Northern Oil and Gas, Inc. — Q2 2018 Form 10-Q
Business and period: Unaudited results for the three and six months ended June 30, 2018. Northern is a non-operated oil and gas producer focused on the Bakken and Three Forks formations in North Dakota and Montana. Q2 average production was 21,046 Boe per day, approximately 84% oil.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Oil, gas and NGL sales, before derivatives | $109.0 million | $48.4 million | $195.9 million | $97.2 million |
| Total revenue, including derivative gains/losses | $66.8 million | $64.9 million | $133.5 million | $130.7 million |
| Operating income | $16.3 million | $30.3 million | $42.2 million | $63.6 million |
| Net income (loss) | $(96.5) million | $13.8 million | $(93.6) million | $30.7 million |
| Operating cash flow | — | $63.6 million | $29.7 million | |
| Cash used in investing activities | — | $159.7 million | $42.6 million |
- Q2 production rose 53% year over year; six-month production rose 44%. Q2 realized price including settled derivatives was $50.58 per Boe, up 25% year over year.
- Derivative results were a $42.2 million Q2 loss and a $62.5 million six-month loss, including substantial non-cash mark-to-market losses. Open commodity derivatives were a net liability of $72.3 million at June 30.
- Q2 net loss included a $90.8 million non-cash loss on extinguishment of debt. The company reported adjusted net income of $18.0 million and adjusted EBITDA of $70.5 million for Q2; both are non-GAAP measures.
- At June 30, cash was $200.9 million, working capital surplus was $118.0 million, and long-term debt net of issuance costs was $834.8 million. Debt principal was $853.8 million: $360.0 million term loans, $344.3 million second-lien notes, and $149.6 million 8% senior notes due 2020. Available committed term-loan borrowing capacity was $40.0 million.
- Cash increased by $98.7 million during the first half, primarily reflecting $194.8 million of financing cash flow, including equity proceeds and additional term-loan borrowing. Investing outflows substantially exceeded operating cash flow.
Material changes and transactions
- On May 15, the company exchanged approximately $496.7 million principal of 2020 notes for about $344.3 million of 8.5% second-lien notes due 2023 and common stock. Separate June exchanges converted $53.8 million principal of 2020 notes into 18.5 million shares. Remaining 2020 notes had $149.6 million principal at quarter-end.
- Equity offerings raised approximately $141.7 million net. Common shares outstanding increased from 66.8 million at year-end 2017 to 293.6 million at June 30, 2018; further dilution is possible from subsequent acquisition consideration and contingent share provisions.
- The June 4 Salt Creek acquisition cost $60.0 million, funded with $44.7 million cash and $15.2 million stock consideration.
- Subsequent to quarter-end, the company signed agreements for Pivotal properties and a separate WR Operating acquisition. These transactions were pending customary closing conditions when reported and included substantial cash and share consideration.
Outlook, risks and unusual items
- Management stated that cash, operating cash flow and available borrowing capacity were expected to fund budgeted capital expenditures and operating expenses for at least the next 12 months. It cautioned that acquisitions and higher drilling activity could prompt efforts to obtain additional capital; availability and terms are not assured.
- Management expected 2018 average well costs to rise 5%–10% amid increased activity and higher-intensity completions. It said the first-half cash-flow shortfall for development and acquisitions was expected to moderate in future periods with higher production and pending acquisitions.
- The company was in compliance with term-loan financial covenants at June 30, but warned that lower oil prices or reduced production could pressure liquidity and covenant compliance. A 1% rise in short-term rates would add approximately $3.6 million in annual interest expense at quarter-end debt levels.
- Commodity prices, production and operating-partner drilling activity, transportation capacity and regional weather remain key risks. The company hedged approximately 51% of Q2 oil production; its hedges reduce downside exposure but also limit participation in price increases.
- A North Dakota riverbed mineral-rights dispute could require reversal of approximately $5.3 million of accrued revenue if resolved adversely. A securities class action remained pending; the company said it intended to defend the matter. Management considered ordinary-course legal matters not expected to have a material financial impact.
- A Section 382 ownership change triggered by the 2018 share issuances may limit use of tax attributes; the analysis was ongoing. A valuation allowance remained against deferred tax assets, and no income-tax provision or benefit was recorded for the reported periods.
Most important facts for investors to verify
- Cash generation versus planned drilling and acquisition spending, including the timing and closing terms of the announced acquisitions.
- Debt maturity and servicing capacity, covenant headroom, borrowing availability, and the conditional 1% PIK feature on second-lien notes.
- Hedge settlements, forward contract exposure and the effect of mark-to-market accounting on reported revenue and earnings.
- Actual well costs, production growth and realized prices relative to management’s expectations, including regional differentials and service-cost inflation.
- Potential further share issuance or cash obligations under debt-exchange and acquisition agreements, as well as outcomes of the riverbed dispute and securities litigation.