Northern Oil & Gas, Inc. — Q3 2012 Form 10-Q
Business and period. The unaudited filing covers the quarter and nine months ended September 30, 2012. Northern is a non-operating oil and gas producer focused on the Bakken and Three Forks formations in North Dakota and Montana. At quarter-end, it held 183,788 net acres, about 47% developed.
Financial and operating results
- Revenue: Q3 oil and gas sales were $80.7 million, up from $43.7 million a year earlier. Total reported revenue was $60.1 million, down 13% from $69.1 million, reflecting a $22.3 million unrealized derivative loss. For the first nine months, oil and gas sales were $216.3 million versus $106.2 million; total revenue was $229.8 million versus $122.4 million.
- Profit: Q3 operating income was $5.7 million and net income was $0.3 million, compared with $46.0 million and $28.6 million, respectively, in Q3 2011. Diluted GAAP EPS rounded to $0.00. Nine-month operating income was $95.7 million and net income was $52.7 million, versus $67.4 million and $42.0 million. Adjusted net income, a non-GAAP measure, was $16.7 million for Q3 and $44.8 million for nine months; adjusted diluted EPS was $0.27 and $0.71, respectively.
- Production and prices: Q3 production averaged 11,282 Boe per day, up 96%; nine-month production averaged 10,075 Boe per day, up 115%. Realized price including settled derivatives was $79.38 per Boe in Q3 and $76.63 for nine months. The oil differential to NYMEX WTI widened to $10.18 per barrel in Q3 and $12.50 for nine months, from $4.91 and $6.93, respectively, in 2011.
- Costs: Q3 production expense rose to $8.7 million from $3.9 million, or $8.42 per Boe from $7.40. Nine-month production expense was $22.5 million, up from $8.5 million. Depletion was $26.93 per Boe in Q3 and $26.00 for nine months, both above prior-year levels. G&A included $4.9 million of former-president separation costs in Q3.
- Cash flow and investment: Nine-month operating cash flow was $136.7 million, versus $49.4 million. Investing cash outflow was $419.9 million, primarily for drilling, development and acquisitions. Financing provided $285.1 million. Cash ended at $8.2 million, up from $6.3 million at December 31, 2011. Approximately $118.9 million of capital expenditures remained in accounts payable at quarter-end.
- Debt and liquidity: Debt totaled $368.0 million: $300 million of 8% senior notes due 2020 and $68 million drawn on the revolving facility. The revolver had a $350 million borrowing base and $282 million of remaining borrowing capacity; it matures January 2017. The company reported compliance with revolver covenants. Current assets of $96.7 million were below current liabilities of $134.8 million; the balance-sheet current ratio was about 0.72, distinct from the covenant calculation. Debt to book capitalization was 39%.
Changes, outlook and risks
- Growth reflected higher production, including 40.6 net wells added to production during the first nine months. The company participated in 1,104 gross (98.5 net) producing wells at September 30.
- In May, Northern issued $300 million of 8% senior notes, receiving about $291.2 million net to fund its exploration, development and acquisition program and general corporate purposes. The borrowing base increased from $120 million to $350 million during the period.
- Management reaffirmed its expectation to participate in spudding approximately 44 net wells in 2012. It estimated average completed-well cost at $8.7 million for the remainder of the year; well costs generally ranged from $7 million to $10 million. Development and acquisition spending is discretionary and may be adjusted with prices, cash flows and expected returns. No formal earnings or production forecast is provided.
- Oil and gas derivatives are not designated as accounting hedges, so fair-value changes flow through earnings. The portfolio was a net derivative asset of $6.3 million at quarter-end, compared with a net liability of $11.9 million at year-end 2011. The company warned that hedging can limit gains when commodity prices rise, and that payments to counterparties may precede production receipts.
- Key risks include commodity-price volatility, Williston Basin transportation capacity and price differentials, weather, drilling and completion costs or delays, dependence on operating partners, access to capital, and interest-rate exposure. Management estimated that a 1% increase in short-term rates would add about $1.0 million of annual interest expense on floating-rate debt.
- Unusual items and contingencies: Former president Ryan Gilbertson’s separation resulted in $4.3 million of non-cash share-based compensation and an estimated $0.6 million of other costs in Q3. After quarter-end, COO James Sankovitz was terminated without cause; his stated severance includes one year of $325,000 base salary, vehicle-related costs and up to 18 months of COBRA reimbursement. A North Dakota quiet-title action could require reversal of about $1.2 million of accrued revenue if resolved adversely; the company says it is vigorously defending its lease interests.
Important facts for investors to verify
- Separate recurring operating performance from derivative mark-to-market effects and the $4.9 million separation charge; reconcile non-GAAP adjusted results to GAAP earnings.
- Review the hedge schedule, volumes and pricing terms, and assess how hedges and Williston Basin differentials affect realized prices and future cash flows.
- Track capital spending, wells awaiting completion, production growth, and the funding needs of the 2012 drilling plan against operating cash flow and remaining revolver capacity.
- Assess debt covenants, the revolver’s semiannual borrowing-base redeterminations, and the fixed 8% notes alongside the balance-sheet working-capital deficit.
- Monitor the quiet-title litigation and the costs and obligations associated with executive departures.