SWN Q2 2014 10-Q

Table of Contents

 

 

 

 

 

 

 

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 June 30, 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.  Yes     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).  Yes  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

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  

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 July 29, 2014

Common Stock, Par Value $0.01

353,159,739

 

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SOUTHWESTERN ENERGY COMPANY

 

INDEX TO FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2014

 

 

 

PART I – FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

3

Item 2.

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

28

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

41

Item 4.

Controls and Procedures

43

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

44

Item 1A.

Risk Factors

46

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

46

Item 3.

Defaults Upon Senior Securities

46

Item 4.

Mine Safety Disclosures

46

Item 5.

Other Information

46

Item 6.

Exhibits

46

 

 

 

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, 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

 

For the six months ended

 

June 30,

 

June 30,

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

 

 

(in millions, except share/per share amounts)

Operating Revenues:

 

 

 

 

 

 

 

 

 

 

 

Gas sales

$

717 

 

$

614 

 

$

1,510 

 

$

1,119 

Gas marketing

 

266 

 

 

201 

 

 

538 

 

 

381 

Oil sales

 

 

 

 

 

 

 

Gas gathering

 

47 

 

 

44 

 

 

93 

 

 

87 

 

 

1,035 

 

 

862 

 

 

2,148 

 

 

1,595 

Operating Costs and Expenses:

 

 

 

 

 

 

 

 

 

 

 

Gas purchases – midstream services

 

261 

 

 

200 

 

 

532 

 

 

380 

Operating expenses

 

101 

 

 

82 

 

 

201 

 

 

146 

General and administrative expenses

 

52 

 

 

48 

 

 

108 

 

 

85 

Depreciation, depletion and amortization

 

230 

 

 

187 

 

 

455 

 

 

366 

Taxes, other than income taxes

 

24 

 

 

20 

 

 

50 

 

 

41 

 

 

668 

 

 

537 

 

 

1,346 

 

 

1,018 

Operating Income

 

367 

 

 

325 

 

 

802 

 

 

577 

Interest Expense:

 

 

 

 

 

 

 

 

 

 

 

Interest on debt

 

25 

 

 

25 

 

 

50 

 

 

49 

Other interest charges

 

–   

 

 

 

 

 

 

Interest capitalized

 

(13)

 

 

(17)

 

 

(26)

 

 

(33)

 

 

12 

 

 

 

 

25 

 

 

19 

 

 

 

 

 

 

 

 

 

 

 

 

Other Gain, Net

 

–   

 

 

 

 

 

 

–   

Gain (Loss) on Derivatives

 

(8)

 

 

93 

 

 

(108)

 

 

64 

 

 

 

 

 

 

 

 

 

 

 

 

Income Before Income Taxes

 

347 

 

 

410 

 

 

670 

 

 

622 

Provision for Income Taxes:

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

 

16 

 

 

 

 

16 

Deferred

 

137 

 

 

148 

 

 

267 

 

 

233 

 

 

140 

 

 

164 

 

 

269 

 

 

249 

Net Income

$

207 

 

$

246 

 

$

401 

 

$

373 

 

 

 

 

 

 

 

 

   

 

 

   

Earnings Per Share:

 

 

 

 

 

 

 

 

 

 

 

Basic

$

0.59 

 

$

0.70 

 

$

1.14 

 

$

1.07 

Diluted

$

0.59 

 

$

0.70 

 

$

1.14 

 

$

1.06 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted Average Common Shares Outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

351,391,582 

 

 

350,448,806 

 

 

351,307,527 

 

 

350,241,768 

Diluted

 

352,579,522 

 

 

351,082,807 

 

 

352,306,268 

 

 

350,911,892 

 

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

 

 

For the six months ended

 

June 30,

 

 

June 30,

 

2014

 

2013

 

 

2014

 

 

2013

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

207 

 

$

246 

 

$

401 

 

$

373 

 

 

 

 

 

 

 

 

 

 

 

 

Change in derivatives:

 

 

 

 

 

 

 

 

 

 

 

Settlements (1) 

 

15 

 

 

(28)

 

 

40 

 

 

(75)

Ineffectiveness (2)

 

      – 

 

 

 

 

 

 

Change in fair value of derivative instruments (3)

 

 

 

68 

 

 

(49)

 

 

22 

Total change in derivatives

 

20 

 

 

41 

 

 

(8)

 

 

(52)

 

 

 

 

 

 

 

 

 

 

 

 

Change in value of pension and other postretirement liabilities:

 

 

 

 

 

 

 

 

 

 

 

Amortization of prior service cost included in net periodic pension cost

 

– 

 

 

– 

 

 

– 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in currency translation adjustment

 

 

 

(1)

 

 

– 

 

 

(2)

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

$

230 

 

$

286 

 

$

393 

 

$

320 

 

 

(1)

Net of $10, ($18),  $27 and ($50) million in taxes for the three months ended June 30, 2014 and 2013, and six months ended June 30, 2014 and 2013, respectively. 

 

(2)

Net of $0,  $1,  $1 and $0 million in taxes for the three months ended June 30, 2014 and 2013, and six months ended June 30, 2014 and 2013, respectively

 

(3)

Net of $4,  $45,  ($32) and $15 million in taxes for the three months ended June 30, 2014 and 2013, and six months ended June 30, 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)

 

 

 

 

 

 

 

June 30,

 

December 31,

 

2014

 

2013

ASSETS

(in millions)

Current assets:

 

 

 

 

 

Cash and cash equivalents

$

20 

 

$

23 

Accounts receivable

 

513 

 

 

464 

Inventories

 

38 

 

 

38 

Derivative assets

 

40 

 

 

71 

Other current assets

 

51 

 

 

48 

Total current assets

 

662 

 

 

644 

Natural gas and oil properties, using the full cost method, including $958 million in 2014 and $957 million in 2013 excluded from amortization

 

14,440 

 

 

13,294 

Gathering systems

 

1,381 

 

 

1,306 

Other

 

730 

 

 

703 

Less: Accumulated depreciation, depletion and amortization

 

(8,462)

 

 

(8,006)

Total property and equipment, net

 

8,089 

 

 

7,297 

Other long-term assets

 

136 

 

 

107 

TOTAL ASSETS

$

8,887 

 

$

8,048 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

$

688 

 

$

507 

Taxes payable

 

66 

 

 

68 

Interest payable

 

34 

 

 

33 

Current deferred income taxes

 

–  

 

 

24 

Derivative liabilities

 

72 

 

 

Other current liabilities

 

26 

 

 

49 

Total current liabilities

 

886 

 

 

688 

Long-term debt

 

1,838 

 

 

1,950 

Deferred income taxes

 

1,832 

 

 

1,532 

Pension and other postretirement liabilities

 

17 

 

 

16 

Other long-term liabilities

 

272 

 

 

240 

Total long-term liabilities

 

3,959 

 

 

3,738 

Commitments and contingencies (Note 11)

 

 

 

 

 

Equity:

 

 

 

 

 

Common stock, $0.01 par value; authorized 1,250,000,000 shares; issued 353,161,843 shares in 2014 and 352,938,584 in 2013

 

 

 

Additional paid-in capital

 

996 

 

 

969 

Retained earnings

 

3,054 

 

 

2,653 

Accumulated other comprehensive loss

 

(12)

 

 

(4)

Total equity

 

4,042 

 

 

3,622 

TOTAL LIABILITIES AND EQUITY

$

8,887 

 

$

8,048 

 

 

 

 

 

 

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 six months ended

 

June 30,

 

2014

 

2013

 

(in millions)

Cash Flows From Operating Activities

 

 

 

 

 

Net income

$

401 

 

$

373 

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

 

 

 

 

 

Depreciation, depletion and amortization

 

455 

 

 

366 

Amortization of debt issuance cost

 

 

 

Deferred income taxes

 

267 

 

 

233 

(Gain) loss on derivatives excluding derivatives, settled

 

62 

 

 

(63)

Stock-based compensation

 

 

 

Other

 

–  

 

 

Change in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(49)

 

 

(68)

Inventories

 

–  

 

 

(6)

Accounts payable

 

53 

 

 

48 

Taxes payable (receivable)

 

(2)

 

 

18 

Advances from partners

 

–  

 

 

(69)

Other assets and liabilities

 

(4)

 

 

37 

Net cash provided by operating activities

 

1,194 

 

 

878 

 

 

 

 

 

 

Cash Flows From Investing Activities

 

 

 

 

 

Capital investments

 

(1,144)

 

 

(1,176)

Proceeds from sale of property and equipment

 

17 

 

 

–  

Transfers from restricted cash

 

–  

 

 

Other

 

 

 

Net cash used in investing activities

 

(1,124)

 

 

(1,161)

 

 

 

 

 

 

Cash Flows From Financing Activities

 

 

 

 

 

Payments on current portion of long-term debt

 

(1)

 

 

(1)

Payments on revolving long-term debt

 

(2,486)

 

 

(1,233)

Borrowings under revolving long-term debt

 

2,375 

 

 

1,463 

Change in bank drafts outstanding

 

30 

 

 

21 

Proceeds from exercise of common stock options

 

 

 

Net cash (used in) provided by financing activities

 

(73)

 

 

255 

 

 

 

 

 

 

Decrease in cash and cash equivalents

 

(3)

 

 

(28)

Cash and cash equivalents at beginning of year

 

23 

 

 

54 

Cash and cash equivalents at end of period

$

20 

 

$

26 

 

 

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

 

 

 

 

Shares

 

 

 

 

Paid-In

 

Retained

 

Comprehensive

 

 

 

 

Issued

 

Amount

 

Capital

 

Earnings

 

Loss

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2013

353 

 

$

 

$

969 

 

$

2,653 

 

$

(4)

 

$

3,622 

Comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

–  

 

 

–  

 

 

–  

 

 

401 

 

 

–  

 

 

401 

Other comprehensive loss

–  

 

 

–  

 

 

–  

 

 

–  

 

 

(8)

 

 

(8)

Total comprehensive income (loss)

–  

 

 

–  

 

 

–  

 

 

401 

 

 

(8)

 

 

393 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

–  

 

 

–  

 

 

18 

 

 

–  

 

 

–  

 

 

18 

Exercise of stock options

–  

 

 

–  

 

 

 

 

–  

 

 

–  

 

 

Balance at June 30, 2014

353 

 

$

 

$

996 

 

$

3,054 

 

$

(12)

 

$

4,042 

 

 

 

 

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 306,000 net acres in northwest Colorado principally in the Niobrara formation for approximately $183 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 is accounting 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 June 30, 2014 and December 31, 2013 consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30,

 

December 31,

 

2014

 

2013

 

 

(in millions)

 

 

 

 

 

 

Prepaid drilling costs

$

 

$

Prepaid insurance

 

 

 

Prepaid taxes

 

12 

 

 

14 

Total

$

16 

 

$

31 

 

(4) INVENTORY

 

Inventory recorded in current assets includes $35 million at June 30, 2014 and $34 million at December 31, 2013 for tubular and other equipment used in the Company’s E&P segment, and $2 million at June 30, 2014 and $4 million at December 31, 2013 for natural gas in underground storage owned by the E&P segment.

 

Other long-term assets include $17 million at June 30, 2014 and $15 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 $4.10 per MMBtu and $96.75 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 June 30, 2014. Cash flow hedges of natural gas production in place increased the ceiling value by $37 million, net of tax, at June 30, 2014.  Decreases in average quoted prices, adjusted for market differentials, from June 30, 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 $3.44 per MMBtu and $88.13 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 June 30, 2013. Cash flow hedges of natural gas production in place increased the ceiling by $151 million, net of tax, at June 30, 2013.

 

All of the Company’s costs directly associated with the acquisition and evaluation of properties in Canada relating to its exploration program at June 30, 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 earnings per share is computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding for the period (the denominator). Diluted earnings per share 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 and six month period ended June 30, 2014 and 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

For the six months ended

 

June 30,

 

June 30,

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

 

Net income (in millions)

$

207 

 

$

246 

 

$

401 

 

$

373 

 

 

 

 

 

 

 

 

 

 

 

 

Number of common shares:

 

 

 

 

 

 

 

 

 

 

 

Weighted average outstanding

 

351,391,582 

 

 

350,448,806 

 

 

351,307,527 

 

 

350,241,768 

Issued upon assumed exercise of outstanding stock options

 

490,302 

 

 

386,999 

 

 

418,987 

 

 

481,528 

Effect of issuance of nonvested restricted common stock

 

577,599 

 

 

247,002 

 

 

472,008 

 

 

188,596 

Effect of issuance of nonvested performance units

 

120,039 

 

 

–  

 

 

107,746 

 

 

–  

Weighted average and potential dilutive outstanding (1)(2)

 

352,579,522 

 

 

351,082,807 

 

 

352,306,268 

 

 

350,911,892 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

Basic

$

0.59 

 

$

0.70 

 

$

1.14 

 

$

1.07 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted

$

0.59 

 

$

0.70 

 

$

1.14 

 

$

1.06 

 

(1)

Options for 654,189 shares and 19,045 shares of restricted stock were excluded from the calculation for the three months ended June 30, 2014 because they would have had an antidilutive effect.  Options for 1,599,246 shares and 29,251 shares of restricted stock were excluded from the calculation for the three months ended June 30, 2013 because they would have had an antidilutive effect.

(2)

Options for 1,026,958 shares and 22,952 shares of restricted stock were excluded from the calculation for the six months ended June 30, 2014 because they would have had an antidilutive effect.  Options for 2,079,849 shares and 246,347 shares of restricted stock were excluded from the calculation for the six months ended June 30, 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 June 30, 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 designated 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 excluding derivatives, settled 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 creditworthy 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 June 30, 2014 and December 31, 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative Assets

 

 

June 30, 2014

 

December 31, 2013

 

 

Balance Sheet Classification

 

Fair Value

 

Balance Sheet Classification

 

Fair Value

 

 

(in millions)

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Fixed price swaps

 

Derivative assets

 

$

11 

 

Derivative assets

 

$

21 

Fixed price swaps

 

Other long-term assets

 

 

16 

 

Other long-term assets

 

 

–  

Total derivatives designated as hedging instruments

 

 

 

$

27 

 

 

 

$

21 

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Basis swaps

 

Derivative assets

 

$

19 

 

Derivative assets

 

$

13 

Fixed price swaps

 

Derivative assets

 

 

10 

 

Derivative assets

 

 

37 

Basis swaps

 

Other long-term assets

 

 

 

Other long-term assets

 

 

–  

Fixed price swaps

 

Other long-term assets

 

 

16 

 

Other long-term assets

 

 

–  

Interest rate swaps

 

Other long-term assets

 

 

 

Other long-term assets

 

 

Total derivatives not designated as hedging instruments

 

 

 

$

51 

 

 

 

$

58 

 

 

 

 

 

 

 

 

 

 

 

Total derivative assets

 

 

 

$

78 

 

 

 

$

79 

 

 

 

 

 

Derivative Liabilities

 

 

June 30, 2014

 

December 31, 2013

 

 

Balance Sheet Classification

 

Fair Value

 

Balance Sheet Classification

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

(in millions)

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Fixed price swaps

 

Derivative liabilities

 

$

24 

 

Derivative liabilities

 

$

Total derivatives designated as hedging instruments

 

 

 

$

24 

 

 

 

$

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

Basis swaps

 

Derivative liabilities

 

$

20 

 

Derivative liabilities

 

$

Fixed price swaps

 

Derivative liabilities

 

 

 

Derivative liabilities

 

 

–  

Fixed price call options

 

Derivative liabilities

 

 

16 

 

Derivative liabilities

 

 

–  

Interest rate swaps

 

Derivative liabilities

 

 

 

Derivative liabilities

 

 

Basis swaps

 

Other long-term liabilities

 

 

 

Other long-term liabilities

 

 

–  

Fixed price call options

 

Other long-term liabilities

 

 

37 

 

Other long-term liabilities

 

 

30 

Interest rate swaps

 

Other long-term liabilities

 

 

 

Other long-term liabilities

 

 

Total derivatives not designated as hedging instruments

 

 

 

$

92 

 

 

 

$

37 

 

 

 

 

 

 

 

 

 

 

 

Total derivative liabilities

 

 

 

$

116 

 

 

 

$

41 

 

As of June 30, 2014, the Company had fixed price swap derivatives designated as hedges and not designated as hedges on the following volumes of natural gas production (in Bcf):

 

 

 

 

 

Year

Fixed price swaps designated for hedge accounting

Fixed price swaps not designated for

hedge accounting

Total

2014

142

91

233

2015

120

120

240

 

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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 June 30, 2014, the Company recorded a net gain in accumulated other comprehensive income related to its hedging activities of $1 million net of a deferred income tax liability of $1 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 June 30, 2014 remain unchanged, the Company would expect to transfer an aggregate after-tax net loss of $8 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 accumulated other 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 and six month periods ended June 30, 2014 and 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (Loss) Recognized in
Other Comprehensive Income

 

 

 

 

(Effective Portion)

 

 

 

 

For the three months ended

 

For the six months ended

 

 

 

 

June 30,

 

June 30,

Derivative Instrument

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

(in millions)

Fixed price swaps

 

 

 

$

 

$

113 

 

$

(81)

 

$

39 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

For the six months ended

 

 

into Earnings

 

June 30,

 

June 30,

Derivative Instrument

 

(Effective Portion)

 

2014

 

2013

 

2014

 

2013

 

 

 

 

(in millions)

Fixed price swaps

 

Gas sales

 

$

(25)

 

$

46 

 

$

(67)

 

$

125 

 

 

 

 

 

 

 

 

 

 

Loss Recognized in

Earnings

 

 

 

 

(Ineffective Portion)

 

 

Classification of Loss

 

For the three months ended

 

For the six months ended

 

 

Recognized in Earnings

 

June 30,

 

June 30,

Derivative Instrument

 

(Ineffective Portion)

 

2014

 

2013

 

2014

 

2013

 

 

 

 

(in millions)

Fixed price swaps

 

Gas sales

 

$

 –

 

$

(2)

 

$

(2)

 

$

(1)

 

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Other Derivative Contracts

 

For other derivative contracts, 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 June 30, 2014, the Company had basis swaps on natural gas production that were not designated for hedge accounting of 17 Bcf, 15 Bcf, and 4 Bcf in 2014, 2015, and 2016, respectively.

 

As of June 30, 2014, the Company had fixed price call options on 200 Bcf and 120 Bcf of natural gas production in 2015 and 2016, respectively, not designated for hedge accounting treatment and fixed price swaps of 91 Bcf and 120 Bcf of natural gas production in 2014 and 2015, respectively, 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 million and expire in June 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 fixed price swaps, basis swaps, fixed price call options and interest rate swaps not designated for hedge accounting on the condensed consolidated statements of operations for the three and six month period ended June 30, 2014 and 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (Loss) on Derivatives

 

 

 

 

Excluding Derivatives, Settled

 

 

 

 

Recognized in Earnings

 

 

 

 

For the three months ended

 

For the six months ended

 

 

Consolidated Statement of Operations

 

June 30,

 

June 30,

Derivative Instrument

 

Classification of Gain (Loss) on Derivatives Excluding Derivatives, Settled

 

2014

 

2013

 

2014

 

2013

 

 

 

 

(in millions)

Basis swaps

 

Gain (Loss) on Derivatives

 

$

(3)

 

$

10 

 

$

(13)

 

$

Fixed price call options

 

Gain (Loss) on Derivatives

 

$

 

$

22 

 

$

(23)

 

$

(35)

Fixed price swaps

 

Gain (Loss) on Derivatives

 

$

 

$

58 

 

$

(21)

 

$

88 

Interest rate swaps

 

Gain (Loss) on Derivatives

 

$

(3)

 

$

 

$

(5)

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (Loss)

 

 

 

 

on Derivatives, Settled (1)

 

 

 

 

Recognized in Earnings

 

 

Consolidated Statement of Operations

 

For the three months ended

 

For the six months ended

 

 

Classification of Gain (Loss)

 

June 30,

 

June 30,

Derivative Instrument

 

on Derivatives, Settled (1)

 

2014

 

2013

 

2014

 

2013

 

 

 

 

(in millions)

Basis swaps

 

Gain (Loss) on Derivatives

 

$

 

$

 –

 

$

(10)

 

$

Fixed price swaps

 

Gain (Loss) on Derivatives

 

$

(13)

 

$

 –

 

 

(36)

 

 

– 

 

(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 six months ended June 30, 2014: