined these agreements represent operating leases with a lease term that equals the primary non-cancelable contract term. The Company has included any renewal options that it has determined are reasonably certain of exercise in the determination of the lease terms. In July 2022, the Company moved its headquarters to a new location. The impact of the Company's new headquarters lease is reflected in the tables below.
Discount Rate
As most of the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The Company's incremental borrowing rate reflects the estimated rate of interest that it would pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment.
Future amounts due under operating lease liabilities as of September 30, 2022 were as follows (in thousands):
| | | | | |
Remaining 2022 | $ | 247 | |
2023 | 966 | |
2024 | 824 | |
2025 | 824 | |
2026 | 550 | |
Total lease payments | $ | 3,411 | |
Less: imputed interest | (351) | |
Total | $ | 3,060 | |
The tables below summarize lease cost for the periods presented (in thousands):
| | | | | | | | | | | |
| Successor |
| Three Months Ended September 30, 2022 | | Three Months Ended September 30, 2021 |
Operating lease cost | $ | 187 | | | $ | 10 | |
Variable lease cost | — | | | — | |
Short-term lease cost | 8,035 | | | 2,873 | |
Total lease cost(1) | $ | 8,222 | | | $ | 2,883 | |
| | | | | | | | | | | | | | | | | | | | |
| Successor | | | Predecessor |
| Nine Months Ended September 30, 2022 | | Period from May 18, 2021 through September 30, 2021 | | | Period from January 1, 2021 through May 17, 2021 |
Operating lease cost | $ | 287 | | | $ | 18 | | | | $ | 41 | |
Variable lease cost | — | | | — | | | | — | |
Short-term lease cost | 26,817 | | | 5,033 | | | | 4,496 | |
Total lease cost(1) | $ | 27,104 | | | $ | 5,051 | | | | $ | 4,537 | |
_____________________(1) The majority of the Company's total lease cost was capitalized to the full cost pool, and the remainder was included in either lease operating expenses or general and administrative expenses in the accompanying consolidated statements of operations.
Supplemental cash flow information related to leases was as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | |
| Successor | | | Predecessor |
| Nine Months Ended September 30, 2022 | | Period from May 18, 2021 through September 30, 2021 | | | Period from January 1, 2021 through May 17, 2021 |
Cash paid for amounts included in the measurement of lease liabilities | | | | | | |
Operating cash flows from operating leases | $ | 354 | | | $ | 46 | | | | $ | 48 | |
The weighted-average remaining lease term as of September 30, 2022 was 3.75 years. The weighted-average discount rate used to determine the operating lease liability as of September 30, 2022 was 5.90%.
12.INCOME TAXES
On August 16, 2022, the U.S. enacted the Inflation Reduction Act of 2022, which, among other things, implements a 15% minimum tax on book income of certain large corporations, a 1% excise tax on net stock repurchases and several tax incentives to promote clean energy. Based on our current analysis of the provisions, we do not believe this legislation will have a material impact on our consolidated financial statements.
The Company records its quarterly tax provision based on an estimate of the annual effective tax rate expected to apply to continuing operations for the various jurisdictions in which it operates. The tax effects of certain items, such as tax rate changes, significant unusual or infrequent items, and certain changes in the assessment of the realizability of deferred taxes, are recognized as discrete items in the period in which they occur and are excluded from the estimated annual effective tax rate.
For the nine months ended September 30, 2022, the Company's estimated annual effective tax rate remained nominal as a result of the valuation allowance on its deferred tax assets. The effective tax rate for the period was 0%, which differs from the statutory rate of 21% primarily as a result of the valuation allowance on the Company's deferred tax assets.
At each reporting period, the Company weighs all available positive and negative evidence to determine whether its deferred tax assets are more likely than not to be realized. A valuation allowance for deferred tax assets, including net operating losses, is recognized when it is more likely than not that some or all of the benefit from the deferred tax assets will not be realized. To assess that likelihood, the Company uses estimates and judgment regarding future taxable income and considers the tax laws in the jurisdiction where such taxable income is generated, to determine whether a valuation allowance is required. Such evidence can include current financial position, results of operations, both actual and forecasted, the reversal of deferred tax liabilities and tax planning strategies as well as the current and forecasted business economics of the oil and gas industry. Based upon the Company’s analysis, the Company determined a full valuation allowance was necessary against its net deferred tax assets as of September 30, 2022.
The Company will continue to evaluate whether the valuation allowance is needed in future reporting periods. The valuation allowance will remain until it is determined that the net deferred tax assets are more likely than not to be realized. Future events or new evidence which may lead us to conclude that it is more likely than not that its net deferred tax assets will be realized include, but are not limited to, cumulative historical pre-tax earnings, improvements in oil prices, and taxable events that could result from one or more transactions. The valuation allowance does not prevent future utilization of the tax attributes if the Company recognizes taxable income. As long as the Company concludes that the valuation allowance against its net deferred tax assets is necessary, the Company likely will not have any additional deferred income tax expense or benefit.
Elements of the Plan provided that the Company’s indebtedness related to Predecessor Senior Notes and certain general unsecured claims were exchanged for New Common Stock in settlement of those claims. Absent an exception, a debtor recognizes CODI upon discharge of its outstanding indebtedness for an amount of consideration that is less than its adjusted issue price. The IRC provides that a debtor in a Chapter 11 bankruptcy case may exclude CODI from taxable income, but must reduce certain of its tax attributes by the amount of any CODI realized as a result of the consummation of a plan of reorganization. The amount of CODI realized by a taxpayer is determined based on the fair market value of the consideration received by the creditors in settlement of outstanding indebtedness. As a result of the market value of equity upon emergence from Chapter 11 bankruptcy proceedings, the estimated amount of CODI and historical interest expense haircut is approximately $661 million, which will reduce the value of the Company’s net operating losses. The actual reduction in tax attributes does not occur until the first day of the Company’s tax year subsequent to the date of emergence, or January 1, 2022. The reduction of net operating losses is expected to be fully offset by a corresponding decrease in valuation allowance.
Emergence from Chapter 11 bankruptcy proceedings resulted in a change in ownership for purposes of IRC Section 382. The Company is applying rules under IRC Section 382(l)(5) that allow the Company to mitigate the limitations imposed under the regulations with respect to the Company’s remaining tax attributes. The Company’s deferred tax assets and liabilities, prior to the valuation allowance, have been computed on such basis. Additionally, under IRC Section 382(l)(5), an ownership change subsequent to the Company’s emergence could severely limit or effectively eliminate its ability to realize the value of its tax attributes.
13.SUBSEQUENT EVENTS
Credit Facility Redetermination
On October 31, 2022, the Company completed its semi-annual borrowing base redetermination during which the borrowing base was reconfirmed at $1.0 billion with the elected commitments remaining at $700 million.