sn_Current folio_10Q

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10‑Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

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: 1‑35372

Sanchez Energy Corporation

(Exact name of registrant as specified in its charter)

 

 

Delaware
(State or other jurisdiction of
incorporation or organization)

45‑3090102
(I.R.S. Employer
Identification No.)

1000 Main Street, Suite 3000
Houston, Texas
(Address of principal executive offices)

77002
(Zip Code)

(713) 783‑8000

(Registrant’s telephone number, including area code)

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 ☐
(Do not check if a
smaller reporting company)

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 ☒

Number of shares of registrant’s common stock, par value $0.01 per share, outstanding as of November 4, 2016: 66,409,582

 

 


 

Table of Contents

 

Sanchez Energy Corporation

Form 10‑Q

For the Quarterly Period Ended September 30, 2016

 

Table of Contents

 

 

 

 

 

PART I

 

Item 1. 

Unaudited Financial Statements

5

 

Condensed Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015

5

 

Condensed Consolidated Statements of Operations for the Three and Nine months Ended September 30, 2016 and 2015

6

 

Condensed Consolidated Statement of Stockholders’ Equity (Deficit) for the Nine months Ended September 30, 2016

7

 

Condensed Consolidated Statements of Cash Flows for the Nine months Ended September 30, 2016 and 2015

8

 

Notes to the Condensed Consolidated Financial Statements

9

Item 2. 

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

38

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

58

Item 4. 

Controls and Procedures

59

 

PART II

 

Item 1. 

Legal Proceedings

59

Item 1A. 

Risk Factors

59

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

59

Item 3. 

Defaults Upon Senior Securities

59

Item 4. 

Mine Safety Disclosures

59

Item 5. 

Other Information

59

Item 6. 

Exhibits

60

SIGNATURES 

62

 

 

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CAUTIONARY NOTE REGARDING FORWARD‑LOOKING STATEMENTS

 

This Quarterly Report on Form 10‑Q contains “forward‑looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, included in this Quarterly Report on Form 10‑Q that address activities, events or developments that we expect, believe or anticipate will or may occur in the future are forward‑looking statements. These statements are based on certain assumptions we made based on management’s experience, perception of historical trends and technical analyses, current conditions, anticipated future developments and other factors believed to be appropriate and reasonable by management. When used in this Quarterly Report on Form 10‑Q, words such as “will,” “potential,” “believe,” “estimate,” “intend,” “expect,” “may,” “should,” “anticipate,” “could,” “plan,” “predict,” “project,” “profile,” “model,” “strategy,” “future” or their negatives or the statements that include these words or other words that convey the uncertainty of future events or outcomes, are intended to identify forward‑looking statements, although not all forward‑looking statements contain such identifying words. In particular, statements, express or implied, concerning our future operating results and returns or our ability to replace or increase reserves, increase production, or generate income or cash flows are forward‑looking statements. Forward‑looking statements are not guarantees of performance. Such statements are subject to a number of assumptions, risks and uncertainties, many of which are beyond our control. Although we believe that the expectations reflected in our forward‑looking statements are reasonable and are based on reasonable assumptions, no assurance can be given that these assumptions are accurate or that any of these expectations will be achieved (in full or at all) or will prove to have been correct. Important factors that could cause our actual results to differ materially from the expectations reflected in the forward‑looking statements include, among others:

 

·

our ability to successfully execute our business and financial strategies;

 

·

our ability to utilize the services, personnel and other assets of Sanchez Oil & Gas Corporation (“SOG”) pursuant to existing services agreements;

 

·

our ability to replace the reserves we produce through drilling and property acquisitions;

 

·

the timing and extent of changes in prices for, and demand for, crude oil and condensate, natural gas liquids (“NGLs”), natural gas and related commodities;

 

·

the realized benefits of the acreage acquired in our various acquisitions and other assets and liabilities assumed in connection therewith;

 

·

the realized benefits of our joint ventures, including with respect to our joint ventures with an affiliate of Targa Resources Corp. (“Targa”);

 

·

the realized benefits of our transactions with Sanchez Production Partners LP (“SPP”), including with respect to the transactions referred to herein;

 

·

the ability to consummate our recently announced pending transactions with SPP or Carrizo (Eagle Ford) LLC described herin or the epected benefits from such transactions;

 

·

the extent to which our drilling plans are successful in economically developing our acreage in, and to produce reserves and achieve anticipated production levels from, our existing and future projects;

 

·

the accuracy of reserve estimates, which by their nature involve the exercise of professional judgment and may, therefore, be imprecise;

 

·

the extent to which we can optimize reserve recovery and economically develop our plays utilizing horizontal and vertical drilling, advanced completion technologies and hydraulic fracturing;

 

·

our ability to successfully execute our hedging strategy and the resulting realized prices therefrom;

 

·

the credit worthiness and performance of our counterparts, including financial institutions, operating partners and other parties;

 

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·

competition in the oil and natural gas exploration and production industry for employees and other personnel, equipment, materials and services and, related thereto, the availability and cost of employees and other personnel, equipment, materials and services;

 

·

our ability to access the credit and capital markets to obtain financing on terms we deem acceptable, if at all, and to otherwise satisfy our capital expenditure requirements;

 

·

the availability, proximity and capacity of, and costs associated with, gathering, processing, compression and transportation facilities;

 

·

our ability to compete with other companies in the oil and natural gas industry;

 

·

the impact of, and changes in, government policies, laws and regulations, including tax laws and regulations, environmental laws and regulations relating to air emissions, waste disposal, hydraulic fracturing and access to and use of water, laws and regulations imposing conditions and restrictions on drilling and completion operations and laws and regulations with respect to derivatives and hedging activities;

 

·

developments in oil‑producing and natural gas‑producing countries, the actions of the Organization of Petroleum Exporting Countries (“OPEC”) and other factors affecting the supply of oil and natural gas;

 

·

our ability to effectively integrate acquired crude oil and natural gas properties into our operations, fully identify existing and potential problems with respect to such properties and accurately estimate reserves, production and costs with respect to such properties;

 

·

the extent to which our crude oil and natural gas properties operated by others are operated successfully and economically;

 

·

the use of competing energy sources and the development of alternative energy sources;

 

·

unexpected results of litigation filed against us;

 

·

the extent to which we incur uninsured losses and liabilities or losses and liabilities in excess of our insurance coverage; and

 

·

the other factors described under “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Part II, Item 1A. Risk Factors” and elsewhere in this Quarterly Report on Form 10‑Q and in our other public filings with the Securities and Exchange Commission (the “SEC”).

 

In light of these risks, uncertainties and assumptions, the events anticipated by our forward‑looking statements may not occur, and, if any of such events do, we may not have correctly anticipated the timing of their occurrence or the extent of their impact on our actual results. Accordingly, you should not place any undue reliance on any of our forward‑looking statements. Any forward‑looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to correct or update any forward‑looking statement, whether as a result of new information, future events or otherwise, except as required by applicable law.

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PART I—FINANCIAL INFORMATION

 

Item 1.  Unaudited Financial Statements

 

Sanchez Energy Corporation

 

Condensed Consolidated Balance Sheets (Unaudited)

 

(in thousands, except par value and share amounts)

 

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

 

    

2016

    

2015

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

328,529

 

$

435,048

 

Oil and natural gas receivables

 

 

34,382

 

 

30,668

 

Joint interest billings receivables

 

 

630

 

 

1,259

 

Accounts receivable - related entities

 

 

2,235

 

 

3,697

 

Fair value of derivative instruments

 

 

29,834

 

 

172,494

 

Other current assets

 

 

15,366

 

 

23,452

 

Total current assets

 

 

410,976

 

 

666,618

 

Oil and natural gas properties, at cost, using the full cost method:

 

 

 

 

 

 

 

Proved oil and natural gas properties

 

 

3,128,200

 

 

2,914,867

 

Unproved oil and natural gas properties

 

 

271,418

 

 

253,529

 

Total oil and natural gas properties

 

 

3,399,618

 

 

3,168,396

 

Less: Accumulated depreciation, depletion, amortization and impairment

 

 

(2,706,324)

 

 

(2,412,293)

 

Total oil and natural gas properties, net

 

 

693,294

 

 

756,103

 

 

 

 

 

 

 

 

 

Other assets:

 

 

 

 

 

 

 

Fair value of derivative instruments

 

 

2,741

 

 

5,789

 

Investments

 

 

53,126

 

 

49,985

 

Other assets

 

 

24,982

 

 

22,809

 

Total assets

 

$

1,185,119

 

$

1,501,304

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

1,507

 

$

4,184

 

Other payables

 

 

2,225

 

 

2,004

 

Accrued liabilities:

 

 

 

 

 

 

 

Capital expenditures

 

 

40,661

 

 

51,983

 

Other

 

 

69,699

 

 

69,974

 

Deferred premium liability

 

 

8,183

 

 

24,548

 

Fair value of derivative instruments

 

 

3,727

 

 

 —

 

Other current liabilities

 

 

19,856

 

 

14,813

 

Total current liabilities

 

 

145,858

 

 

167,506

 

Long term debt, net of premium, discount and debt issuance costs

 

 

1,710,634

 

 

1,705,927

 

Asset retirement obligations

 

 

28,667

 

 

25,907

 

Fair value of derivative instruments

 

 

2,293

 

 

 —

 

Other liabilities

 

 

58,811

 

 

58,133

 

Total liabilities

 

 

1,946,263

 

 

1,957,473

 

Commitments and contingencies (Note 16)

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

 

Preferred stock ($0.01 par value, 15,000,000 shares authorized; 1,838,985 shares issued and outstanding as of September 30, 2016 and December 31, 2015 of 4.875% Convertible Perpetual Preferred Stock, Series A; 3,527,830 shares issued and outstanding as of September 30, 2016 and December 31, 2015 of 6.500% Convertible Perpetual Preferred Stock, Series B)

 

 

53

 

 

53

 

Common stock ($0.01 par value, 150,000,000 shares authorized; 65,934,336 shares issued and outstanding as of September 30, 2016 and 61,928,089 shares issued and outstanding as of December 31, 2015)

 

 

663

 

 

619

 

Additional paid-in capital

 

 

1,101,361

 

 

1,079,513

 

Accumulated deficit

 

 

(1,863,221)

 

 

(1,536,354)

 

Total stockholders' deficit

 

 

(761,144)

 

 

(456,169)

 

Total liabilities and stockholders' deficit

 

$

1,185,119

 

$

1,501,304

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Sanchez Energy Corporation

 

Condensed Consolidated Statements of Operations (Unaudited)

 

(in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30, 

 

September 30, 

 

    

2016

    

2015

    

2016

    

2015

REVENUES:

 

 

 

 

 

 

 

 

 

 

 

 

Oil sales

 

$

64,041

 

$

69,532

 

$

172,509

 

$

244,554

Natural gas liquid sales

 

 

19,511

 

 

17,055

 

 

56,535

 

 

48,602

Natural gas sales

 

 

31,255

 

 

27,939

 

 

76,547

 

 

73,091

Total revenues

 

 

114,807

 

 

114,526

 

 

305,591

 

 

366,247

OPERATING COSTS AND EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

 

Oil and natural gas production expenses

 

 

38,997

 

 

40,345

 

 

128,609

 

 

110,166

Production and ad valorem taxes

 

 

3,921

 

 

3,038

 

 

14,052

 

 

20,011

Depreciation, depletion, amortization and accretion

 

 

37,651

 

 

89,167

 

 

127,959

 

 

296,541

Impairment of oil and natural gas properties

 

 

59,582

 

 

454,628

 

 

169,046

 

 

1,365,000

General and administrative (inclusive of stock-based compensation expense of $12,802 and $355, respectively, for the three months ended September 30, 2016 and 2015, and $26,025 and $15,924, respectively, for the nine months ended September 30, 2016 and 2015)

 

 

26,936

 

 

15,851

 

 

70,399

 

 

59,290

Total operating costs and expenses

 

 

167,087

 

 

603,029

 

 

510,065

 

 

1,851,008

Operating loss

 

 

(52,280)

 

 

(488,503)

 

 

(204,474)

 

 

(1,484,761)

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

146

 

 

65

 

 

629

 

 

249

Other income (expense)

 

 

7

 

 

(818)

 

 

(196)

 

 

(2,053)

Interest expense

 

 

(31,797)

 

 

(31,442)

 

 

(95,225)

 

 

(94,500)

Earnings from equity investments

 

 

463

 

 

 —

 

 

3,154

 

 

 —

Net gains (losses) on commodity derivatives

 

 

18,640

 

 

103,996

 

 

(17,353)

 

 

111,550

Total other income (expense)

 

 

(12,541)

 

 

71,801

 

 

(108,991)

 

 

15,246

Loss before income taxes

 

 

(64,821)

 

 

(416,702)

 

 

(313,465)

 

 

(1,469,515)

Income tax expense

 

 

1,441

 

 

158

 

 

1,441

 

 

7,600

Net loss

 

 

(66,262)

 

 

(416,860)

 

 

(314,906)

 

 

(1,477,115)

Less:

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock dividends

 

 

(3,987)

 

 

(3,991)

 

 

(11,961)

 

 

(11,973)

Net income allocable to participating securities

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Net loss attributable to common stockholders

 

$

(70,249)

 

$

(420,851)

 

$

(326,867)

 

$

(1,489,088)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss per common share - basic and diluted

 

$

(1.19)

 

$

(7.33)

 

$

(5.56)

 

$

(26.06)

Weighted average number of shares used to calculate net loss attributable to common stockholders - basic and diluted

 

 

59,190

 

 

57,426

 

 

58,782

 

 

57,141

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Sanchez Energy Corporation

 

Condensed Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2016 (Unaudited)

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Series A

 

Series B

 

 

 

 

 

 

Additional

 

 

 

 

Total

 

 

 

Preferred Stock

 

Preferred Stock

 

Common Stock

 

Paid-in

 

Accumulated

 

Stockholders'

 

 

    

Shares

    

Amount

    

Shares

    

Amount

    

Shares

    

Amount

    

Capital

    

Deficit

    

Deficit

 

BALANCE, December 31, 2015

 

1,839

 

$

18

 

3,528

 

$

35

 

61,928

 

$

619

 

$

1,079,513

 

$

(1,536,354)

 

$

(456,169)

 

Preferred stock dividends

 

 —

 

 

 —

 

 —

 

 

 —

 

500

 

 

5

 

 

3,982

 

 

(11,961)

 

 

(7,974)

 

Restricted stock awards, net of forfeitures

 

 —

 

 

 —

 

 —

 

 

 —

 

3,870

 

 

39

 

 

(39)

 

 

 —

 

 

 —

 

Stock-based compensation

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 

17,905

 

 

 —

 

 

17,905

 

Net loss

 

 —

 

 

 —

 

 —

 

 

 —

 

 —

 

 

 —

 

 

 —

 

 

(314,906)

 

 

(314,906)

 

BALANCE, September 30, 2016

 

1,839

 

$

18

 

3,528

 

$

35

 

66,298

 

$

663

 

$

1,101,361

 

$

(1,863,221)

 

$

(761,144)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Sanchez Energy Corporation

 

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

September 30, 

 

 

    

2016

    

2015

    

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net loss

 

$

(314,906)

 

$

(1,477,115)

 

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

 

 

 

 

 

 

 

Depreciation, depletion, amortization and accretion

 

 

127,959

 

 

296,541

 

Impairment of oil and natural gas properties

 

 

169,046

 

 

1,365,000

 

Stock-based compensation expense

 

 

26,025

 

 

15,924

 

Net losses (gains) on commodity derivative contracts

 

 

17,353

 

 

(111,550)

 

Net cash settlement received on commodity derivative contracts

 

 

105,111

 

 

89,558

 

Cash reimbursements received for operating leasehold improvements

 

 

 —

 

 

2,650

 

Losses (gains) incurred on premiums for derivative contracts

 

 

18,377

 

 

(121)

 

Loss on investment in SPP

 

 

 —

 

 

864

 

Amortization of deferred gain on Western Catarina Midstream Divestiture

 

 

(11,109)

 

 

 —

 

Amortization of debt issuance costs

 

 

5,865

 

 

5,312

 

Accretion of debt discount, net

 

 

475

 

 

544

 

Deferred taxes

 

 

 —

 

 

7,443

 

Loss on inventory market adjustment

 

 

479

 

 

 —

 

Distributions from equity investments

 

 

428

 

 

 —

 

Earnings from equity investments

 

 

(3,154)

 

 

 —

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

(3,085)

 

 

52,138

 

Other current assets

 

 

2,608

 

 

3,792

 

Accounts payable

 

 

(2,677)

 

 

(12,945)

 

Accounts receivable - related entities

 

 

1,462

 

 

(3,404)

 

Other payables

 

 

221

 

 

(836)

 

Accrued liabilities

 

 

(4,262)

 

 

(1,181)

 

Other current liabilities

 

 

 —

 

 

(5,166)

 

Other liabilities

 

 

 —

 

 

1,190

 

Net cash provided by operating activities

 

 

136,216

 

 

228,638

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Payments for oil and natural gas properties

 

 

(241,323)

 

 

(562,599)

 

Payments for other property and equipment

 

 

(3,962)

 

 

(4,572)

 

Proceeds from sale of oil and natural gas properties

 

 

 —

 

 

81,734

 

Acquisition of oil and natural gas properties

 

 

 —

 

 

(7,658)

 

Payments for investments

 

 

(28,682)

 

 

 —

 

Proceeds from sale of investments

 

 

36,977

 

 

 —

 

Net cash used in investing activities

 

 

(236,990)

 

 

(493,095)

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Proceeds from borrowings

 

 

60,000

 

 

 —

 

Repayment of borrowings

 

 

(60,000)

 

 

 —

 

Financing costs

 

 

(1,758)

 

 

(400)

 

Preferred dividends paid

 

 

(3,987)

 

 

(11,973)

 

Net cash used in financing activities

 

 

(5,745)

 

 

(12,373)

 

 

 

 

 

 

 

 

 

Decrease in cash and cash equivalents

 

 

(106,519)

 

 

(276,830)

 

Cash and cash equivalents, beginning of period

 

 

435,048

 

 

473,714

 

Cash and cash equivalents, end of period

 

$

328,529

 

$

196,884

 

 

 

 

 

 

 

 

 

NON-CASH INVESTING AND FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Change in asset retirement obligations

 

$

1,222

 

$

7,451

 

Change in accrued capital expenditures

 

 

(11,322)

 

 

(90,632)

 

SUPPLEMENTAL DISCLOSURE:

 

 

 

 

 

 

 

Cash paid for taxes

 

$

1,996

 

$

 —

 

Cash paid for interest

 

 

94,869

 

 

98,104

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Sanchez Energy Corporation

 

Notes to the Condensed Consolidated Financial Statements

 

(Unaudited)

 

Note 1. Organization

 

Sanchez Energy Corporation (together with our consolidated subsidiaries, the “Company,” “we,” “our,” “us” or similar terms), a Delaware corporation formed in August 2011, is an independent exploration and production company focused on the acquisition and development of unconventional oil and natural gas resources in the onshore U.S. Gulf Coast, with a current focus on the horizontal development of significant resource potential from the Eagle Ford Shale in South Texas and the Tuscaloosa Marine Shale (“TMS”) in Mississippi and Louisiana. We have accumulated net leasehold acreage in the oil and condensate, or black oil and volatile oil, windows of the Eagle Ford Shale and in what we believe to be the core of the TMS.

 

 

Note 2. Basis of Presentation and Summary of Significant Accounting Policies

 

The accompanying condensed consolidated financial statements are unaudited and were prepared from the Company’s records. The condensed consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP” or “U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The Company derived the condensed consolidated balance sheet as of December 31, 2015 from the audited financial statements filed in its Annual Report on Form 10-K for the fiscal year ended December 31, 2015 (the “2015 Annual Report”). Because this is an interim period filing presented using a condensed format, it does not include all of the disclosures required by U.S. GAAP. These condensed consolidated financial statements should be read in connection with the consolidated financial statements and notes thereto included in the 2015 Annual Report, which contains a summary of the Company’s significant accounting policies and other disclosures. In the opinion of management, these financial statements include the adjustments and accruals, all of which are of a normal recurring nature, which are necessary for a fair presentation of the results for the interim periods. These interim results are not necessarily indicative of results to be expected for the entire year.

 

As of September 30, 2016, the Company’s significant accounting policies are consistent with those discussed in Note 2, “Basis of Presentation and Summary of Significant Accounting Policies,” in the notes to the Company’s consolidated financial statements contained in the 2015 Annual Report.

 

Principles of Consolidation

 

The Company’s condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany balances and transactions have been eliminated.

 

Use of Estimates

 

The condensed consolidated financial statements are prepared in conformity with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates pertain to proved oil and natural gas reserves and related cash flow estimates used in the calculation of depletion and impairment of oil and natural gas properties, the evaluation of unproved properties for impairment, the fair value of commodity derivative contracts and asset retirement obligations, accrued oil and natural gas revenues and expenses and the allocation of general and administrative expenses. Actual results could differ materially from those estimates.

 

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Recent Accounting Pronouncements

 

In October 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-16 “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory,” which eliminates a current exception in U.S. GAAP to the recognition of the income tax effects of temporary differences that result from intra-entity transfers of non-inventory assets. The intra-entity exception is being eliminated under the ASU. The standard is required to be applied on a modified retrospective basis and will be effective beginning with the first quarter of 2018.  Early adoption is permitted, and we are currently in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.

 

In August 2016, the FASB issued ASU No. 2016-15 “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments”. This ASU is intended to clarify the presentation of cash receipts and payments in specific situations. The amendments in this ASU are effective for financial statements issued for annual periods beginning after December 15, 2017, including interim periods within those annual periods, and early application is permitted. The Company does not anticipate that ASU 2016-15 will have a material effect on its consolidated and condensed financial statements and related disclosures.

 

In March 2016, the FASB issued ASU No. 2016-09 “Improvements to Employee Share-Based Payment Accounting,” effective for annual and interim periods for public companies beginning after December 15, 2016, with a cumulative-effect and prospective approach to be used for implementation. ASU 2016-09 changes several aspects of the accounting for share-based payment award transactions including accounting for income taxes, classification of excess tax benefits on the statement of cash flows, forfeitures, minimum statutory tax withholding requirements and classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes. We are currently in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02 “Leases (Topic 842),” effective for annual and interim periods for public companies beginning after December 15, 2018, with a modified retrospective approach to be used for implementation. ASU 2016-02 updates the previous lease guidance by requiring the recognition of a right-to-use asset and lease liability on the statement of financial position for those leases previously classified as operating leases under the old guidance. In addition, ASU 2016-02 updates the criteria for a lessee’s classification of a finance lease. We are currently in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.

 

In April 2015, the FASB issued ASU 2015-03, “Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” In August 2015, the FASB issued ASU 2015-15, “Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements,” which is effective upon the adoption of ASU 2015-03. This guidance is intended to more closely align the presentation of debt issuance costs under U.S. GAAP with the presentation requirements under the International Financial Reporting Standards. Under this new standard, debt issuance costs related to a recognized debt liability will be presented on the balance sheet as a direct deduction from the debt liability, similar to the presentation of debt discounts, rather than as a separate asset as previously presented. This guidance is effective for fiscal years and interim periods beginning after December 15, 2015. During the first quarter 2016, the Company adopted ASU 2015-03 retrospectively to the comparable periods in this Form 10-Q. Adoption of this guidance affected the balance sheets as of December 31, 2015 as follows (in thousands):

 

·

Decrease in Long term debt, net of premium, discount and debt issuance costs of approximately $41,039

·

Decrease in Debt issuance costs, net (Other Assets) of approximately $41,039

 

In February 2015, the FASB issued ASU 2015-02, “Consolidation—Amendments to the Consolidation Analysis.” This ASU will simplify existing requirements by reducing the number of acceptable consolidation models and placing more emphasis on risk of loss when determining a controlling financial interest. The provisions of this new standard will affect how limited partnerships and similar entities are assessed for consolidation, including the elimination of the presumption that a general partner should consolidate a limited partnership. This guidance is effective for fiscal years and interim periods beginning in 2016. During the first quarter 2016, the Company adopted ASU 2015-02 retrospectively to the comparable periods in this Form 10-Q. See further disclosure around the adoption of ASU 2015-02, and the impact on the Company’s consolidated financial statements in Note 19, “Variable Interest Entities.”

 

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In July 2015, FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory,” effective for annual and interim periods beginning after December 15, 2016. ASU 2015-11 changes the inventory measurement principle for entities using the first-in, first out (FIFO) or average cost methods. For entities utilizing one of these methods, the inventory measurement principle will change from lower of cost or market to the lower of cost and net realizable value. We are currently in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements, but we do not expect the impact to be material.

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” This guidance outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This new revenue recognition model provides a five-step analysis in determining when and how revenue is recognized. The new model will require revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration a company expects to receive in exchange for those goods and services. The new guidance is effective for fiscal years and interim periods beginning after December 15, 2017. Early adoption is not permitted. The guidance may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of initial application. We are currently in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements, but we do not expect the impact to be material.     

 

Note 3. Acquisitions and Divestitures

 

Our acquisitions are accounted for under the acquisition method of accounting in accordance with Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations.” A business combination may result in the recognition of a gain or goodwill based on the measurement of the fair value of the assets acquired at the acquisition date as compared to the fair value of consideration transferred, adjusted for purchase price adjustments. The initial accounting for acquisitions may not be complete and adjustments to provisional amounts, or recognition of additional assets acquired or liabilities assumed, may occur as more detailed analyses are completed and additional information is obtained about the facts and circumstances that existed as of the acquisition dates. The results of operations of the properties acquired in our acquisitions have been included in the condensed consolidated financial statements since the closing dates of the acquisitions.

 

Catarina Acquisition

 

On June 30, 2014, we completed our acquisition of contiguous acreage in Dimmit, LaSalle and Webb Counties, Texas with 176 gross producing wells for an aggregate adjusted purchase price of $557.1 million (the “Catarina Acquisition”). The effective date of the transaction was January 1, 2014. The purchase price was funded with a portion of the proceeds from the Original 6.125% Notes (as defined below in Note 6, “Long-Term Debt”) and cash on hand. The total purchase price was allocated to the assets purchased and liabilities assumed based upon their fair values on the date of acquisition as follows (in thousands):

 

 

 

 

 

 

Proved oil and natural gas properties

    

$

446,906

  

Unproved properties

 

 

122,224

 

Other assets acquired

 

 

2,682

 

Fair value of assets acquired

 

 

571,812

 

Asset retirement obligations

 

 

(14,723)

 

Fair value of net assets acquired

 

$

557,089

 

 

Palmetto Divestiture

 

On March 31, 2015, we sold escalating working interests in 59 wellbores located in Gonzales County, Texas to a subsidiary of SPP for an adjusted purchase price of approximately $83.4 million (the “Palmetto Divestiture”). The effective date of the transaction was January 1, 2015. The aggregate average working interest percentage initially conveyed was 18.25% per wellbore and, upon January 1 of each subsequent year after the closing, the purchaser’s working interest will automatically increase in incremental amounts according to the purchase agreement until January 1, 2019, at which point the purchaser will own a 47.5% working interest and we will own a 2.5% working interest in each of the wellbores. We received consideration consisting of approximately $83.0 million (approximately $81.4 million as adjusted) cash and 1,052,632 common units of SPP valued at approximately $2.0 million as of the date of the

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closing (as discussed further in Note 8, “Investments”). The Company did not record any gains or losses related to the Palmetto Divestiture. On August 4, 2015, the common units of SPP were subject to a 1-for-10 reverse split, at which time we owned 105,263 common units of SPP.

 

Western Catarina Midstream Divestiture

 

On October 14, 2015, the Company and SN Catarina, LLC (“SN Catarina”) completed the sale of SN Catarina’s interests in Catarina Midstream, LLC, a wholly-owned subsidiary of SN Catarina (“Catarina Midstream”), which as of the closing date, owned certain midstream gathering and processing assets located in Dimmit County and Webb County, Texas and 105,263 common units of SPP, to SPP for an adjusted purchase price of $345.8 million in cash (the “Western Catarina Midstream Divestiture”). In connection with the closing of the Western Catarina Midstream Divestiture, SN Catarina and Catarina Midstream entered into a Firm Gathering and Processing Agreement effective October 14, 2015 (the “Gathering Agreement”) for an initial term of 15 years pursuant to which production from approximately 35,000 acres that we operate in Dimmit County and Webb County, Texas will be dedicated for gathering by Catarina Midstream. In addition, for the first five years of the Gathering Agreement, SN Catarina is required to meet a minimum quarterly volume delivery commitment of 10,200 Bbls per day of crude oil and condensate and 142,000 Mcf per day of natural gas, subject to certain adjustments.  SN Catarina will be required to pay gathering and processing fees of $0.96 per Bbl for crude oil and condensate and $0.74 per Mcf for natural gas tendered through the gathering system, in each case, subject to an annual escalation for a positive increase in the consumer price index. In addition, SN Catarina has, under certain circumstances, a right of first refusal during the term of the Gathering Agreement and afterwards with respect to dispositions by Catarina Midstream of its ownership interest in the gathering system. The Company recorded a deferred gain of approximately $74.1 million as a result of the Gathering Agreement being accounted for as an operating lease. This deferred gain will be amortized straight-line over the firm commitment term of five years as an offset to the transportation fees paid to Catarina Midstream under the Gathering Agreement.

 

Note 4. Cash and Cash Equivalents

 

As of September 30, 2016 and December 31, 2015, cash and cash equivalents consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

 

    

2016

    

2015

  

Cash at banks

 

$

215,448

 

$

35,600

 

Money market funds

 

 

113,081

 

 

399,448

 

Total cash and cash equivalents

 

$

328,529

 

$

435,048

 

 

 

Note 5. Oil and Natural Gas Properties

 

The Company’s oil and natural gas properties are accounted for using the full cost method of accounting. All direct costs and certain indirect costs associated with the acquisition, exploration and development of oil and natural gas properties are capitalized. Once evaluated, these costs, as well as the estimated costs to retire the assets, are included in the amortization base and amortized to depletion expense using the units‑of‑production method. Depletion is calculated based on estimated proved oil and natural gas reserves. Proceeds from the sale or disposition of oil and natural gas properties are applied to reduce net capitalized costs unless the sale or disposition causes a significant change in the relationship between costs and the estimated quantity of proved reserves.

 

Full Cost Ceiling Test—Capitalized costs (net of accumulated depreciation, depletion and amortization and deferred income taxes) of proved oil and natural gas properties are subject to a full cost ceiling limitation. The ceiling limits these costs to an amount equal to the present value, discounted at 10%, of estimated future net cash flows from estimated proved reserves less estimated future operating and development costs, abandonment costs (net of salvage value) and estimated related future income taxes. In accordance with SEC rules, the oil and natural gas prices used to calculate the full cost ceiling are the 12-month average prices, calculated as the unweighted arithmetic average of the first-day-of-the-month price for each month within the 12-month period prior to the end of the reporting period, unless prices are defined by contractual arrangements. Prices are adjusted for “basis” or location differentials. Prices are held constant over the life of the reserves. If unamortized costs capitalized within the cost pool exceed the ceiling, the excess is charged to expense and separately disclosed during the period in which the excess occurs. Amounts thus required to be written off are not reinstated for any subsequent increase in the cost center ceiling. During the three and nine month 

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periods ended September 30, 2016, the Company recorded a full cost ceiling test impairment after income taxes of $59.6 million and $169.0 million, respectively.  While there is a possibility that the Company will incur additional impairments to our full cost pool in 2016, factors impacting the full cost ceiling test impairment calculation have not yet been determined. Based upon known improvements in the current NYMEX forward prices, we believe that there is a reasonable likelihood of an increase in the average 12 month trailing first-day-of-the-month pricing in the fourth quarter of 2016.  

 

Costs associated with unproved properties and properties under development, including costs associated with seismic data, leasehold acreage and the current drilling of wells, are excluded from the full cost amortization base until the properties have been evaluated. Unproved properties are identified on a project basis, with a project being an area in which significant leasehold interests are acquired within a contiguous area. Unproved properties are reviewed periodically by management and when management determines that a project area has been evaluated through drilling operations or a thorough geologic evaluation, the project area is transferred into the full cost pool subject to amortization. The Company assesses the carrying value of its unproved properties that are not subject to amortization for impairment periodically. If the results of an assessment indicate that the properties are impaired, the amount of the asset impaired is added to the full cost pool subject to both periodic amortization and the ceiling test.

 

Note 6. Long‑Term Debt

 

Long-term debt on September 30, 2016, consisted of $1.15 billion face value of 6.125% senior notes (consisting of $850 million in Original 6.125% Notes (defined below) and $300 million in Additional 6.125% Notes (defined below), which were issued at a premium to face value of $2.3 million), maturing on January 15, 2023, and $600 million principal amount of 7.75% senior notes (consisting of $400 million in Original 7.75% Notes (defined below) and $200 million in Additional 7.75% Notes (defined below), which were issued at a discount to face value of $7.0 million), maturing on June 15, 2021. During the first quarter 2016, the Company adopted ASU 2015-03 retrospectively to the comparable periods in this Form 10-Q. Adoption of this guidance affected the balance sheets as of December 31, 2015 as follows (in thousands):

 

Decrease in Long term debt, net of premium, discount and debt issuance costs of approximately $41,039

Decrease in Debt issuance costs, net (Other Assets) of approximately $41,039

 

As of September 30, 2016, and December 31, 2015, the Company’s long‑term debt consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount Outstanding

 

 

 

 

 

 

 

(in thousands) as of

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

 

    

Interest Rate

    

Maturity date

    

2016

    

2015

 

Second Amended and Restated Credit Agreement

 

Variable

 

June 30, 2019

 

$

 —

 

$

 —

 

7.75% Notes

 

7.75%

 

June 15, 2021

 

 

600,000

 

 

600,000

 

6.125% Notes

 

6.125%

 

January 15, 2023

 

 

1,150,000

 

 

1,150,000

 

 

 

 

 

 

 

 

1,750,000

 

 

1,750,000

 

Unamortized discount on Additional 7.75% Notes

 

 

 

 

 

 

(4,256)

 

 

(4,933)

 

Unamortized premium on Additional 6.125% Notes

 

 

 

 

 

 

1,697

 

 

1,899

 

Unamortized debt issuance costs

 

 

 

 

 

 

(36,807)

 

 

(41,039)

 

Total long-term debt

 

 

 

 

 

$

1,710,634

 

$

1,705,927

 

 

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The components of interest expense are (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

    

September 30, 

 

September 30, 

 

 

2016

    

2015

    

2016

    

2015

Interest on Senior Notes

 

$

(29,234)

 

$

(29,234)

 

$

(87,704)

 

$

(87,704)

Interest expense and commitment fees on credit agreement

 

 

(429)

 

 

(301)

 

 

(1,181)

 

 

(940)

Amortization of debt issuance costs

 

 

(1,975)

 

 

(1,748)

 

 

(5,865)

 

 

(5,312)

Amortization of discount on Additional 7.75% Notes

 

 

(226)

 

 

(226)

 

 

(677)

 

 

(678)

Amortization of premium on Additional 6.125% Notes

 

 

67

 

 

67

 

 

202

 

 

134

Total interest expense

 

$

(31,797)

 

$

(31,442)

 

$

(95,225)

 

$

(94,500)

 

Credit Facility

 

Previous Credit Agreement:  On May 31, 2013, we and our subsidiaries, SEP Holdings III, LLC (“SEP III”), SN Marquis LLC (“SN Marquis”) and SN Cotulla Assets, LLC (“SN Cotulla”), collectively, as the borrowers, entered into a revolving credit facility represented by a  $500 million Amended and Restated Credit Agreement with Royal Bank of Canada, as the administrative agent and collateral agent, and the lenders party thereto (the “Amended and Restated Credit Agreement”). The Amended and Restated Credit Agreement was to mature on May 31, 2018.

 

On May 12, 2014, the Company borrowed $100 million under the Amended and Restated Credit Agreement. The Company used proceeds from the issuance of the Original 6.125% Notes to repay the $100 million outstanding.

 

Second Amended and Restated Credit Agreement:  On June 30, 2014, the Company, as borrower, and SEP III, SN Marquis, SN Cotulla, SN Operating, LLC, SN TMS, LLC and SN Catarina, LLC as loan parties, entered into a revolving credit facility represented by a $1.5 billion Second Amended and Restated Credit Agreement with Royal Bank of Canada, as the administrative agent and collateral agent, and the lenders party thereto (together with all subsequent amendments, the ‘‘Second Amended and Restated Credit Agreement’’). The Second Amended and Restated Credit Agreement provides for the issuance of letters of credit, limited in the aggregate to the lesser of $80 million and the total availability thereunder. As of September 30, 2016, there were no borrowings and no letters of credit outstanding under the Second Amended and Restated Credit Agreement, which had a borrowing base of $350 million and aggregate elected commitments of $300 million. Availability under the Second Amended and Restated Credit Agreement is at all times subject to customary conditions and the then applicable borrowing base and aggregate elected commitment amount. All of the $300 million aggregate elected commitment amount was available for future revolver borrowings as of September 30, 2016.

 

The Second Amended and Restated Credit Agreement matures on June 30, 2019. The borrowing base under the Second Amended and Restated Credit Agreement is redetermined semi-annually by the lenders based on, among other things, an evaluation of the Company’s and its restricted subsidiaries’ oil and natural gas reserves. Semi-annual redeterminations of the borrowing base are generally scheduled to occur on or before April 1 and October 1 of each year. The borrowing base is also subject to (i) automatic reduction by 25% of the amount of any increase in the aggregate amount of the Company’s high yield debt and second lien debt, other than high yield or second lien debt issued in exchange for or to refinance existing high yield debt, permitted second lien debt incurred to refinance or replace permitted second lien debt, and permitted second lien debt representing the payment of interest in kind, (ii) interim redetermination at the election of the Company once between each scheduled redetermination, (iii) interim redetermination at the election of a majority of the lenders once between each scheduled redetermination, and (iv) if the required lenders so direct, in connection with asset sales and swap terminations during the period since the most recent borrowing base determination with a combined borrowing base value of more than 10% of the value of the proved developed oil and gas properties included in the most recent reserve report, a reduction in an amount equal to the borrowing base value, as determined by the administrative agent in its reasonable judgment, of such assets and swaps.

 

The Company’s obligations under the Second Amended and Restated Credit Agreement are guaranteed by all of the Company’s existing and future subsidiaries not designated as “unrestricted subsidiaries” and secured by a first priority lien on substantially all of the Company’s assets and the assets of its existing and future subsidiaries, not designated as “unrestricted subsidiaries,” including a first priority lien on all ownership interests in existing and future subsidiaries, including the SPV, defined below, an “unrestricted subsidiary,” but excluding other subsidiaries designated as “unrestricted subsidiaries.”

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At the Company’s election, interest on borrowings under the Second Amended and Restated Credit Agreement may be calculated based on an alternate base rate or an adjusted eurodollar (LIBOR) rate, plus an applicable margin. The applicable margin varies from 1.00% to 2.00% for alternate base rate borrowings and from 2.00% to 3.00% for eurodollar (LIBOR) borrowings and letters of credit, if any, depending on the Company’s utilization of the borrowing base. The Company is also required to pay a commitment fee of 0.50% per annum on any unused aggregate elected commitment amount.

 

The Second Amended and Restated Credit Agreement contains various affirmative and negative covenants and events of default that limit the Company’s ability to, among other things, incur indebtedness, make restricted payments, grant liens, consolidate or merge, dispose of certain assets, make investments, engage in transactions with affiliates, enter into hedge transactions, and make acquisitions. The Second Amended and Restated Credit Agreement also provides for cross default between the Second Amended and Restated Credit Agreement and the other debt (including debt under the 6.125% Notes and the 7.75% Notes) and obligations in respect of hedging agreements (on a mark-to-market basis), of the Company and its restricted subsidiaries, in an aggregate principal amount in excess of $10 million. Furthermore, the Second Amended and Restated Credit Agreement contains financial covenants that require the Company to satisfy the following tests: (i) current assets plus undrawn borrowing capacity on the Second Amended and Restated Credit Agreement to current liabilities of at least 1.0 to 1.0 at all times, and (ii) net first lien debt (defined as the excess of first lien debt over cash) to consolidated last twelve months EBITDA of not greater than 2.00 to 1.0 as of the last day of any fiscal quarter. As of September 30, 2016, the Company was in compliance with the covenants of the Second Amended and Restated Credit Agreement.

 

The Second Amended and Restated Credit Amendment, among other things, also (a) permits the repurchase by the Company and its restricted subsidiaries, or by a special purpose unrestricted subsidiary of the Company (the “SPV”), of the Company’s senior unsecured notes and common and preferred equity securities, from cash in excess of lender credit exposure in an aggregate amount up to approximately $298.5 million subject to certain caps on purchases of the Company’s common and preferred equity securities and other limitations; (b) permits (i) the formation and capitalization of the SPV with up to $150 million, (ii) the SPV to purchase, hold and dispose of, including by way of distribution to its immediate parent, up to $150 million of the Company’s senior unsecured notes and common and preferred equity securities, (iii) the SPV to hold cash received from its immediate parent in a deposit account maintained with a lender under the Second Amended and Restated Credit Agreement, and (iv) the SPV to distribute cash to its immediate parent; (c) requires (i) the Company to cause the SPV to distribute all cash held by it or in its name as of the close of business on December 31, 2016 to its immediate parent, (ii) the equity interests in the SPV to be pledged in favor of the secured parties and (iii) the Company to maintain all deposits, securities and commodity accounts with lenders or affiliates of lenders under the Second Amended and Restated Credit Agreement and to enter into account control agreements in favor of the administrative agent for the benefit of the secured parties in respect of each of such accounts; (d) provides that, in the event of a borrowing base deficiency, the Company shall use unrestricted cash of the Company and its subsidiaries in excess of $35 million to prepay borrowings and cash collateralize letter of credit exposure, as applicable; and (e) restricts the Company from increasing its aggregate elected commitment amount until the lenders’ next regularly scheduled borrowing base redetermination, which is expected to occur in the fourth quarter 2016.

 

From time to time, the agents, arrangers, book runners and lenders under the Second Amended and Restated Credit Agreement and their affiliates have provided, and may provide in the future, investment banking, commercial lending, hedging and financial advisory services to the Company and its affiliates in the ordinary course of business, for which they have received, or may in the future receive, customary fees and commissions for these transactions.

 

7.75% Senior Notes Due 2021

 

On June 13, 2013, we completed a private offering of $400 million in aggregate principal amount of the Company’s 7.75% senior notes that will mature on June 15, 2021 (the “Original 7.75% Notes”). Interest on the notes is payable on each June 15 and December 15. We received net proceeds from this offering of approximately $388 million, after deducting initial purchasers’ discounts and offering expenses, which we used to repay outstanding indebtedness under our credit facilities. The Original 7.75% Notes are senior unsecured obligations and are guaranteed on a joint and several senior unsecured basis by, with certain exceptions, substantially all of our existing and future subsidiaries.

 

On September 18, 2013, we issued an additional $200 million in aggregate principal amount of our 7.75% senior notes due 2021 (the “Additional 7.75% Notes” and, together with the Original 7.75% Notes, the “7.75% Notes”)

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in a private offering at an issue price of 96.5% of the principal amount of the Additional 7.75% Notes. We received net proceeds of $188.8 million (after deducting the initial purchasers’ discounts and offering expenses of $4.2 million) from the sale of the Additional 7.75% Notes. The Company also received cash for accrued interest from June 13, 2013 through the date of issuance of $4.1 million, for total net proceeds of $192.9 million from the sale of the Additional 7.75% Notes. The Additional 7.75% Notes were issued under the same indenture as the Original 7.75% Notes, and are, therefore, treated as a single class of securities under the indenture. We used the net proceeds from the offering to partially fund our acquisition of contiguous acreage in McMullen County, Texas with 13 gross producing wells (the “Wycross Acquisition”) completed in October 2013, a portion of the 2013 and 2014 capital budgets and for general corporate purposes.

 

The 7.75% Notes are senior unsecured obligations and rank equally in right of payment with all of our existing and future senior unsecured indebtedness. The 7.75% Notes rank senior in right of payment to our future subordinated indebtedness. The 7.75% Notes are effectively junior in right of payment to all of our existing and future secured debt (including under our Second Amended and Restated Credit Agreement) to the extent of the value of the assets securing such debt. The 7.75% Notes are fully and unconditionally guaranteed (except for customary release provisions) on a joint and several senior unsecured basis by the subsidiary guarantors party to the indenture governing the 7.75% Notes. To the extent set forth in the indenture governing the 7.75% Notes, certain of our subsidiaries will be required to fully and unconditionally guarantee the 7.75% Notes on a joint and several senior unsecured basis in the future.

 

The indenture governing the 7.75% Notes, among other things, restricts our ability and our restricted subsidiaries’ ability to: (i) incur, assume, or guarantee additional indebtedness or issue certain types of equity securities; (ii) pay distributions on, purchase or redeem shares or purchase or redeem subordinated debt; (iii) make certain investments; (iv) enter into certain transactions with affiliates; (v) create or incur liens on their assets; (vi) sell assets; (vii) consolidate, merge or transfer all or substantially all of their assets; (viii) restrict distributions or other payments from the Company’s restricted subsidiaries; and (ix) designate subsidiaries as unrestricted subsidiaries.

 

We have the option to redeem all or a portion of the 7.75% Notes at any time on or after June 15, 2017 at the applicable redemption prices specified in the indenture plus accrued and unpaid interest. We may also redeem the 7.75% Notes, in whole or in part, at a redemption price equal to 100% of their principal amount plus a make whole premium, together with accrued and unpaid interest and additional interest, if any, to the redemption date, at any time prior to June 15, 2017. In addition, we may be required to repurchase the 7.75% Notes upon a change of control or if we sell certain of our assets.

 

On July 18, 2014, we completed an exchange offer of $600 million aggregate principal amount of the 7.75% Notes that had been registered under the Securities Act of 1933, as amended (the “Securities Act”), for an equal amount of the 7.75% Notes that had not been registered under the Securities Act.

 

6.125% Senior Notes Due 2023

 

On June 27, 2014, the Company completed a private offering of $850 million in aggregate principal amount senior unsecured 6.125% notes due 2023 (the “Original 6.125% Notes”). Interest on the notes is payable on each July 15 and January 15. The Company received net proceeds from this offering of approximately $829 million, after deducting initial purchasers’ discounts and estimated offering expenses, which the Company used to repay all of the $100 million in borrowings outstanding under its Amended and Restated Credit Agreement and to finance a portion of the purchase price of the Catarina Acquisition. We used the remaining proceeds from the offering to fund a portion of the remaining 2014 capital budget and for general corporate purposes. The Original 6.125% Notes are the senior unsecured obligations of the Company and are guaranteed on a joint and several senior unsecured basis by, with certain exceptions, substantially all of the Company’s existing and future subsidiaries.

 

On September 12, 2014, we issued an additional $300 million in aggregate principal amount of our 6.125% senior notes due 2023 (the “Additional 6.125% Notes” and, together with the Original 6.125% Notes, the “6.125% Notes” and, together with the 7.75% Notes, the “Senior Notes”) in a private offering at an issue price of 100.75% of the principal amount of the Additional 6.125% Notes. We received net proceeds of $295.9 million, after deducting the initial purchasers’ discounts, adding premiums to face value of $2.3 million and deducting estimated offering expenses of $6.4 million.  The Company also received cash for accrued interest from June 27, 2014 through the date of the issuance of $3.8 million, for total net proceeds of $299.7 million from the sale of the Additional 6.125% Notes. The Additional 6.125% Notes were issued under the same indenture as the Original 6.125% Notes, and are, therefore, treated as a single

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class of securities under the indenture. We used a portion of the net proceeds from the offering to fund a portion of the 2014 capital budget and used the remainder of the net proceeds to fund a portion of the 2015 capital budget, and for general corporate purposes.

 

The 6.125% Notes are senior unsecured obligations and rank equally in right of payment with all of our existing and future senior unsecured indebtedness. The 6.125% Notes rank senior in right of payment to the Company’s future subordinated indebtedness. The 6.125% Notes are effectively junior in right of payment to all of the Company’s existing and future secured debt (including under the Second Amended and Restated Credit Agreement) to the extent of the value of the assets securing such debt. The 6.125% Notes are fully and unconditionally guaranteed (except for customary release provisions) on a joint and several senior unsecured basis by the subsidiary guarantors party to the indenture governing the 6.125% Notes. To the extent set forth in the indenture governing the 6.125% Notes, certain of our subsidiaries will be required to fully and unconditionally guarantee the 6.125% Notes on a joint and several senior unsecured basis in the future.

 

The indenture governing the 6.125% Notes, among other things, restricts our ability and our restricted subsidiaries’ ability to: (i) incur, assume or guarantee additional indebtedness or issue certain types of equity securities; (ii) pay distributions on, purchase or redeem shares or purchase or redeem subordinated debt; (iii) make certain investments; (iv) enter into certain transactions with affiliates; (v) create or incur liens on their assets; (vi) sell assets; (vii) consolidate, merge or transfer all or substantially all of their assets; (viii) restrict distributions or other payments from the Company’s restricted subsidiaries; and (ix) designate subsidiaries as unrestricted subsidiaries.

 

The Company has the option to redeem all or a portion of the 6.125% Notes, at any time on or after July 15, 2018 at the applicable redemption prices specified in the indenture plus accrued and unpaid interest. The Company may also redeem the 6.125% Notes, in whole or in part, at a redemption price equal to 100% of their principal amount plus a make whole premium, together with accrued and unpaid interest and additional interest, if any, to the redemption date, at any time prior to July 15, 2018. In addition, the Company may redeem up to 35% of the 6.125% Notes prior to July 15, 2017 under certain circumstances with an amount not greater than the net cash proceeds of one or more equity offerings at the redemption price specified in the indenture. The Company may also be required to repurchase the 6.125% Notes upon a change of control or if we sell certain Company assets.

 

On February 27, 2015, we completed an exchange offer of $1.15 billion aggregate principal amount of the 6.125% Notes that had been registered under the Securities Act for an equal amount of the 6.125% Notes that had not been registered under the Securities Act.

 

Pursuant to tripartite agreements by and among the Company, U.S. Bank National Association (“U.S. Bank”) and Delaware Trust Company (“Delaware Trust”), effective May 20, 2016, U.S. Bank resigned as the Trustee, Notes Custodian, Registar and Paying Agent (“Trustee”) under the indentures of the Senior Notes and Delaware Trust was appointed as successor Trustee.  No other changes to the indentures for the 6.125% Notes or the 7.75% Notes were made at the time of the change in Trustee.

 

Note 7. Derivative Instruments

 

To reduce the impact of fluctuations in oil and natural gas prices on the Company’s business and results of operations, and to protect the economics of property acquisitions at the time of execution, the Company periodically enters into derivative contracts with respect to a portion of its projected oil and natural gas production through various transactions that fix or modify the future prices to be realized. The derivative contracts may include fixed-for-floating price swaps (whereby, on the settlement date, the Company will receive or pay an amount based on the difference between a pre-determined fixed price and a variable market price for a notional quantity of production), put options (whereby the Company pays a cash premium in order to establish a fixed floor price for a notional quantity of production and, on the settlement date, receives the excess, if any, of the fixed price floor over a variable market price), and costless collars (whereby, on the settlement date, the Company receives the excess, if any, of a variable market price over a fixed floor price up to a fixed ceiling price for a notional quantity of production). In addition, the Company periodically enters into call swaptions as a way to achieve greater downside price protection than offered under prevailing fixed-for-floating price swaps by agreeing to expand the notional quantity hedged under a fixed-for-floating price swap at the counterparty’s election on a designated date.

 

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These hedging activities, which are governed by the terms of our Second Amended and Restated Credit Agreement, are intended to support oil and natural gas prices at targeted levels and manage exposure to oil and natural gas price fluctuations.  It is our policy to enter into derivative contracts only with counterparties that are creditworthy and competitive market makers. All of our derivatives with lenders, or affiliates of lenders, in our Second Amended and Restated Credit Agreement are collateralized by the assets securing our Second Amended and Restated Credit Agreement and, therefore, do not currently require the posting of cash collateral. Our existing derivatives with non-lender counterparties, as designated under the Second Amended and Restated Credit Agreement, are unsecured and do not require the posting of cash collateral. It is never the Company’s intention to enter into derivative contracts for speculative trading purposes.  

 

All of our derivatives are accounted for as mark-to-market activities. Under ASC Topic 815, “Derivatives and Hedging,” these instruments are recorded on the condensed consolidated balance sheets at fair value as either short term or long term assets or liabilities based on their anticipated settlement date. The Company nets derivative assets and liabilities by commodity for counterparties where a legal right to such offset exists. Changes in the derivatives’ fair values are recognized in current earnings since the Company has elected not to designate its current derivative contracts as cash flow hedges for accounting purposes.

The following table presents derivative positions for the periods indicated as of September 30, 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

October 1 - December 31, 2016

 

2017

 

2018

 

2019

 

Oil positions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed-for-floating price swaps (NYMEX WTI):

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedged volume (Bbls)

 

 

644,000

 

 

1,460,000

 

 

 -

 

 

 -

 

Average price ($/Bbl)

 

$

70.11

 

$

52.13

 

$

 -

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Call swaptions (NYMEX WTI):

 

 

 

 

 

 

 

 

 

 

 

 

 

Option volume (Bbls) (1)

 

 

 -

 

 

365,000

 

 

 -

 

 

 -

 

Average price ($/Bbl)

 

$

 -

 

$

50.00

 

$

 -

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Put options (NYMEX WTI):

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedged volume (Bbls)

 

 

1,012,000

 

 

 -

 

 

 -

 

 

 -

 

Average price ($/Bbl)

 

$

60.00

 

$

 -

 

$

 -

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collars (NYMEX WTI):

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedged volume (Bbls)

 

 

 -

 

 

730,000

 

 

 -

 

 

 -

 

Average long put price ($/Bbl)

 

$

 -

 

$

45.00

 

$

 -

 

$

 -

 

Average short call price ($/Bbl)

 

$

 -

 

$

62.00

 

$

 -

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural gas positions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed-for-floating price swaps (NYMEX Henry Hub):

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedged volume (MMBtu)

 

 

8,280,000

 

 

34,135,000

 

 

14,600,000

 

 

7,300,000

 

Average price ($/MMBtu)

 

$

3.17

 

$

3.02

 

$

3.01

 

$

3.02

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Call swaptions (NYMEX Henry Hub):

 

 

 

 

 

 

 

 

 

 

 

 

 

Option volume (MMBtu) (1)

 

 

 -

 

 

 -

 

 

3,650,000

 

 

 -

 

Average price ($/MMBtu)

 

$

 -

 

$

 -

 

$

3.00

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

Represent options which settle into fixed-for-floating price swaps for the respective commodity at the counterparty's election on a designated date in the preceding year.

 

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 The following table sets forth a reconciliation of the changes in fair value of the Company’s commodity derivatives for the nine months ended September 30, 2016, and the year ended December 31, 2015 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

Year Ended

 

 

 

September 30, 

 

December 31, 

 

 

    

2016

    

2015

 

Beginning fair value of commodity derivatives

 

$

178,283

 

$

123,316

 

Net losses on crude oil derivatives

 

 

(31,826)

 

 

170,592

 

Net losses on natural gas derivatives

 

 

(3,904)

 

 

26,843

 

Net settlements on derivative contracts:

 

 

 

 

 

 

 

Crude oil

 

 

(111,305)

 

 

(123,946)

 

Natural gas

 

 

(23,070)

 

 

(18,522)

 

Net premiums on derivative contracts:

 

 

 

 

 

 

 

Crude oil

 

 

18,377

 

 

 -

 

Ending fair value of commodity derivatives

 

$

26,555

 

$

178,283

 

 

Balance Sheet Presentation

 

The Company nets derivative assets and liabilities by commodity for counterparties where legal right to such offset exists. Therefore, the Company’s derivatives are presented on a net basis as “Fair value of derivative instruments” on the condensed consolidated balance sheets. The following information summarizes the gross fair values of derivative instruments, presenting the impact of offsetting the derivative assets and liabilities on the Company’s condensed consolidated balance sheets (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2016

 

 

 

 

 

 

Gross Amounts

 

Net Amounts

 

 

 

Gross Amount

 

Offset in the

 

Presented in the

 

 

 

of Recognized

 

Consolidated

 

Consolidated

 

 

    

Assets

    

Balance Sheets

    

Balance Sheets

  

Offsetting Derivative Assets:

 

 

 

 

 

 

 

 

 

 

Current asset

 

$

32,767

 

$

(2,933)

 

$

29,834

 

Long-term asset

 

 

4,270

 

 

(1,529)

 

 

2,741

 

Total asset

 

$

37,037

 

$

(4,462)

 

$

32,575

 

Offsetting Derivative Liabilities:

 

 

 

 

 

 

 

 

 

 

Current liability

 

$

(6,660)

 

$

2,933

 

$

(3,727)

 

Long-term liability

 

 

(3,822)

 

 

1,529

 

 

(2,293)

 

Total liability

 

$

(10,482)

 

$

4,462

 

$

(6,020)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

 

 

 

Gross Amounts

 

Net Amounts

 

 

 

Gross Amount

 

Offset in the

 

Presented in the

 

 

 

of Recognized

 

Consolidated

 

Consolidated

 

 

    

Assets

    

Balance Sheets

    

Balance Sheets

  

Offsetting Derivative Assets:

 

 

 

 

 

 

 

 

 

 

Current asset

 

$

172,518

 

$

(24)

 

$

172,494

 

Long-term asset

 

 

5,821

 

 

(32)

 

 

5,789

 

Total asset

 

$

178,339

 

$

(56)

 

$

178,283

 

Offsetting Derivative Liabilities:

 

 

 

 

 

 

 

 

 

 

Current liability

 

$

(24)

 

$

24

 

$

 —

 

Long-term liability

 

 

(32)

 

 

32

 

 

 —

 

Total liability

 

$

(56)

 

$

56

 

$

 —

 

 

 

 

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Note 8. Investments

 

On October 2, 2015, the Company, through SN Midstream, LLC, a wholly-owned subsidiary of the Company (“SN Midstream”), entered into joint venture agreements with an affiliate of Targa to, among other things, construct a new cryogenic natural gas processing plant (the “Processing Plant”) and associated high pressure gathering pipelines near the Company’s Catarina asset in the Eagle Ford Shale. The Processing Plant, owned by the joint venture Carnero Processing, LLC (“Carnero Processing”), which is currently under construction and located in La Salle County, Texas, is expected to have initial capacity of 200 MMcf per day with the ability to increase to 260 MMcf per day. In connection with the Processing Plant joint venture agreement, SN Midstream committed to invest approximately $80 million and received a 50% ownership interest in Carnero Processing. Construction is expected to be completed in 2017. In connection with the gathering pipelines joint venture agreement, SN Midstream committed to invest approximately $35 million and received a 50% ownership interest in the joint venture, Carnero Gathering, LLC (“Carnero Gathering”), owning the gathering pipelines that will connect the Company's existing Catarina gathering system to the Processing Plant.

On July 5, 2016, SN Midstream sold its membership interests in Carnero Gathering to SPP for an initial payment of approximately $37.0 million and the assumption by SPP of remaining capital commitments to Carnero Gathering, estimated at approximately $7.4 million (the “Carnero Gathering Transaction”). Prior to the sale, the Company had invested approximately $26.0 million in Carnero Gathering joint venture. As part of the Carnero Gathering Transaction, SPP is required to pay SN Midstream a monthly earnout based on gas received at Carnero Gathering’s receipt points from SN Catarina and gas delivered and processed at the Processing Plant by other producers.  The membership interests disposed of constitute 50% of the outstanding membership interests in Carnero Gathering. The remaining 50% membership interests of Carnero Gathering are owned by an affiliate of Targa. Prior to the sale of Carnero Gathering, the Company recorded earnings of approximately $2.3 million from equity investments during 2016. The Company recorded a deferred gain of approximately $8.7 million included in “Other Liabilities” as a result of the gas gathering agreement that remains between the Company and Targa and a transportation services agreement between Targa and Carnero Gathering. This deferred gain will be amortized periodically over the term of this gas gathering agreement according to volumes delivered through the Carnero Gathering pipelines.

 

As of September 30, 2016, the Company had invested approximately $40.2 million in Carnero Processing. The Company is accounting for this investment as an equity method investments as Targa is the operator of the joint venture and has the most influence with respect to the normal day-to-day construction and operating decisions. We have included the equity method investment balance in the “Other Assets - Investments” long-term asset line on the balance sheet. The Company recorded losses of approximately $39 thousand and $66 thousand from equity investments from Carnero Processing for the three and nine months ended September 30, 2016, respectively. We have included these equity method earnings and losses in the “Earnings from equity investments” line on the statement of operations. On October 6, 2016, the Company announced a definitive agreement to sell its interests and any remaining commitment to invest in Carnero Processing to SPP (see further discussion in Note 20, “Subsequent Events”).

 

On October 2, 2015, the Company, via SN Catarina, purchased from a subsidiary of Targa a 10% undivided interest in the Silver Oak II Gas Processing Facility (the “SOII Facility”) in Bee County, Texas for a purchase price of $12.5 million. Targa owns the remaining undivided 90% interest in the SOII Facility, which is operated by Targa. Concurrently with the execution of the purchase and sale agreement for the SOII Facility, the Company entered into a firm gas processing agreement, whereby Targa began processing a firm quantity, 125,000 Mcf per day, on March 1, 2016 until the in-service date of the Processing Plant discussed above. The Company is accounting for its interest in the SOII Facility as an equity method investment as Targa is the operator and majority interest owner of the SOII Facility. As of September 30, 2016, the Company had invested $12.5 million in the SOII Facility. The Company recorded earnings of approximately $502  thousand and $930  thousand from the equity interest in the SOII Facility for the three and nine months ended September 30, 2016.

 

 

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Note 9. Fair Value of Financial Instruments

 

Measurements of fair value of derivative instruments are classified according to the fair value hierarchy, which prioritizes the inputs to the valuation techniques used to measure fair value. Fair value is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are classified and disclosed in one of the following categories:

 

Level 1: Measured based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Active markets are considered those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 

Level 2: Measured based on quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes those derivative instruments that can be valued using observable market data. Substantially all of these inputs are observable in the marketplace throughout the term of the derivative instrument, can be derived from observable data, or supported by observable levels at which transactions are executed in the marketplace.

 

Level 3: Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e. supported by little or no market activity). The valuation models used to value derivatives associated with the Company’s oil and natural gas production are primarily industry standard models that consider various inputs including: (a) quoted forward prices for commodities, (b) time value and (c) current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Although third-party quotes are utilized to assess the reasonableness of the prices and valuation techniques, there is not sufficient corroborating evidence to support classifying these assets and liabilities as Level 2.

 

Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. Management’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.

 

Fair Value on a Recurring Basis

 

The following tables set forth, by level within the fair value hierarchy, the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of September 30, 2016

 

 

 

Active Market

 

 

 

 

 

 

 

 

 

 

 

 

for Identical

 

Observable

 

Unobservable

 

Total

 

 

 

Assets

 

Inputs

 

Inputs

 

Carrying

 

 

    

(Level 1)

    

(Level 2)

    

(Level 3)

    

Value

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

113,081

 

$

 —

 

$

 —

 

$

113,081

 

Oil derivative instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Swaps

 

 

 —

 

 

14,251

 

 

 —

 

 

14,251

 

Call swaptions

 

 

 —

 

 

(1,573)

 

 

 —

 

 

(1,573)

 

Collars

 

 

 —

 

 

754

 

 

 —

 

 

754

 

Puts

 

 

 —

 

 

11,284

 

 

 —

 

 

11,284

 

Gas derivative instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Swaps

 

 

 —

 

 

1,988

 

 

 —

 

 

1,988

 

Call swaptions

 

 

 —

 

 

(149)

 

 

 —

 

 

(149)

 

Total

 

$

113,081

 

$

26,555

 

$

 —

 

$

139,636

 

 

 

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Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2015

 

 

 

Active Market

 

 

 

 

 

 

 

 

 

 

 

 

for Identical

 

Observable

 

Unobservable

 

Total

 

 

 

Assets

 

Inputs

 

Inputs

 

Carrying

 

 

    

(Level 1)

    

(Level 2)

    

(Level 3)

    

Value

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

399,448

 

$

 —

 

$

 —

 

$

399,448

 

Oil derivative instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Swaps

 

 

 —

 

 

72,887

 

 

 —

 

 

72,887

 

Puts

 

 

 —

 

 

76,583

 

 

 —

 

 

76,583

 

Gas derivative instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Swaps

 

 

 —

 

 

28,813

 

 

 —

 

 

28,813

 

Total

 

$

399,448

 

$

178,283

 

$

 —

 

$

577,731

 

 

Financial Instruments:  The Level 1 instruments presented in the tables above consist of money market funds and time deposits included in cash and cash equivalents on the Company’s condensed consolidated balance sheets at September 30, 2016 and December 31, 2015. The Company’s money market funds and time deposits represent cash equivalents backed by the assets of high-quality banks and financial institutions. The Company identified the money market funds and time deposits as Level 1 instruments due to the fact that these instruments have daily liquidity, quoted prices for the underlying investments can be obtained and there are active markets for the underlying investments.

 

The Company’s derivative instruments, which consist of swaps, puts, call swaptions and collars, are classified as Level 2 as of September 30, 2016 and December 31, 2015 in the table above. The fair values of the Company’s derivatives are based on third-party pricing models which utilize inputs that are either readily available in the public market, such as forward curves, or can be corroborated from active markets of broker quotes. Swaps and collars generally have no unobservable inputs and they are classified as Level 2. Puts and call swaption derivatives have inputs which are observable, either directly or indirectly, using market data. As of September 30, 2016, the Company believes that substantially all of the inputs required to calculate the fair value of puts and call swaptions are observable in the marketplace throughout the term of these derivative instruments or supported by observable levels at which transactions are executed in the marketplace, and are, therefore, classified as Level 2. As of December 31, 2015, the Company believes that substantially all of the inputs required to calculate the fair value of swaps and puts are observable in the marketplace throughout the term of these derivative instruments or supported by observable levels at which transactions are executed in the marketplace, and are, therefore, classified as Level 2. Derivative instruments are also subject to the risk that counterparties will be unable to meet their obligations. Such non-performance risk is considered in the valuation of the Company’s derivative instruments, but to date has not had a material impact on estimates of fair values. Significant changes in the quoted forward prices for commodities and changes in market volatility generally lead to corresponding changes in the fair value measurement of the Company’s derivative instruments.

 

There were no derivative instruments classified as Level 3 as of September 30, 2016 or December 31, 2015. 

 

Fair Value on a Non‑Recurring Basis

 

The Company follows the provisions of ASC 820-10 for nonfinancial assets and liabilities measured at fair value on a non-recurring basis. Fair value measurements of assets acquired and liabilities assumed in business combinations are based on inputs that are not observable in the market and thus represent Level 3 inputs. The fair value of acquired properties is based on market and cost approaches. Our purchase price allocation for the Catarina Acquisition is presented in Note 3, “Acquisitions and Divestitures.” Liabilities assumed include asset retirement obligations existing at the date of acquisition. Asset retirement obligation estimates are derived from historical costs as well as management’s expectation of future cost environments. As there is no corroborating market activity to support the assumptions, the Company has designated these liabilities as Level 3. A reconciliation of the beginning and ending balances of the Company’s asset retirement obligations is presented in Note 10, “Asset Retirement Obligations.”

 

In connection with the exchange agreements entered into in February, May and August 2014 by the Company with certain holders of the Company’s Series A Convertible Perpetual Preferred Stock (“Series A Preferred Stock”) and Series B Convertible Perpetual Preferred Stock (“Series B Preferred Stock”), the Company issued common stock

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according to the conversion rate pursuant to each agreement and additional shares to induce the holders of the preferred stock to convert prior to the date the Company could mandate conversion. In addition, on November 20, 2015, a holder of our Series B Preferred Stock exercised its right to convert 4,500 shares of our Series B Preferred Stock, at the prescribed initial conversion rate of 2.337 shares of common stock per share of Series B Preferred Stock, in exchange for 10,517 shares of our common stock. The fair value of the common stock issued is based on the price of the Company’s common stock on the date of issuance. As there is an active market for the Company’s common stock, the Company has designated this fair value measurement as Level 1. A detailed description of the Company’s common stock and preferred stock issuances and redemptions is presented in Note 13, “Stockholders’ Equity.”

 

Fair Value of Other Financial Instruments

 

The carrying amounts of our oil and natural gas receivables, accounts payable and accrued liabilities approximate fair value due to the highly liquid nature of these short-term instruments. The registered 7.75% Notes are traded in an active market, and as such, are classified as Level 1 financial instruments. The estimated fair value of the 7.75% Notes was $525.0 million as of September 30, 2016 and was calculated using quoted market prices based on trades of such debt as of that date. The registered 6.125% Notes are traded in an active market, and as such, are classified as Level 1 financial instruments. The estimated fair value of the 6.125% Notes was $914.3 million as of September 30, 2016 and was calculated using quoted market prices based on trades of such debt as of that date.

 

Note 10. Asset Retirement Obligations

 

Asset retirement obligations represent the present value of the estimated cash flows expected to be incurred to plug, abandon and remediate producing properties, excluding salvage values, at the end of their productive lives in accordance with applicable laws.

 

The significant unobservable inputs to this fair value measurement include estimates of plugging, abandonment and remediation costs, well life, inflation and credit‑adjusted risk‑free rate. The inputs are calculated based on third-party historical data as well as current estimates. When the liability is initially recorded, the carrying amount of the related long‑lived asset is increased. Over time, accretion of the liability is recognized each period, and the capitalized cost is amortized over the useful life of the related asset. Upon settlement of the liability, any gain or loss is treated as an adjustment to the full cost pool.

 

Revisions in estimated liabilities can include, but are not limited to, revisions of estimates of asset retirement costs, revisions of estimated inflation rates, changes in property lives, and the expected timing of settlement. The changes in the asset retirement obligation for the nine months ended September 30, 2016 and the year ended December 31, 2015 were as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2016

 

Year Ended December 31, 2015

 

Abandonment liability, beginning of period

 

$

25,907

 

$

25,694

 

Liabilities incurred during period

 

 

1,134

 

 

6,021

 

Acquisitions

 

 

219

 

 

 —

 

Divestitures

 

 

(131)

 

 

(379)

 

Revisions

 

 

 —

 

 

(7,623)

 

Accretion expense

 

 

1,538

 

 

2,194

 

Abandonment liability, end of period

 

$

28,667

 

$

25,907

 

 

 

 

Note 11. Related Party Transactions

 

SOG, headquartered in Houston, Texas, is a private full service oil and natural gas company engaged in the exploration and development of oil and natural gas primarily in the South Texas and onshore Gulf Coast areas on behalf of its affiliates. The Company refers to SOG, Sanchez Energy Partners I, LP (“SEP I”), and their affiliates (but excluding the Company) collectively as the “Sanchez Group.” The Company does not have any employees. On December 19, 2011 the Company entered into a services agreement with SOG pursuant to which specified employees of SOG provide certain services with respect to the Company’s business under the direction, supervision and control of SOG. Pursuant to this arrangement, SOG performs centralized corporate functions for the Company, such as general and administrative

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services, geological, geophysical and reserve engineering, lease and land administration, marketing, accounting, operational services, information technology services, compliance, insurance maintenance and management of outside professionals. The Company compensates SOG for the services at a price equal to SOG’s cost of providing such services, including all direct costs and indirect administrative and overhead costs (including the allocable portion of salary, bonus, incentive compensation and other amounts paid to persons that provide the services on SOG’s behalf) allocated in accordance with SOG’s regular and consistent accounting practices, including for any such costs arising from amounts paid directly by other members of the Sanchez Group on SOG’s behalf or borrowed by SOG from other members of the Sanchez Group, in each case, in connection with the performance by SOG of services on the Company’s behalf. The Company also reimburses SOG for sales, use or other taxes, or other fees or assessments imposed by law in connection with the provision of services to the Company (other than income, franchise or margin taxes measured by SOG’s net income or margin and other than any gross receipts or other privilege taxes imposed on SOG) and for any costs and expenses arising from or related to the engagement or retention of third-party service providers.

 

Salaries and associated benefits of SOG employees and are allocated to the Company based on a fixed percentage that is reviewed quarterly and adjusted, if needed, based on a detailed analysis of actual time spent by the professional staff on Company projects and activities. General and administrative expenses such as office rent, utilities, supplies and other overhead costs, are allocated on the same percentages as the SOG employee salaries. Expenses allocated to the Company for general and administrative expenses for the three and nine months ended September 30, 2016 and 2015, are as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

    

2016

    

2015

    

2016

    

2015

    

  

Administrative fees

 

$

8,028

 

$

6,694

 

$

28,028

 

$

19,548

 

 

Third-party expenses

 

 

700

 

 

1,534

 

 

4,357

 

 

3,550

 

 

Total included in general and administrative expenses

 

$

8,728

 

$

8,228

 

$

32,385

 

$

23,098

 

 

 

As of September 30, 2016 and December 31, 2015, the Company had a net receivable from SOG and other members of the Sanchez Group of $2.2 million and $3.7 million, respectively, which are reflected as “Accounts receivable—related entities” in the condensed consolidated balance sheets. The net receivable as of September 30, 2016 and December 31, 2015 consists primarily of advances paid related to general and administrative and other costs paid to SOG.

 

As of September 30, 2016 and December 31, 2015, the Company had a net payable to SPP of approximately $8.7 million and $4.4 million, respectively, that consists primarily of the accrual for fees associated with the Gathering Agreement (see Note 3, “Acquisitions and Divestitures” for further discussion), which is reflected in the “Accrued Liabilities - Other” account on the consolidated balance sheets. 

 

Palmetto Divestiture

 

On March 31, 2015, we completed the Palmetto Divestiture discussed above to a subsidiary of SPP, which is a related party (see Note 3, “Acquisitions and Divestitures”). The second phase of the escalating working interests on the sold Palmetto wells was effective on January 1, 2016.

 

Western Catarina Midstream Divestiture

 

On October 14, 2015, we completed the Western Catarina Midstream Divestiture discussed above to SPP, which is a related party (see Note 3, “Acquisitions and Divestitures”).

 

Carnero Gathering Sale

 

On July 5, 2016, the Company sold its interests and any remaining commitment to invest in Carnero Gathering to SPP (see further discussion in Note 8, “Investments”).

 

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TMS Asset Purchase

 

In August 2013, we acquired rights to approximately 40,000 net undeveloped acres in what we believe to be the core of the TMS (the ‘‘TMS Transaction’’) for cash and shares of our common stock plus an initial 3 gross (1.5 net) well drilling carry (the ‘‘Initial Well Carry’’). In connection with the TMS Transaction, we established an Area of Mutual Interest (‘‘AMI’’) in the TMS with SR Acquisition I, LLC (“SR”), a subsidiary of our affiliate Sanchez Resources, LLC (“Sanchez Resources”), which transaction included a carry on drilling costs for up to 6 gross (3 net) wells. Patricio Sanchez and Ana Lee Sanchez Jacobs, each an immediate family member of our President, Chief Executive Officer and the Executive Chairman of the Company’s Board of Directors (the “Board”), collectively with Messrs. Sanchez, Jr., Sanchez, III and Eduardo Sanchez, either directly or indirectly, own a majority of  the equity interests of Sanchez Resources. Sanchez Resources is managed by our President, Eduardo Sanchez.  In addition, Ms. Hink and Mr. Heinson own 15 and 65 units of phantom equity in Sanchez Resources, respectively

 

As part of the transaction, we acquired all of the working interests in the AMI owned at closing from three sellers (two third parties and one related party of the Company, SR) resulting in our owning an undivided 50% working interest across the AMI through the TMS.

 

Total consideration for the TMS Transaction consisted of approximately $70 million in cash and the issuance of 342,760 shares of common stock of the Company, valued at approximately $7.5 million. The cash consideration provided to SR was $14.4 million, before consideration of any well carries. The acquisitions were accounted for as the purchase of assets at cost on the acquisition date. We also committed, as a part of the total consideration, to carry SR for its 50% working interest in an initial 3 gross (1.5 net) TMS wells to be drilled within the AMI (the “Initial Well Carry”) with an option to drill an additional 6 gross (3 net) TMS wells (“Additional Wells”) within the AMI. In August 2015, the Company signed an agreement with SR whereby the Company paid SR approximately $8 million in lieu of drilling the remaining two Additional Wells (the “Buyout Agreement”). The Buyout Agreement stipulates that SN has earned full rights to all acreage stated in the TMS Transaction and effectively terminates any future well carry commitments.

 

Subsequent Transactions

 

See Note 20, “Subsequent Events” for a discussion of three additional agreements with SPP entered into on October 6, 2016.

 

 

Note 12. Accrued Liabilities

 

The following information summarizes accrued liabilities as of September 30, 2016 and December 31, 2015 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

 

    

2016

    

2015

  

Capital expenditures

 

$

40,661

 

$

51,983

 

Other:

 

 

 

 

 

 

 

General and administrative costs

 

 

5,369

 

 

5,214

 

Production taxes

 

 

2,151

 

 

2,532

 

Ad valorem taxes

 

 

3,093

 

 

886

 

Lease operating expenses

 

 

26,818

 

 

27,077

 

Interest payable

 

 

28,281

 

 

34,265

 

Preferred dividends payable

 

 

3,987

 

 

 —

 

Total Other

 

$

69,699

 

$

69,974

 

Total accrued liabilities

 

$

110,360

 

$

121,957

 

 

 

Note 13. Stockholders’ Equity

 

Common Stock Offerings— On September 18, 2013, the Company completed a public offering of 11,040,000 shares of common stock (including 1,440,000 shares purchased pursuant to the full exercise of the underwriters’ overallotment option), at an issue price of $23.00 per share. The Company received net proceeds from this offering of $241.4 million, after deducting underwriters’ fees and offering expenses of $12.5 million. The Company used the net

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proceeds from the offering to partially fund the Wycross Acquisition completed in October 2013 and a portion of the 2013 and 2014 capital budgets, and for general corporate purposes.

 

On June 12, 2014, the Company completed a public offering of 5,000,000 shares of common stock, at an issue price of $35.25 per share. The Company received net proceeds from this offering of $167.5 million, after deducting underwriters’ fees and offering expenses of $8.7 million. The Company used the net proceeds from the offering to partially fund the 2014 capital budget and for general corporate purposes.

 

Series A Preferred Stock Offering—On September 17, 2012, the Company completed a private placement of 3,000,000 shares of Series A Preferred Stock, which were sold to a group of qualified institutional buyers pursuant to the Rule 144A exemption from registration under the Securities Act. The issue price of each share of the Series A Preferred Stock was $50.00. The Company received net proceeds from the private placement of $144.5 million, after deducting initial purchasers’ discounts and commissions and offering costs of $5.5 million.

 

Each share of Series A Preferred Stock is convertible at any time at the option of the holder thereof at an initial conversion rate of 2.325 shares of common stock per share of Series A Preferred Stock (which is equal to an initial conversion price of $21.51 per share of common stock) and is subject to specified adjustments. As of September 30, 2016, based on the initial conversion price, approximately 4,275,640 shares of common stock would be issuable upon conversion of all of the outstanding shares of the Series A Preferred Stock.

 

The annual dividend on each share of Series A Preferred Stock is 4.875% on the liquidation preference of $50.00 per share and is payable quarterly, in arrears, on each January 1, April 1, July 1 and October 1, when, as and if declared by the Board. The Company may, at its option, pay dividends in cash and, subject to certain conditions, common stock or any combination thereof. Dividends are cumulative, and as of September 30, 2016, all dividends accumulated through that date had been paid. The dividends accrued for the period from July 1 to September 30, 2016, were declared by the Board and paid with the Company’s common stock on October 3, 2016. 

 

Except as required by law or the Company’s Amended and Restated Certificate of Incorporation (the “Charter”), holders of the Series A Preferred Stock will have no voting rights unless dividends fall into arrears for six or more quarterly periods (whether or not consecutive). In that event and until such arrearage is paid in full, the holders of the Series A Preferred Stock and the holders of the Series B Preferred Stock, voting as a single class, will be entitled to elect two directors and the number of directors on the Board will increase by that same number.

 

At any time on or after October 5, 2017, the Company may at its option cause all outstanding shares of the Series A Preferred Stock to be automatically converted into common stock at the conversion price, if, among other conditions, the closing sale price (as defined) of the Company’s common stock equals or exceeds 130% of the conversion price for a specified period prior to the conversion.

 

If a holder elects to convert shares of Series A Preferred Stock upon the occurrence of certain specified fundamental changes, the Company will be obligated to deliver an additional number of shares above the applicable conversion rate to compensate the holder for lost option time value of the shares of Series A Preferred Stock as a result of the fundamental change.

 

Series B Preferred Stock Offering—On March 26, 2013, the Company completed a private placement of 4,500,000 shares of Series B Preferred Stock. The issue price of each share of the Series B Preferred Stock was $50.00. The Company received net proceeds from the private placement of $216.6 million, after deducting placement agent’s fees and offering costs of $8.4 million.

 

Each share of Series B Preferred Stock is convertible at any time at the option of the holder thereof at an initial conversion rate of 2.337 shares of common stock per share of Series B Preferred Stock (which is equal to an initial conversion price of $21.40 per share of common stock) and is subject to specified adjustments. As of September 30, 2016, based on the initial conversion price, approximately 8,244,539 shares of common stock would be issuable upon conversion of all of the outstanding shares of the Series B Preferred Stock.

 

The annual dividend on each share of Series B Preferred Stock is 6.500% on the liquidation preference of $50.00 per share and is payable quarterly, in arrears, on each January 1, April 1, July 1 and October 1, when, as and if declared by the Board. The Company may, at its option, pay dividends in cash and, subject to certain conditions,

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common stock or any combination thereof. Dividends are cumulative, and as of September 30, 2016, all dividends accumulated through that date had been paid. The dividends accrued for the period from July 1 to September 30, 2016, were declared by the Board and paid with the Company’s common stock on October 3, 2016. 

 

Except as required by law or the Charter, holders of the Series B Preferred Stock will have no voting rights unless dividends fall into arrears for six or more quarterly periods (whether or not consecutive). In that event and until such arrearage is paid in full, the holders of the Series B Preferred Stock and the holders of the Series A Preferred Stock, voting as a single class, will be entitled to elect two directors and the number of directors on the Board will increase by that same number.

 

At any time on or after April 6, 2018, the Company may at its option cause all outstanding shares of the Series B Preferred Stock to be automatically converted into common stock at the conversion price, if, among other conditions, the closing sale price (as defined) of the Company’s common stock equals or exceeds 130% of the conversion price for a specified period prior to the conversion.

 

If a holder elects to convert shares of Series B Preferred Stock upon the occurrence of certain specified fundamental changes, the Company will be obligated to deliver an additional number of shares above the applicable conversion rate to compensate the holder for lost option time value of the shares of Series B Preferred Stock as a result of the fundamental change.

 

Preferred Stock Exchange—On February 12, 2014 and February 13, 2014, the Company entered into exchange agreements with certain holders (the “February 2014 Holders”) of the Series A Preferred Stock and the Series B Preferred Stock pursuant to which such holders agreed to exchange an aggregate of (i) 947,490 shares of the Series A Preferred Stock (and waive their rights to any accrued and unpaid dividends thereon) for 2,425,574 shares of the Company’s common stock, and (ii) 756,850 shares of the Series B Preferred Stock (and waive their rights to any accrued and unpaid dividends thereon) for 2,021,066 shares of the Company’s common stock.

 

Additionally, on May 29, 2014, the Company entered into exchange agreements with certain holders (the “May 2014 Holders”) of the Series A Preferred Stock and the Series B Preferred Stock pursuant to which such holders agreed to exchange an aggregate of (i) 166,025 shares of the Series A Preferred Stock (and waive their rights to any accrued and unpaid dividends thereon) for 418,715 shares of the Company’s common stock, and (ii) 210,820 shares of the Series B Preferred Stock (and waive their rights to any accrued and unpaid dividends thereon) for 553,980 shares of the Company’s common stock.

 

Further, on August 28, 2014, the Company entered into exchange agreements with certain holders (the “August 2014 Holders,” and together with the May 2014 Holders and the February 2014 Holders, the “Holders”) of the Series A Preferred Stock, pursuant to which such holders agreed to exchange an aggregate of 47,500 shares of the Series A Preferred Stock (and waive their rights to any accrued and unpaid dividends thereon) for 119,320 shares of the Company’s common stock.

 

Since the Holders were not entitled to any consideration over and above the initial conversion rates of 2.325 and 2.337 shares of common stock for each preferred share exchanged for Series A Preferred Stock and Series B Preferred Stock, respectively, any consideration is considered an inducement for the Holders to convert earlier than the Company could have forced conversion.

 

The Company has determined the fair value of consideration transferred to the Holders and the fair value of consideration transferrable pursuant to the original conversion terms. The $13.9 million, $3.1 million and $0.3 million excess of the fair value of the shares of common stock issued over the carrying value of the Series A Preferred Stock and Series B Preferred Stock redeemed in connection with the exchange agreements entered into in February, May and August 2014, respectively, has been reflected as an additional preferred stock dividend (i.e., as an increase in accumulated deficit) to arrive at net loss attributable to common stockholders in our condensed consolidated financial statements.

 

Preferred Stock Conversion—On November 20, 2015, a holder of our Series B Convertible Perpetual Preferred Stock exercised its right to convert 4,500 shares our Series B Convertible Perpetual Preferred Stock, at the prescribed initial conversion rate of 2.337 shares of common stock per share of Series B Convertible Perpetual Preferred Stock, in exchange for 10,517 shares of our common stock.

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NOL Rights Plan—On July 28, 2015, the Company entered into a net operating loss carryforwards (“NOLs”) rights plan with Continental Stock Transfer & Trust Company, as rights agent. In connection therewith, the Board declared a dividend of one preferred share purchase right (“Right”) for each outstanding share of the Company’s common stock. The dividend was paid on August 10, 2015 to stockholders of record as of the close of business on August 7, 2015 (the “NOL Record Date”). In addition, one Right automatically attached to each share of common stock issued between the NOL Record Date and such date as when the Rights become exercisable.

 

Earnings (Loss) Per Share—The following table shows the computation of basic and diluted net loss per share for the three and nine months ended September 30, 2016 and 2015 (in thousands, except per share amounts):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 

 

September 30, 

 

 

    

2016

    

2015

    

2016

    

2015

    

Net loss

 

$

(66,262)

 

$

(416,860)

 

$

(314,906)

 

$

(1,477,115)

 

Less:

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock dividends

 

 

(3,987)

 

 

(3,991)

 

 

(11,961)

 

 

(11,973)

 

Net loss allocable to participating securities(1)(2)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Net loss attributable to common stockholders

 

$

(70,249)

 

$

(420,851)

 

$

(326,867)

 

$

(1,489,088)

 

Weighted average number of unrestricted outstanding common shares used to calculate basic net loss per share

 

 

59,190

 

 

57,426

 

 

58,782

 

 

57,141

 

Dilutive shares(3)(4)

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

Denominator for diluted loss per common share

 

 

59,190

 

 

57,426

 

 

58,782

 

 

57,141

 

Net loss per common share - basic and diluted

 

$

(1.19)

 

$

(7.33)

 

$

(5.56)

 

$

(26.06)

 

 


(1)

The Company’s restricted shares of common stock are participating securities.

 

(2)

For the three and nine months ended September 30, 2016 and 2015, no losses were allocated to participating restricted stock because such securities do not have a contractual obligation to share in the Company’s losses.

 

(3)

The three and nine months ended September 30, 2016 excludes 1,035,102 and 1,565,007 shares, respectively, of weighted average restricted stock and 12,520,179 shares of common stock resulting from an assumed conversion of the Series A Preferred Stock and Series B Preferred Stock from the calculation of the denominator for diluted earnings per common share as these shares were anti-dilutive.

 

(4)

The three and nine months ended September 30, 2015 excludes 597,910 and 2,663,010 shares, respectively, of weighted average restricted stock and 12,530,695 shares of common stock resulting from an assumed conversion of the Series A Preferred Stock and Series B Preferred Stock from the calculation of the denominator for diluted earnings per common share as these shares were anti-dilutive.  

 

Note 14. Stock‑Based Compensation

 

At the Annual Meeting of Stockholders of the Company held on May 24, 2016 (“2016 Annual Meeting”), the Company’s stockholders approved the Sanchez Energy Corporation Third Amended and Restated 2011 Long Term Incentive Plan (the “LTIP”).

 

The Company’s directors and consultants as well as employees of the Sanchez Group who provide services to the Company are eligible to participate in the LTIP. Awards to participants may be made in the form of stock options, stock appreciation rights, restricted shares, phantom stock, other stock-based awards or stock awards, or any combination thereof. The maximum shares of common stock that may be delivered with respect to awards under the LTIP  shall be (i) 17,239,790 shares plus (ii) upon the issuance of additional shares of common stock from time to time after April 1, 2016, an automatic increase equal to the lesser of (A) 15% of such issuance of additional shares of common stock and (B) such lesser number of shares of common stock as determined by the Board or Compensation Committee; provided, however, shares withheld to satisfy tax withholding obligations are not considered to be delivered under the LTIP. If any award is forfeited, cancelled, exercised, paid, or otherwise terminates or expires without the actual delivery of shares of common stock pursuant to such award (the grant of restricted stock is not a delivery of shares of common stock for this purpose), the shares of common stock subject to such award shall again be available for awards

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under the LTIP. There shall not be any limitation on the number of awards that may be paid in cash.  Any shares delivered pursuant to an award shall consist, in whole or in part, of shares of common stock newly issued by the Company, shares of common stock acquired in the open market, from any affiliate of the Company, or any combination of the foregoing, as determined by the Board or Compensation Committee in its discretion.

 

The LTIP is administered by the Compensation Committee of the Board as appointed by the Board. The Board may terminate or amend the LTIP at any time with respect to any shares for which a grant has not yet been made. The Board has the right to alter or amend the LTIP or any part of the LTIP from time to time, including increasing the number of shares that may be granted, subject to stockholder approval as may be required by the exchange upon which the shares of common stock are listed at that time, if any. No change may be made in any outstanding grant that would materially reduce the benefits of the participant without the consent of the participant. The LTIP will expire upon its termination by the Board or, if earlier, when no shares remain available under the LTIP for awards. Upon termination of the LTIP, awards then outstanding will continue pursuant to the terms of their grants.

 

The Company records stock-based compensation expense for awards granted to its directors (for their services as directors) in accordance with the provisions of ASC 718, “Compensation—Stock Compensation.” Stock-based compensation expense for these awards is based on the grant-date fair value and recognized over the vesting period using the straight-line method.

 

Awards granted to employees of the Sanchez Group (including those employees of the Sanchez Group who also serve as the Company’s officers) and consultants in exchange for services are considered awards to non-employees and the Company records stock-based compensation expense for these awards at fair value in accordance with the provisions of ASC 505-50, “Equity-Based Payments to Non-Employees.” For awards granted to non-employees, the Company records compensation expenses equal to the fair value of the stock-based award at the measurement date, which is determined to be the earlier of the performance commitment date or the service completion date. Compensation expense for unvested awards to non-employees is revalued at each period end and is amortized over the vesting period of the stock-based award. Stock-based payments are measured based on the fair value of the equity instruments granted, as it is more determinable than the value of the services rendered.

 

For the restricted stock awards granted to non-employees, stock-based compensation expense is based on fair value re-measured at each reporting period and recognized over the vesting period using the straight-line method. Compensation expense for these awards will be revalued at each period end until vested.

 

During the three and nine months ended September 30, 2016, the Company issued approximately 0.1 million shares of restricted common stock pursuant to the LTIP to directors of the Company.

 

During the three and nine months ended September 30, 2016, the Company issued approximately 0.1 million and 4.2 million, respectively, shares of restricted common stock pursuant to the LTIP to certain employees (including the Company’s officers) and consultants of SOG, with whom the Company has a services agreement. The majority of these shares of restricted common stock vest in equal annual amounts over a three-year period.

 

In February 2016 and April 2016, the Compensation Committee approved several new forms of agreement for use in equity awards pursuant to the LTIP. The new forms of agreements consist of two new forms of restricted stock award agreements, one of which provides for vesting in equal annual increments over a three year period from the grant date (the “Grant Date”)  and the other of which provides for cliff vesting five years after the Grant Date or earlier if the common stock closing price equals or exceeds certain benchmarks as set forth in the form of agreement (the “Performance Accelerated Restricted Stock” or “PARS”), and two new forms of phantom stock agreements payable only in cash, one of which provides for vesting in equal annual increments over a three year period from the Grant Date (the “Phantom Stock”) and the other of which provides for cliff vesting five years after the Grant Date or earlier if the Company’s common stock closing price equals or exceeds certain benchmarks as set forth in the form of agreement (the “Performance Accelerated Phantom Stock” or “PAPS”).

 

The PARS, PAPS and Phantom Stock awards granted to certain employees of the Sanchez Group (including those employees of the Sanchez Group who also serve as the Company’s officers) and consultants in exchange for services are considered awards to non-employees and the Company records stock-based compensation expense for these awards at fair value in accordance with the provisions of ASC 718, “Compensation – Stock Compensation.” In accordance with the guidance, the inclusion of market performance acceleration conditions does not change the

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accounting classification as compared to the restricted stock without market performance acceleration conditions, as both are still classified as equity within the Company’s balance sheet. The Phantom Stock awards are required to be settled in cash by the Company and, per the guidance, should be classified as a liability.  Compensation expense for the unvested awards is revalued at each period end and is amortized over the vesting period of the stock-based award.

 

The Company recognized the following stock-based compensation expense (in thousands) which is included in general and administrative expense in the condensed consolidated statements of operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 

 

September 30, 

 

 

    

2016

    

2015

    

2016

    

2015

    

Restricted stock awards, directors

 

$

242

 

$

274

 

$

693

 

$

842

 

Restricted stock awards, non-employees

 

 

12,560

 

 

81

 

 

25,332

 

 

15,082

 

Total stock-based compensation expense

 

$

12,802

 

$

355

 

$

26,025

 

$

15,924

 

 

Based on the $8.84 per share closing price of the Company’s common stock on September 30, 2016, there was approximately $25.2 million of unrecognized compensation cost related to the non‑vested restricted shares outstanding. The cost is expected to be recognized over an average period of approximately 2.0 years.

 

Based on the $8.84 per share closing price of the Company’s common stock on September 30, 2016, there was approximately $30.2 million of unrecognized compensation cost related to the non‑vested PARS, PAPS, and Phantom Stock award shares outstanding. The cost is expected to be recognized over an average period of approximately 2.59 years.

 

A summary of the status of the non-vested shares for the nine months ended September 30, 2016 and 2015 is presented below (in thousands):

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

    

2016

 

2015

Non-vested common stock, beginning of period

 

 

4,426

 

 

2,718

Granted

 

 

4,329

 

 

3,421

Vested

 

 

(1,588)

 

 

(1,601)

Forfeited

 

 

(459)

 

 

(117)

Non-vested common stock, end of period

 

 

6,708

 

 

4,421

 

As of September 30, 2016, approximately 6.8 million shares remain available for future issuance to participants under the LTIP.

 

Note 15. Income Taxes

 

The Company's effective tax rate for the nine months ended September 30, 2016 and 2015 was (0.5)% and (0.5)%, respectively.  The difference between the statutory federal income taxes calculated using a U.S. Federal statutory corporate income tax rate of 35% and the Company’s effective tax rate of (0.5)% for the nine months ended September 30, 2016 is primarily related to the valuation allowance on deferred tax assets.  The difference between the statutory federal income taxes calculated using a U.S. Federal statutory corporate income tax rate of 35% and the Company’s effective tax rate of (0.5)% for the nine months ended September 30, 2015 is primarily related to related to the valuation allowance on deferred tax assets. 

 

The Company provides for deferred income taxes on the difference between the tax basis of an asset or liability and its carrying amount in the financial statements in accordance with authoritative guidance for accounting for income taxes. This difference will result in taxable income or deductions in future years when the reported amount of the asset or liability is recovered or settled, respectively.  In recording deferred income tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the periods in which those deferred income tax assets would be deductible. The Company believes that after considering all the available objective evidence, both positive and negative, historical and prospective, with greater weight given to historical evidence, management is not able to determine that it is more likely than not that the deferred tax assets will be realized

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and, therefore, has established a valuation allowance to reduce the net deferred tax asset to $0 at September 30, 2016. The Company will continue to assess the valuation allowance against deferred tax assets considering all available information obtained in future reporting periods.

 

At September 30, 2016, the Company had no material uncertain tax positions.

 

 

Note 16. Commitments and Contingencies

 

Litigation

 

From time to time, the Company may be involved in lawsuits that arise in the normal course of its business. We are not aware of any material governmental proceedings against us or contemplated to be brought against us.

 

On December 4, 2013, and December 16, 2013, three derivative actions were filed in the Court of Chancery of the State of Delaware against the Company, certain of its officers and directors, Sanchez Resources, Altpoint Capital Partners LLC and Altpoint Sanchez Holdings, LLC (Friedman v. A.R. Sanchez, Jr. et al., No. 9158; City of Roseville Employees’ Retirement System v. A.R. Sanchez, Jr. et al., No. 9132; and Delaware County Employees Retirement Fund v. A.R. Sanchez, Jr. et al., No. 9165 (collectively, the ‘‘Consolidated Derivative Actions’’)).

 

On December 20, 2013, the Consolidated Derivative Actions were consolidated, co-lead counsel for the plaintiffs was appointed and the plaintiffs were ordered to file an amended consolidated complaint (In re Sanchez Energy Derivative Litigation, Consolidated C.A. No. 9132-VCG, hereinafter, the “Delaware Derivative Action”). On January 28, 2014, a verified consolidated stockholder derivative complaint was filed. The Consolidated Derivative Actions concern the Company’s purchase of working interests in the TMS from SR. Plaintiffs alleged breaches of fiduciary duty against the individual defendants as directors of the Company; breaches of fiduciary duty against Antonio R. Sanchez, III as an executive director of the Company; aiding and abetting breaches of fiduciary duty against SR, Eduardo Sanchez, Altpoint Capital Partners LLC and Altpoint Sanchez Holdings, LLC; and unjust enrichment against A.R. Sanchez, Jr. and Antonio R. Sanchez, III. All of the defendants filed a motion to dismiss on April 1, 2014. Briefing concerning the motions to dismiss concluded on June 27, 2014. A hearing was held on August 11, 2014, on the motions to dismiss, and the court subsequently granted the motions to dismiss. The plaintiffs appealed the case to the Delaware Supreme Court for which the parties fully briefed the appeal and provided oral argument. On October 2, 2015, the Delaware Supreme Court reversed the motions to dismiss and remanded the case to the Court of Chancery of the State of Delaware. The Consolidated Derivative Actions are currently in the early stages of discovery.  A mediation in connection with the matter was held on July 7, 2016. The Company is unable to reasonably predict an outcome or to reasonably estimate a range of possible loss.

 

On January 9, 2014, a derivative action was filed in 333rd district court in Harris County, Texas against the Company and certain of its officers and directors, styled Martin v. Sanchez, No. 2014-01028 (333rd Dist. Harris County, Texas). The complaint alleged a breach of fiduciary duty, corporate waste and unjust enrichment against various officers and directors. No action has been taken to date and damages are unspecified. On March 14, 2014, this action was stayed following a ruling on the motion to dismiss in the Delaware Derivative Action. After the motions to dismiss were granted in the Delaware Derivative Action, the parties entered into another agreed stay pending the appeal of the Delaware Derivative Action to the Delaware Supreme Court. This stay was entered by the court on February 5, 2015. This action is in its preliminary stages, and the Company is unable to reasonably predict an outcome or to estimate a range of reasonably possible loss.

 

Defendants believe that the allegations contained in the matters described above are without merit and intend to vigorously defend themselves against the claims raised.

 

Catarina Drilling Obligation

 

In connection with the Catarina Acquisition, the 77,000 acres of undeveloped acreage that were included in the acquisition are subject to a continuous drilling obligation. Such drilling obligation requires us to drill (i) 50 wells in each annual period commencing on July 1, 2014 and (ii) at least one well in any consecutive 120-day period in order to maintain rights to any future undeveloped acreage. Up to 30 wells drilled in excess of the minimum 50 wells in a given annual period can be carried over to satisfy part of the 50 well requirement in the subsequent annual period on a well-for-well basis. The lease also created a customary security interest in the production therefrom in order to secure royalty

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payments to the lessor and other lease obligations. Our current capital budget and plans include the drilling of at least the minimum number of wells required to maintain access to such undeveloped acreage.

 

Lease Payment Obligations

 

As of September 30, 2016, the Company had $229.2 million in lease payment obligations that satisfy operating lease criteria. These obligations include: (i) $169.2 million in payments due with respect to firm commitment of oil and natural gas volumes under the Gathering Agreement contract signed with SPP as part of the Western Catarina Midstream Divestiture that commenced on October 14, 2015 and continues until October 13, 2020, (ii) $47.0 million for a new corporate office lease that commenced in the fourth quarter of 2014 and has an expiration date in March 2025, (iii) $7.1 million for a ground lease agreement for land owned by the Calhoun Port Authority that commenced during the third quarter of 2014 and has an expiration date in August 2024, and (iv) $5.9 million for a 10 year acreage lease agreement for a promotional ranch managed by the Company in Kenedy County, Texas.

 

The Company’s ground lease with the Calhoun Port Authority is terminable upon 180 days written notice by the Company to the lessor in addition to a $1 million termination payment. SPP has an option to acquire the lease. See Note 20, “Subsequent Events.”

 

The lease agreement for the acreage in Kenedy County, Texas includes a contractual requirement for the Company to spend a minimum of $4 million to make permanent improvements over the ten year life of the lease. The lease agreement does not specify the timing for such improvements to be made within the lease term. The Company has the right to terminate the lease obligation without penalty at any time with nine months advanced written notice and payment of any accrued leasehold expenses.

 

Joint Venture Agreements

 

As discussed in Note 8, “Investments” above, SN Midstream entered into joint venture agreements with Carnero Processing and Carnero Gathering to construct the Processing Plant and associated high pressure gathering pipelines, respectively, near the Company’s Catarina asset. In connection with the Carnero Processing joint venture agreement, SN Midstream has committed to invest approximately $80 million and receive a 50% ownership interest in Carnero Processing. Construction is expected to be completed in 2017. As of September 30, 2016, the Company had invested approximately $40.2 million and has guaranteed SN Midstream’s remaining commitment to invest approximately $39.8 million in Carnero Processing.

 

 As noted above in Note 8, “Investments,” SN Midstream sold its membership interests in Carnero Gathering on July 5, 2016 to SPP for an initial payment of approximately $37 million and the assumption by SPP of remaining capital commitments to Carnero Gathering. As result of the Carnero Gathering Transaction, the Company does not have any remaining commitments related to Carnero Gathering as of September 30, 2016. As noted in Note 20, “Subsequent Events,” SN Midstream has entered into a definitive agreement with SPP to dispose of its membership interest in Carnero Processing.

 

Membership percentage interests in Carnero Processing for the Company and Targa are calculated based on the aggregate capital contributions made by each party related to the total capital contributions made by both parties. If SN Midstream fails to make capital contributions, or the Company fails to fulfill the guarantee or the Company does not elect to contribute more than $80 million (if the cost to construct the Processing Plant exceeds $160 million) our membership interest in the joint venture may be reduced. If our membership interest falls below 20% in the joint venture, we may lose appointed board seats and voting rights.

 

Note 17. Subsidiary Guarantors

 

The Company filed registration statements on Form S-3 with the SEC, which became effective January 14, 2013, June 11, 2014 and April 25, 2016 and registered, among other securities, debt securities. The subsidiaries of the Company named therein are co-registrants with the Company, and the registration statement registered guarantees of debt securities by such subsidiaries. As of September 30, 2016, such subsidiaries are 100 percent owned by the Company and any guarantees by these subsidiaries will be full and unconditional (except for customary release provisions). In the event that more than one of these subsidiaries provide guarantees of any debt securities issued by the Company, such guarantees will constitute joint and several obligations.

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The Company also filed a registration statement on Form S-4 with the SEC, which became effective on June 20, 2014, pursuant to which the Company completed an offering of the 7.75% Notes, which are guaranteed by its subsidiaries named therein. As of September 30, 2016, such guarantor subsidiaries are 100 percent owned by the Company and the guarantees by these subsidiaries are full and unconditional (except for customary release provisions) and are joint and several. The Company also filed a registration statement on Form S-4 with the SEC, which became effective on January 23, 2015, pursuant to which the Company completed an offering of the 6.125% Notes, which are guaranteed by its subsidiaries named therein. As of September 30, 2016, such guarantor subsidiaries are 100 percent owned by the Company and the guarantees by these subsidiaries are full and unconditional (except for customary release provisions) and are joint and several.

 

The rules of Regulation S-X Rule 3-10 require that condensed consolidating financial information be provided for a subsidiary that has guaranteed the debt of a registrant issued in a public offering, where the guarantee is full, unconditional and joint and several and where the voting interest of the subsidiary is 100% owned by the registrant. See Note 18, “Condensed Consolidating Financial Information” for further discussion regarding the condensed consolidating financial information for guarantor and non-guarantor subsidiaries.

 

The Company has no assets or operations independent of its subsidiaries and there are no significant restrictions upon the ability of its subsidiaries to distribute funds to the Company.

 

Not

Note 18. Condensed Consolidating Financial Information

 

As noted above, the rules of the SEC require that condensed consolidating financial information be provided for a subsidiary that has guaranteed the debt of a registrant issued in a public offering, where the guarantee is full, unconditional and joint and several and where the voting interest of the subsidiary is 100% owned by the registrant. The Company is, therefore, presenting condensed consolidating financial information on a parent company, combined guarantor subsidiaries, combined non-guarantor subsidiaries and consolidated basis (in thousands) and should be read in conjunction with the consolidated financial statements. The financial information may not necessarily be indicative of results of operations, cash flows, or financial position had such guarantor subsidiaries operated as independent entities.

 

Investments in subsidiaries are accounted for by the respective parent company using the equity method for purposes of this presentation. Results of operations of subsidiaries are, therefore, reflected in the parent company’s investment accounts and earnings. The principal elimination entries set forth below eliminate investments in subsidiaries and intercompany balances and transactions. Typically in a condensed consolidating financial statement, the net income and equity of the parent company equals the net income and equity of the consolidated entity.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2016

Assets

 

Parent Company

 

Combined Guarantor Subsidiaries

 

Combined Non-Guarantor Subsidiaries

 

Eliminations

 

Consolidated

Total current assets

 

$

487,120

 

$

3,929

 

$

236,081

 

$

(316,154)

 

$

410,976

Total oil and natural gas properties, net

 

 

 -

 

 

693,294

 

 

 -

 

 

 -

 

 

693,294

Investment in subsidiaries

 

 

568,568

 

 

 -

 

 

 -

 

 

(568,568)

 

 

 -

Other assets

 

 

15,650

 

 

16,527

 

 

48,672

 

 

 -

 

 

80,849

Total Assets

 

$

1,071,338

 

$

713,750

 

$

284,753

 

$

(884,722)

 

$

1,185,119

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

$

69,454

 

$

122,154

 

$

270,404

 

$

(316,154)

 

$

145,858

Long-term liabilities

 

 

1,763,028

 

 

28,667

 

 

8,710

 

 

 -

 

 

1,800,405

Total shareholders' equity (deficit)

 

 

(761,144)

 

 

562,929

 

 

5,639

 

 

(568,568)

 

 

(761,144)

Total Liabilities and Shareholders' Equity (deficit)

 

$

1,071,338

 

$

713,750

 

$

284,753

 

$

(884,722)

 

$

1,185,119

 

 

 

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December 31, 2015

Assets

 

Parent Company

 

Combined Guarantor Subsidiaries

 

Combined Non-Guarantor Subsidiaries

 

Eliminations

 

Consolidated

Total current assets

 

$

671,278

 

$

37,005

 

$

704

 

$

(42,369)

 

$

666,618

Total oil and natural gas properties, net

 

 

 -

 

 

756,103

 

 

 -

 

 

 -

 

 

756,103

Investment in subsidiaries

 

 

700,053

 

 

 -

 

 

 -

 

 

(700,053)

 

 

 -

Other assets

 

 

14,481

 

 

17,737

 

 

46,365

 

 

 -

 

 

78,583

Total Assets

 

$

1,385,812

 

$

810,845

 

$

47,069

 

$

(742,422)

 

$

1,501,304

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

$

78,840

 

$

88,666

 

$

42,369

 

$

(42,369)

 

$

167,506

Long-term liabilities

 

 

1,764,060

 

 

25,907

 

 

 -

 

 

 -

 

 

1,789,967

Total shareholders' equity (deficit)

 

 

(457,088)

 

 

696,272

 

 

4,700

 

 

(700,053)

 

 

(456,169)

Total Liabilities and Shareholders' Equity (deficit)

 

$

1,385,812

 

$

810,845

 

$

47,069

 

$

(742,422)

 

$

1,501,304

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2016

 

 

Parent Company

 

Combined Guarantor Subsidiaries

 

Combined Non-Guarantor Subsidiaries

 

Eliminations

 

Consolidated

Total revenues

 

$

 -

 

$

114,807

 

$

 -

 

$

 -

 

$

114,807

Total operating costs and expenses

 

 

27,191

 

 

139,426

 

 

470

 

 

 -

 

 

167,087

Other income (expense)

 

 

(11,051)

 

 

(1,556)

 

 

66

 

 

 -

 

 

(12,541)

Income (loss) before income taxes

 

 

(38,242)

 

 

(26,175)

 

 

(404)

 

 

 -

 

 

(64,821)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

 

1,441

 

 

 -

 

 

 -

 

 

 -

 

 

1,441

Equity in income (loss) of subsidiaries

 

 

(26,581)

 

 

 -

 

 

 -

 

 

26,581

 

 

 -

Net income (loss)

 

$

(66,264)

 

$

(26,175)

 

$

(404)

 

$

26,581

 

$

(66,262)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2015

 

 

Parent Company

 

Combined Guarantor Subsidiaries

 

Combined Non-Guarantor Subsidiaries

 

Eliminations

 

Consolidated

Total revenues

 

$

 -

 

$

114,526

 

$

 -

 

$

 -

 

$

114,526

Total operating costs and expenses

 

 

12,753

 

 

589,810

 

 

466

 

 

 -

 

 

603,029

Other income (expense)

 

 

71,735

 

 

66

 

 

 -

 

 

 -

 

 

71,801

Income (loss) before income taxes

 

 

58,982

 

 

(475,218)

 

 

(466)

 

 

 -

 

 

(416,702)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

 

158

 

 

 

 

 

 

 

 

 -

 

 

158

Equity in income (loss) of subsidiaries

 

 

(475,684)

 

 

 -

 

 

 -

 

 

475,684

 

 

 -

Net income (loss)

 

$

(416,860)

 

$

(475,218)

 

$

(466)

 

$

475,684

 

$

(416,860)

 

 

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Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2016

 

 

Parent Company

 

Combined Guarantor Subsidiaries

 

Combined Non-Guarantor Subsidiaries

 

Eliminations

 

Consolidated

Total revenues

 

$

 -

 

$

305,591

 

$

 -

 

$

 -

 

$

305,591

Total operating costs and expenses

 

 

70,982

 

 

437,603

 

 

1,480

 

 

 -

 

 

510,065

Other income (expense)

 

 

(110,078)

 

 

(1,331)

 

 

2,418

 

 

 -

 

 

(108,991)

Income (loss) before income taxes

 

 

(181,060)

 

 

(133,343)

 

 

938

 

 

 -

 

 

(313,465)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

 

1,441

 

 

 -

 

 

 -

 

 

 -

 

 

1,441

Equity in income (loss) of subsidiaries

 

 

(132,406)

 

 

 -

 

 

 -

 

 

132,406

 

 

 -

Net income (loss)

 

$

(314,907)

 

$

(133,343)

 

$

938

 

$

132,406

 

$

(314,906)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2015

 

 

Parent Company

 

Combined Guarantor Subsidiaries

 

Combined Non-Guarantor Subsidiaries

 

Eliminations

 

Consolidated

Total revenues

 

$

 -

 

$

366,247

 

$

 -

 

$

 -

 

$

366,247

Total operating costs and expenses

 

 

56,767

 

 

1,793,055

 

 

1,186

 

 

 -

 

 

1,851,008

Other income (expense)

 

 

15,144

 

 

102

 

 

 -

 

 

 -

 

 

15,246

Income (loss) before income taxes

 

 

(41,623)

 

 

(1,426,706)

 

 

(1,186)

 

 

 -

 

 

(1,469,515)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

 

7,600

 

 

 -

 

 

 -

 

 

 -

 

 

7,600

Equity in income (loss) of subsidiaries

 

 

(1,427,892)

 

 

 -

 

 

 -

 

 

1,427,892

 

 

 -

Net income (loss)

 

$

(1,477,115)

 

$

(1,426,706)

 

$

(1,186)

 

$

1,427,892

 

$

(1,477,115)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2016

 

 

Parent Company

 

Combined Guarantor Subsidiaries

 

Combined Non-Guarantor Subsidiaries

 

Eliminations

 

Consolidated

Net cash provided by (used in) operating activities

 

$

(13,099)

 

$

149,765

 

$

(450)

 

$

 -

 

$

136,216

Net cash provided by (used in) investing activities

 

 

(323,583)

 

 

(241,349)

 

 

8,322

 

 

319,620

 

 

(236,990)

Net cash provided by (used in) financing activities

 

 

(5,745)

 

 

91,584

 

 

228,036

 

 

(319,620)

 

 

(5,745)

Net increase (decrease) in cash and cash equivalents

 

 

(342,427)

 

 

 -

 

 

235,908

 

 

 -

 

 

(106,519)

Cash and cash equivalents, beginning of period

 

 

434,933

 

 

 -

 

 

115

 

 

 -

 

 

435,048

Cash and cash equivalents, end of period

 

$

92,506

 

$

 -

 

$

236,023

 

$

 -

 

$

328,529

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2015

 

 

Parent Company

    

Combined Guarantor Subsidiaries

    

Combined Non-Guarantor Subsidiaries

    

Eliminations

    

Consolidated

Net cash provided by (used in) operating activities

 

$

(43,448)

 

$

273,284

 

$

(1,198)

 

$

 -

 

$

228,638

Net cash provided by (used in) investing activities

 

 

(221,120)

 

 

(488,523)

 

 

 -

 

 

216,548

 

 

(493,095)

Net cash provided by (used in) financing activities

 

 

(12,373)

 

 

215,239

 

 

1,309

 

 

(216,548)

 

 

(12,373)

Net increase (decrease) in cash and cash equivalents

 

 

(276,941)

 

 

 -

 

 

111

 

 

 -

 

 

(276,830)

Cash and cash equivalents, beginning of period

 

 

473,714

 

 

 -

 

 

 -

 

 

 -

 

 

473,714

Cash and cash equivalents, end of period

 

$

196,773

 

$

 -

 

$

111

 

$

 -

 

$

196,884

 

 

 

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Note 19. Variable Interest Entities

 

During the first quarter of 2016, the Company adopted ASU 2015-02, “Consolidation—Amendments to the Consolidation Analysis,” which introduces a separate analysis for determining if limited partnerships and similar entities are variable interest entities (“VIEs”) and clarifies the steps a reporting entity would have to take to determine whether the voting rights of stockholders in a corporation or similar entity are substantive.

 

As noted above in Note 8, “Investments,” the Company, through SN Midstream, entered into joint venture agreements with an affiliate of Targa in October 2015 to, among other things, construct the Processing Plant and associated high pressure gathering pipelines near the Company’s Catarina asset in South Texas. In addition, the Company, via SN Catarina, purchased from a subsidiary of Targa a 10% undivided interest in the SOII Facility. As noted above in Note 8, “Investments,” on July 5, 2016, the Company sold its interests, and any remaining commitment to invest in Carnero Gathering to SPP. The Company determined that Carnero Processing and ownership in the SOII Facility are more similar to limited partnerships than corporations. Under the revised guidance of ASU 2015-02, a limited partnership or similar entity with equity at risk will not be a VIE if they are able to exercise kick-out rights over the general partner(s) or they are able to exercise substantive participating rights. We concluded that Carnero Processing and the investment in SOII Facility are VIEs under the revised guidance because we cannot remove Targa as operator and we do not have substantive participating rights. In addition, Targa has the  discretion to direct activities of the VIEs regarding the risks associated with price, operations, and capital investment which have the most significant impact on the VIEs economic performance.

 

The Company’s investment in Carnero Processing and the SOII Facility represent VIEs that could expose the Company to losses. The amount of losses the Company could be exposed to from the Carnero Processing joint venture is limited to the capital investment guaranteed of approximately $80 million. The amount of losses the Company could be exposed to from the investment in the SOII Facility is limited to the equity in the investment at any point in time.

 

As of September 30, 2016, the Company had invested approximately $40.2 million in the Processing Plant joint venture, and approximately $12.5 million in the SOII Facility. As of September 30, 2016, no debt has been incurred by Carnero Processing joint venture or the SOII Facility. The Company is accounting for these VIEs as equity method investments and determined that Targa is the primary beneficiary of the VIEs as Targa is the operator of both Carnero Processing and the SOII Facility and has the most influence with respect to the normal day-to-day operating decisions of these facilities. We have included these VIEs in the “Other Assets - Investments” long-term asset line on the balance sheet.

 

Below is a tabular comparison of the carrying amounts of the assets and liabilities of the VIEs and the Company’s maximum exposure to loss as of September 30, 2016 and December 31, 2015 (in thousands):

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

    

2016

    

2015

Capital investments

 

$

49,972

 

$

49,985

Earnings in equity investments

 

 

3,154

 

 

 —

Equity in equity investments

 

$

53,126

 

$

49,985

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

 

2016

    

2015

Equity in equity investments

 

$

53,126

 

$

49,985

Guarantees of capital investments

 

 

39,865

 

 

65,526

  Maximum exposure to loss

 

$

92,991

 

$

115,511

 

 

 

 

Note 20. Subsequent Events

 

On October 3, 2016, dividends declared by the Board and accrued for the period from July 1 to September 30, 2016 for the Series A Preferred Stock and Series B Preferred Stock were paid with the Company’s common stock.

 

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On October 6, 2016, the Company announced the execution of definitive agreements with SPP pursuant to which the Company anticipates the following:

 

(1)

SPP will acquire the Company’s 50% interest in Carnero Processing for an initial payment of approximately $47.7 million in cash and the assumption by SPP of remaining capital commitments to Carnero Processing, which are estimated at approximately $32.3 million (the “Carnero Processing Transaction”) provided that the cash payment will increase and the amount of assumed capital commitments will decrease to the extent the Company makes additional capital contributions to Carnero Processing before the closing of the transaction; and

 

(2)

SPP will acquire certain non-core producing oil and gas assets, located in South Texas, from the Company for total consideration of $27 million, prior to normal and customary closing adjustments (the “Production Asset Transaction”); and

 

The transactions are expected to close in the fourth quarter 2016, subject to satisfaction of customary closing conditions, including receipt by SPP of sufficient proceeds to finance the transactions.

 

In addition, SPP obtained an option to acquire a lease, currently held by a wholly-owned subsidiary of the Company, for a tract of land leased from the Calhoun Port Authority in Point Comfort, Texas, the location of which is intended for the construction of a marine crude storage terminal.

 

 

On October 24, 2016, the Company announced the execution of a Purchase and Sale Agreement between SN Cotulla Assets, LLC, a wholly-owned subsidiary of the Company, for the limited purposes set forth therein, the Company, Carrizo (Eagle Ford) LLC and, for the limited purposes set forth therein, Carrizo Oil & Gas, Inc., to sell certain oil and gas interests and associated assets located in Dimmit County, Frio County, LaSalle County, Zavala County and McMullen County, Texas for total consideration of approximately $181 million in cash upon closing, subject to normal and customary closing adjustments (the “Cotulla Transaction”).  The effective date of the Cotulla Transaction is June 1, 2016.   

 

In October 2016, the Company hedged an additional 12,500 MMBtu per day of its 2018 natural gas production (4,562,500 MMBtu in total) at a fixed price of $3.00/MMBtu.

 

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing in Part I, Item 1 of this Quarterly Report on Form 10‑Q and information contained in our 2015 Annual Report. The following discussion contains “forward‑looking statements” that reflect our future plans, estimates, beliefs and expected performance. Please see “Cautionary Note Regarding Forward‑Looking Statements.”

 

Business Overview

 

Sanchez Energy Corporation (together with our consolidated subsidiaries, the “Company,” “we,” “our,” “us” or similar terms), a Delaware corporation formed in August 2011, is an independent exploration and production company focused on the acquisition and development of unconventional oil and natural gas resources in the onshore U.S. Gulf Coast, with a current focus on the horizontal development of significant resource potential from the Eagle Ford Shale in South Texas and the TMS in Mississippi and Louisiana. We have accumulated net leasehold acreage in the oil and condensate, or black oil and volatile oil, windows of the Eagle Ford Shale and in what we believe to be the core of the TMS.

 

We plan to invest approximately 100% of our 2016 drilling and completion capital budget in the Eagle Ford Shale. We are continuously evaluating opportunities to grow both our acreage and our producing assets through acquisitions. Our successful acquisition of such assets will depend on both the opportunities and the financing alternatives available to us at the time we consider such opportunities.

 

Listed below is a table of our significant transactions since January 1, 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Transaction

    

Transaction Date

    

Transaction Effective Date

    

Core Area

    

Net Acreage Acquired

    

Net Acreage Remaining at 9/30/16

    

Purchase / Divestiture Price (millions)

    

Carnero Gathering Transaction

 

7/5/2016

 

7/5/2016

 

Midstream, Eagle Ford

 

N/A

 

N/A

 

$

37

 

Western Catarina Midstream Divestiture

 

10/14/2015

 

10/14/2015

 

Catarina, Eagle Ford

 

N/A

 

N/A

 

$

346

 

Palmetto Divestiture

 

3/31/2015

 

1/1/2015

 

Palmetto, Eagle Ford

 

N/A

 

N/A

 

$

83

 

Catarina Acquisition

 

6/30/2014

 

1/1/2014

 

Catarina, Eagle Ford

 

106,100

 

106,100

 

$

557

 

Wycross Acquisition

 

10/4/2013

 

7/1/2013

 

Wycross, Eagle Ford

 

3,600

 

3,400

 

$

230

 

TMS Transaction

 

8/16/2013

 

8/16/2013

 

TMS

 

69,000

 

51,100

 

$

78

 

Five Mile Creek Acquisition

 

7/1/2013

 

7/1/2013

 

Marquis, Eagle Ford

 

10,300

 

4,900

 

$

29

 

Cotulla Acquisition

 

5/31/2013

 

3/1/2013

 

Cotulla, Eagle Ford

 

44,500

 

31,000

 

$

281

 

 

On July 5, 2016, the Company completed the Carnero Gathering Transaction (as defined above in Note 8, “Investments of Part 1, Item 1. Financial Statements) for a purchase price of approximately $37.0 million. In addition, SPP assumed the remaining capital commitments to Carnero Gathering, estimated at approximately $7.4 million, and SPP is required to pay SN Midstream a monthly earnout based on gas received at Carnero Gathering’s receipt points from SN Catarina and gas delivered and processed at the Processing Plant by other producers.

 

On October 14, 2015, the Company completed the Western Catarina Midstream Divestiture (as defined above in Note 3, “Acquisitions and Divestitures” of Part 1, Item 1. Financial Statements) for an adjusted purchase price of $345.8 million in cash. In connection with the closing of the Western Catarina Midstream Divestiture, the Company entered into the Gathering Agreement on October 14, 2015 for an initial term of 15 years pursuant to which production from approximately 35,000 acres that we operate in Dimmit County and Webb County, Texas will be dedicated for gathering by Catarina Midstream. In addition, for the first five years of the Gathering Agreement, SN Catarina is required to meet a minimum quarterly volume delivery commitment of 10,200 Bbls per day of crude oil and condensate and 142,000 Mcf per day of natural gas, subject to certain adjustments. 

 

On March 31, 2015, we completed the Palmetto Divestiture (as defined above in Note 3, “Acquisitions and Divestitures” of Part 1, Item 1. Financial Statements) for an adjusted purchase price of approximately $83.4 million. The effective date of the transaction was January 1, 2015. The aggregate average working interest percentage initially conveyed was 18.25% per wellbore and, on January 1, 2016, the working interest of the purchaser, a wholly-owned

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subsidiary of SPP, automatically increased in incremental amounts and will continue to automatically increase in incremental amounts according to the purchase agreement until January 1, 2019, at which point the purchaser will own a 47.5% working interest, and we will own a 2.5% working interest in each of the wellbores.

 

On June 30, 2014, we completed the Catarina Acquisition (as defined above in Note 3, “Acquisitions and Divestitures” of Part 1, Item 1. Financial Statements) in the Eagle Ford Shale with an effective date of January 1, 2014. As of the acquisition date, all proved reserves in the Catarina area were covered under lease acreage that is held by production, which acreage amounted to approximately 29,000 acres. Under the lease, we have a 100% working interest and 75% net revenue interest in the lease acreage over the Eagle Ford Shale formation from the top of the Austin Chalk formation to the base of the Buda Lime formation. The 77,000 acres of undeveloped acreage that were included in the Catarina Acquisition are subject to a continuous drilling obligation. Such drilling obligation requires us to drill (i) 50 wells in each annual period commencing on July 1, 2014 and (ii) at least one well in any consecutive 120-day period in order to maintain rights to any future undeveloped acreage. Up to 30 wells drilled in excess of the minimum 50 wells in a given annual period can be carried over to satisfy part of the 50 well requirement in the subsequent annual period on a well-for well-basis. The lease also created a customary security interest in the production therefrom in order to secure royalty payments to the lessor and other lease obligations. Our current capital budget and plans include drilling at least the minimum annual well requirement necessary to maintain access to such undeveloped acreage. As of September 30, 2016, the Company had drilled 39 wells that were credited toward its next 50 well annual commitment period which commenced on July 1, 2016 and will end on June 30, 2017. 

 

On October 4, 2013, we completed the Wycross Acquisition (as defined above in Note 6, “Long-Term Debt” of Part 1, Item 1. Financial Statements). The properties acquired in the Wycross Acquisition are included in our Cotulla area described below.

 

On August 16, 2013, we completed the TMS Transaction (as defined above in Note 11, “Related Party Transactions” of Part 1, Item 1. Financial Statements). As of September 30, 2016, the AMI held rights to approximately 118,500 (77,300 net) acres, of which we owned approximately 52,800 net acres.

 

In July 2013, we acquired approximately 10,300 net acres in Fayette, Gonzales and Lavaca Counties, Texas (the “Five Mile Creek Acquisition”). The properties acquired in the Five Mile Creek Acquisition are included in our Marquis area.

 

On May 31, 2013, we completed our acquisition of 44,461 net acres in Dimmit, Frio, LaSalle and Zavala Counties, Texas (the “Cotulla Acquisition”). We combined our Cotulla assets with our previous Maverick area to form one operating area now known as our Cotulla area. As noted above, the Cotulla area also includes the properties acquired in the Wycross Acquisition.

 

Our updated 2016 capital budget of $250 million to $300 million, which was announced in August 2016, is allocated approximately 85% to the drilling of 71 net wells and the completing of 75 net wells, at the midpoint of capital guidance, with the remainder allocated to facilities, leasing, and seismic activities.

 

Basis of Presentation

 

The condensed consolidated financial statements have been prepared in accordance with U.S. GAAP.

 

Our Properties

 

Eagle Ford Shale

 

We and our predecessor entities have a long history in the Eagle Ford Shale, where we have assembled greater than 200,000 net leasehold acres with an average working interest of approximately 95%. Using approximately 40 acre well-spacing for our Cotulla and Palmetto areas, approximately 60 acre well-spacing for our Marquis area, and approximately 75 acre well-spacing for our Catarina area plus up to 650 additional upper Eagle Ford Catarina locations, and assuming 80% of the acreage is drillable for Cotulla, Marquis and Catarina, and 90% of the acreage is drillable for Palmetto, we believe that there could be greater than 3,000 gross (3,000 net) locations for potential future drilling. Consistent with other operators in this area, we perform multi-stage hydraulic fracturing up to 30 stages on each well

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depending upon the length of the lateral section. In 2016, we plan to invest substantially all of our capital budget in the Eagle Ford Shale.

 

In our Catarina area, located in Dimmit, LaSalle and Webb Counties, Texas we have a 100% working interest. We anticipate drilling, completion and facilities costs on our acreage to be approximately $3.0 million per well based on our current estimates and historical well costs. Current Estimated Ultimate Recovery (“EUR”) per well in Catarina is expected to range between 400 MBoe and 1,200 MBoe. We have identified between 1,350 and 1,650 gross and net locations for potential future drilling on our Catarina acreage. For the year 2016, we plan to spend $150 million to $160 million to spud 49 net wells and complete 52 net wells in our Catarina area.

 

In our Marquis area, located in southwest Fayette and northeast Lavaca Counties, Texas we have an approximate 100% working interest. We believe that our Marquis acreage lies in the volatile oil window, where we anticipate drilling, completion and facilities costs on our acreage to be between $3.7 million and $4.2 million per well based on our current estimates and historical well costs. Current EUR per well in Marquis is expected to range between 275 MBoe and 375 MBoe. We have identified up to approximately 225 gross and net locations based on 60 acre well-spacing for potential future drilling on our Marquis acreage. In 2016, we are not allocating any capital budgeted for drilling and completions in our Marquis area.

 

In our Cotulla area, located in Dimmit, Frio, LaSalle, Zavala, and McMullen Counties, Texas we have an average working interest of approximately 95%. We believe that our Cotulla acreage lies in the black oil window, where we anticipate drilling, completion and facilities costs on our acreage to be approximately $3.0 million per well based on our current estimates and historical well costs. Current EUR per well in Cotulla is expected to range between 300 MBoe and 400 MBoe. We have identified over 1,000 gross and net locations based on 40 acre well-spacing for potential future drilling on our Cotulla area. In 2016, we plan to spend $60 million to $70 million to spud 21 net wells and complete 21 net wells in our Cotulla area. As noted in Note 20, “Subsequent Events” of Part 1, Item 1. Financial Statements, the Company executed a Purchase and Sale Agreement on October 24, 2016, for the Cotulla Transaction to sell certain oil and gas interests and associated assets located in our Cotulla area.

 

In our Palmetto area, located in Gonzales County, Texas we have an average working interest for future development locations of approximately 49%. We believe that our Palmetto acreage lies in the volatile oil window where we anticipate drilling, completion and facilities costs on our acreage to be between $5.0 and $6.0 million per well based on our current estimates and historical well costs. Current EUR per well in Palmetto is expected to range between 500 MBoe and 600 MBoe. We have identified up to 300 gross (150 net) locations based on 40 acre well-spacing for potential future drilling in our Palmetto area. In 2016, we plan to spend $10 million to $20 million to spud two gross (one net) wells and complete four gross (two net) wells in our Palmetto area.

 

Tuscaloosa Marine Shale

 

In August 2013, we acquired approximately 40,000 net undeveloped acres in what we believe to be the core of the TMS for cash and shares of our common stock. In connection with the TMS Transaction, we established an AMI in the TMS with SR, which transaction included a carry on drilling costs for up to 6 gross (3 net) wells. As part of the transaction, we acquired all of the working interests in the AMI owned at closing from three sellers (two third parties and one related party of the Company, SR), resulting in our owning an undivided 50% working interest across the AMI through the TMS formation. As of September 30, 2016, the AMI held rights to approximately 118,500 (77,300 net) acres, of which we owned approximately 51,100 net acres.

 

Well results in the TMS remain strong although development is currently challenged due to high well costs and depressed commodity prices. We believe that the TMS play has significant development potential and still has significant upside as changes in technology, commodity prices, and service prices occur. The average remaining lease term on the acreage is over 3 years, which we believe gives us ample time to allow other industry participants to further de-risk the play.

 

Recent Developments

 

During the fourth quarter of 2014, oil prices began a substantial and rapid decline, which continued throughout 2015 and the first half of 2016. In the face of an uncertain operating environment, the Company significantly reduced its capital budget and undertook other strategic measures to enhance liquidity.  These strategic measures encompass, among

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other things, a focus on continuous improvement in our operations, organic growth underpinned by an extensive inventory of drilling opportunities that are economic at current prices, pursuit of distressed opportunities that may become available in the marketplace, and our relationship with SPP, which may allow us to realize improved economics on the Company’s development projects without incurring equity dilution or additional leverage.

 

Our 2016 capital budget, announced in January 2016, was initially set at $200 million to $250 million which, at the time of the announcement, was expected to maintain production around 48,000 to 52,000 Boe per day.

 

Based on modest improvements in market conditions and our results for the first six months of 2016, which include stronger production, lower costs, and better well results than anticipated at the time we initially developed our plans for 2016, in August 2016 the Company updated its 2016 capital budget to range between $250 million to $300 million. At our updated level of upstream capital spending, we anticipate that the Company will be able to maintain relatively flat production in 2016. 

 

On October 6, 2016, the Company executed definitive agreements with SPP to enhance the Company’s liquidity position. The Carnero Processing Transaction involves the sale of the Company’s 50% interest in Carnero Processing to SPP for an initial payment of approximately $47.7 million in cash and the assumption by SPP of remaining capital commitments to Carnero Processing, which are estimated at approximately $32.3 million provided that the cash payment will increase and the amount of assumed capital commitments will decrease to the extent the Company makes additional capital contributions to Carnero Processing before the closing of the transaction. The Company does not expect to record any loss related to the Carnero Processing Transaction. The Production Asset Transaction involves the sale of certain non-core producing oil and gas assets, located in South Texas, to SPP for total consideration of $27 million, prior to normal and customary closing adjustments. The Production Asset Transaction encompasses working interests in 23 producing Eagle Ford wellbores located in Dimmit and Zavala counties in South Texas together with escalating working interests in an additional 11 producing wellbores located in the Palmetto Field in Gonzales County, Texas. The Company does not expect to record any loss related to the Production Asset Transaction. Also on October 6, 2016, the Company executed a definitive agreement that provides SPP with an option to acquire a lease, currently held by a wholly-owned subsidiary of the Company, for a tract of land leased from the Calhoun Port Authority in Point Comfort, Texas, the location of which is intended for the construction of a marine crude storage terminal. The Company expects to incur an immaterial loss related to the transfer of the land leased from the Calhoun Port Athority.

 

On October 24, 2016, the Company announced the execution the Cotulla Transaction for total consideration of approximately $181 million in cash upon closing, subject to normal and customary closing adjustments.  The effective date of the Cotulla Transaction is June 1, 2016.

 

Outlook

 

Although capital markets have shown signs of improvement recently, our operating environment continues to be influenced by commodity price volatility.  As a result, we face persistent uncertainty with respect to the future of our industry, which may continue through the remainder of 2016 and later years. In this environment, the Company plans to strategically divest certain non-core assets and carefully manage its capital spending and operating activities in order to preserve liquidity.  The Company maintains significant operational and financial flexibility to respond to changes in market and operating conditions, and our capital budget remains at all times subject to adjustment.

 

We expect to use a portion of our cash on hand, internally generated cash flows from operations, and funds raised through the strategic sale of certain non-core assets, to fund our remaining 2016 capital expenditures, and currently project no borrowings under the Second Amended and Restated Credit Agreement for purposes of our development activity at our planned level of capital spending. We will continuously evaluate our capital spending and operating activities in light of realized commodity prices and the results of our operations, and may make further adjustments to our capital spending program as warranted. In addition, we will continuously review acquisition and divestiture opportunities involving third parties, SPP and/or other members of the Sanchez Group.

 

For the 12-month period ended September 30, 2016, the oil price (WTI Cushing) used in the SEC methodology for calculating PV 10 and Standardized Measures, and for performing impairment tests under the full cost method, which is calculated as the unweighted arithmetic average of the first of the month reported price for the 12 month historical period, was $41.68 per Bbl. The average natural gas price (Henry Hub) calculated in the same manner was $2.28 per

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MMBtu. At these price levels, SEC prices for oil have decreased approximately 3% and increased for natural gas approximately 2% since June 30, 2016, and have decreased 22% and 16%, respectively, since December 31, 2015.

 

As a result of less favorable commodity prices adversely impacting our proved reserve values, and the impact of commodity price volatility on our future drilling opportunities, we recorded a full cost ceiling test impairment after income taxes of $59.6 million and $169.0 million, for the three and nine months ended September 30, 2016, respectively. While there is a possibility that the Company will incur additional impairments to our full cost pool in 2016, factors impacting the full cost ceiling test impairment calculation have not yet been determined. Based upon known improvements in the current NYMEX forward prices, we believe that there is a reasonable likelihood of an increase in the average 12 month trailing first-day-of-the-month pricing in the fourth quarter of 2016.  

 

Results of Operations

 

Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015

 

Revenue and Production

 

The following table summarizes production, average sales prices and operating revenue for our oil, NGLs and natural gas operations for the periods indicated (in thousands, except average sales price and percentages):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Increase

 

 

 

September 30, 

 

(Decrease)

 

 

    

2016

    

2015

    

2016 vs 2015

 

Net Production:

 

 

 

 

 

 

 

 

 

 

 

 

Oil (MBbl)

 

 

1,562

 

 

1,671

 

 

(109)

 

(7)

%

NGLs (MBbl)

 

 

1,412

 

 

1,509

 

 

(97)

 

(6)

%

Natural gas (MMcf)

 

 

10,595

 

 

10,090

 

 

505

 

5

%

Total oil equivalent (MBoe)

 

 

4,741

 

 

4,862

 

 

(121)

 

(2)

%

Average Sales Price Excluding Derivatives(1):

 

 

 

 

 

 

 

 

 

 

 

 

Oil ($ per Bbl)

 

$

40.99

 

$

41.61

 

$

(0.62)

 

(1)

%

NGLs ($ per Bbl)

 

 

13.81

 

 

11.30

 

 

2.51

 

22

%

Natural gas ($ per Mcf)

 

 

2.95

 

 

2.77

 

 

0.18

 

6

%

Oil equivalent ($ per Boe)

 

$

24.22

 

$

23.56

 

$

0.66

 

3

%

Average Sales Price Including Derivatives(2):

 

 

 

 

 

 

 

 

 

 

 

 

Oil ($ per Bbl)

 

$

57.18

 

$

62.25

 

$

(5.07)

 

(8)

%

NGLs ($ per Bbl)

 

 

13.81

 

 

11.30

 

 

2.51

 

22

%

Natural gas ($ per Mcf)

 

 

3.22

 

 

3.26

 

 

(0.04)

 

(1)

%

Oil equivalent ($ per Boe)

 

$

30.15

 

$

31.68

 

$

(1.53)

 

(5)

%

REVENUES(1):

 

 

 

 

 

 

 

 

 

 

 

 

Oil sales

 

$

64,041

 

$

69,532

 

$

(5,491)

 

(8)

%

NGL sales

 

 

19,511

 

 

17,055

 

 

2,456

 

14

%

Natural gas sales

 

 

31,255

 

 

27,939

 

 

3,316

 

12

%

Total revenues

 

$

114,807

 

$

114,526

 

$

281

 

0

%

 


(1)

Excludes the impact of derivative instrument settlements.

 

(2)

Includes the impact of derivative instrument settlements.

 

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The following table sets forth information regarding combined net production of oil, NGLs and natural gas attributable to our properties for each of the periods presented:

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

September 30, 

 

 

    

2016

    

2015

    

Production:

 

 

 

 

 

 

 

Oil - MBbl

 

 

 

 

 

 

 

Catarina

 

 

852

 

 

837

 

Marquis

 

 

157

 

 

306

 

Cotulla

 

 

463

 

 

401

 

Palmetto

 

 

80

 

 

111

 

Other

 

 

10

 

 

16

 

Total

 

 

1,562

 

 

1,671

 

NGLs - MBbl

 

 

   

 

 

 

 

Catarina

 

 

1,290

 

 

1,355

 

Marquis

 

 

36

 

 

42

 

Cotulla

 

 

66

 

 

87

 

Palmetto

 

 

20

 

 

25

 

Other

 

 

 —

 

 

 —

 

Total

 

 

1,412

 

 

1,509

 

Natural gas - MMcf

 

 

 

 

 

 

 

Catarina

 

 

9,911

 

 

9,247

 

Marquis

 

 

159

 

 

186

 

Cotulla

 

 

397

 

 

507

 

Palmetto

 

 

126

 

 

148

 

Other

 

 

2

 

 

2

 

Total

 

 

10,595

 

 

10,090

 

Net production volumes:

 

 

 

 

 

 

 

Total oil equivalent (Mboe)

 

 

4,741

 

 

4,862

 

Average daily production (Boe/d)

 

 

51,533

 

 

52,844

 

Average Sales Price (1):  

 

 

 

 

 

 

 

Oil ($ per Bbl)

 

$

40.99

 

$

41.61

 

NGLs ($ per Bbl)

 

$

13.81

 

$

11.30

 

Natural gas ($ per Mcf)

 

$

2.95

 

$

2.77

 

Oil equivalent ($ per Boe)

 

$

24.22

 

$

23.56

 

Average unit costs per Boe:

 

 

 

 

 

 

 

Oil and natural gas production expenses

 

$

8.23

 

$

8.30

 

Production and ad valorem taxes

 

$

0.83

 

$

0.62

 

General and administrative (2)

 

$

2.98

 

$

3.19

 

Depreciation, depletion, amortization and accretion

 

$

7.94

 

$

18.34

 

Impairment of oil and natural gas properties

 

$

12.57

 

$

93.51

 

 

(1)

Excludes the impact of derivative instruments.

 

(2)

For the three months ended September 30, 2016 and 2015, general and administrative excludes non-cash stock-based compensation expense of approximately $12.8 million ($2.70 per Boe) and $0.4 million ($0.07 per Boe), respectively.

 

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Net Production.  Production decreased from 4,862 MBoe for the three months ended September 30, 2015 to 4,741 MBoe for the three months ended September 30, 2016 due to natural well decline. The number of gross wells producing at the period end and the production for the periods were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

 

 

2016

 

2015

 

 

    

# Wells

    

MBoe

    

# Wells

    

MBoe

 

Catarina

 

311

 

3,795

 

264

 

3,733

 

Cotulla

 

153

 

596

 

103

 

379

 

Marquis

 

103

 

220

 

139

 

573

 

Palmetto

 

76

 

120

 

72

 

161

 

Other

 

14

 

10

 

14

 

16

 

Total

 

657

 

4,741

 

592

 

4,862

 

 

For the three months ended September 30, 2016, 33% of our production was oil, 30% was NGLs and 37% was natural gas compared to the three months ended September 30, 2015 production that was 34% oil, 31% NGLs and 35% natural gas. Since the acquisition of the Catarina wells, production from Catarina has continued to increase in proportion to the total production, and as such, a higher proportion of NGLs and natural gas was produced as compared to oil.

 

Revenues.  Oil, NGLs, and natural gas sales revenues totaled $114.8 million and $114.5 million for the three months ended September 30, 2016 and 2015, respectively. Oil sales revenues for the three months ended September 30, 2016 decreased $5.5 million, while sales revenue for natural gas and NGLs for the three months ended September 30, 2016 increased $2.5 million and $3.3 million, respectively, as compared to the three months ended September 30, 2015.

 

The tables below provide an analysis of the impacts of changes in production volumes and average realized prices between the periods on our revenues from the quarter ended September 30, 2016 to the quarter ended September 30, 2015 (in thousands, except average sales price). The slight increase in average realized prices from the quarter ended September 30, 2015 to the quarter ended September 30, 2016 can be attributed to the slight increase in natural gas and NGL commodity prices and the increased percentage of NGLs and natural gas production relative to oil production that comprises our total production mix.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

    

 

 

    

 

    

 

 

 

 

 

Q3 2016

 

Q3 2015

 

Production

 

Q3 2015

 

Revenue

 

 

 

Production

 

Production

 

Volume

 

Average Sales

 

Increase/(Decrease)

 

 

    

Volume

    

Volume

    

Difference

    

Price

    

due to Production

 

Oil (MBbl)

 

 

1,562

 

 

1,671

 

 

(109)

 

$

41.61

 

$

(4,534)

 

NGLs (MBbl)

 

 

1,412

 

 

1,509

 

 

(97)

 

$

11.30

 

$

(1,086)

 

Natural gas (MMcf)

 

 

10,595

 

 

10,090

 

 

505

 

$

2.77

 

$

1,400

 

Total oil equivalent (MBoe)

 

 

4,741

 

 

4,862

 

 

(121)

 

$

23.56

 

$

(4,220)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

    

 

    

 

    

 

    

 

 

 

 

 

Q3 2016

 

Q3 2015

 

 

 

 

Q3 2015

 

Revenue

 

 

 

Average Sales

 

Average Sales

 

Average Sales

 

Production

 

Increase/(Decrease)

 

 

    

Price

    

Price

    

Price Difference

    

Volume

    

due to Price

 

Oil (MBbl)

 

$

40.99

 

$

41.61

 

$

(0.62)

 

 

1,562

 

$

(957)

 

NGLs (MBbl)

 

$

13.81

 

$

11.30

 

$

2.51

 

 

1,412

 

$

3,542

 

Natural gas (MMcf)

 

$

2.95

 

$

2.77

 

$

0.18

 

 

10,595

 

$

1,916

 

Total oil equivalent (MBoe)

 

$

24.22

 

$

23.56

 

$

0.66

 

 

4,741

 

$

4,501

 

 

Additionally, a 10% increase in our average realized sales prices, excluding the impact of derivatives, would have increased our revenues for the three months ended September 30, 2016 by approximately $11.5 million, and a 10% decrease in our average realized sales prices, excluding the impact of derivatives, would have decreased our revenues for the three months ended September 30, 2016 by approximately $11.5 million.

 

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Operating Costs and Expenses

 

The table below presents a detail of operating costs and expenses for the periods indicated (in thousands, except percentages):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Increase (Decrease)

 

 

September 30, 

 

2016 vs 2015

 

 

    

2016

    

2015

    

$

    

%

    

OPERATING COSTS AND EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

 

Oil and natural gas production expenses

 

$

38,997

 

$

40,345

 

$

(1,348)

 

(3)

%

Production and ad valorem taxes

 

 

3,921

 

 

3,038

 

 

883

 

29

%

Depreciation, depletion, amortization and accretion

 

 

37,651

 

 

89,167

 

 

(51,516)

 

(58)

%

Impairment of oil and natural gas properties

 

 

59,582

 

 

454,628

 

 

(395,046)

 

(87)

%

General and administrative (1)

 

 

26,936

 

 

15,851

 

 

11,085

 

70

%

Total operating costs and expenses

 

 

167,087

 

 

603,029

 

 

(435,942)

 

(72)

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

146

 

 

65

 

 

81

 

125

%

Other income (expense)

 

 

7

 

 

(818)

 

 

825

 

(101)

%

Interest expense

 

 

(31,797)

 

 

(31,442)

 

 

(355)

 

1

%

Earnings from equity investments

 

 

463

 

 

 —

 

 

463

 

*

 

Net gains on commodity derivatives

 

 

18,640

 

 

103,996

 

 

(85,356)

 

(82)

%

Income tax expense

 

 

1,441

 

 

158

 

 

1,283

 

*

 

 


(1)

Inclusive of stock-based compensation expense of $12.8 million and $0.4 million for the three months ended September 30, 2016 and 2015, respectively.

 

Oil and Natural Gas Production Expenses.  Oil and natural gas production expenses are the costs incurred to produce our oil and natural gas, as well as the daily costs incurred to maintain our producing properties. Such costs also include field personnel costs, utilities, chemical additives, salt water disposal, maintenance, repairs and occasional well workover expenses related to our oil and natural gas properties. Our oil and natural gas production expenses decreased 3% to approximately $39.0 million for the three months ended September 30, 2016 as compared to $40.3 million for the same period in 2015. The slight decrease in oil and natural gas production expenses in the third quarter of 2016 compared to the same period of 2015 is attributable to our operating cost savings from efficiencies realized throughout the production chain. These cost savings were offset by the increase in gathering and transportation costs related to the Gathering Agreement with SPP that began in October 2015. Our average production expenses decreased from $8.30 per Boe during the three months ended September 30, 2015 to $8.23 per Boe for the three months ended September 30, 2016. This decrease was due primarily to the decrease in production expenses described above. While we expect our oil and natural gas production expenses to increase as we add producing wells, we expect to continue our efficient operation of our properties.

 

Production and Ad Valorem Taxes.  Production and ad valorem taxes are paid on produced oil and natural gas based upon a percentage of gross revenues or at fixed rates established by state or local taxing authorities. Our production and ad valorem taxes totaled $3.9 million and $3.0 million for the three months ended September 30, 2016 and 2015, respectively. The decrease in overall commodity prices has caused a decrease in property value and related ad valorem taxes. The increase in production and ad valorem taxes in the third quarter of 2016 compared to the same period in 2015 was primarily due to the significant reduction in the ad valorem tax expense estimate for the three months ended September 30, 2015, which was greater than the reduction in the ad valorem tax expense estimate for the three months ended September 30, 2016. This increase was slightly offset by lower production taxes and tight gas tax credits applied to our wells for the three months ended September 30, 2016 compared to the same period in 2015.  The majority of our horizontal wells are characterized as tight gas wells, which apply a reduced production tax rate after certification from the state regulatory body.  Until the Company receives the proper certification, the normal production tax rates are applied to the wells. Once the certification is approved, the reduced rates are applied and tax credits are received from the state.  The timing of receipt of the certifications and tax credits vary from well to well. Our average production and ad valorem taxes increased from $0.62 per Boe during the three months ended September 30, 2015 to $0.83 per Boe for the three months ended September 30, 2016.

 

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Depreciation, Depletion, Amortization and Accretion.  Depreciation, depletion, amortization and accretion (“DD&A”) reflects the systematic expensing of the capitalized costs incurred in the acquisition, exploration and development of oil and natural gas properties. We use the full‑cost method of accounting and accordingly, we capitalize all costs associated with the acquisition, exploration and development of oil and natural gas properties, including unproved and unevaluated property costs. Internal costs are capitalized only to the extent they are directly related to acquisition, exploration and development activities and do not include any costs related to production, selling or general corporate administrative activities. Capitalized costs of oil and natural gas properties are amortized using the units of production method based upon production and estimates of proved oil and natural gas reserve quantities. Unproved and unevaluated property costs are excluded from the amortizable base used to determine DD&A expense.

 

Our DD&A expense decreased $51.5 million from $89.2 million ($18.34 per Boe) for the three months ended September 30, 2015 to $37.7 million ($7.94 per Boe) for the three months ended September 30, 2016. The majority of the decrease in DD&A is related to the decrease in depletion rate due to the cumulative effect of full cost ceiling impairments recorded since the fourth quarter of 2014 and the decrease in the full cost pool related to the Western Catarina Midstream Divestiture in the fourth quarter of 2015. Lower production during the three months ended September 30, 2016 as compared to the same period in 2015 resulted in a $2.2 million decrease in depletion expense and the decrease in the depletion rate resulted in a $49.3 million decrease in depletion expense.

 

Impairment of Oil and Natural Gas Properties.  We utilize the full cost method of accounting to account for our oil and natural gas exploration and development activities. Under this method of accounting, we are required on a quarterly basis to determine whether the book value of our oil and natural gas properties (excluding unevaluated properties) is less than or equal to the “ceiling,” based upon the expected after tax present value (discounted at 10%) of the future net cash flows from our proved reserves. Any excess of the net book value of our oil and natural gas properties over the ceiling must be recognized as a non‑cash impairment expense. We recorded a full cost ceiling test impairment after income taxes of $59.6 million for the three months ended September 30, 2016. The impact of less favorable commodity prices adversely affecting proved reserve volumes and future revenues was the main contributor to the ceiling impairment recorded at September 30, 2016. Changes in production rates, levels of reserves, future development costs, transfers of unevaluated properties, and other factors will determine our actual ceiling test calculation and impairment analyses in future periods. We recorded a full cost ceiling test impairment after income taxes of $454.6 million for the three months ended September 30, 2015. While there is a possibility that the Company will incur additional impairments to our full cost pool in 2016, factors impacting the full cost ceiling test impairment calculation have not yet been determined. Based upon known improvements in the current NYMEX forward prices, we believe that there is a reasonable likelihood of an increase in the average 12 month trailing first-day-of-the-month pricing in the fourth quarter of 2016.  

 

If the simple average of oil, natural gas, and NGL prices as of the first day of each month for the trailing 12‑month period ended September 30, 2016 had been $42.64 per Bbl of oil, $2.45 per MMBtu for natural gas, and $19.69 per Bbl of propane, while all other factors remained constant, our ceiling test limitation related to the net book value of our proved oil and natural gas properties would have increased by approximately $54.4 million. The aforementioned prices were calculated based on a 12‑month simple average, which includes the oil and natural gas prices on the first day of the month for the 10 months ended October 2016 and the October 2016 prices were held constant for the remaining two months. The increase in the ceiling test limitation is a result of the increase in the simple average for oil, natural gas and NGL prices as compared to the simple average prices for the trailing 12-month period ended September 30, 2016. This calculation of the impact of forward-looking commodity prices is prepared based on the presumption that all other inputs and assumptions are held constant with the exception of prices for oil, natural gas, and NGLs. Therefore, this calculation strictly isolates the impact of commodity prices on our ceiling test limitation and proved reserves. The impact of price is only a single variable in the estimation of our proved reserves and other factors noted above could have a significant impact on future reserves and the present value of future cash flows. There are numerous uncertainties inherent in the estimation of proved reserves and accounting for oil and natural gas properties in subsequent periods and this pro forma estimate should not be construed as indicative of our development plans or future results.

 

General and Administrative Expenses.  Our general and administrative (“G&A”) expenses, including stock‑based compensation expense, totaled $26.9 million for the three months ended September 30, 2016 compared to $15.9 million for the same period in 2015. Excluding the stock‑based compensation, G&A expenses for the three months ended September 30, 2016 and 2015 were $14.1 million and $15.5 million, respectively. The decrease in G&A expenses, excluding stock-based compensation, for the third quarter 2016 compared to the same period of 2015 was primarily due

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to a decrease in legal expenses. Our G&A expenses, excluding stock‑based compensation expense, decreased from $3.19 per Boe during the three months ended September 30, 2015 to $2.98 per Boe for the three months ended September 30, 2016.

 

For the three months ended September 30, 2016 and 2015, we recorded non‑cash stock‑based compensation expense of approximately $12.8 million and $0.4 million, respectively. The increase in the stock-based compensation expense amount was caused by an increase in the Company’s stock price and an increase in the awards outstanding and the associated amortization expense recognized. Because the Company records stock‑based compensation expense for awards granted to non‑employees at fair value and the unvested awards are revalued each period, impacting the amortization over the remaining life of the awards, the Company’s increase in stock price will cause an increase to the stock‑based compensation expense recognized during the quarter.

 

Interest Expense.  For the three months ended September 30, 2016, interest expense totaled $31.8 million and included $2.0 million in amortization of debt issuance costs. This is compared to the three months ended September 30, 2015, for which interest expense totaled $31.4 million and included $1.7 million in amortization of debt issuance costs. The interest expense incurred during the three months ended September 30, 2016 and September 30, 2015 is primarily related to the 7.75% Notes issued in June and September 2013 and the 6.125% Notes issued in June and September 2015.

 

Commodity Derivative Transactions.  We apply mark‑to‑market accounting to our derivative contracts; therefore, the full volatility of the non‑cash change in fair value of our outstanding contracts is reflected in other income and expense. During the three months ended September 30, 2016, we recognized a total gain of $18.6 million on our commodity derivative contracts primarily related to settlement gains on oil and natural gas derivatives of $25.3 million and $2.8 million, respectively. These gains were primarily the result of decreases in commodity prices from the time the trades were entered until the time of cash settlement for trades that liquidated by their terms during the current period. In addition, we recognized a mark-to-market gain on natural gas derivatives of $5.1 million due to a decrease in the commodity price over the current period. These gains were slightly offset by mark-to-market losses on oil derivatives of $14.6 million as a result of the increase in the commodity price over the current period.

 

During the three months ended September 30, 2015, we recognized a total gain of $104.0 million on our commodity derivative contracts primarily related to mark-to-market gains due to oil price decreases during the quarter. The total net gain also included a net gain of $39.5 million associated with the settlements of commodity derivative contracts. These gains were primarily the result of the decreases in commodity prices from the time the deals were entered to the settlement period.

 

Income Tax Expense.  For the three months ended September 30, 2016, the Company recorded income tax expense of approximately $1.4 million. Due to the full cost ceiling impairments recorded, the Company was in a net loss position for the quarter but had current income tax expense related to adjustments for immaterial differences on the alternative minimum tax calculation from the 2015 income tax return filed in September 2016 to the accrual for 2015 income taxes recorded in December 2015. Our effective tax rate for the three months ended September 30, 2016 was approximately (0.5)% compared to a statutory rate of 35%. The difference between the statutory rate and the Company’s effective tax rate is related to a valuation allowance recorded during the period. For the three months ended September 30, 2015, the Company recorded income tax expense of $158,000. Due to the full cost ceiling impairment recorded, the Company was in a net loss position for the quarter but had current income tax expense related to adjustments for immaterial differences from the 2014 income tax return filed in September 2015 to the accrual for 2014 income taxes recorded in December 2014. Our effective tax rate for the three months ended September 30, 2015 rounded to approximately 0% compared to a statutory rate of 35%. The difference between the statutory rate and the Company’s effective tax rate is related to a valuation allowance recorded during the period. 

 

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Nine months Ended September 30, 2016 Compared to Nine months Ended September 30, 2015

 

Revenue and Production

 

The following table summarizes production, average sales prices and operating revenue for our oil, NGLs and natural gas operations for the periods indicated (in thousands, except average sales price and percentages):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 

 

Increase (Decrease)

 

 

    

2016

    

2015

 

2016 vs 2015

 

Net Production:

 

 

 

 

 

 

 

 

 

 

 

 

Oil (MBbl)

 

 

4,836

 

 

5,372

 

 

(536)

 

(10)

%

NGLs (MBbl)

 

 

4,620

 

 

4,097

 

 

523

 

13

%

Natural gas (MMcf)

 

 

33,092

 

 

26,217

 

 

6,875

 

26

%

Total oil equivalent (MBoe)

 

 

14,971

 

 

13,839

 

 

1,132

 

8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Average Sales Price Excluding Derivatives(1):  

 

 

 

 

 

 

 

 

 

 

 

 

Oil ($ per Bbl)

 

$

35.67

 

$

45.53

 

$

(9.86)

 

(22)

%

NGLs ($ per Bbl)

 

 

12.24

 

 

11.86

 

 

0.38

 

3

%

Natural gas ($ per Mcf)

 

 

2.31

 

 

2.79

 

 

(0.48)

 

(17)

%

Oil equivalent ($ per Boe)

 

$

20.41

 

$

26.47

 

$

(6.06)

 

(23)

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Average Sales Price Including Derivatives(2):  

 

 

 

 

 

 

 

 

 

 

 

 

Oil ($ per Bbl)

 

$

54.89

 

$

61.15

 

$

(6.26)

 

(10)

%

NGLs ($ per Bbl)

 

 

12.24

 

 

11.86

 

 

0.38

 

3

%

Natural gas ($ per Mcf)

 

 

3.01

 

 

3.29

 

 

(0.28)

 

(9)

%

Oil equivalent ($ per Boe)

 

$

28.16

 

$

33.48

 

$

(5.32)

 

(16)

%

 

 

 

 

 

 

 

 

 

 

 

 

 

REVENUES(1):

 

 

 

 

 

 

 

 

 

 

 

 

Oil sales

 

$

172,509

 

$

244,554

 

$

(72,045)

 

(29)

%

Natural gas liquids sales

 

 

56,535

 

 

48,602

 

 

7,933

 

16

%

Natural gas sales

 

 

76,547

 

 

73,091

 

 

3,456

 

5

%

Total revenues

 

$

305,591

 

$

366,247

 

$

(60,656)

 

(17)

%

 


(1)

Excludes the impact of derivative instrument settlements.

 

(2)

Includes the impact of derivative instrument settlements.

 

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The following table sets forth information regarding combined net production of oil, NGLs and natural gas attributable to our properties for each of the periods presented:

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

September 30, 

 

 

    

2016

    

2015

 

Production:

 

 

 

 

 

 

 

Oil - MBbl

 

 

 

 

 

 

 

Catarina

 

 

2,721

 

 

2,235

 

Marquis

 

 

554

 

 

1,188

 

Cotulla

 

 

1,234

 

 

1,399

 

Palmetto

 

 

291

 

 

497

 

Other

 

 

36

 

 

53

 

Total

 

 

4,836

 

 

5,372

 

NGLs - MBbl

 

 

 

 

 

 

 

Catarina

 

 

4,231

 

 

3,564

 

Marquis

 

 

123

 

 

166

 

Cotulla

 

 

202

 

 

256

 

Palmetto

 

 

64

 

 

111

 

Other

 

 

 —

 

 

 —

 

Total

 

 

4,620

 

 

4,097

 

Natural gas - MMcf

 

 

 

 

 

 

 

Catarina

 

 

30,948

 

 

23,227

 

Marquis

 

 

518

 

 

684

 

Cotulla

 

 

1,215

 

 

1,663

 

Palmetto

 

 

404

 

 

620

 

Other

 

 

7

 

 

23

 

Total

 

 

33,092

 

 

26,217

 

Net production volumes:

 

 

 

 

 

 

 

Total oil equivalent (MBoe)

 

 

14,971

 

 

13,839

 

Average daily production (Boe/d)

 

 

54,639

 

 

50,690

 

Average Sales Price (1):  

 

 

 

 

 

 

 

Oil ($ per Bbl)

 

$

35.67

 

$

45.53

 

NGLs ($ per Bbl)

 

$

12.24

 

$

11.86

 

Natural gas ($ per Mcf)

 

$

2.31

 

$

2.79

 

Oil equivalent ($ per Boe)

 

$

20.41

 

$

26.47

 

Average unit costs per Boe:

 

 

 

 

 

 

 

Oil and natural gas production expenses

 

$

8.59

 

$

7.96

 

Production and ad valorem taxes

 

$

0.94

 

$

1.45

 

General and administrative (2)

 

$

2.96

 

$

3.13

 

Depreciation, depletion, amortization and accretion

 

$

8.55

 

$

21.43

 

Impairment of oil and natural gas properties

 

$

11.29

 

$

98.63

 

 

(1)

Excludes the impact of derivative instruments.

 

(2)

For the nine months ended September 30, 2016 and 2015, general and administrative excludes non-cash stock-based compensation expense of approximately $26.0 million ($1.74 per Boe) and $15.9 million ($1.15 per Boe), respectively.

 

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Net Production.  Production increased from 13,839 MBoe for the nine months ended September 30, 2015 to 14,971 MBoe for the nine months ended September 30, 2016 due to our drilling program. The number of gross wells producing at the period end and the production for the periods were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

 

2016

 

2015

 

 

    

# Wells

    

MBoe

    

# Wells

    

MBoe

 

Catarina

 

311

 

12,110

 

264

 

9,670

 

Cotulla

 

153

 

1,639

 

103

 

1,467

 

Marquis

 

103

 

763

 

139

 

1,933

 

Palmetto

 

76

 

422

 

72

 

712

 

Other

 

14

 

37

 

14

 

57

 

Total

 

657

 

14,971

 

592

 

13,839

 

 

For the nine months ended September 30, 2016, 32% of our production was oil, 31% was NGLs and 37% was natural gas compared to the nine months ended September 30, 2015 production that was 39% oil, 30% NGLs and 31% natural gas. The change in production mix between the periods was due to the increased production from the Catarina wells and the higher proportion of NGLs and natural gas production as compared to oil production from this area. Since the acquisition of the Catarina wells, production from Catarina has continued to increase in proportion to total production, and as such, a higher proportion of NGLs and natural gas was produced as compared to oil.

 

Revenues.  Oil, NGLs, and natural gas sales revenues totaled approximately $305.6 million and $366.2 million for the nine months ended September 30, 2016 and 2015, respectively. Oil sales revenues for the nine months ended September 30, 2016 decreased $72.0 million, while sales revenues for NGLs and Natural gas for the nine months ended September 30, 2016 increased $7.9 million and $3.5 million, respectively, as compared to the nine months ended September 30, 2015.

 

The tables below provide an analysis of the impacts of changes in production volumes and average realized prices between the periods on our revenues from the nine months ended September 30, 2016 to the nine months ended September 30, 2015 (in thousands, except average sales price). The decrease in average realized prices from the nine months ended September 30, 2015 to the nine months ended September 30, 2016 can be attributed to both the significant decline in commodity prices and the increased percentage of NGLs and natural gas production relative to oil production that comprises our total production mix.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

YTD Q3

    

YTD Q3

    

 

 

    

 

 

    

 

 

 

 

 

2016

 

2015

 

Production

 

YTD Q3 2015

 

Revenue

 

 

 

Production

 

Production

 

Volume

 

Average Sales

 

Increase/(Decrease)

 

 

 

Volume

 

Volume

 

Difference

 

Price

 

due to Production

 

Oil (MBbl)

 

 

4,836

 

 

5,372

 

 

(536)

 

$

45.53

 

$

(24,384)

 

NGLs (MBbl)

 

 

4,620

 

 

4,097

 

 

523

 

$

11.86

 

$

6,209

 

Natural gas (MMcf)

 

 

33,092

 

 

26,217

 

 

6,875

 

$

2.79

 

$

19,166

 

Total oil equivalent (MBoe)

 

 

14,971

 

 

13,839

 

 

1,132

 

$

26.47

 

$

991

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

YTD Q3

 

YTD Q3

 

 

 

 

 

 

 

 

 

 

 

 

2016

 

2015

 

Average

 

YTD Q3

 

Revenue

 

 

 

 

Average Sales

 

Average Sales

 

 

Sales Price

 

2016

 

Increase/(Decrease)

 

 

    

Price

    

Price

    

 

Difference

    

Volume

    

due to Price

 

Oil (MBbl)

 

$

35.67

 

$

45.53

 

$

(9.86)

 

 

4,836

 

$

(47,661)

 

NGLs (MBbl)

 

$

12.24

 

$

11.86

 

$

0.38

 

 

4,620

 

$

1,724

 

Natural gas (MMcf)

 

$

2.31

 

$

2.79

 

$

(0.48)

 

 

33,092

 

$

(15,710)

 

Total oil equivalent (MBoe)

 

$

20.41

 

$

26.47

 

$

(6.06)

 

 

14,971

 

$

(61,647)

 

 

Additionally, a 10% increase in our average realized sales prices, excluding the impact of derivatives, would have increased our revenues for the nine months ended September 30, 2016 by approximately $30.6 million, and a 10%

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decrease in our average realized sales prices, excluding the impact of derivatives, would have decreased our revenues for the nine months ended September 30, 2016 by approximately $30.6 million.

 

Operating Costs and Expenses

 

The table below presents a detail of operating costs and expenses for the periods indicated (in thousands, except percentages):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

Increase (Decrease)

 

 

September 30, 

 

2016 vs 2015

 

 

    

2016

    

2015

    

 

$  

    

%

    

OPERATING COSTS AND EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

 

Oil and natural gas production expenses

 

$

128,609

 

$

110,166

 

$

18,443

 

17

%

Production and ad valorem taxes

 

 

14,052

 

 

20,011

 

 

(5,959)

 

(30)

%

Depreciation, depletion, amortization and accretion

 

 

127,959

 

 

296,541

 

 

(168,582)

 

(57)

%

Impairment of oil and natural gas properties

 

 

169,046

 

 

1,365,000

 

 

(1,195,954)

 

(88)

%

General and administrative (1)

 

 

70,399

 

 

59,290

 

 

11,109

 

19

%

Total operating costs and expenses

 

 

510,065

 

 

1,851,008

 

 

(1,340,943)

 

(72)

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

629

249

 

380

 

153

%

Other income (expense)

 

 

(196)

 

 

(2,053)

 

 

1,857

 

(90)

%

Interest expense

 

 

(95,225)

 

 

(94,500)

 

 

(725)

 

1

%

Earnings from equity investments

 

 

3,154

 

 

 —

 

 

3,154

 

*

 

Net gains (losses) on commodity derivatives

 

 

(17,353)

 

 

111,550

 

 

(128,903)

 

(116)

%

Income tax expense

 

 

1,441

 

 

7,600

 

 

(6,159)

 

(81)

%

 


(1)

Inclusive of stock-based compensation expense of $26.0 million and $15.9 million for the nine months ended September 30, 2016 and 2015, respectively.

 

Oil and Natural Gas Production Expenses.  Oil and natural gas production expenses are the costs incurred to produce our oil and natural gas, as well as the daily costs incurred to maintain our producing properties. Such costs also include field personnel costs, utilities, chemical additives, salt water disposal, maintenance, repairs and occasional well workover expenses related to our oil and natural gas properties. Our oil and natural gas production expenses increased 17% to approximately $128.6 million for the nine months ended September 30, 2016 as compared to $110.2 million for the same period in 2015. The increase in oil and natural gas production expenses in the third quarter of 2016 compared to the same period of 2015 is attributable to our increased production activities and well count on our existing acreage. In addition, there was an increase in gathering and transportation costs related to the Gathering Agreement with SPP that began in October 2015. Our average production expenses increased from $7.96 per Boe during the nine months ended September 30, 2015 to $8.59 per Boe for the nine months ended September 30, 2016. This increase was due primarily to the gathering and transportation expenses related to the Gathering Agreement with SPP. While we expect our oil and natural gas production expenses to increase as we add producing wells, we expect to continue our efficient operation of our properties.

 

Production and Ad Valorem Taxes.  Production and ad valorem taxes are paid on produced oil and natural gas based upon a percentage of gross revenues or at fixed rates established by state or local taxing authorities. Our production and ad valorem taxes totaled $14.1 million and $20.0 million for the nine months ended September 30, 2016 and 2015, respectively. The decrease in production and ad valorem taxes in the nine months of 2016 compared to the same period in 2015 was due to lower production taxes and tight gas tax credits applied to our wells for the nine months ended September 30, 2016 compared to the same period in 2015.  The majority of our horizontal wells are characterized as tight gas wells, which apply a reduced production tax rate after certification from the state regulatory body.  Until the Company receives the proper certification, the normal production tax rates are applied to the wells. Once the certification is approved, the reduced rates are applied and tax credits are received from the state.  The timing of receipt of the certifications and tax credits vary from well to well. Our average production and ad valorem taxes decreased from $1.45 per Boe during the nine months ended September 30, 2015 to $0.94 per Boe for the nine months ended September 30, 2016.

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Depreciation, Depletion, Amortization and Accretion.  For definition of DD&A under the full-cost method of accounting, see “—Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015—Operating Costs and Expenses—Depreciation, Depletion, Amortization, and Accretion,” above.

 

Our DD&A expense decreased $168.6 million from $296.5 million ($21.43 per Boe) for the nine months ended September 30, 2015 to $128.0 million ($8.55 per Boe) for the nine months ended September 30, 2016. The majority of the decrease in DD&A is related to the decrease in depletion rate due to accumulated full cost ceiling impairments recorded and the decrease in the full cost pool related to the Western Catarina Midstream Divestiture in the fourth quarter of 2015. Higher production during the nine months ended September 30, 2016 as compared to the same period in 2015 resulted in a $192.8 million decrease in depletion expense and the increase in the depletion rate resulted in a $24.2 million increase in depletion expense.

 

Impairment of Oil and Natural Gas Properties.  For definition of impairment under the full-cost method of accounting, see “—Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015—Operating Costs and Expenses—Impairment of Oil and Natural Gas Properties,” above. We recorded a full cost ceiling test impairment after income taxes of $169.0 million for the nine months ended September 30, 2016. The impact of less favorable commodity prices adversely affecting proved reserve values was the main contributor to the ceiling impairment recorded for the nine months ended September 30, 2016. Changes in production rates, levels of reserves, future development costs, transfers of unevaluated properties, and other factors will determine our actual ceiling test calculation and impairment analyses in future periods. We recorded a full cost ceiling test impairment after income taxes of $1,365 million for the nine months ended September 30, 2015. While there is a possibility that the Company will incur additional impairments to our full cost pool in 2016, factors impacting the full cost ceiling test impairment calculation have not yet been determined. Based upon known improvements in the current NYMEX forward prices, we believe that there is a reasonable likelihood of an increase in the average 12 month trailing first-day-of-the-month pricing in the fourth quarter of 2016.  

 

General and Administrative Expenses.  Our general and administrative (“G&A”) expenses, including stock‑based compensation expense, totaled $70.4 million for the nine months ended September 30, 2016 compared to $59.3 million for the same period in 2015. Excluding the stock‑based compensation, G&A expenses for the nine months ended September 30, 2016 and 2015 were $44.4 million and $43.4 million, respectively, which is consistent period over period. Our G&A expenses, excluding stock‑based compensation expense, decreased from $3.13 per Boe during the nine months ended September 30, 2015 to $2.96 per Boe for the nine months ended September 30, 2016.

 

For the nine months ended September 30, 2016 and 2015, we recorded non‑cash stock‑based compensation expense of approximately $26.0 million and $15.9 million, respectively. The increase in the stock-based compensation expense amount was caused by an increase in the Company’s stock price during the third quarter 2016, and an increase in awards outstanding and the associated amortization expense recognized. Because the Company records stock‑based compensation expense for awards granted to non‑employees at fair value and the unvested awards are revalued each period, impacting the amortization over the remaining life of the awards, the Company’s increase in stock price will cause an increase to the stock‑based compensation expense recognized during the quarter.

 

Interest Expense.  For the nine months ended September 30, 2016, interest expense totaled $95.2 million and included $5.9 million in amortization of debt issuance costs. This is compared to the nine months ended September 30, 2015, for which interest expense totaled $94.5 million and included $5.3 million in amortization of debt issuance costs. The interest expense incurred during the nine months ended September 30, 2016 and September 30, 2015 is primarily related to the 7.75% Notes issued in June and September 2013 and the 6.125% Notes issued in June and September 2015.

 

Commodity Derivative Transactions.  We apply mark‑to‑market accounting to our derivative contracts; therefore, the full volatility of the non‑cash change in fair value of our outstanding contracts is reflected in other income and expense. During the nine months ended September 30, 2016, we recognized a net loss of $17.4 million on our commodity derivative contracts primarily related to mark-to-market losses on oil and natural gas derivatives of $106.4 million and $27.0 million, respectively, associated with the increase in oil and natural prices from December 31, 2015 to September 30, 2016. These mark-to-market losses were offset by settlements of commodity derivative contracts of $116.0 million. These gains were primarily the result of the decreases in commodity prices from the time the trades were entered until the time of cash settlement for trades that liquidated by their terms during the current period. During

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the nine months ended September 30, 2015, we recognized a net gain of $111.6 million on our commodity derivative contracts related to settlements of commodity derivative contracts of $97.0 million and mark-to-market gains on commodity derivatives of $14.7 million.

 

Income Tax Expense.    For the nine months ended September 30, 2016, the Company recorded income tax expense of approximately $1.4 million. Due to the full cost ceiling impairments recorded, the Company was in a net loss position for the quarter but had current income tax expense related to adjustments for immaterial differences on the alternative minimum tax calculation from the 2015 income tax return filed in September 2016 to the accrual for 2015 income taxes recorded in December 2015. Our effective tax rate for the nine months ended September 30, 2016 was approximately (0.5)% compared to a statutory rate of 35%. The difference between the statutory rate and the Company’s effective tax rate is related to a valuation allowance recorded during the period. For the nine months ended September 30, 2015, the Company recorded income tax expense of $7.6 million. Our effective tax rate for the nine months ended September 30, 2015 was (0.5)%. The primary difference between the statutory federal income taxes calculated using a U.S. Federal statutory corporate income tax rate of 35% and the Company’s effective tax rate of (0.5)% for the nine months ended September 30, 2015 is related to a valuation allowance recorded during the period.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in accordance with U.S. GAAP requires our management to select and apply accounting policies that best provide the framework to report our results of operations and financial position. The selection and application of those policies requires our management to make difficult subjective or complex judgments concerning reported amounts of revenue and expenses during the reporting period and the reported amounts of assets and liabilities at the date of the financial statements. As a result, there exists the likelihood that materially different amounts would be reported under different conditions or using different assumptions.

 

As of September 30, 2016, our critical accounting policies were consistent with those discussed in our 2015 Annual Report.

 

Use of Estimates

 

The condensed consolidated financial statements are prepared in conformity with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates pertain to proved oil and natural gas reserves and related cash flow estimates used in the depletion and impairment of oil and natural gas properties, the evaluation of unproved properties for impairment, the fair value of commodity derivative contracts and asset retirement obligations, accrued oil and natural gas revenues and expenses and the allocation of general and administrative expenses. Actual results could differ materially from those estimates.

 

Liquidity and Capital Resources

 

As of September 30, 2016, we had approximately $329 million in cash and cash equivalents and $300 million in borrowing capacity at the aggregate elected commitment amount under the Second Amended and Restated Credit Agreement with a syndicate of 16 participating banks, resulting in available liquidity of approximately $629 million. The borrowing base under the Second Amended and Restated Credit Agreement was set at $350 million in March 2016. Pursuant to amendments to the Second Amended and Restated Credit Agreement executed at that time, the $300 million aggregate elected commitment amount will remain fixed until the lenders’ next regularly scheduled borrowing base redetermination, which is expected to occur in the fourth quarter 2016.

 

Based on modest improvements in market conditions and our results for the first nine months of 2016, which include stronger production, lower costs, and better well results than anticipated at the time we initially developed our plans for 2016, in August 2016 the Company updated its 2016 capital budget to range between $250 million to $300 million. We expect to use a portion of our cash on hand, internally generated cash flows from operations, and funds raised through the strategic sale of certain non-core assets (such as the pending sale transactions contemplated by the Carnero Processing, Production Asset and Cotulla Transactions, if consummated, among others), to fund our remaining 2016 capital expenditures, and currently project no borrowings under the Second Amended and Restated Credit Agreement for purposes of our development activity at our planned level of capital spending. We believe that our cash

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on hand and internally generated cash flows from operations will adequately meet our liquidity needs for the next twelve months. 

 

For a description of current and previous credit agreements along with the indentures covering our Senior Notes refer to Note 6, “Long Term Debt” of Part 1, Item 1. Financial Statements.

 

In July 2016, the Company hedged an additional 6,190,000 MMBtu of its 2017 natural gas production, in variable quantities that range from 2,500 MMBtu per day to 27,500 MMBtu per day, at a fixed price of $3.10/MMBtu.  Please refer to Note 7, “Derivative Instruments” for a description of all of the Company’s derivatives covering anticipated future production as of September 30, 2016.

 

Cash Flows

 

Our cash flows for the nine months ended September 30, 2016 and 2015 (in thousands) are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

 

September 30, 

 

 

 

    

2016

    

2015

    

 

Cash Flow Data:

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

136,216

 

$

228,638

 

 

Net cash used in investing activities

 

$

(236,990)

 

$

(493,095)

 

 

Net cash used in financing activities

 

$

(5,745)

 

$

(12,373)

 

 

 

Net Cash Provided by Operating Activities.  Net cash provided by operating activities was $136.2 million for the nine months ended September 30, 2016 compared to $228.6 million for the same period in 2015. This decrease was primarily related to lower revenues due to the impact of lower average commodity prices between these periods. This decrease was partially offset by higher cash settlements received on commodity derivative contracts between these periods.

 

One of the primary sources of variability in the Company’s cash flows from operating activities is fluctuations in commodity prices, the impact of which the Company partially mitigates by entering into commodity derivatives. Sales volume changes also impact cash flow. The Company’s cash flows from operating activities are also dependent on the costs related to continued operations and debt service.

 

Net Cash Used in Investing Activities.  Net cash flows used in investing activities totaled $237.0 million for the nine months ended September 30, 2016 compared to $493.1 million for the same period in 2015. Capital expenditures for leasehold and drilling activities for the nine months ended September 30, 2016 totaled $241.3 million, primarily associated with bringing 36 gross wells on-line. The Company invested $28.7 million in the joint ventures with Targa, which was offset by the $37.0 million cash inflows from the sale of the Carnero Gathering interests. In addition, we invested $4.0 million in other property and equipment during the nine months ended September 30, 2016. For the nine months ended September 30, 2015, we incurred capital expenditures for leasehold and drilling activities of $562.6 million, primarily associated with bringing 107 gross wells on-line. In connection with the Palmetto Divestiture on March 31, 2015, we received cash consideration of approximately $81.7 million. In connection with the Buyout Agreement in August 2015, we spent approximately $7.7 million. In addition, we invested $4.6 million in other property and equipment during the nine months ended September 30, 2015.

 

Net Cash Used in Financing Activities.  Net cash flows used in financing activities totaled an outflow of $5.7 million for the nine months ended September 30, 2016 compared to $12.4 million for the same period in 2015. During the nine months ended September 30, 2016, we made payments of approximately $4.0 million for dividends on our Series A Preferred Stock and Series B Preferred Stock and payments of approximately $1.7 million for deferred financing costs associated with the Sixth Amendment to the Second Amended and Restated Credit Agreement.  During the nine months ended September 30, 2015, we made payments of $12.0 million for dividends on our Series A Convertible Perpetual Preferred Stock and Series B Convertible Perpetual Preferred Stock.

 

Off‑Balance Sheet Arrangements

 

As of September 30, 2016, we did not have any off‑balance sheet arrangements.

 

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Commitments and Contractual Obligations

 

Refer to Note 16, “Commitments and Contingencies” for a description of lawsuits pending against the Company.

 

There have been no material changes in our contractual obligations during the three months ended September 30, 2016.

 

Non‑GAAP Financial Measures

 

Adjusted EBITDA

 

We present adjusted EBITDA attributable to common stockholders (“Adjusted EBITDA”) in addition to our reported net income (loss) in accordance with U.S. GAAP. Adjusted EBITDA is a non‑GAAP financial measure that is used as a supplemental financial measure by our management and by external users of our financial statements, such as investors, commercial banks and others, to assess our operating performance as compared to that of other companies in our industry, without regard to financing methods, capital structure or historical costs basis. It is also used to assess our ability to incur and service debt and fund capital expenditures. We define Adjusted EBITDA as net income (loss):

 

Plus:

 

·

Interest expense, including net losses (gains) on interest rate derivative contracts;

 

·

Net losses (gains) on commodity derivative contracts;

 

·

Net settlements received (paid) on commodity derivative contracts;

 

·

Depreciation, depletion, amortization, and accretion;

 

·

Stock‑based compensation expense;

 

·

Acquisition and divestiture costs included in general and administrative;

 

·

Income tax expense (benefit);

 

·

Loss (gain) on sale of oil and natural gas properties;

 

·

Impairment of oil and natural gas properties; and

 

·

Certain other items that we deem appropriate.

 

Less:

 

·

Amortization of deferred gain on Western Catarina Midstream Divestiture;

 

·

Interest income; and

 

·

Certain other items that we deem appropriate.

 

Our Adjusted EBITDA should not be considered an alternative to net income (loss), operating income (loss), cash flows provided by (used in) operating activities or any other measure of financial performance or liquidity presented in accordance with U.S. GAAP. Our Adjusted EBITDA may not be comparable to similarly titled measures of another company because all companies may not calculate Adjusted EBITDA in the same manner.

 

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The following table presents a reconciliation of our net loss to Adjusted EBITDA (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30, 

 

    

2016

    

2015

 

2016

    

2015

Net loss

 

$

(66,262)

 

$

(416,860)

 

$

(314,906)

 

$

(1,477,115)

Plus:

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

31,797

 

 

31,442

 

 

95,225

 

 

94,500

Net losses (gains) on commodity derivative contracts

 

 

(18,640)

 

 

(103,996)

 

 

17,353

 

 

(111,550)

Net settlements received on commodity derivative contracts (1)

 

 

28,120

 

 

39,488

 

 

115,998

 

 

96,981

Depreciation, depletion, amortization and accretion

 

 

37,651

 

 

89,167

 

 

127,959

 

 

296,541

Impairment of oil and natural gas properties

 

 

59,582

 

 

454,628

 

 

169,046

 

 

1,365,000

Stock-based compensation expense

 

 

12,802

 

 

355

 

 

26,025

 

 

15,924

Acquisition and divestiture costs included in general and administrative

 

 

1,133

 

 

 —

 

 

1,555

 

 

 —

Write off of joint venture receivable, non-recurring

 

 

 —

 

 

 —

 

 

 —

 

 

2,251

Income tax expense

 

 

1,441

 

 

158

 

 

1,441

 

 

7,600

Less:

 

 

 

 

 

 

 

 

 

 

 

 

  Amortization of deferred gain on Western Catarina Midstream Divestiture

 

 

(3,703)

 

 

 —

 

 

(11,110)

 

 

 —

Interest income

 

 

(146)

 

 

(65)

 

 

(629)

 

 

(249)

Adjusted EBITDA

 

$

83,775

 

$

94,317

 

$

227,957

 

$

289,883

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

This amount has been reduced by premiums associated with derivatives that settled during the respective periods, which may include premiums accrued but not yet paid as of the end of the quarter based on timing of cash settlement payments with counterparties.

 

The following table presents a reconciliation of net cash provided by operating activities to Adjusted EBITDA (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30, 

 

 

2016

 

2015

 

    

2016

    

2015

    

Net cash provided by operating activities

$

49,346

 

$

79,234

 

 

$

136,216

 

$

228,638

 

Net change in operating assets and liabilities

 

243

 

 

(17,033)

 

 

 

5,733

 

 

(33,589)

 

Cash reimbursements received for operating leasehold improvements

 

 —

 

 

(2,650)

 

 

 

 —

 

 

(2,650)

 

Interest expense, net (1)

 

29,517

 

 

29,470

 

 

 

88,255

 

 

88,395

 

Settlements on commodity derivative contracts, non-cash

 

1,959

 

 

6,034

 

 

 

(7,490)

 

 

7,544

 

Loss on inventory market adjustment

 

 —

 

 

 —

 

 

 

(479)

 

 

 —

 

Distributions from equity investments

 

(327)

 

 

 —

 

 

 

(428)

 

 

 —

 

Earnings from equity investments

 

463

 

 

 —

 

 

 

3,154

 

 

 —

 

Income tax expense

 

1,441

 

 

158

 

 

 

1,441

 

 

158

 

Write off of joint venture receivable, non-cash

 

 —

 

 

 —

 

 

 

 —

 

 

2,251

 

Acquisition and divestiture costs included in general and administrative

 

1,133

 

 

 —

 

 

 

1,555

 

 

 —

 

Loss on investment in SPP

 

 —

 

 

(896)

 

 

 

 —

 

 

(864)

 

Adjusted EBITDA

$

83,775

 

$

94,317

 

 

$

227,957

 

$

289,883

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


(1)

This amount includes cash interest expense on our Senior Notes and credit agreements, net of interest income.

 

Adjusted Net Income

 

We present adjusted net income (loss) attributable to common stockholders (“Adjusted Net Income (Loss)”) in addition to our reported net income (loss) in accordance with U.S. GAAP. This information is provided because management believes exclusion of the impact of the items included in our definition of Adjusted Net Income (Loss) below will help investors compare results between periods, identify operating trends that could otherwise be masked by these items and highlight the impact that commodity price volatility has on our results. We define Adjusted Net Income (Loss) as net income (loss):

 

Plus:

 

·

Non‑cash preferred stock dividends associated with conversion;

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·

Net losses (gains) on commodity derivative contracts;

 

·

Net settlements received (paid) on commodity derivative contracts;

 

·

Stock‑based compensation expense;

 

·

Acquisition and divestiture costs included in general and administrative;

 

·

Impairment of oil and natural gas properties;

 

·

Certain other items that we deem appropriate; and

 

·

Tax impact of adjustments to net income (loss).

 

Less:

 

·

Amortization of deferred gain on Western Catarina Midstream Divestiture;

 

·

Preferred stock dividends; and

 

·

Certain other items that we deem appropriate.

 

The following table presents a reconciliation of our net income (loss) to Adjusted Net Income (Loss) (in thousands, except per share data):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 

 

Nine Months Ended September 30, 

 

 

2016

    

2015

    

2016

    

2015

 

 

 

 

 

 

 

 

 

 

 

Net loss

$

(66,262)

 

$

(416,860)

 

$

(314,906)

 

$

(1,477,115)

 

Less: Preferred stock dividends

 

(3,987)

 

 

(3,991)

 

 

(11,961)

 

 

(11,973)

 

Net loss attributable to common shares and participating securities

 

(70,249)

 

 

(420,851)

 

 

(326,867)

 

 

(1,489,088)

 

Plus:

 

 

 

 

 

 

 

 

 

 

 

 

Non-cash write off of joint venture receivables

 

 —

 

 

 —

 

 

 —

 

 

2,251

 

Net losses (gains) on commodity derivatives contracts

 

(18,640)

 

 

(103,996)

 

 

17,353

 

 

(111,550)

 

Net settlements received on commodity derivative contracts (1)

 

28,120

 

 

39,488

 

 

115,998

 

 

96,981

 

Impairment of oil and natural gas properties

 

59,582

 

 

454,628

 

 

169,046

 

 

1,365,000

 

Stock-based compensation expense

 

12,802

 

 

355

 

 

26,025

 

 

15,924

 

Acquisition and divestiture costs included in general and administrative

 

1,133

 

 

 —

 

 

1,555

 

 

 —

 

Amortization of deferred gain on Western Catarina Midstream Divestiture

 

(3,703)

 

 

 —

 

 

(11,110)

 

 

 —

 

Tax impact of adjustments to net income (loss) (2)

 

365

 

 

2,020

 

 

365

 

 

12,470

 

Adjusted net income (loss)

 

9,410

 

 

(28,356)

 

 

(7,635)

 

 

(108,012)

 

Adjusted net income (loss) allocable to participating securities

 

(962)

 

 

 —

 

 

 —

 

 

 —

 

Adjusted net income (loss) attributable to common stockholders (3)

$

8,448

 

$

(28,356)

 

$

(7,635)

 

$

(108,012)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares used to calculate net income (loss) attributable to common stockholders - basic and diluted

 

59,190

 

 

57,426

 

 

58,782

 

 

57,141

 

 

 

 

 

 

 

 

 

 

 

 

 

 


(1)

This amount has been reduced by premiums associated with derivatives that settled during the respective periods, which may include premiums accrued but not yet paid as of the end of the quarter based on timing of cash settlement payments with counterparties.

 

(2)

The tax impact is computed by utilizing the Company’s effective tax rate on the adjustments to reconcile net income (loss) to adjusted net income (loss).

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(3)

The Company’s restricted shares of common stock are participating securities.

 

Adjusted Net Income (Loss) is not intended to represent cash flows for the period, nor is it presented as a substitute for net income (loss), operating income (loss), cash flows provided by (used in) operating activities or any other measure of financial performance or liquidity presented in accordance with U.S. GAAP.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

We are exposed to a variety of market risks, including the effects of adverse changes in commodity prices and, potentially, interest rates as described below.

 

The primary objective of the following information is to provide quantitative and qualitative information about our potential exposure to market risks. The disclosures are not meant to be precise indicators of expected future losses, but rather indicators of reasonably possible losses. All of our market risk sensitive instruments were entered into for purposes other than speculative trading.

 

Commodity Price Risk

 

Our major market risk exposure is in the pricing that we receive for our oil, NGLs and natural gas production. Realized pricing is primarily driven by the prevailing market prices applicable to our oil, NGLs and natural gas production. Pricing for oil, NGLs and natural gas has been volatile and unpredictable for several years, and this volatility is expected to continue in the future. The prices we receive for our oil, NGLs and natural gas production depend on many factors outside of our control, such as the relative strength of the global economy and the actions of OPEC.

 

To reduce the impact of fluctuations in oil and natural gas prices on the Company’s revenues, and to protect the economics of property acquisitions at the time of execution, the Company periodically enters into derivative contracts with respect to a portion of its projected oil and natural gas production through various transactions that fix or modify the future prices to be realized. These derivative contracts may include price swaps (whereby the Company will receive a fixed price for its production and pay a variable market price to the contract counterparty) and collars (whereby the Company receives the excess, if any, of a floating price over a fixed floor price up to a fixed ceiling price). In addition, the Company periodically enters into option and swaption transactions as a way to manage its exposure to fluctuating prices, enhance the value of fixed price swaps, and/or expand the notional quantity hedged under fixed price swaps. These hedging activities are intended to support oil and natural gas prices at targeted levels and to manage exposure to oil and natural gas price fluctuations. It is never the Company’s intention to enter into derivative contracts for speculative trading purposes. Please refer to Note 7, “Derivative Instruments” for a description of all of the Company’s derivatives covering anticipated future production as of September 30, 2016.

 

At September 30, 2016, the fair value of our commodity derivative contracts was a net asset of approximately $26.6 million and the fair value of the premiums associated with our commodity derivative puts was a liability of approximately $8.2 million. A 10% increase in the oil and natural gas index prices above the September 30, 2016 prices would result in a decrease in the fair value of our commodity derivative contracts of $37.6 million; conversely, a 10% decrease in the oil index price would result in an increase of $36.8 million.

 

Interest Rate Risk

 

As of September 30, 2016, no amounts were outstanding under our Second Amended and Restated Credit Agreement. Our 7.75% Notes bear a fixed interest rate of 7.75% with an expected maturity date of June 15, 2021, and we had $600 million outstanding as of September 30, 2016. Our 6.125% Notes bear a fixed interest rate of 6.125% with an expected maturity date of January 15, 2023, and we had $1.15 billion outstanding as of September 30, 2016. We currently do not have any interest rate derivative contracts in place. If we incur significant debt with a risk of fluctuating interest rates in the future, such as borrowings under out Second Amended and Restated Credit Agreement, we may enter into interest rate derivative contracts on a portion of our then outstanding debt to mitigate the risk of fluctuating interest rates.

 

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Item 4.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We carried out an evaluation, under the supervision and with the participation of management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15 promulgated pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that material information required to be disclosed by us in reports that we file or submit under the Exchange Act is appropriately recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and that information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Changes in Internal Controls

 

There was no change in our internal control over financial reporting during the three months ended September 30, 2016 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II—OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

For a description of our material pending legal proceedings, please refer to Note 16, “Commitments and Contingencies.”

 

Item 1A.  Risk Factors

 

Consider carefully the risk factors under the caption "Risk Factors" under Part I, Item 1A in our 2015 Annual Report, together with all of the other information included in this Quarterly Report on Form 10-Q; in our 2015 Annual Report; and in our other public filings, press releases, and public discussions with our management. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may materially adversely affect our business, financial condition or results of operations.

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3.  Defaults Upon Senior Securities

 

None.

 

Item 4.  Mine Safety Disclosures

 

Not applicable.

 

Item 5.  Other Information

 

None.

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Item 6.  Exhibits

 

EXHIBIT INDEX

 

 

 

2.1 

 **

 

 

Purchase and Sale Agreement, dated as of July 5, 2016, by and among Sanchez Energy Corporation, SN Midstream, LLC and Sanchez Production Partners LP (filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K on July 6, 2016 (File No. 001-35372) and incorporated herein by reference).

 

 

 

 

 

 

 

2.2 

**

 

 

Purchase and Sale Agreement, dated October 6, 2016, by and among Sanchez Energy Corporation, SN Midstream, LLC and Sanchez Production Partners LP (filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K on October 6, 2016 (File No. 001-35372) and incorporated herein by reference).

 

 

 

 

 

 

 

2.3 

**

 

 

Purchase and Sale Agreement, dated October 6, 2016, by and among SN Cotulla Assets, LLC, SN Palmetto, LLC, SEP Holdings IV, LLC and Sanchez Production Partners LP (filed as Exhibit 2.2 to the Company’s Current Report on Form 8-K on October 6, 2016 (File No. 001-35372) and incorporated herein by reference).

 

 

 

 

 

 

 

2.4 

**

 

 

Purchase and Sale Agreement, dated October 6, 2016, by and among Sanchez Energy Corporation, SN Terminal, LLC and Sanchez Production Partners LP (filed as Exhibit 2.3 to the Company’s Current Report on Form 8-K on October 6, 2016 (File No. 001-35372) and incorporated herein by reference).

 

 

 

 

 

 

 

3.1 

 

 

 

Certificate of Amendment of Amended and Restated Certificate of Incorporation of Sanchez Energy Corporation (filed as Exhibit 3.1 to the Company's Current Report on Form 8-K on May 28, 2013 (File No. 001-35372) and incorporated herein by reference).

 

  

 

 

 

 

 

3.2 

 

 

 

Restated Certificate of Incorporation of Sanchez Energy Corporation, effective as of May 28, 2013 (filed as Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q on November 8, 2013 (File No. 001-35372) and incorporated herein by reference).

 

  

 

 

 

 

 

3.3 

 

 

 

Certificate of Designations of Series C Junior Participating Preferred Stock of Sanchez Energy Corporation (filed as Exhibit 3.1 to the Company's Current Report on Form 8-K on July 29, 2015 (File No. 001-35372)  and incorporated herein by reference).

 

  

 

 

 

 

 

3.4 

 

 

 

Amended and Restated Bylaws, dated as of December 13, 2011 (filed as Exhibit 3.2 to the Company's Current Report on Form 8-K on December 19, 2011 (File No. 001-35372)  and incorporated herein by reference).

 

 

 

 

 

 

 

10.1 

*

 

 

Indemnification Agreement, dated as of August 2, 2016, between Sanchez Energy Corporation and Robert V. Nelson, III (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K on August 2, 2016 (File No. 001-35372) and incorporated herein by reference).

 

 

 

 

 

 

 

10.2 

*

 

 

Indemnification Agreement, dated as of October 10, 2016, between Sanchez Energy Corporation and Howard Thill (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K on October 10, 2016 (File No. 001-35372) and incorporated herein by reference).

 

 

 

 

 

 

 

10.3 

*

 

 

Restricted Stock Agreement, dated as of October 10, 2016, between Sanchez Energy Corporation and Howard J. Thill (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K on October 10, 2016 (File No. 001-35372) and incorporated herein by reference).

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10.4 

*

 

 

Phantom Stock Agreement, dated as of October 10, 2016, between Sanchez Energy Corporation and Howard J. Thill (filed as Exhibit 10.3 to the Company’s Current Report on Form 8-K on October 10, 2016 (File No. 001-35372) and incorporated herein by reference).

 

 

 

 

 

 

 

31.1 

(a)

 

 

Sarbanes-Oxley Section 302 certification of Principal Executive Officer.

 

  

 

 

 

 

 

31.2 

(a)

 

 

Sarbanes-Oxley Section 302 certification of Principal Financial Officer.

 

  

 

 

 

 

 

32.1 

(b)

 

 

Sarbanes-Oxley Section 906 certification of Principal Executive Officer.

 

  

 

 

 

 

 

32.2 

(b)

 

 

Sarbanes-Oxley Section 906 certification of Principal Financial Officer.

 

  

 

 

 

 

 

101.INS

(a)

 

XBRL Instance Document.

 

  

 

 

 

 

 

101.SCH

(a)

 

XBRL Taxonomy Extension Schema Document.

 

  

 

 

 

 

 

101.CAL

(a)

 

XBRL Taxonomy Extension Calculation Linkbase Document.

 

  

 

 

 

 

 

101.DEF

(a)

 

XBRL Taxonomy Extension Definition Linkbase Document.

 

  

 

 

 

 

 

101.LAB

(a)

 

XBRL Taxonomy Extension Labels Linkbase Document.

 

 

 

 

 

 

 

101.PRE

(a)

 

 

XBRL Taxonomny Extension Presentation Linkbase Document


(a)

Filed herewith.

 

(b)

Furnished herewith.

 

*     Management contract or compensatory plan or arrangement.

 

**The exhibits and schedules to the Purchase and Sale Agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company will furnish copies of such omitted exhibits and schedules to the Securities and Exchange Commission upon request. Descriptions of such exhibits and schedules are set forth on page iii of the Purchase and Sale Agreement.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on November 7, 2016.

 

 

 

 

 

SANCHEZ ENERGY CORPORATION

 

 

 

 

By:

/s/ Kirsten A. Hink

 

 

Kirsten A. Hink

 

 

Senior Vice President and Chief Accounting Officer

(Duly Authorized Officer)

 

 

 

 

By:

/s/ Howard J. Thill

 

 

Howard J. Thill

 

 

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)

 

 

62