SWN Q1 2014 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

 

 

 

 

 

Form 10-Q

 

 

 

 

(Mark One)

[X]   Quarterly Report pursuant to Section 13 or 15(d) of the Securities

Exchange Act of 1934

For the quarterly period ended March 31, 2014

 

 

 

 

Or

 

 

 

 

[  ] Transition Report pursuant to Section 13 or 15(d) of the Securities

Exchange Act of 1934

For the transition period from __________ to __________

 

 

 

 

Commission file number:  1-08246

 

 

Southwestern Energy Company

(Exact name of registrant as specified in its charter)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Delaware

71-0205415

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

 

 

 

2350 North Sam Houston Parkway East, Suite 125, Houston, Texas

77032

(Address of principal executive offices)

(Zip Code)

 

 

 

 

(281) 618-4700

(Registrant’s telephone number, including area code)

 

 

 

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yesx  No 

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

Large accelerated filer x

Accelerated filer

Non-accelerated filer

Smaller reporting company

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Class

Outstanding as of April 28, 2014

Common Stock, Par Value $0.01

353,073,499

 

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SOUTHWESTERN ENERGY COMPANY

 

INDEX TO FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2014

 

 

 

PART I – FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

3

Item 2.

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

27

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

36

Item 4.

Controls and Procedures

38

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

39

Item 1A.

Risk Factors

41

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

41

Item 3.

Defaults Upon Senior Securities

41

Item 4.

Mine Safety Disclosures

41

Item 5.

Other Information

41

Item 6.

Exhibits

41

 

 

 

CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS

 

All statements, other than historical fact or present financial information, may be deemed to be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (“Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended. All statements that address activities, outcomes and other matters that should or may occur in the future, including, without limitation, statements regarding the financial position, business strategy, production and reserve growth and other plans and objectives for our future operations, are forward-looking statements. Although we believe the expectations expressed in such forward-looking statements are based on reasonable assumptions, such statements are not guarantees of future performance. We have no obligation and make no undertaking to publicly update or revise any forward-looking statements, except as may be required by law.

 

Forward-looking statements include the items identified in the preceding paragraph, information concerning possible or assumed future results of operations and other statements in this Form 10-Q identified by words such as “anticipate,” “project,” “intend,” “estimate,” “expect,” “believe,” “predict,” “budget,” “projection,” “goal,” “plan,” “forecast,” “target” or similar expressions.

 

You should not place undue reliance on forward-looking statements. They are subject to known and unknown risks, uncertainties and other factors that may affect our operations, markets, products, services and prices and cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. In addition to any assumptions and other factors referred to specifically in connection with forward-looking statements, risks, uncertainties and factors that could cause our actual results to differ materially from those indicated in any forward-looking statement include, but are not limited to:

 

·

the timing and extent of changes in market conditions and prices for natural gas and oil (including regional basis differentials);

·

our ability to fund our planned capital investments;

·

our ability to transport our production to the most favorable markets or at all;

·

the timing and extent of our success in discovering, developing, producing and estimating reserves;

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·

the economic viability of, and our success in drilling, our large acreage position in the Fayetteville Shale and the Marcellus Shale overall as well as relative to other productive shale gas plays and our competitors;

·

the impact of government regulation, including any increase in severance or similar taxes, legislation relating to hydraulic fracturing, the climate and over the counter derivatives;

·

the costs and availability of oilfield personnel, services and drilling supplies, raw materials, and equipment, including pressure pumping equipment and crews;

·

our future property acquisition or divestiture activities;

·

the impact of the adverse outcome of any material litigation against us;

·

the effects of weather;

·

increased competition and regulation;

·

the financial impact of accounting regulations and critical accounting policies;

·

the comparative cost of alternative fuels;

·

the different risks and uncertainties associated with Canadian exploration and production;

·

conditions in capital markets, changes in interest rates and the ability of our lenders to provide us with funds as agreed;

·

credit risk relating to the risk of loss as a result of non-performance by our counterparties; and

·

any other factors listed in the reports we have filed and may file with the Securities and Exchange Commission (“SEC”).

 

We caution you that forward-looking statements contained in this Form 10-Q are subject to all of the risks and uncertainties, many of which are beyond our control, incident to the exploration for and development, production and sale of natural gas and oil. These risks include, but are not limited to, commodity price volatility, third-party interruption of sales to market, inflation, lack of availability of goods and services, environmental risks, drilling and other operating risks, regulatory changes, the uncertainty inherent in estimating proved natural gas and oil reserves and in projecting future rates of production and timing of development expenditures and the other risks described in our Annual Report on Form 10-K for the year ended December 31, 2013 (the “2013 Annual Report on Form 10-K”), and all quarterly reports on Form 10-Q filed subsequently thereto, including this Form 10-Q (“Form 10-Qs”).

 

Should one or more of the risks or uncertainties described above or elsewhere in this Form 10-Q occur, or should underlying assumptions prove incorrect, our actual results and plans could differ materially from those expressed in any forward-looking statements. We specifically disclaim all responsibility to publicly update any information contained in a forward-looking statement or any forward-looking statement in its entirety and therefore disclaim any resulting liability for potentially related damages.

 

All forward-looking statements attributable to us are expressly qualified in their entirety by this cautionary statement.

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PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

 

 

 

 

 

 

 

SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

 

 

 

 

For the three months ended

 

March 31,

 

2014

 

2013

 

(in thousands, except share/per share amounts)

Operating Revenues:

 

 

 

 

 

Gas sales

$

793,352 

 

$

504,496 

Gas marketing

 

272,161 

 

 

179,841 

Oil sales

 

2,048 

 

 

5,350 

Gas gathering

 

45,216 

 

 

43,962 

 

 

1,112,777 

 

 

733,649 

Operating Costs and Expenses:

 

 

 

 

 

Gas purchases – midstream services

 

271,120 

 

 

179,956 

Operating expenses

 

100,153 

 

 

64,224 

General and administrative expenses

 

56,387 

 

 

37,215 

Depreciation, depletion and amortization

 

225,076 

 

 

179,467 

Taxes, other than income taxes

 

25,422 

 

 

20,827 

 

 

678,158 

 

 

481,689 

Operating Income

 

434,619 

 

 

251,960 

Interest Expense:

 

 

 

 

 

Interest on debt

 

25,229 

 

 

24,097 

Other interest charges

 

1,062 

 

 

1,110 

Interest capitalized

 

(13,384)

 

 

(16,186)

 

 

12,907 

 

 

9,021 

 

 

 

 

 

 

Other Gain (Loss), Net

 

1,193 

 

 

(533)

Loss on Derivatives

 

(99,720)

 

 

(29,794)

 

 

 

 

 

 

Income Before Income Taxes

 

323,185 

 

 

212,612 

Provision for Income Taxes:

 

 

 

 

 

Current

 

(520)

 

 

136 

Deferred

 

129,515 

 

 

84,961 

 

 

128,995 

 

 

85,097 

Net Income

$

194,190 

 

$

127,515 

 

 

 

 

 

 

Earnings Per Share:

 

 

 

 

 

Basic

$

0.55 

 

$

0.36 

Diluted

$

0.55 

 

$

0.36 

 

 

 

 

 

 

Weighted Average Common Shares Outstanding:

 

 

 

 

 

Basic

 

351,222,538 

 

 

350,032,430 

Diluted

 

351,985,821 

 

 

350,738,309 

 

The accompanying notes are an integral part of these

unaudited condensed consolidated financial statements.

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SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

March 31,

 

2014

 

2013

 

(in thousands)

 

 

 

 

 

 

Net income

$

194,190 

 

$

127,515 

 

 

 

 

 

 

Change in derivatives:

 

 

 

 

 

Settlements (1) 

 

25,186 

 

 

(47,173)

Ineffectiveness (2)

 

1,164 

 

 

(781)

Change in fair value of derivative instruments (3)

 

(54,200)

 

 

(45,481)

Total change in derivatives

 

(27,850)

 

 

(93,435)

 

 

 

 

 

 

Change in value of pension and other postretirement liabilities:

 

 

 

 

 

Amortization of prior service cost included in net periodic pension cost (4)

 

81 

 

 

267 

 

 

 

 

 

 

Change in currency translation adjustment

 

(2,856)

 

 

(1,029)

 

 

 

 

 

 

Comprehensive income

$

163,565 

 

$

33,318 

 

 

(1)

Net of $16.8 and ($31.4) million in taxes for the three months ended March 31, 2014 and 2013, respectively. 

 

(2)

Net of $0.8 and ($0.5) million in taxes for the three months ended March 31, 2014 and 2013, respectively. 

 

(3)

Net of ($36.1) and ($30.3) million in taxes for the three months ended March 31, 2014 and 2013, respectively.

 

(4)

Net of $0.1 and $0.2 million in taxes for the three months ended March 31, 2014 and 2013, respectively. 

 

 

The accompanying notes are an integral part of these

unaudited condensed consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

 

 

 

 

March 31,

 

December 31,

 

2014

 

2013

ASSETS

(in thousands)

Current assets:

 

 

 

 

 

Cash and cash equivalents

$

18,719 

 

$

22,938 

Accounts receivable

 

542,037 

 

 

464,045 

Inventories

 

38,846 

 

 

37,745 

Derivative assets

 

11,444 

 

 

70,871 

Other current assets

 

72,055 

 

 

48,576 

Total current assets

 

683,101 

 

 

644,175 

Natural gas and oil properties, using the full cost method, including $878.7

  million in 2014 and $956.5 million in 2013 excluded from amortization

 

13,773,604 

 

 

13,293,841 

Gathering systems

 

1,344,607 

 

 

1,306,074 

Other

 

709,856 

 

 

702,544 

Less: Accumulated depreciation, depletion and amortization

 

(8,225,394)

 

 

(8,005,836)

Total property and equipment, net

 

7,602,673 

 

 

7,296,623 

Other long-term assets

 

137,390 

 

 

106,928 

TOTAL ASSETS

$

8,423,164 

 

$

8,047,726 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

$

642,744 

 

$

507,468 

Taxes payable

 

55,156 

 

 

68,019 

Interest payable

 

14,109 

 

 

33,485 

Current deferred income taxes

 

–  

 

 

24,353 

Other current liabilities

 

123,146 

 

 

54,686 

Total current liabilities

 

835,155 

 

 

688,011 

Long-term debt

 

1,827,426 

 

 

1,950,096 

Deferred income taxes

 

1,694,196 

 

 

1,532,329 

Pension and other postretirement liabilities

 

16,413 

 

 

15,823 

Other long-term liabilities

 

249,534 

 

 

239,437 

Total long-term liabilities

 

3,787,569 

 

 

3,737,685 

Commitments and contingencies (Note 11)

 

 

 

 

 

Equity:

 

 

 

 

 

Common stock, $0.01 par value; authorized 1,250,000,000 shares; issued 353,083,763 shares in 2014 and 352,938,584 in 2013

 

3,531 

 

 

3,529 

Additional paid-in capital

 

985,396 

 

 

970,524 

Retained earnings

 

2,846,843 

 

 

2,652,653 

Accumulated other comprehensive loss

 

(34,967)

 

 

(4,342)

Common stock in treasury, 10,608 shares in 2014 and 9,924 in 2013

 

(363)

 

 

(334)

Total equity

 

3,800,440 

 

 

3,622,030 

TOTAL LIABILITIES AND EQUITY

$

8,423,164 

 

$

8,047,726 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these

unaudited consolidated financial statements.

 

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SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

 

 

 

 

For the three months ended

 

March 31,

 

2014

 

2013

 

(in thousands)

Cash Flows From Operating Activities

 

 

 

 

 

Net income

$

194,190 

 

$

127,515 

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

 

 

 

 

 

Depreciation, depletion and amortization

 

226,080 

 

 

180,458 

Deferred income taxes

 

129,515 

 

 

84,961 

Loss on derivatives, net of settlement

 

61,900 

 

 

30,800 

Stock-based compensation

 

4,490 

 

 

2,994 

Other

 

508 

 

 

(476)

Change in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(78,154)

 

 

(9,689)

Inventories

 

564 

 

 

(1,944)

Accounts payable

 

94,346 

 

 

7,312 

Taxes payable

 

(12,863)

 

 

(14,177)

Interest payable

 

(9,512)

 

 

(7,245)

Advances from partners

 

56 

 

 

(44,408)

Other assets and liabilities

 

(2,254)

 

 

16,037 

Net cash provided by operating activities

 

608,866 

 

 

372,138 

 

 

 

 

 

 

Cash Flows From Investing Activities

 

 

 

 

 

Capital investments

 

(533,787)

 

 

(483,634)

Proceeds from sale of property and equipment

 

16,794 

 

 

–  

Transfers from restricted cash

 

–  

 

 

1,434 

Other

 

1,309 

 

 

1,038 

Net cash used in investing activities

 

(515,684)

 

 

(481,162)

 

 

 

 

 

 

Cash Flows From Financing Activities

 

 

 

 

 

Payments on revolving long-term debt

 

(1,131,300)

 

 

(369,700)

Borrowings under revolving long-term debt

 

1,008,600 

 

 

404,800 

Change in bank drafts outstanding

 

19,388 

 

 

33,046 

Proceeds from exercise of common stock options

 

5,983 

 

 

4,799 

Net cash (used in) provided by financing activities

 

(97,329)

 

 

72,945 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(72)

 

 

Decrease in cash and cash equivalents

 

(4,219)

 

 

(36,075)

Cash and cash equivalents at beginning of year

 

22,938 

 

 

53,583 

Cash and cash equivalents at end of period

$

18,719 

 

$

17,508 

 

 

The accompanying notes are an integral part of these

unaudited condensed consolidated financial statements.

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SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

Common Stock

 

Additional

 

 

 

 

Other

 

Common

 

 

 

 

Shares

 

 

 

 

Paid-In

 

Retained

 

Comprehensive

 

Stock in

 

 

 

 

Issued

 

Amount

 

Capital

 

Earnings

 

Loss

 

Treasury

 

Total

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2013

352,939 

 

$

3,529 

 

$

970,524 

 

$

2,652,653 

 

$

(4,342)

 

$

(334)

 

$

3,622,030 

Comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

–  

 

 

–  

 

 

–  

 

 

194,190 

 

 

–  

 

 

–  

 

 

194,190 

Other comprehensive loss

–  

 

 

–  

 

 

–  

 

 

–  

 

 

(30,625)

 

 

–  

 

 

(30,625)

Total comprehensive income

–  

 

 

–  

 

 

–  

 

 

194,190 

 

 

(30,625)

 

 

–  

 

 

163,565 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

–  

 

 

–  

 

 

9,030 

 

 

–  

 

 

–  

 

 

–  

 

 

9,030 

Exercise of stock options

177 

 

 

 

 

5,841 

 

 

–  

 

 

–  

 

 

 

 

 

5,843 

Issuance of restricted stock

 

 

–  

 

 

–  

 

 

–  

 

 

–  

 

 

–  

 

 

–  

Cancellation of restricted stock

(41)

 

 

–  

 

 

–  

 

 

–  

 

 

–  

 

 

–  

 

 

–  

Treasury stock – non-qualified plan

–  

 

 

–  

 

 

 

 

–  

 

 

–  

 

 

(29)

 

 

(28)

Balance at March 31, 2014

353,084 

 

$

3,531 

 

$

985,396 

 

$

2,846,843 

 

$

(34,967)

 

$

(363)

 

$

3,800,440 

 

 

 

 

The accompanying notes are an integral part of these

unaudited condensed consolidated financial statements.

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SOUTHWESTERN ENERGY COMPANY AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(1) BASIS OF PRESENTATION

 

Southwestern Energy Company (including its subsidiaries, collectively, “we”, “Southwestern” or the “Company”) is an independent energy company engaged in natural gas and oil exploration, development and production. The Company engages in natural gas and oil exploration and production, natural gas gathering and natural gas marketing through its subsidiaries. Southwestern’s exploration, development and production (“E&P”) activities are focused within the United States.   The Company is actively engaged in exploration and production activities in Arkansas, where we are targeting the unconventional gas reservoir known as the Fayetteville Shale, in Pennsylvania, where we are targeting the unconventional gas reservoir known as the Marcellus Shale, and to a lesser extent in Texas and in Arkansas and Oklahoma in the Arkoma Basin.  The Company also actively seeks to find and develop new oil and natural gas plays with significant exploration and exploitation potential. Southwestern’s natural gas gathering and marketing (“Midstream Services”) activities primarily support the Company’s E&P activities in Arkansas, Pennsylvania, Louisiana and Texas.  

 

The accompanying unaudited condensed consolidated financial statements were prepared using accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission. Certain information relating to the Company’s organization and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been appropriately condensed or omitted in this Quarterly Report on Form 10-Q. The Company believes the disclosures made are adequate to make the information presented not misleading.

 

The unaudited condensed consolidated financial statements contained in this report include all normal and recurring material adjustments that, in the opinion of management, are necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods presented herein. It is recommended that these unaudited condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 (“2013 Annual Report on Form 10-K”).

 

The Company’s significant accounting policies, which have been reviewed and approved by the Audit Committee of the Company’s Board of Directors, are summarized in Note 1 in the Notes to the Consolidated Financial Statements included in the Company’s 2013 Annual Report on Form 10-K.

 

Certain reclassifications have been made to the prior year financial statements to conform to the 2014 presentation. The effects of the reclassifications were not material to the Company’s unaudited condensed consolidated financial statements.

 

 

 

(2) ACQUISITIONS AND DIVESTITURES

 

In March 2014, the Company signed an agreement to purchase approximately 312,000 net acres in northwest Colorado principally in the Niobrara formation for approximately $180 million, subject to closing adjustments. The Company utilized its Credit Facility to finance the acquisition. The Company closed on the acquisition on May 1, 2014 and plans to account for it as an asset acquisition.

 

In April 2013, the Company entered into a definitive purchase agreement to acquire natural gas properties located in Pennsylvania prospective for the Marcellus Shale for approximately $93 million, subject to closing conditions.  The Company utilized its revolving credit facility to finance the acquisition.  The Company closed on the acquisition during the second quarter of 2013 and accounted for it as an asset acquisition.

 

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(3) PREPAID EXPENSES

 

The components of prepaid expenses included in other current assets as of March 31, 2014 and December 31, 2013 consisted of the following:

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

2014

 

2013

 

 

(in thousands)

 

 

 

 

 

 

Prepaid drilling costs

$

6,362 

 

$

9,560 

Prepaid insurance

 

4,766 

 

 

7,619 

Prepaid taxes

 

13,699 

 

 

13,624 

Total

$

24,827 

 

$

30,803 

 

(4) INVENTORY

 

Inventory recorded in current assets includes $2.3 million at March 31, 2014 and $3.7 million at December 31, 2013 for natural gas in underground storage owned by the Company’s E&P segment, and $36.4 million at March 31, 2014 and $34.1 million at December 31, 2013 for tubular and other equipment used in the E&P segment.

 

Other long-term assets include $17.0 million at March 31, 2014 and $15.1 million at December 31, 2013, respectively, for inventory held by the Midstream Services segment consisting primarily of pipe that will be used to construct gathering systems.

 

(5) NATURAL GAS AND OIL PROPERTIES

 

The Company utilizes the full cost method of accounting for costs related to the exploration, development and acquisition of natural gas and oil reserves. Under this method, all such costs (productive and nonproductive), including salaries, benefits and other internal costs directly attributable to these activities are capitalized on a country by country basis and amortized over the estimated lives of the properties using the units-of-production method. These capitalized costs, less accumulated amortization and related deferred income taxes, are subject to a ceiling test that limits such pooled costs to the aggregate of the present value of future net revenues attributable to proved natural gas and oil reserves, net of taxes, discounted at 10 percent plus the lower of cost or market value of unproved properties. Any costs in excess of the ceiling are written off as a non-cash expense. The expense may not be reversed in future periods, even though higher natural gas and oil prices may subsequently increase the ceiling. Full cost companies must use the average quoted price from the first day of each month from the previous 12 months, including the impact of derivatives qualifying as cash flow hedges, to calculate the ceiling value of their reserves.

 

Using the average quoted price from the first day of each month from the previous 12 months for Henry Hub natural gas of $3.99 per MMBtu and $94.92 per barrel for West Texas Intermediate oil, adjusted for market differentials, the Company’s net book value of its United States natural gas and oil properties did not exceed the ceiling amount and did not result in a ceiling test impairment at March 31, 2014. Cash flow hedges of natural gas production in place increased the ceiling value by $40.2 million, net of tax, at March 31, 2014.  Decreases in average quoted prices from March 31, 2014 levels as well as changes in production rates, levels of reserves, capitalized costs, the evaluation of costs excluded from amortization, future development costs, service costs and taxes could result in future ceiling test impairments.

 

Using the average quoted price from the first day of each month from the previous 12 months for Henry Hub natural gas of $2.95 per MMBtu and $89.17 per barrel for West Texas Intermediate oil, adjusted for market differentials, the Company’s net book value of its United States natural gas and oil properties did not exceed the ceiling amount and did not result in a ceiling test impairment at March 31, 2013. Cash flow hedges of natural gas production in place increased the ceiling by $185.8 million at March 31, 2013.

 

All of the Company’s costs directly associated with the acquisition and evaluation of properties in Canada relating to its exploration program at March 31, 2014 were unproved and did not exceed the ceiling amount.  If the exploration program in Canada is unsuccessful on all or a portion of these properties, a ceiling test impairment may result in the future.

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(6) EARNINGS PER SHARE

 

Basic EPS is computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding for the period (the denominator). Diluted EPS is similarly calculated except that the denominator is increased using the treasury stock method to reflect the potential dilution that could occur if outstanding stock options were exercised and unvested restricted stock and performance unit awards were vested at the end of the applicable period.

 

The following table presents the computation of earnings per share for the three month period ended March 31, 2014 and 2013:

 

 

 

 

 

 

 

 

For the three months ended

 

March 31,

 

2014

 

2013

 

 

 

 

 

 

Net income (in thousands)

$

194,190 

 

$

127,515 

 

 

 

 

 

 

Number of common shares:

 

 

 

 

 

Weighted average outstanding

 

351,222,538 

 

 

350,032,430 

Issued upon assumed exercise of outstanding stock options

 

348,798 

 

 

579,022 

Effect of issuance of nonvested restricted common stock

 

349,608 

 

 

126,857 

Effect of issuance of nonvested performance units

 

64,877 

 

 

–  

Weighted average and potential dilutive outstanding(1)

 

351,985,821 

 

 

350,738,309 

 

 

 

 

 

 

Earnings (loss) per share:

 

 

 

 

 

Basic

$

0.55 

 

$

0.36 

 

 

 

 

 

 

Diluted

$

0.55 

 

$

0.36 

 

(1)

Options for 1,179,914 shares and 29,688 shares of restricted stock were excluded from the calculation for the three months ended March 31, 2014 because they would have had an antidilutive effect.  Options for 2,112,679 shares and 271,674 shares of restricted stock were excluded from the calculation for the three months ended March 31, 2013 because they would have had an antidilutive effect.

 

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(7) DERIVATIVES AND RISK MANAGEMENT

 

The Company is exposed to volatility in market prices and basis differentials for natural gas and crude oil which impacts the predictability of its cash flows related to the sale of natural gas and oil, and is exposed to volatility in interest rates. These risks are managed by the Company’s use of certain derivative financial instruments.  At March 31, 2014 and December 31, 2013, the Company’s derivative financial instruments consisted of fixed price swaps, basis swaps, fixed price call options, and interest rate swaps. A description of the Company’s derivative financial instruments is provided below:

 

 

 

Fixed price swaps

The Company receives a fixed price for the contract and pays a floating market price to the counterparty.

 

 

Basis swaps

 

 

Arrangements that guarantee a price differential for natural gas from a specified delivery point. The Company receives a payment from the counterparty if the price differential is greater than the stated terms of the contract and pays the counterparty if the price differential is less than the stated terms of the contract.

 

 

Fixed price call options

The Company sells fixed price call options in exchange for a premium. At the time of settlement, if the market price exceeds the fixed price of the call option, the Company pays the counterparty such excess on sold fixed price call options. If the market price settles below the fixed price of the call option, no payment is due from either party.

 

 

Interest rate swaps

Interest-rate swaps are used to fix or float interest rates on existing or anticipated indebtedness. The purpose of these instruments is to manage the Company’s existing or anticipated exposure to unfavorable interest-rate changes.

 

GAAP requires that all derivatives be recognized in the balance sheet as either an asset or liability and be measured at fair value other than transactions for which normal purchase/normal sale is applied. Under GAAP, certain criteria must be satisfied in order for derivative financial instruments to be classified and accounted for as either a cash flow or a fair value hedge. Accounting for qualifying hedges requires a derivative’s gains and losses to be recorded either in earnings or as a component of other comprehensive income. Gains and losses on derivatives that are not elected for hedge accounting treatment or that do not meet hedge accounting requirements are recorded in earnings as a component of gain (loss) on derivatives. Within the gain (loss) on derivatives component of the statement of operations are gains (losses) on derivatives, net of settlement and gains (losses) on derivatives, settled. The Company calculates gains (losses) on derivatives, settled, as the summation of gains and losses on positions which have settled within the period.

 

The Company utilizes counterparties for its derivative instruments that it believes are credit-worthy at the time the transactions are entered into and the Company closely monitors the credit ratings of these counterparties. Additionally, the Company performs both quantitative and qualitative assessments of these counterparties based on their credit ratings and credit default swap rates where applicable. However, the events in the financial markets in recent years demonstrate there can be no assurance that a counterparty will be able to meet its obligations to the Company.

 

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The balance sheet classification of the assets related to derivative financial instruments are summarized below at March 31, 2014 and December 31, 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative Assets

 

 

March 31, 2014

 

December 31, 2013

 

 

Balance Sheet Classification

 

Fair Value

 

Balance Sheet Classification

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Fixed price swaps

 

Derivative assets

 

$

1,362 

 

Derivative assets

 

$

20,631 

Total derivatives designated as hedging instruments

 

 

 

$

1,362 

 

 

 

$

20,631 

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Basis swaps

 

Derivative assets

 

$

9,692 

 

Derivative assets

 

$

12,858 

Fixed price swaps

 

Derivative assets

 

 

390 

 

Derivative assets

 

 

37,382 

Basis swaps

 

Other long-term assets

 

 

–  

 

Other long-term assets

 

 

107 

Fixed price swaps

 

Other long-term assets

 

 

30,245 

 

Other long-term assets

 

 

–  

Interest rate swaps

 

Other long-term assets

 

 

5,464 

 

Other long-term assets

 

 

7,525 

Total derivatives not designated as hedging instruments

 

 

 

$

45,791 

 

 

 

$

57,872 

 

 

 

 

 

 

 

 

 

 

 

Total derivative assets

 

 

 

$

47,153 

 

 

 

$

78,503 

 

 

 

 

 

Derivative Liabilities

 

 

March 31, 2014

 

December 31, 2013

 

 

Balance Sheet Classification

 

Fair Value

 

Balance Sheet Classification

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Fixed price swaps

 

Other current liabilities

 

$

32,971 

 

Other current liabilities

 

$

3,884 

Total derivatives designated as hedging instruments

 

 

 

$

32,971 

 

 

 

$

3,884 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Basis swaps

 

Other current liabilities

 

$

7,808 

 

Other current liabilities

 

$

1,501 

Fixed price swaps

 

Other current liabilities

 

 

16,022 

 

Other current liabilities

 

 

185 

Fixed price call options

 

Other current liabilities

 

 

17,273 

 

Other current liabilities

 

 

–  

Interest rate swaps

 

Other current liabilities

 

 

2,177 

 

Other current liabilities

 

 

1,520 

Basis swaps

 

Other long-term liabilities

 

 

603 

 

Other long-term liabilities

 

 

–  

Fixed price call options

 

Other long-term liabilities

 

 

40,029 

 

Other long-term liabilities

 

 

30,388 

Interest rate swaps

 

Other long-term liabilities

 

 

2,495 

 

Other long-term liabilities

 

 

3,012 

Total derivatives not designated as hedging instruments

 

 

 

$

86,407 

 

 

 

$

36,606 

 

 

 

 

 

 

 

 

 

 

 

Total derivative liabilities

 

 

 

$

119,378 

 

 

 

$

40,490 

 

As of March 31, 2014, the Company had derivatives designated as cash flow hedges and derivatives not designated as hedges on the following volumes of natural gas production (in Bcf):

 

 

 

 

 

Year

Fixed price swaps

Fixed price swaps not designated for

hedge accounting

Total

2014

211.8

136.8

348.6

2015

-

119.5

119.5

 

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Cash Flow Hedges

 

The reporting of gains and losses on cash flow derivative hedging instruments depends on whether the gains or losses are effective at offsetting changes in the cash flows of the hedged item. The effective portion of the gains and losses on the derivative hedging instruments are recorded in other comprehensive income until recognized in earnings during the period that the hedged transaction takes place. The ineffective portion of the gains and losses from the derivative hedging instrument is recognized in earnings immediately.

 

As of March 31, 2014, the Company recorded a net loss in accumulated other comprehensive income related to its hedging activities of $18.6 million net of a deferred income tax benefit of $12.4 million. The amount recorded in accumulated other comprehensive income will be relieved over time and recognized in the statement of operations as the physical transactions being hedged occur. Assuming the market prices of natural gas futures as of March 31, 2014 remain unchanged, the Company would expect to transfer an aggregate after-tax net loss of $18.6 million from accumulated other comprehensive income to earnings during the next 12 months. Gains or losses from derivative instruments designated as cash flow hedges are reflected as adjustments to natural gas sales in the consolidated statements of operations. Volatility in net income, comprehensive income and comprehensive income may occur in the future as a result of the Company’s derivative activities.

 

The following tables summarize the before tax effect of all cash flow hedges on the unaudited condensed consolidated financial statements for the three-month period ended March 31, 2014 and 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss Recognized in
Other Comprehensive Income

 

 

 

 

(Effective Portion)

 

 

 

 

For the three months ended

 

 

 

 

March 31,

Derivative Instrument

 

 

 

2014

 

2013

 

 

 

 

(in thousands)

Fixed price swaps

 

 

 

$

(90,334)

 

$

(73,902)

 

 

 

 

 

 

 

 

 

 

 

Classification of Gain (Loss)

 

Gain (Loss) Reclassified from Accumulated

 

 

Reclassified from

 

Other Comprehensive Income

 

 

Accumulated Other

 

into Earnings (Effective Portion)

 

 

Comprehensive Income

 

For the three months ended

 

 

into Earnings

 

March 31,

Derivative Instrument

 

(Effective Portion)

 

2014

 

2013

 

 

 

 

(in thousands)

Fixed price swaps

 

Gas sales

 

$

(41,978)

 

$

78,621 

 

 

 

 

 

 

 

 

 

 

Gain (Loss) Recognized in
Earnings

 

 

 

 

(Ineffective Portion)

 

 

Classification of Gain (Loss)

 

For the three months ended

 

 

Recognized in Earnings

 

March 31,

Derivative Instrument

 

(Ineffective Portion)

 

2014

 

2013

 

 

 

 

(in thousands)

Fixed price swaps

 

Gas sales

 

$

(1,940)

 

$

1,301 

 

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Fair Value Hedges and Other Derivative Contracts

 

For fair value hedges, the gain or loss on the derivative instrument as well as the offsetting gain or loss on the hedged item are recognized in earnings immediately. 

 

Although the Company’s basis swaps meet the objective of managing commodity price exposure, these trades are typically not entered into concurrent with the Company’s derivative instruments that qualify as cash flow hedges and therefore do not generally qualify for hedge accounting. Basis swap derivative instruments that are not designated for hedge accounting are recorded on the balance sheet at their fair values under derivative assets, other long-term assets, other current liabilities, and other long-term liabilities, as applicable and all gains and losses related to these contracts are recognized immediately in the consolidated statement of operations as a component of gain (loss) on derivatives.

 

As of March 31, 2014, the Company had basis swaps on natural gas production that were not designated for hedge accounting of 21.1 Bcf, 8.7 Bcf, and 0.9 Bcf in 2014, 2015, and 2016, respectively.

 

As of March 31, 2014, the Company had fixed price call options on 199.8 Bcf and 119.9 Bcf of 2015 and 2016 natural gas production, respectively, not designated for hedge accounting treatment and fixed price swaps of 136.8 Bcf and 119.5 Bcf of 2014 and 2015 natural gas production not designated for hedge accounting.

 

The Company is a party to interest rate swaps that were entered into in order to mitigate the Company’s exposure to volatility in interest rates related to construction of its new corporate office complex. The interest rate swaps build to a notional amount of $170.0 million and expire on June 20, 2020. The Company did not designate the interest rate swaps for hedge accounting.  Changes in the fair value of the interest rate swaps are included in gain (loss) on derivatives in the consolidated statements of operations.

 

The following table summarizes the before tax effect of fair value hedges, fixed price call and basis swaps that were not designated for hedge accounting, and fixed price swaps and interest rate swaps not designated for hedge accounting on the uncondensed consolidated statements of operations for the three-month period ended March 31, 2014 and 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (Loss) on Derivatives

 

 

 

 

net of settlement

 

 

 

 

Recognized in Earnings

 

 

 

 

For the three months ended

 

 

Consolidated Statement of Operations

 

March 31,

Derivative Instrument

 

Classification of Gain (Loss) on Derivatives, Net of Settlement

 

2014

 

2013

 

 

 

 

(in thousands)

Basis swaps

 

Gain (Loss) on Derivatives

 

$

(10,184)

 

$

(2,950)

Fixed price call options

 

Gain (Loss) on Derivatives

 

$

(26,913)

 

$

(57,082)

Fixed price swaps

 

Gain (Loss) on Derivatives

 

$

(22,585)

 

$

29,232 

Interest rate swaps

 

Gain (Loss) on Derivatives

 

$

(2,202)

 

$

–  

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (Loss)

 

 

 

 

on Derivatives, Settled (1)

 

 

 

 

Recognized in Earnings

 

 

Consolidated Statement of Operations

 

For the three months ended

 

 

Classification of Gain (Loss)

 

March 31,

Derivative Instrument

 

on Derivatives, Settled (1)

 

2014

 

2013

 

 

 

 

(in thousands)

Basis swaps

 

Gain (Loss) on Derivatives

 

$

(14,270)

 

$

1,007 

Fixed price swaps

 

Gain (Loss) on Derivatives

 

$

(23,453)

 

$

–  

Interest rate swaps

 

Gain (Loss) on Derivatives

 

$

(113)

 

$

–  

 

(1)

The Company calculates gain (loss) on derivatives, settled, as the summation of gains and losses on positions that have settled within the period reported.

 

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(8RECLASSIFICATIONS FROM ACCUMULATED OTHER COMPREHENSIVE LOSS

 

The following tables detail the components of accumulated other comprehensive loss and the related tax effects for the three months ended March 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

 

March 31, 2014

 

 

(in thousands) (1)

 

 

Gains and Losses on Cash Flow Hedges

 

 

Pension and Other Postretirement

 

 

Foreign Currency

 

 

Total

Beginning balance, December 31, 2013

 

$

9,270 

 

 

$

(9,558)

 

 

$

(4,054)

 

 

$

(4,342)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive loss before reclassifications

 

 

(54,200)

 

 

 

–  

 

 

 

(2,856)

 

 

 

(57,056)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts reclassified from accumulated other comprehensive loss (2)

 

 

26,350 

 

 

 

81 

 

 

 

–  

 

 

 

26,431 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net current-period other comprehensive income (loss)

 

 

(27,850)

 

 

 

81 

 

 

 

(2,856)

 

 

 

(30,625)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balance, March 31,2014

 

$

(18,580)

 

 

$

(9,477)

 

 

$

(6,910)

 

 

$

(34,967)

 

(1)

All amounts are net-of-tax.

(2)

See separate table below for details about these reclassifications.

 

The following table details the amounts reclassified from accumulated other comprehensive loss into earnings for the three months ended March 31, 2014:

 

 

 

 

 

 

 

 

Details about Accumulated Other Comprehensive Loss

 

 

Affected Line Item in the Consolidated Statement of Operations

 

Amount Reclassified from Accumulated Other Comprehensive Loss

 

 

 

 

 

For the three months ended
March 31, 2014

 

 

 

 

 

(in thousands)

Gains (losses) on cash flow hedges

 

 

 

 

 

Settlements

 

 

Gas sales

$

(41,978)

Ineffectiveness

 

 

Gas sales

 

(1,940)

 

 

 

Income before income taxes

 

(43,918)

 

 

 

Provision for income taxes

 

(17,568)

 

 

 

Net income

$

(26,350)

 

 

 

 

 

 

Pension and other postretirement

 

 

 

 

 

Amortization of prior service cost included in net periodic pension cost (1)

 

 

General and administrative expenses

$

(135)

 

 

 

Loss before income taxes

 

(135)

 

 

 

Benefit for income taxes

 

(54)

 

 

 

Net loss

$

(81)

 

 

 

 

 

 

Total reclassifications for the period

 

 

Net income

$

(26,431)

 

(1)

Included in the computation of net periodic pension cost (see Footnote 13 for additional details).

 

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(9) FAIR VALUE MEASUREMENTS

 

The carrying amounts and estimated fair values of the Company’s financial instruments as of March 31, 2014 and December 31, 2013 were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

2014

 

2013

 

Carrying

 

Fair

 

Carrying

 

Fair

 

Amount

 

Value

 

Amount

 

Value

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

$

18,719 

 

$

18,719 

 

$

22,938 

 

$

22,938 

Credit facility

$

160,200 

 

$

160,200 

 

$

282,900 

 

$

282,900 

Senior notes

$

1,668,426 

 

$

1,825,949 

 

$

1,668,396 

 

$

1,795,935 

Derivative instruments

$

(72,225)

 

$

(72,225)

 

$

38,013 

 

$

38,013 

 

The carrying values of cash and cash equivalents, accounts receivable, accounts payable, other current assets and current liabilities on the unaudited condensed consolidated balance sheets approximate fair value because of their short-term nature. For debt and derivative instruments, the following methods and assumptions were used to estimate fair value:

 

Debt: The fair values of the Company’s senior notes were based on the market for the Company’s publicly-traded debt as determined based on yield of the Company’s 7.5% Senior Notes due 2018, which was 2.4% at March 31, 2014 and