Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

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

 

For the quarterly period ended June 30, 2012

 

OR

 

o         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 001-32960

 


 

GeoMet, Inc.

(Exact name of registrant as specified in its charter)

 


 

Delaware

 

76-0662382

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

909 Fannin, Suite 1850

Houston, Texas 77010

(713) 659-3855

(Address of principal executive offices and telephone number, including area code)

 

N/A

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

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes     o  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).    x  Yes    o  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 o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company x

 

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

 

As of August 1, 2012, 40,390,077 shares and 4,989,309 shares, respectively, of the registrant’s common stock and preferred stock, par value $0.001 per share, were outstanding.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

 

 

Part I. Financial Information

 

 

 

 

Item 1.

Consolidated Financial Statements (Unaudited)

 

 

Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011

3

 

Consolidated Statements of Operations for the three and six months ended June 30, 2012 and 2011

4

 

Consolidated Statements of Comprehensive (Loss) Income for the three and six months ended June 30, 2012 and 2011

5

 

Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011

6

 

Notes to Consolidated Financial Statements (Unaudited)

7

 

 

 

Item 2.

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

21

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

32

 

 

 

Item 4.

Controls and Procedures

32

 

 

 

Part II. Other Information

 

 

 

 

Item 1.

Legal Proceedings

33

 

 

 

Item 1A.

Risk Factors

33

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

33

 

 

 

Item 3.

Defaults Upon Senior Securities

33

 

 

 

Item 4.

Mine Safety Disclosures

33

 

 

 

Item 5.

Other Information

33

 

 

 

Item 6.

Exhibits

33

 

2



Table of Contents

 

Part I. FINANCIAL INFORMATION

 

Item  1.                                  Financial Statements

 

GEOMET, INC. AND SUBSIDIARIES

 

Consolidated Balance Sheets (Unaudited)

 

 

 

June 30, 2012

 

December 31, 2011

 

ASSETS

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

5,423,504

 

$

457,865

 

Accounts receivable, net of allowance of $17,634 at June 30, 2012 and December 31, 2011

 

3,588,237

 

4,402,065

 

Inventory

 

627,353

 

597,197

 

Derivative asset—natural gas contracts

 

14,448,265

 

20,685,187

 

Other current assets

 

1,245,619

 

1,141,310

 

 

 

 

 

 

 

Total current assets

 

25,332,978

 

27,283,624

 

 

 

 

 

 

 

Gas properties—utilizing the full cost method of accounting:

 

 

 

 

 

Proved gas properties

 

533,954,535

 

561,451,504

 

Other property and equipment

 

3,724,360

 

3,671,123

 

 

 

 

 

 

 

Total property and equipment

 

537,678,895

 

565,122,627

 

Less accumulated depreciation, depletion, amortization and impairment of gas properties

 

(425,511,930

)

(388,730,093

)

 

 

 

 

 

 

Property and equipment—net

 

112,166,965

 

176,392,534

 

 

 

 

 

 

 

Other noncurrent assets:

 

 

 

 

 

Derivative asset—natural gas contracts

 

 

1,765,450

 

Deferred income taxes

 

3,888,373

 

48,171,298

 

Other

 

3,090,254

 

3,532,882

 

 

 

 

 

 

 

Total other noncurrent assets

 

6,978,627

 

53,469,630

 

 

 

 

 

 

 

TOTAL ASSETS

 

$

144,478,570

 

$

257,145,788

 

 

 

 

 

 

 

LIABILITIES, MEZZANINE AND STOCKHOLDERS’ (DEFICIT) EQUITY

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Accounts payable

 

$

6,754,228

 

$

7,500,768

 

Accrued liabilities

 

4,016,281

 

3,936,070

 

Deferred income taxes

 

3,888,373

 

4,153,099

 

Derivative liability—natural gas contracts

 

78,745

 

 

Asset retirement liability

 

 

32,028

 

Current portion of long-term debt

 

15,900,000

 

91,757

 

 

 

 

 

 

 

Total current liabilities

 

30,637,627

 

15,713,722

 

 

 

 

 

 

 

Long-term debt

 

132,700,000

 

158,171,662

 

Asset retirement liability

 

8,318,427

 

8,138,551

 

Derivative liability—natural gas contracts

 

1,823,289

 

 

Other long-term accrued liabilities

 

75,622

 

8,145

 

 

 

 

 

 

 

TOTAL LIABILITIES

 

173,554,965

 

182,032,080

 

 

 

 

 

 

 

Commitments and contingencies (Note 14)

 

 

 

 

 

Mezzanine equity:

 

 

 

 

 

Series A Convertible Redeemable Preferred Stock—net of offering costs of $1,660,435; redemption amount $48,381,810; $.001 par value; 7,401,832 shares authorized, 4,838,181 and 4,549,537 shares were issued and outstanding at June 30, 2012 and December 31, 2011, respectively

 

32,178,347

 

28,482,624

 

Stockholders’ (Deficit) Equity:

 

 

 

 

 

Preferred stock, $0.001 par value—2,598,168 shares authorized, none issued

 

 

 

Common stock, $0.001 par value—authorized 125,000,000 shares; issued and outstanding 40,390,077 and 40,010,188 at June 30, 2012 and December 31, 2011, respectively

 

40,390

 

40,010

 

Treasury stock—10,432 shares at June 30, 2012 and December 31, 2011

 

(94,424

)

(94,424

)

Paid-in capital

 

197,964,143

 

200,344,209

 

Accumulated other comprehensive income (loss)

 

36,952

 

(1,309,926

)

Retained deficit

 

(258,956,576

)

(152,104,329

)

Less notes receivable

 

(245,227

)

(244,456

)

 

 

 

 

 

 

Total stockholders’ (deficit) equity

 

(61,254,742

)

46,631,084

 

 

 

 

 

 

 

TOTAL LIABILITIES, MEZZANINE AND STOCKHOLDERS’ (DEFICIT) EQUITY

 

$

144,478,570

 

$

257,145,788

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

 

3



Table of Contents

 

GEOMET, INC. AND SUBSIDIARIES

 

Consolidated Statements of Operations

(Unaudited)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Revenues:

 

 

 

 

 

 

 

 

 

Gas sales

 

$

7,711,969

 

$

8,330,680

 

$

17,855,143

 

$

16,181,728

 

Operating fees

 

59,446

 

72,914

 

135,211

 

145,686

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

7,771,415

 

8,403,594

 

17,990,354

 

16,327,414

 

Expenses:

 

 

 

 

 

 

 

 

 

Lease operating expense

 

4,491,593

 

2,855,821

 

8,933,027

 

5,810,951

 

Compression and transportation expense

 

2,300,765

 

962,354

 

4,540,254

 

1,877,064

 

Production taxes

 

364,437

 

365,321

 

834,086

 

687,709

 

Depreciation, depletion and amortization

 

3,290,420

 

1,604,380

 

6,920,889

 

3,223,798

 

Impairment of gas properties

 

42,255,847

 

 

58,035,288

 

 

General and administrative

 

1,366,142

 

1,495,413

 

2,668,167

 

2,924,558

 

Restructuring costs

 

765,233

 

 

765,233

 

 

Realized gains on derivative contracts

 

(5,311,266

)

(1,536,056

)

(10,104,135

)

(5,033,118

)

Unrealized losses (gains) from the change in market value of open derivative contracts

 

10,202,879

 

(197,154

)

4,978,668

 

2,653,014

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

59,726,050

 

5,550,079

 

77,571,477

 

12,143,976

 

Operating (loss) income

 

(51,954,635

)

2,853,515

 

(59,581,123

)

4,183,438

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

597

 

4,287

 

4,299

 

8,761

 

Interest expense (net of amounts capitalized)

 

(1,268,399

)

(823,703

)

(2,544,243

)

(1,663,772

)

Other

 

253

 

(9,007

)

(4,099

)

(4,325

)

 

 

 

 

 

 

 

 

 

 

Total other income (expense):

 

(1,267,549

)

(828,423

)

(2,544,043

)

(1,659,336

)

 

 

 

 

 

 

 

 

 

 

(Loss) income before income taxes

 

(53,222,184

)

2,025,092

 

(62,125,166

)

2,524,102

 

Income tax expense

 

(6,250

)

(902,107

)

(44,030,700

)

(907,297

)

 

 

 

 

 

 

 

 

 

 

(Loss) income before discontinued operations

 

(53,228,434

)

1,122,985

 

(106,155,866

)

1,616,805

 

Discontinued operations, net of tax

 

(675,809

)

(51,247

)

(696,381

)

(93,988

)

 

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(53,904,243

)

$

1,071,738

 

$

(106,852,247

)

$

1,522,817

 

 

 

 

 

 

 

 

 

 

 

Accretion of Series A Convertible Redeemable Preferred Stock

 

(470,953

)

(436,029

)

(932,969

)

(859,172

)

Paid-in-kind dividends on Series A Convertible Redeemable Preferred Stock

 

(619,625

)

(1,336,250

)

(1,860,345

)

(2,632,110

)

Cash dividends paid on Series A Convertible Redeemable Preferred Stock

 

(651

)

(664

)

(1,296

)

(1,222

)

 

 

 

 

 

 

 

 

 

 

Net loss available to common stockholders

 

$

(54,995,472

)

$

(701,205

)

$

(109,646,857

)

$

(1,969,687

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss per share:

 

 

 

 

 

 

 

 

 

Net loss per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

(1.37

)

$

(0.02

)

$

(2.75

)

$

(0.05

)

 

 

 

 

 

 

 

 

 

 

Diluted

 

$

(1.37

)

$

(0.02

)

$

(2.75

)

$

(0.05

)

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares:

 

 

 

 

 

 

 

 

 

Basic

 

40,003,977

 

39,617,625

 

39,883,409

 

39,544,361

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

40,003,977

 

39,617,625

 

39,883,409

 

39,544,361

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

 

4



Table of Contents

 

GEOMET, INC. AND SUBSIDIARIES

 

Consolidated Statements of Comprehensive (Loss) Income

(Unaudited)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net (loss) income

 

$

(53,904,243

)

$

1,071,738

 

$

(106,852,247

)

$

1,522,817

 

Gain (loss) on foreign currency translation adjustment

 

9,470

 

293

 

2,019

 

740

 

Unrealized gain on available for sale securities

 

36,952

 

 

36,952

 

 

Gain on interest rate swap

 

 

 

 

10,862

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive (loss) income

 

$

(53,857,821

)

$

1,072,031

 

$

(106,813,276

)

$

1,534,419

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

 

5



Table of Contents

 

GEOMET, INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

Cash flows provided by operating activities:

 

 

 

 

 

Net (loss) income

 

$

(106,852,247

)

$

1,522,817

 

Adjustments to reconcile net (loss) income to net cash flows provided by operating activities:

 

 

 

 

 

Depreciation, depletion and amortization

 

6,919,168

 

3,254,514

 

Impairment of gas properties

 

58,035,288

 

 

Amortization of debt issuance costs

 

316,671

 

287,309

 

Deferred income tax expense

 

44,018,200

 

894,797

 

Unrealized losses from the change in market value of open derivative contracts

 

4,978,668

 

2,665,998

 

Stock-based compensation

 

393,536

 

451,853

 

Loss on sale of Hudson’s Hope Gas, Ltd

 

683,154

 

 

Loss on sale of other assets

 

5,200

 

12,086

 

Accretion expense—asset retirement obligation

 

391,687

 

270,913

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

810,421

 

(66,033

)

Other assets

 

477,654

 

(219,917

)

Accounts payable

 

(675,844

)

(1,159,720

)

Other accrued liabilities

 

912,190

 

237,329

 

 

 

 

 

 

 

Net cash provided by operating activities

 

10,413,746

 

8,151,946

 

 

 

 

 

 

 

Cash flows provided by (used in) investing activities:

 

 

 

 

 

Capital expenditures

 

(508,657

)

(6,595,291

)

Return of original basis through the settlement of natural gas derivative contracts

 

4,925,738

 

 

Proceeds from sale of other property and equipment

 

3,500

 

 

Other assets

 

 

18,816

 

 

 

 

 

 

 

Net cash provided by (used in) investing activities

 

4,420,581

 

(6,576,475

)

 

 

 

 

 

 

Cash flows used in financing activities:

 

 

 

 

 

Proceeds from revolving credit facility borrowings

 

10,500,000

 

15,800,000

 

Payments on revolving credit facility

 

(19,800,000

)

(16,900,000

)

Proceeds from exercise of stock options

 

 

3,791

 

Deferred financing costs

 

(403,383

)

(142,153

)

Payments on other debt

 

(167,087

)

(89,907

)

Purchase and cancellation of treasury stock

 

(2,037

)

(2,145

)

Cash dividends paid on Series A Convertible Redeemable Preferred Stock

 

(1,296

)

(1,222

)

 

 

 

 

 

 

Net cash used in financing activities

 

(9,873,803

)

(1,331,636

)

Effect of exchange rate changes on cash

 

5,115

 

3,409

 

 

 

 

 

 

 

Increase in cash and cash equivalents

 

4,965,639

 

247,244

 

Cash and cash equivalents at beginning of period

 

457,865

 

536,533

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

5,423,504

 

$

783,777

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid during the period for interest expense

 

$

2,509,404

 

$

1,714,434

 

 

 

 

 

 

 

Cash paid during the period for income taxes

 

$

12,500

 

$

12,500

 

 

 

 

 

 

 

Significant noncash investing and financing activities:

 

 

 

 

 

Accrued capital expenditures

 

$

817,015

 

$

2,603,369

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

 

6



Table of Contents

 

GEOMET, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(Unaudited)

 

Note 1—Organization and Our Business

 

GeoMet, Inc. (“GeoMet,” “Company,” “we,” or “our”) (formerly GeoMet Resources, Inc.) was incorporated under the laws of the state of Delaware on November 9, 2000. We are an independent natural gas producer primarily involved in the exploration, development and production of natural gas from coal seams (coalbed methane) and non-conventional shallow gas. Our principal operations and producing properties are located in Alabama, West Virginia and Virginia.

 

The accompanying unaudited consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. The unaudited consolidated financial statements reflect, in the opinion of our management, all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly the financial position as of, and results of operations for, the interim periods presented. These unaudited consolidated financial statements have been prepared in accordance with the guidelines of interim reporting; therefore, they do not include all disclosures required for our year-end audited consolidated financial statements prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Interim period results are not necessarily indicative of results of operations or cash flows for the full year. These unaudited consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements for the fiscal year ended December 31, 2011 and the accompanying notes included in our Annual Report on Form 10-K, which we filed with the Securities and Exchange Commission (the “SEC”) on March 30, 2012.

 

Note 2—Liquidity and Going Concern Considerations

 

As previously disclosed in our Quarterly Report on Form 10-Q for the period ended March 31, 2012 (“First Quarter Report”), as of May 15, 2012, we had $148.6 million outstanding under our Fifth Amended and Restated Credit Agreement (the “Credit Agreement”). As previously disclosed, the Credit Agreement provides that the borrowing base is set at the sole discretion of our lenders in June and December of each year based, in part, on the value of our estimated reserves as determined by the lenders using natural gas prices forecasted by the lenders. As of the filing date of our First Quarter Report, we expected that, due to the decline in the bank group’s price projections, the outstanding balance under the Credit Agreement at the June determination date would exceed the new borrowing base, resulting in a borrowing base deficiency which we would not be able to cure absent reaching a new agreement. As of the filing date of our First Quarter Report, the aforementioned conditions raised substantial doubt about our ability to continue as a going concern for the twelve months ended March 31, 2013.

 

As expected, on June 8, 2012, our bank lending group completed its June 2012 re-determination of our borrowing base under the Credit Agreement and notified us that our new borrowing base was $115.0 million, a reduction from the previous borrowing base of $180 million. As of June 8, 2012, we had $148.6 million drawn under the Credit Agreement, which resulted in a borrowing base deficiency of $33.6 million. As a result of this borrowing base deficiency, we were no longer able to borrow under the Credit Agreement.

 

In response to this borrowing base deficiency, we entered into the Fourth Amendment to our Fifth Amended and Restated Credit Agreement (the “Amendment”), effective August 8, 2012. The Amendment provides for an initial conforming borrowing base of $115.0 million (“Tranche A”) with the balance then remaining in the amount of $33.6 million constituting a non-conforming tranche (“Tranche B”). We are obligated, among other things, to reduce the balance of Tranche B each month by a certain amount of our excess cash flows for the period, as defined by the Amendment. In addition, we are no longer able to borrow any additional funds under the Credit Agreement, as amended.

 

The borrowing base will continue to be determined as of each June and December with the next determination scheduled to be completed by December 31, 2012. This Credit Agreement, as amended, matures on April 1, 2014.  We believe this amendment will allow us to continue normal production operations for at least the next twelve months and management believes we have the ability to comply with the terms of the Credit Agreement, as amended; however due to the uncertainty of natural gas prices, there are no assurances that there will not be an additional borrowing base deficiency at the December 2012 or any subsequent borrowing base redetermination, which is at the sole discretion of our lenders. For additional information related to the Credit Agreement, as amended, see Note 10—Long-Term Debt.

 

Note 3—Recent Pronouncements

 

On June 16, 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-05, Presentation of Comprehensive Income, which revises the manner in which entities present comprehensive income in their financial statements. The new guidance removes the presentation options in Accounting Standards Codification (“ASC”) 220 and requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The ASU does not change the items that must be reported in other comprehensive income. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company has adopted and applied the provisions of this update for the three and six months ended June 30, 2012.

 

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Table of Contents

 

On May 12, 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”). The ASU is the result of joint efforts by the FASB and IASB to develop a single, converged fair value framework—that is, converged guidance on how (not when) to measure fair value and on what disclosures to provide about fair value measurements. Thus, there are few differences between the ASU and its international counterpart, IFRS 13. While the ASU is largely consistent with existing fair value measurement principles in U.S. GAAP, it expands ASC 820’s existing disclosure requirements for fair value measurements and makes other amendments. Many of these amendments were made to eliminate unnecessary wording differences between U.S. GAAP and IFRS. However, some could change how the fair value measurement guidance in ASC 820 is applied. The ASU is effective for interim and annual periods beginning after December 15, 2011. The Company has adopted and applied the provisions of this update for the three and six months ended June 30, 2012. See disclosure provided in Note 10—Long-Term Debt and Note 12—Series A Convertible Redeemable Preferred Stock.

 

Note 4—Net Loss Per Common Share

 

Net loss per common share—basic is calculated by dividing Net loss available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Net loss per common share—diluted assumes the conversion of all potentially dilutive securities and is calculated by dividing Net loss available to common stockholders by the sum of the weighted average number of shares of common stock outstanding plus potentially dilutive securities. Net loss per common share—diluted considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares would have an anti-dilutive effect. A reconciliation of Loss per common share is as follows:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net (loss) income

 

$

(53,904,243

)

$

1,071,738

 

$

(106,852,247

)

$

1,522,817

 

 

 

 

 

 

 

 

 

 

 

Accretion of Series A Convertible Redeemable Preferred Stock

 

(470,953

)

(436,029

)

(932,969

)

(859,172

)

Paid-in-kind dividends on Series A Convertible Redeemable Preferred Stock

 

(619,625

)

(1,336,250

)

(1,860,345

)

(2,632,110

)

Cash dividends paid on Series A Convertible Redeemable Preferred Stock

 

(651

)

(664

)

(1,296

)

(1,222

)

 

 

 

 

 

 

 

 

 

 

Net loss available to common stockholders

 

$

(54,995,472

)

$

(701,205

)

$

(109,646,857

)

$

(1,969,687

)

 

 

 

 

 

 

 

 

 

 

Net loss per share:

 

 

 

 

 

 

 

 

 

Net loss available to common stockholders

 

 

 

 

 

 

 

 

 

Basic

 

$

(1.37

)

$

(0.02

)

$

(2.75

)

$

(0.05

)

 

 

 

 

 

 

 

 

 

 

Diluted

 

$

(1.37

)

$

(0.02

)

$

(2.75

)

$

(0.05

)

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares:

 

 

 

 

 

 

 

 

 

Basic

 

40,003,977

 

39,617,625

 

39,883,409

 

39,544,361

 

 

 

 

 

 

 

 

 

 

 

Add potentially dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options, non-vested restricted stock and non-vested restricted stock units

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

40,003,977

 

39,617,625

 

39,883,409

 

39,544,361

 

 

Net loss per common share—diluted for the three months ended June 30, 2012 excluded the effect of outstanding exercisable options to purchase 2,490,558 shares, 164,565 weighted average restricted stock units for which common shares are distributed upon achievement of certain performance targets, 268,739 weighted average restricted shares outstanding, and 4,691,632 shares of Series A Convertible Redeemable Preferred Stock (36,089,476 in dilutive shares, as converted, which assumes conversion on the first day of the period) because we reported a net loss available to common stockholders which caused the options, restricted stock units, restricted shares and preferred shares to be anti-dilutive.

 

Net loss per common share—diluted for the six months ended June 30, 2012 excluded the effect of outstanding exercisable options to purchase 2,490,558 shares, 198,327 restricted stock units for which common shares are distributed upon achievement of certain performance targets, 258,399 weighted average restricted shares outstanding, and 4,549,537 shares of Series A Convertible Redeemable Preferred Stock (34,996,440 in dilutive shares, as converted, which assumes conversion on the first day of the period) because we reported a net loss available to common stockholders which caused the options, restricted stock units, restricted shares and preferred shares to be anti-dilutive.

 

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Table of Contents

 

Net loss per common share—diluted for the three months ended June 30, 2011 excluded the effect of outstanding exercisable options to purchase 2,603,536 shares, 232,089 restricted stock units for which common shares are distributed upon achievement of certain performance targets, 350,906 weighted average restricted shares outstanding, and 4,278,124 shares of Series A Convertible Redeemable Preferred Stock (32,908,646 in dilutive shares, as converted, which assumes conversion on the first day of the period) because we reported a net loss available to common stockholders which caused the options, restricted stock units, restricted shares and preferred shares to be anti-dilutive.

 

Net loss per common share—diluted for the six months ended June 30, 2011 excluded the effect of outstanding exercisable options to purchase 2,603,536 shares, 232,089 restricted stock units for which common shares are distributed upon achievement of certain performance targets, 366,975 weighted average restricted shares outstanding, and 4,148,538 shares of Series A Convertible Redeemable Preferred Stock (31,911,830 in dilutive shares, as converted, which assumes conversion on the first day of the period) because we reported a net loss available to common stockholders which caused the options, restricted stock units, restricted shares and preferred shares to be anti-dilutive.

 

Note 5—Discontinued Operations

 

On June 20, 2012, we sold Hudson’s Hope Gas, Ltd., a subsidiary which held our Canadian gas properties, in exchange for two million shares of Canada Energy Partners, Inc. (“CEP shares”) which we are restricted to sell for one year. We recognized a loss on the sale in the amount of $0.7 million, which was made up of a $1.3 million loss related to the currency translation adjustment, offset by $0.3 million in asset retirement liabilities conveyed to the buyer and the proceeds consisting of the $0.3 million in fair value of the CEP shares received. The loss on the sale has been included in Discontinued operations, net of tax in the Consolidated Statements of Operations (Unaudited). Additionally, all historical operating results related to the disposed company have been removed from Operating (loss) income and included in Discontinued operations, net of tax in the Consolidated Statements of Operations (Unaudited) for all periods presented.

 

As a result of the sale, we are treating these activities as a discontinued operation for all the periods presented. Results for activities reported as discontinued operations were as follows:

 

Statements of Operations (Unaudited):

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Revenues

 

$

 

$

 

$

 

$

 

Total operating benefit (expenses)

 

7,426

 

(51,247

)

(13,123

)

(93,988

)

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

7,426

 

(51,247

)

(13,123

)

(93,988

)

Loss on sale of Hudson’s Hope, Ltd.

 

(683,154

)

 

(683,154

)

 

Other income (expense)

 

(81

)

 

(104

)

 

Income tax expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(675,809

)

$

(51,247

)

$

(696,381

)

$

(93,988

)

 

Balance Sheets (Unaudited):

 

 

 

June 30, 2012

 

December 31, 2011

 

ASSETS

 

 

 

 

 

Total current assets

 

$

 

$

33,474

 

Gas properties—utilizing the full cost method of accounting:

 

 

 

 

 

Proved gas properties

 

 

28,073,293

 

Less accumulated depreciation, depletion, amortization and impairment of gas properties

 

 

(28,073,293

)

 

 

 

 

 

 

Property and equipment—net

 

 

 

Total other noncurrent assets

 

 

2,941

 

 

 

 

 

 

 

TOTAL ASSETS

 

$

 

$

36,415

 

 

 

 

 

 

 

LIABILITIES, MEZZANINE AND STOCKHOLDERS’ (DEFICIT) EQUITY

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Total current liabilities

 

$

 

$

54,827

 

Asset retirement liability

 

 

303,169

 

 

 

 

 

 

 

TOTAL LIABILITIES

 

 

357,996

 

Total stockholders’ deficit

 

 

(321,581

)

 

 

 

 

 

 

TOTAL LIABILITIES, MEZZANINE AND STOCKHOLDERS’ (DEFICIT) EQUITY

 

$

 

$

36,415

 

 

9



Table of Contents

 

Note 6—Gas Properties

 

The method of accounting for gas properties determines what costs are capitalized and how these costs are ultimately matched with revenues and expenses. We use the full cost method of accounting for gas properties as prescribed by the SEC. Under this method, all direct costs and certain indirect costs associated with the acquisition, exploration, and development of our gas properties are capitalized.

 

Gas properties are depleted using the units-of-production method. The depletion expense is significantly affected by the unamortized historical and future development costs and the estimated proved gas reserves. Depletion rates for the three and six months ended June 30, 2012 were $0.92 and $0.95 per Mcf, respectively. Depletion rates for the three and six months ended June 30, 2011 were both $0.83 per Mcf.

 

Estimation of proved gas reserves relies on professional judgment and use of factors that cannot be precisely determined. Subsequent proved reserve estimates materially different from those reported would change the depletion expense recognized during future reporting periods. No gains or losses are recognized upon the sale or disposition of gas properties unless the sale or disposition represents a significant quantity of gas reserves, which would have a significant impact on the depreciation, depletion and amortization rate.

 

Under full cost accounting rules, total capitalized costs are limited to a ceiling equal to the present value of estimated future net revenues, discounted at 10% per annum, plus cost of properties not being amortized plus the lower of cost or fair value of unevaluated properties less income tax effects (the “ceiling limitation”). We perform a quarterly ceiling test to evaluate whether the net book value of our full cost pool exceeds the ceiling limitation. If capitalized costs (net of accumulated depreciation, depletion and amortization) less related deferred taxes are greater than the discounted future net revenues or ceiling limitation, a write-down or impairment of the full cost pool is required. A write-down of the carrying value of the full cost pool is a non-cash charge that reduces earnings and impacts stockholders’ (deficit) equity in the period of occurrence and typically results in lower depreciation, depletion and amortization expense in future periods. Once incurred, a write-down is not reversible at a later date.

 

The ceiling test is calculated using the unweighted arithmetic average of the natural gas price on the first day of each month within the twelve-month period prior to the end of the reporting period, unless prices are defined by contractual arrangements, excluding escalations based on future conditions, as allowed by the guidelines of the SEC. In addition, subsequent to the adoption of ASC 410-20-25, the future cash outflows associated with settling asset retirement obligations were not included in the computation of the discounted present value of future net revenues for the purposes of the ceiling test calculation.

 

For the twelve months ended June 30, 2012, the unweighted arithmetic average of the Henry Hub spot market price on the first day of each month was $3.17 per Mcf, resulting in a natural gas price of $3.34 per Mcf when adjusted for regional price differentials. For the three and six months ended June 30, 2012, we recorded a $42.3 million and a $58.0 million write-downs, respectively, of the carrying value of our U.S. full cost pool.

 

Note 7—Asset Retirement Liability

 

We record an asset retirement obligation (“ARO”) on the Consolidated Balance Sheets (Unaudited) and capitalize the asset retirement costs in gas properties in the period in which the retirement obligation is incurred. The amount of the ARO and the costs capitalized are equal to the estimated future costs to satisfy the obligation using current prices that are escalated by an assumed inflation factor up to the estimated settlement date, which is then discounted back to the date we incurred the abandonment obligation using an assumed interest rate. Once the ARO is recorded, it is then accreted to its estimated future value using the same assumed interest rate.

 

The following table details the changes to our asset retirement liability for the six months ended June 30, 2012:

 

Current portion of liability at January 1, 2012

 

$

32,028

 

Add: Long-term asset retirement liability at January 1, 2012

 

8,138,551

 

 

 

 

 

Asset retirement liability at January 1, 2012

 

8,170,579

 

Liabilities incurred

 

14,252

 

Liabilities conveyed to buyer of Hudson’s Hope Gas Ltd.

 

(345,226

)

Settlements

 

(158,777

)

Accretion

 

391,687

 

Revisions in estimates

 

241,317

 

Foreign currency translation

 

4,595

 

 

 

 

 

Asset retirement liability at June 30, 2012

 

8,318,427

 

Less: Current portion of liability

 

 

 

 

 

 

Long-term asset retirement liability

 

$

8,318,427

 

 

10



Table of Contents

 

The following table details the changes to our asset retirement liability for the six months ended June 30, 2011:

 

Current portion of liability at January 1, 2011

 

$

32,893

 

Add: Long-term asset retirement liability at January 1, 2011

 

5,465,798

 

 

 

 

 

Asset retirement liability at January 1, 2011

 

5,498,691

 

Liabilities incurred

 

19,714

 

Accretion

 

270,913

 

Foreign currency translation

 

7,723

 

 

 

 

 

Asset retirement liability at June 30, 2011

 

5,797,041

 

Less: Current portion of liability

 

(33,684

)

 

 

 

 

Long-term asset retirement liability

 

$

5,763,357

 

 

Note 8—Derivative Instruments and Hedging Activities

 

The energy markets have historically been volatile, and there can be no assurance that future natural gas prices will not be subject to wide fluctuations. In an effort to reduce the effects of the volatility of the price of natural gas on our operations, management has adopted a policy of hedging natural gas prices from time to time primarily using derivative instruments in the form of three-way collars, traditional collars and swaps. While the use of these hedging arrangements limits the downside risk of adverse price movements, it also limits future gains from favorable movements. Our price risk management policy strictly prohibits the use of derivatives for speculative positions.

 

We enter into hedging transactions, generally for forward periods up to two years or more, which increase the probability of achieving our targeted level of cash flows. We are limited by our credit facility (discussed in Note 10—Long-Term Debt ) to the amount of our natural gas derivative contracts during any period to no more than 85% of the then expected gas production for such future periods. Swaps exchange floating price risk in the future for a fixed price at the time of the hedge.

 

Costless collars set both a maximum ceiling (a sold ceiling) and a minimum floor (a bought floor) future price. We have accounted for these transactions using the mark-to-market accounting method. Generally, we incur accounting losses on derivatives during periods where prices are rising and gains during periods where prices are falling which may cause significant fluctuations in our Consolidated Balance Sheets (Unaudited) and Consolidated Statements of Operations (Unaudited).

 

Commodity Price Risk and Related Hedging Activities

 

At June 30, 2012, we had the following natural gas collar positions:

 

Period

 

Volume
(MMBtu)

 

Sold
Ceiling

 

Bought
Floor

 

Sold
Floor

 

Fair
Value

 

January 2014 through December 2015

 

3,650,000

 

$

4.30

 

$

3.60

 

 

$

(439,438

)

January 2014 through December 2015

 

3,650,000

 

$

4.20

 

$

3.50

 

 

(729,409

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7,300,000

 

 

 

 

 

 

 

$

(1,168,847

)

 

At June 30, 2012, we had the following natural gas swap positions:

 

Period 

 

Volume
(MMBtu)

 

Fixed
Price

 

Fair
Value

 

July through December 2012

 

276,000

 

$

5.11

 

$

592,738

 

July through December 2012

 

114,000

 

$

5.12

 

245,966

 

July through December 2012

 

526,051

 

$

6.85

 

2,044,859

 

July through December 2012

 

247,337

 

$

6.99

 

1,005,101

 

July through December 2012

 

404,093

 

$

7.05

 

1,678,083

 

July through October 2012

 

492,000

 

$

5.73

 

1,426,944

 

July through October 2012

 

984,000

 

$

4.94

 

2,072,357

 

July through October 2012

 

1,845,000

 

$

2.89

 

115,547

 

November 2012 through March 2013

 

604,000

 

$

6.42

 

1,821,273

 

November 2012 through March 2013

 

906,000

 

$

5.50

 

1,906,376

 

November 2012 through March 2013

 

4,128,000

 

$

3.81

 

796,037

 

November 2012 through March 2013

 

4,128,000

 

$

3.82

 

836,969

 

January 2013 through December 2013

 

2,190,000

 

$

3.60

 

42,024

 

April 2013 through December 2013

 

2,750,000

 

$

3.25

 

(889,214

)

 

 

 

 

 

 

 

 

 

 

19,594,481

 

 

 

$

13,695,060

 

 

11



Table of Contents

 

At December 31, 2011, we had the following natural gas swap positions:

 

Period 

 

Volume
(MMBtu)

 

Fixed
Price

 

Fair
Value

 

January through March 2012

 

364,000

 

$

7.12

 

$

1,487,299

 

January through March 2012

 

364,000

 

$

6.12

 

1,121,787

 

January through March 2012

 

546,000

 

$

5.08

 

1,118,044

 

January through December 2012

 

552,000

 

$

5.11

 

1,028,519

 

January through December 2012

 

228,000

 

$

5.12

 

427,089

 

January through December 2012

 

1,070,715

 

$

6.85

 

3,851,739

 

January through December 2012

 

528,995

 

$

6.99

 

1,977,837

 

January through December 2012

 

859,269

 

$

7.05

 

3,239,221

 

July through October 2012

 

856,000

 

$

5.73

 

2,137,811

 

July through October 2012

 

1,712,000

 

$

4.94

 

2,923,067

 

November 2012 through March 2013

 

604,000

 

$

6.42

 

1,575,321

 

November 2012 through March 2013

 

906,000

 

$

5.50

 

1,544,680

 

 

 

 

 

 

 

 

 

 

 

8,590,979

 

 

 

$

22,432,414

 

 

At June 30, 2012, we had the following natural gas basis swap position:

 

Period 

 

Volume
(MMBtu)

 

Fixed
Basis

 

Fair
Value

 

July through December 2012

 

276,000

 

$

0.04

 

$

20,018

 

 

At December 31, 2011, we had the following natural gas basis swap position:

 

Period

 

Volume
(MMBtu)

 

Fixed
Basis

 

Fair
Value

 

July through December 2012

 

552,000

 

$

0.04

 

$

18,223

 

 

We have reviewed the financial strength of our hedge counterparties and believe our credit risk to be minimal. Our hedge counterparties are participants in our Credit Agreement and the collateral for the outstanding borrowings under our Credit Agreement is used as collateral for our hedges. We do not have rights to collateral from our counterparties, nor do we have rights of offset against borrowings under our Credit Agreement.

 

The application of ASC 820-10-55, Fair Value Measurements, currently applies to our derivative instruments. Under the provisions of ASC 820-10-55, we estimate the fair value of our natural gas derivative contracts using the income approach. The income approach uses valuation techniques that convert future cash flows to a single discounted value. ASC 820-10-55 clarifies that a fair value measurement for an asset or liability reflects its nonperformance risk, the risk that the obligation will not be fulfilled. Because nonperformance risk includes our counterparties’ and our credit risk, we have considered the effect of credit risk on the fair value of the assets and liabilities related to the items stated below. The consideration for discounting our counterparties’ liabilities (our assets) was based on the difference between the S&P credit rating of a comparable company to our counterparties and the 13-week Treasury bill rate, both at the reporting date. The consideration for discounting our liabilities was based on the difference between the market weighted average cost of debt capital plus a premium over the capital asset pricing model and the stated interest rates of the debt instruments included in our long-term debt.

 

In order to estimate the fair value of our natural gas derivative contracts, a forward price curve and volatility estimates were compiled from sources that include NYMEX settlements and observed trading activity in the Over-the-Counter (“OTC”) markets. Pricing estimates for the theoretical market value of hedge positions were developed using analytical models accepted and employed by a broad cross-section of industry participants. To extrapolate future cash flows, discount factors incorporating our counterparties’ and our credit standing are used to discount future cash flows.

 

12



Table of Contents

 

We did not have any transfers of assets and liabilities between Level 1 and Level 2 of the fair value measurement hierarchy during the three and six months ended June 30, 2012. Based on the use of observable market inputs, we have designated these types of instruments as Level 2 for ASC 820-10-55 reporting purposes. The fair value of our derivative instruments was as follows:

 

 

 

Asset Derivatives

 

Liability Derivatives

 

 

 

June 30, 2012

 

December 31, 2011

 

June 30, 2012

 

December 31, 2011

 

 

 

Balance Sheet
Location

 

Fair
Value

 

Balance Sheet
Location

 

Fair
Value

 

Balance Sheet
Location

 

Fair
Value

 

Balance Sheet
Location

 

Fair
Value

 

Derivatives not designated as hedging instruments under ASC 815-20-25

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Derivative asset (current)

 

$

 —

 

Derivative asset (current)

 

$

 —

 

Derivative liability (current)

 

$

 —

 

Derivative liability (current)

 

$

 —

 

Natural gas hedge positions

 

Derivative asset (current)

 

14,448,265

 

Derivative asset (current)

 

20,685,187

 

Derivative liability (current)

 

78,745

 

Derivative liability (current)

 

 

Natural gas hedge positions

 

Derivative asset (non-current)

 

 

Derivative asset (non-current)

 

1,765,450

 

Derivative liability (non-current)

 

1,823,289

 

Derivative liability (non-current)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total derivatives not designated as hedging instruments under ASC 815-20-25

 

 

 

$

 14,448,265

 

 

 

$

 22,450,637

 

 

 

$

 1,902,034

 

 

 

$

 —

 

 

The following (gains) losses on our hedging instruments included in the Consolidated Statements of Operations (Unaudited) and Other Comprehensive (Loss) Income (Unaudited) (“OCI”) are as follows:

 

The Effect of Derivative Instruments on the Consolidated Statements of Operations (Unaudited) and

Other Comprehensive (Loss) Income (Unaudited) for the Three and Six Months Ended June 30, 2012 and 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount of (Gain) or Loss
Recognized in Income on
Derivative

 

 

 

Location of (Gain)

 

Three Months Ended

 

Six Months Ended

 

 

 

or Loss Recognized in

 

June 30,

 

June 30,

 

Derivatives

 

Income on Derivative

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments under ASC 815-20-25

 

 

 

 

 

 

 

 

 

 

 

Natural gas collar/swap positions

 

Realized gains on derivative contracts

 

$

(5,311,266

)

$

(1,536,056

)

$

(10,104,135

)

$

(5,033,118

)

Natural gas collar/swap positions

 

Unrealized (gains) losses from the change in market value of open derivative contracts

 

10,202,879

 

(197,154

)

4,978,668

 

2,653,014

 

 

 

 

 

 

 

 

 

 

 

 

 

Total (gain) loss

 

 

 

$

4,891,613

 

$

(1,733,210

)

$

(5,125,467

)

$

(2,380,104

)

 

13



Table of Contents

 

We had an interest rate swap mature on January 6, 2011 that had previously been designated as cash flow hedges under ASC 815-20-25.  On the maturity date, a loss of $17,782 was released from Accumulated Other Comprehensive Income (Loss) in the Consolidated Balance Sheet (Unaudited) and recognized as Interest expense in the Consolidated Statements of Operations (Unaudited).

 

At June 30, 2012, we own two million shares of Canada Energy Partners (“CEP”), discussed in Note 5—Discontinued Operations, which we classify as available for sale and mark-to-market in Other noncurrent assets on the Consolidated Balance Sheets (Unaudited) based on the closing price of the shares on the TSX Venture Exchange on that date. Gains or losses on the shares of CEP are held in Accumulated other comprehensive income (loss), net of tax. At June 30, 2012, the value of the shares recorded in Other noncurrent assets was $330,721. The Accumulated other comprehensive income of $36,952 as of June 30, 2012 consisted entirely of unrealized gains on the CEP shares.

 

Accumulated other comprehensive loss of $1,309,926 as of December 31, 2011 consisted entirely of foreign currency translation adjustments.

 

Note 9—Restructuring Costs

 

We recognized pretax restructuring costs of $0.8 million during the three and six months ended June 30, 2012.  Restructuring activities consist of senior management and board of director changes.  The restructuring costs included cash payments to our former Chief Executive Officer (“CEO”) of $0.6 million, share-based awards conveyed to our former CEO of $0.1 million and legal and consulting services of $0.1 million.

 

Note 10—Long-Term Debt

 

On November 18, 2011, our Fifth Amended and Restated Credit Agreement (the “Credit Agreement”) with a group of six banks became effective. The Credit Agreement replaced our Fourth Amended and Restated Credit Agreement and provided for revolving credit borrowings of up to $250 million with an initial borrowing base of $180 million. Effective August 8, 2012, we entered into the Fourth Amendment (the “Amendment”) to our Credit Agreement. Borrowings under the Credit Agreement at that time totaled $148.6 million. The Amendment provides for an initial conforming borrowing base of $115.0 million (the “Tranche A Borrowing Base”) with the balance then remaining in the amount of $33.6 million constituting a non-conforming tranche (the “Tranche B Borrowing Base”).  The borrowing base will be determined as of each June and December with the next determination scheduled to be completed by December 31, 2012.  Upon any determination of the borrowing base, the redetermined amount of the conforming borrowing base shall constitute the new Tranche A Borrowing Base, with any decrease in the Tranche A Borrowing Base causing an automatic corresponding increase in the Tranche B Borrowing Base and any increase in the Tranche A Borrowing Base causing an automatic corresponding decrease in the Tranche B Borrowing Base. At the next borrowing base determination, the Tranche B Borrowing Base shall not increase by more than fifty percent (50%) of the amount of the principal payments made on Tranche B Loans since the prior redetermination of the borrowing base.  Thereafter, at each subsequent redetermination of the borrowing base, the Tranche B Borrowing Base shall not increase by more than twenty-five percent (25%) of the amount of the principal payments made on Tranche B Loans since the prior redetermination of the borrowing base.  Should a future determination of the borrowing base result in the amount of the Tranche B Loan exceeding $33.6 million, the Company has 30 days to repay such excess. The Credit Agreement, as amended, will no longer provide for loans to be available on a revolving basis up to the amount of the borrowing base. As a result, the current outstanding loans, once repaid, may not be re-borrowed by the Company. All outstanding borrowings under the Credit Agreement, as amended, are due and payable on April 1, 2014. In addition, the Amendment obligates us to reduce our borrowings under the Credit Agreement, as amended, monthly by an amount equal to our bank cash, excluding (i) outstanding checks and (ii) an amount equal to $1 million as calculated on the 24th day of each month. The Amendment provides for interest to accrue at a rate calculated, at the Company’s option, at the Adjusted Base Rate plus a margin of 2.00% on the Tranche A Loans and 4.00% on Tranche B Loans or the London Interbank Offered Rate (the “LIBOR Rate”) plus a margin of 3.00% on the Tranche A loans and 5.00% on the Tranche B Loans. Adjusted Base Rate is defined to be the greater of (i) the agent’s base rate or (ii) the federal funds rate plus one half of one percent or (iii) the LIBOR Rate plus a margin of 1.00%. The banks will be paid an additional fee based on the amount of the Tranche B Loans as follows:

 

Calculation Date

 

Fee Amount

 

Date Payable

11/25/2012

 

75 bps

 

12/1/2012

2/25/2013

 

100 bps

 

3/1/2013

5/25/2013

 

125 bps

 

6/1/2013

8/25/2013

 

150 bps

 

9/1/2013

11/25/2013

 

175 bps

 

12/1/2013

 

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All financial covenants were deleted by the Amendment and were replaced with a capital expenditure covenant (a maximum of $1.5 million in 2012 and $1.0 million in 2013) and a maximum debt covenant as follows:

 

Quarter Ending

 

Maximum Principal Outstanding

 

9/30/2012

 

$

146,200,000

 

12/31/2012

 

$

139,300,000

 

3/31/2013

 

$

136,000,000

 

6/30/2013

 

$

132,700,000

 

9/30/2013

 

$

131,500,000

 

12/31/2013

 

$

129,000,000

 

 

Deferred financing costs were $0.4 million for the three and six months ended June 30, 2012. Additionally, an amendment fee of 50 basis points on the amount of Tranche B was capitalized in Deferred financing costs in the amount of $0.2 million on August 8, 2012 in connection with the execution of the Amendment. Deferred financing costs of $2.1 million as of August 8, 2012 related to the Credit Agreement prior to the Amendment were fully amortized upon execution of the Amendment due to the significant change in the terms of the amended Credit Agreement.

 

As of June 30, 2012, we had $148.6 million of borrowings outstanding under our Credit Agreement. The rates at June 30, 2012 and December 31, 2011 were 3.05% and 2.84% per annum, respectively.

 

For the three months ended June 30, 2012 we borrowed $3.1 million and made payments of $4.0 million under the Credit Agreement. For the six months ended June 30, 2012 we borrowed $10.5 million and made payments of $19.8 million under the Credit Agreement.

 

For the three months ended June 30, 2011 we borrowed $8.6 million and made payments of $7.7 million under the Credit Agreement. For the six months ended June 30, 2011 we borrowed $15.8 million and made payments of $16.9 million under the Credit Agreement.

 

For the three months ended June 30, 2012 and 2011, interest on the borrowings averaged 2.99% and 3.39% per annum, respectively. For the six months ended June 30, 2012 and 2011, interest on the borrowings averaged 2.94% and 3.40% per annum, respectively.

 

The following is a summary of our long-term debt at June 30, 2012 and December 31, 2011:

 

 

 

June 30,
2012

 

December 31,
2011

 

Borrowings under revolving Credit Agreement

 

$

148,600,000

 

$

157,900,000

 

Note payable to an individual, semi-monthly installments of $644, through September 2015, interest-bearing at 12.6% annually, unsecured

 

 

78,012

 

Salary continuation payable to an individual, semi-monthly installments of $3,958, through December 2015, non-interest-bearing (less amortization discount of $572,074, with an effective rate of 8.25%), unsecured

 

 

285,407

 

 

 

 

 

 

 

Total debt

 

148,600,000

 

158,263,419

 

Less current maturities included in current liabilities

 

(15,900,000

)

(91,757

)

 

 

 

 

 

 

Total long-term debt

 

$

132,700,000

 

$

158,171,662

 

 

We record our debt instruments based on contractual terms. We did not elect to apply the alternative U.S. GAAP provisions of the fair value option for recording financial assets and financial liabilities. On January 1, 2012, we adopted ASU 2011-04 “Fair Value Measurement” which requires the categorization by level of the fair value hierarchy for items not measured at fair value on our Consolidated Balance Sheets (Unaudited) but for which fair value is required to be disclosed. We measure the fair value of our debt instruments using discounted cash flow analyses based on our current borrowing rates for similar types of borrowing arrangements (categorized as level 3). We do not have any debt instruments with fair value measurements categorized as level 1 or 2 within the fair value hierarchy. ASC 820-10-55 clarifies that a fair value measurement for an asset or liability reflects its nonperformance risk, the risk that the obligation will not be fulfilled. Because nonperformance risk includes our credit risk, we have considered the effect of our credit risk on the fair value of the long-term debt. This consideration involved discounting our long-term debt based on the difference between the market weighted average cost of equity capital plus a premium over the capital asset pricing model and the stated interest rates of the debt instruments included in our long-term debt.  The fair value of long-term debt at June 30, 2012 and December 31, 2011 was estimated to be approximately $136.1 million and $131.1 million, respectively.

 

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Note 11—Common Stock

 

At June 30, 2012 and December 31, 2011, there were 40,390,077 and 40,010,188 shares, respectively, of common stock outstanding, both including 10,432 shares of treasury stock held by the Company. Also included in common stock outstanding at June 30, 2012 and December 31, 2011 were 275,623 and 293,166 shares of restricted stock, respectively.

 

On March 28, 2012 and May 11, 2012, 64,284 and 97,824 shares of common stock, respectively, were issued under the 2006 Plan to our independent directors, each representing 12.5% of their annual retainer. The compensation cost was determined using NASDAQ’s closing price of our common stock on the day of issuance.

 

For the three and six months ended June 30, 2012, no shares of common stock were issued upon the exercise of stock options granted under our 2006 Long-Term Incentive Plan. During the same periods, no common stock was issued upon the exercise of stock options granted under our 2005 Stock Option Plan which was terminated on March 11, 2011.

 

On January 5, 2011, 98,416 shares of restricted stock were granted in exchange for 566,968 options. For the details related to the “Option Exchange”, see Note 13—Share-Based Awards.

 

On March 24, 2011 and June 15, 2011, 819 shares and 744 shares of common stock, respectively, were purchased by us from two non-executive employees for the payment of $1,335 and $811, respectively, in withholding taxes due on vested shares of restricted stock issued under our 2006 Long-Term Incentive Plan. The shares were not retained as treasury stock as they were immediately cancelled.

 

On April 5, 2011, we issued 113,208 shares of common stock to our independent directors, representing 50% of their 2011 annual retainer.

 

Note 12—Series A Convertible Redeemable Preferred Stock

 

At June 30, 2012 and December 31, 2011, 4,838,181 and 4,549,537 shares of preferred stock were issued and outstanding, respectively. At June 30, 2012, an additional 2,563,651 shares of our Series A Convertible Redeemable Preferred Stock (“Preferred Stock”) are reserved exclusively for the payment of paid-in-kind dividends (“PIK dividends”). We measure the fair value of PIK dividends using a discounted cash flow analysis based on our current borrowing rates (categorized as level 3).

 

The following table details the activity related to the Preferred Stock for the six months ended June 30, 2012:

 

 

 

Dividend Period
(Three Months Ended)

 

Date Issued

 

Number of Shares

 

Balance

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2011

 

 

 

 

 

4,549,537

 

$

28,482,624

 

Accretion of Preferred Stock

 

 

 

 

 

 

 

932,969

 

PIK Dividends Issued for Preferred Stock :

 

12/31/11

 

1/3/12

 

142,095

 

1,522,035

 

 

 

3/31/12

 

4/2/12

 

146,549

 

1,240,719

 

 

 

 

 

 

 

 

 

 

 

Balance At June 30, 2012

 

 

 

 

 

4,838,181

 

$

32,178,347

 

 

On June 8, 2012, we declared a quarterly dividend of 151,128 shares of Preferred Stock covering the period April 1, 2012 through June 30, 2012. As those shares were not issued until July 2, 2012, they have not been included in the Preferred Stock balance at June 30, 2012. As such, we recorded a dividend payable in Current liabilities in the Consolidated Balance Sheet (Unaudited) at June 30, 2012 at an estimated fair value of $619,625. Additionally, on March 31, 2012 and June 30, 2012, cash dividends of $645 and $651, respectively, were paid for fractional share dividends not paid-in-kind.

 

The following table details the activity related to the Preferred Stock for the six months ended June 30, 2011:

 

 

 

Dividend Period
(Three Months Ended)

 

Date Issued

 

Number of Shares

 

Balance

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2010

 

 

 

 

 

4,148,538

 

$

22,074,320

 

Accretion of Preferred Stock

 

 

 

 

 

 

 

859,172

 

PIK Dividends Issued for Preferred Stock :

 

3/31/11

 

3/31/11

 

129,586

 

1,295,860

 

 

 

6/30/11

 

6/30/11

 

133,625

 

1,336,250

 

Other

 

 

 

 

 

 

 

(128,393

)

 

 

 

 

 

 

 

 

 

 

Balance At June 30, 2011

 

 

 

 

 

4,411,749

 

$

25,437,209

 

 

Additionally, on March 31, 2011 and June 30, 2011, cash dividends of $558 and $664, respectively, were paid for fractional share dividends not paid-in-kind.

 

Note 13—Share-Based Awards

 

As of June 30, 2012, our 2006 Long-Term Incentive Plan (the “2006 Plan”) is our only authorized stock-based award plan. Our 2005 Stock Option Plan was terminated on March 11, 2011 as no options granted under the plan remained outstanding at that time. Our 2006 Plan authorizes the granting of incentive stock options, non-qualified stock options, stock appreciation rights, stock awards, restricted stock, restricted stock units and performance awards. A maximum of 4,000,000 shares are available for grant under this plan. The 2006 Plan is available to our employees and independent directors and is designed to attract and retain employees and independent directors, to further align the interests of our employees and independent directors with the interests of our stockholders,

 

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and to closely link compensation with our performance. The exercise price of stock options granted under this plan may not be less than the fair market value of the common stock on the date of grant. The options generally have a term of seven years and vest evenly over three years, except performance based awards which are granted solely to our named executive officers, and options issued to directors. Performance based awards granted under the 2006 Long-Term Incentive Plan vest once the performance criteria have been met. Options granted to our directors vest immediately.

 

During the three months ended June 30, 2012, we recorded a compensation expense accrual of $282,350 of which $12,433 was allocated to lease operating expenses, $135,220 was allocated to general and administrative expenses, $131,127 was allocated to restructuring costs, and $3,570 was capitalized to gas properties. During the six months ended June 30, 2012, we recorded a compensation expense accrual of $414,149 of which $22,294 was allocated to lease operating expenses, $240,116 was allocated to general and administrative expenses, $131,127 was allocated to restructuring costs, and $20,612 was capitalized to gas properties. The future compensation cost of all the outstanding awards at June 30, 2012 is $473,597 which will be amortized over the vesting period of such awards. The weighted average remaining useful life of the future compensation cost is 1.02 years.

 

During the three months ended June 30, 2011, we recorded a compensation expense accrual of $354,287 which was allocated as an addition of $8,376 to lease operating expenses, an addition of $309,579 to general and administrative expense, and $36,332 was capitalized to unevaluated gas properties. During the six months ended June 30, 2011, we recorded a compensation expense accrual of $517,154 of which $20,163 was allocated to lease operating expenses, $431,692 was allocated to general and administrative expenses, and $65,300 was capitalized to gas properties. The weighted average remaining useful life of the future compensation cost was 1.29 years.

 

On May 15, 2012, 150,000 shares of restricted stock were granted to our executive officers. On March 28, 2012 and May 11, 2012, 64,284 and 97,824 shares of common stock, respectively, were issued under the 2006 Plan to our independent directors, each representing 12.5% of their annual retainer. The compensation cost was determined using NASDAQ’s closing price of our common stock on the day of issuance.

 

On April 5, 2011, we granted 673,551 stock options with time vesting criteria to certain key employees, including our five executive officers, 232,089 restricted stock units with performance vesting criteria to our five executive officers and 113,208 shares of common stock to our independent directors, representing 50% of their annual retainer. The significant assumptions used in determining the compensation costs included an expected volatility of 87.2%, risk-free interest rate of 2.28%, an expected term from 4.38 to 4.83 years, forfeiture rates from 5% to 15%, and no expected dividends.

 

Option Exchange

 

On December 7, 2010, we offered our eligible employees the opportunity to exchange certain outstanding stock options for new restricted shares of GeoMet common stock to be granted under the 2006 Plan (“Option Exchange”). Options eligible for exchange, or eligible options, included those options, whether vested or unvested, that met all of the following requirements:

 

·                  the options had a per share exercise price greater than $5.00;

 

·                  the options were granted under one of our existing equity incentive plans;

 

·                  the options were outstanding and unexercised as of January 5, 2010;

 

·                  the options were not granted within the twelve-month period immediately preceding the commencement of this offer, December 7, 2010; and

 

·                  the options did not have a remaining term of less than 12 months immediately following January 5, 2010.

 

On January 5, 2011, 98,416 shares of restricted stock were granted to those eligible employees as follows:

 

Exercise Price Per Share 

 

Number of  Eligible
Options

 

Number of New
Restricted  Shares To
Be Granted in
Exchange

 

$

5.04

 

85,122

 

32,391

 

$

6.98

 

65,244

 

993

 

$

7.64

 

16,000

 

244

 

$

8.30

 

247,359

 

57,287

 

$

10.88

 

8,265

 

881

 

$

13.00

 

144,978

 

6,620

 

 

 

 

 

 

 

 

 

566,968

 

98,416

 

 

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The Option Exchange was accounted for as a modification of an award in accordance with ASC 718-20-35-3. We recognize the incremental compensation expense of $102,348 over the remaining requisite service period. The incremental compensation expense is the excess of the fair value of the shares of restricted stock granted (using the closing market price) over the fair value of the cancelled options (using the black-scholes model) on January 5, 2011.

 

Incentive Stock Options

 

The table below summarizes incentive stock option activity for the six months ended June 30, 2012:

 

 

 

Number of
Options

 

Weighted
Average
Exercise
Price

 

Average
Remaining
Contractual
Life

 

Aggregate
Intrinsic
Value

 

Outstanding at December 31, 2011

 

1,574,886

 

$

1.11

 

 

 

 

 

Forfeited

 

(76,600

)

$

1.17

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2012

 

1,498,286

 

$

1.10

 

4.8

 

$

 

 

 

 

 

 

 

 

 

 

 

Options exercisable at June 30, 2012

 

879,601

 

$

1.00

 

4.7

 

$

 

 

The table below summarizes incentive stock option activity for the six months ended June 30, 2011:

 

 

 

Number of
Options

 

Weighted
Average
Exercise
Price

 

Average
Remaining
Contractual
Life

 

Aggregate
Intrinsic
Value

 

Outstanding at December 31, 2010

 

1,391,611

 

$

2.85

 

 

 

 

 

Exchanged in Option Exchange

 

(328,220

)

$

8.41

 

 

 

 

 

Granted

 

593,079

 

$

1.59

 

 

 

 

 

Exercised

 

(5,265

)

$

0.72

 

 

 

 

 

Forfeited

 

(39,941

)

$

9.24

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2011

 

1,611,264

 

$

1.10

 

3.6

 

$

873,276

 

 

 

 

 

 

 

 

 

 

 

Options exercisable at June 30, 2011

 

278,324

 

$

0.72

 

4.7

 

$

256,058

 

 

During the three and six months ended June 30, 2011, 3,333 and 5,265 incentive stock options, respectively, were exercised with an intrinsic value of $2,266 and $3,793, respectively.

 

Non-Qualified Stock Options

 

The table below summarizes non-qualified stock option activity for the six months ended June 30, 2012:

 

 

 

Number of
Options

 

Weighted
Average
Exercise
Price

 

Average
Remaining
Contractual
Life

 

Aggregate
Intrinsic
Value

 

Outstanding at December 31, 2011

 

992,272

 

$

2.32

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2012

 

992,272

 

$

2.32

 

1.9

 

$

 

 

 

 

 

 

 

 

 

 

 

Options exercisable at June 30, 2012

 

935,242

 

$

2.42

 

1.8

 

$

 

 

The table below summarizes non-qualified stock option activity for the six months ended June 30, 2011:

 

 

 

Number of
Options

 

Weighted
Average
Exercise
Price

 

Average
Remaining
Contractual
Life

 

Aggregate
Intrinsic
Value

 

Outstanding at December 31, 2010

 

1,150,548

 

$

3.87

 

 

 

 

 

Exchanged in Option Exchange

 

(238,748

)

$

9.52

 

 

 

 

 

Granted

 

80,472

 

$

1.59

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2011

 

992,272

 

$

2.32

 

2.9

 

$

99,520

 

 

 

 

 

 

 

 

 

 

 

Options exercisable at June 30, 2011

 

808,000

 

$

2.60

 

2.3

 

$

 

 

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Table of Contents

 

Restricted Stock Awards

 

The table below summarizes non-vested restricted stock awards activity for the six months ended June 30, 2012:

 

 

 

Number of
Shares

 

Weighted
Average Value at
Grant Date

 

Non-vested restricted stock at December 31, 2011

 

293,166

 

$

3.03

 

Granted

 

150,000

 

$

0.43

 

Vested

 

(138,615

)

$

1.32

 

Forfeited

 

(28,928

)

$

3.77

 

 

 

 

 

 

 

Non-vested restricted stock at June 30, 2012

 

275,623

 

$

2.40

 

 

During the three and six months ended June 30, 2012, 107,182 shares and 138,615 shares of restricted stock, respectively, vested with a weighted average vesting date fair value of $0.52 and $0.61 per share, respectively.

 

The table below summarizes non-vested restricted stock awards activity for the six months ended June 30, 2011:

 

 

 

Number of
Shares

 

Weighted
Average Value at
Grant Date

 

Non-vested restricted stock at December 31, 2010

 

292,512

 

$

3.95

 

Vested

 

(51,890

)

$

6.80

 

Granted in Option Exchange

 

98,416

 

$

1.32

 

 

 

 

 

 

 

Non-vested restricted stock at June 30, 2011

 

339,038

 

$

2.75

 

 

During the three and six months ended June 30, 2011, 14,400 and 51,890 shares of restricted stock, respectively, vested with a vesting date fair value of $1.09 and $1.48 per share, respectively.

 

Restricted Stock Unit Awards

 

On April 5, 2011, we granted 232,089 restricted stock units to our five executive officers. These restricted stock units vest upon the Company’s achievement of certain performance targets, but no earlier than ratably over the three year period following the grant date, at which time one common share will be issued and exchanged for each restricted stock unit held. The restricted stock units are included in the calculation of diluted earnings per share utilizing the treasury stock method. On April 30, 2012, 99,108 restricted stock units vested with a vesting date fair value of $0.53 per share. There have been no grants or forfeitures of restricted stock units subsequent to the aforementioned grant.

 

Note 14—Commitments and Contingencies

 

From time to time we are a party to litigation in the normal course of business. Management does not believe that the outcome of lawsuits or other proceedings against us will have an adverse effect on our financial condition, results of operations or cash flows.

 

Lease Revenue Audit—The lessor from one of our leases recently completed a five year revenue audit where the examiner claims to have identified an exception related to compressor fuel deductions. In May 2012, the claim was settled for $356,146, which was the amount recorded in the Consolidated Balance Sheet (Unaudited) as of March 31, 2012 and the Consolidated Statement of Operations (Unaudited) for the three months ended March 31, 2012 related to this matter.

 

Environmental and Regulatory

 

As of June 30, 2012, there were no known environmental or other regulatory matters related to our operations that are reasonably expected to result in a material liability to us.

 

Note 15—Income Taxes

 

We record our income taxes using an asset and liability approach in accordance with the provisions of ASC 740. This results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax basis of assets and liabilities using enacted tax rates at the end of the period. Under ASC 740, the effect of a change in tax rates of deferred tax assets and liabilities is recognized in the year of the enacted change.

 

For tax reporting purposes, we have federal and state net operating losses (“NOL’s”) of approximately $131.9 million and $137.6 million, respectively, at June 30, 2012 that are available to reduce future taxable income. For tax reporting purposes, we had federal and state NOL’s of approximately $126.0 million and $132.3 million, respectively, at December 31, 2011 that were available to reduce future taxable income. Our first material NOL carryforward expires in 2022 and the last one expires in 2031.

 

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Additionally, for tax reporting purposes, we have a federal capital loss carryforward generated by the sale of Hudson’s Hope Gas, Ltd., as described in Note 5—Discontinued Operations, of approximately $34.9 million at June 30, 2012 that is available to reduce future taxable capital gains and expiring in 2017.

 

In determining the carrying value of a deferred tax asset, ASC 740 provides for the weighing of all available evidence in estimating whether and how much of a deferred tax asset may be recoverable. In order to assess the realization of our net deferred tax asset as of June 30, 2012 and December 31, 2011, the Company considered all available negative and positive evidence. The Company had incurred a cumulative pre-tax loss of $140.9 million, which includes ceiling impairment charges of $156.0 million, over the three year period ended June 30, 2012. The Company evaluated all available evidence including historical operating results, historical pricing, natural gas reserves as estimated and appraised by an independent third party engineer, the forward natural gas price curve, and the length of the carryforward period available.

 

Our recent cumulative net losses and the forward natural gas price curve represented sufficient negative evidence to outweigh the positive evidence under the evaluation guidance of ASC 740. As a result, we established a full valuation allowance for our U.S. net deferred tax assets at March 31, 2012 of $47.3 million. For the three months ended June 30, 2012, we recorded an income tax benefit of $20.3 million related to our pretax loss of $53.9 million, for which we provided a full valuation allowance. Additionally, we generated a deferred tax asset for the capital loss recognized on the sale of Hudson’s Hope Gas, Ltd., for which we also provided a full valuation allowance, as described in Note 5—Discontinued Operations, in the amount of $13.2 million. Our valuation allowance for our net deferred tax assets as of June 30, 2012 is $80.8 million. These tax benefits will be available, prior to the expiration of carryforwards, to reduce future income tax expense resulting from earnings or increases in deferred tax liabilities.

 

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

 

Statement Regarding Forward-Looking Information

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations and other items in this Quarterly Report on Form 10-Q contain forward-looking statements and information that are based on management’s beliefs, as well as assumptions made by, and information currently available to, management. When used in this document, the words “believe,” “anticipate,” “estimate,” “expect,” “intend,” “may,” “will,” “project,” “forecast,” “plan,” and similar expressions are intended to identify forward-looking statements. Although management believes that the expectations reflected in these forward-looking statements are reasonable, it can give no assurance that these expectations will prove to have been correct. These statements are subject to certain risks, uncertainties and assumptions. Certain of these risks are summarized under “Item 1A. Risk Factors” in our 2011 Annual Report on Form 10-K that we filed with the SEC on March 30, 2012, which you should read carefully in connection with our forward-looking statements. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated. We undertake no obligation to release publicly any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

You should read “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in conjunction with the corresponding sections and our audited consolidated financial statements for the fiscal year ended December 31, 2011, which are included in our 2011 Annual Report on Form 10-K.

 

Overview

 

GeoMet, Inc. is an independent energy company primarily engaged in the exploration for and development and production of natural gas from coal seams (“coalbed methane” or “CBM”) and non-conventional shallow gas. We were originally founded as a consulting company to the coalbed methane industry in 1985 and have been active as an operator, developer and producer of coalbed methane properties since 1993. Our principal operations and producing properties are located in the Cahaba and Black Warrior Basins in Alabama and the central Appalachian Basin in Virginia and West Virginia. We also own additional coalbed methane and oil and gas development rights, principally in Alabama, Virginia, and West Virginia. As of June 30, 2012, we own a total of approximately 186,000 net acres of coalbed methane and oil and gas development rights.

 

The natural gas industry is capital intensive. We have historically made substantial capital expenditures in the exploration for, development and acquisition of natural gas reserves. Our capital expenditures have been financed primarily with internally generated cash from operations and proceeds from bank borrowings. The continued availability of these capital sources depends upon a number of variables, including proved reserves, production from existing wells, the sales prices for natural gas, the existence of hedging opportunities, our ability to acquire, locate and produce new reserves, and events occurring within the global capital markets.

 

Natural gas prices continue to adversely affect the natural gas industry and GeoMet by reducing our cash flows, capital expenditures and debt capacity. During 2011 and the first five months of 2012, prices received for natural gas in the United States continued to decline significantly which we believe, among other things, is due to over-supply, primarily from shale drilling, and reduced demand due to milder weather. On April 21, 2012, the Henry Hub spot price closed at $1.825/Mmbtu, its lowest in over 10 years. Presented below are the NYMEX Settle Prices for the period January 2012 through August 2012 and the NYMEX Forward Curve Prices (as of August 9, 2012) for natural gas for the period September 2012 through December 2013:

 

 

Liquidity and Bank Agreement

 

Cash flows provided by operations for the six months ended June 30, 2012 and 2011 were $10.4 million and $8.2 million, respectively.  As of June 30, 2012, we had a working capital deficit of $5.3 million and, at December 31, 2011, we had working capital of $11.6 million.  The working capital deficit as of June 30, 2012 was primarily the result of the classification of $15.9 million of our borrowings under the new Credit Agreement as a current liability in the Consolidated Balance Sheet (Unaudited). We believe that our cash flow from operations, as adjusted to comply with the terms of the new Credit Agreement, will provide us with sufficient capital resources to fund our working capital deficit and to meet our limited capital expenditure requirements to operate our properties effectively for at least the next twelve months.

 

           On November 18, 2011, our Fifth Amended and Restated Credit Agreement (the “Credit Agreement”) with a group of six banks became effective. The Credit Agreement replaced our Fourth Amended and Restated Credit Agreement and provided for revolving credit borrowings of up to $250 million with an initial borrowing base of $180 million. Effective August 8, 2012, we entered into the Fourth Amendment (the “Amendment”) to our Credit Agreement. Borrowings under the Credit Agreement at that time totaled $148.6 million. The Amendment provides for an initial conforming borrowing base of $115.0 million (the “Tranche A Borrowing Base”) with the balance then remaining in the amount of $33.6 million constituting a non-conforming tranche (the “Tranche B Borrowing Base”).  The borrowing base will be determined as of each June and December with the next determination scheduled to be completed by December 31, 2012.  Upon any determination of the borrowing base, the redetermined amount of the conforming borrowing base shall constitute the new Tranche A Borrowing Base, with any decrease in the Tranche A Borrowing Base causing an automatic corresponding increase in the Tranche B Borrowing Base and any increase in the Tranche A Borrowing Base causing an automatic corresponding decrease in the Tranche B Borrowing Base. At the next borrowing base determination, the Tranche B Borrowing Base shall not increase by more than fifty percent (50%) of the amount of the principal payments made on Tranche B Loans since the prior redetermination of the borrowing base.  Thereafter, at each subsequent redetermination of the borrowing base, the Tranche B Borrowing Base shall not increase by more than twenty-five percent (25%) of the amount of the principal payments made on Tranche B Loans since the prior redetermination of the borrowing base. 

 

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Should a future determination of the borrowing base result in the amount of the Tranche B Loan exceeding $33.6 million, the Company has 30 days to repay such excess. The Credit Agreement, as amended, will no longer provide for loans to be available on a revolving basis up to the amount of the borrowing base. As a result, the current outstanding loans, once repaid, may not be re-borrowed by the Company. All outstanding borrowings under the Credit Agreement, as amended, are due and payable on April 1, 2014. In addition, the Amendment obligates us to reduce our borrowings under the Credit Agreement, as amended, monthly by an amount equal to our bank cash, excluding (i) outstanding checks and (ii) an amount equal to $1 million as calculated on the 24th day of each month. The Amendment provides for interest to accrue at a rate calculated, at the Company’s option, at the Adjusted Base Rate plus a margin of 2.00% on the Tranche A Loans and 4.00% on Tranche B Loans or the London Interbank Offered Rate (the “LIBOR Rate”) plus a margin of 3.00% on the Tranche A loans and 5.00% on the Tranche B Loans. Adjusted Base Rate is defined to be the greater of (i) the agent’s base rate or (ii) the federal funds rate plus one half of one percent or (iii) the LIBOR Rate plus a margin of 1.00%. The banks will be paid an additional fee based on the amount of the Tranche B Loans as follows:

 

Calculation Date

 

Fee Amount

 

Date Payable

11/25/2012

 

75 bps

 

12/1/2012

2/25/2013

 

100 bps

 

3/1/2013

5/25/2013

 

125 bps

 

6/1/2013

8/25/2013

 

150 bps

 

9/1/2013

11/25/2013

 

175 bps

 

12/1/2013

 

All financial covenants were deleted by the Amendment and were replaced with a capital expenditure covenant (a maximum of $1.5 million in 2012 and $1.0 million in 2013) and a maximum debt covenant as follows:

 

Quarter Ending

 

Maximum Principal Outstanding

 

9/30/2012

 

$

 146,200,000

 

12/31/2012

 

$

 139,300,000

 

3/31/2013

 

$

 136,000,000

 

6/30/2013

 

$

 132,700,000

 

9/30/2013

 

$

 131,500,000

 

12/31/2013

 

$

 129,000,000

 

 

An amendment fee of 50 basis points on the amount of Tranche B was capitalized in Deferred financing costs in the amount of $0.2 million on August 8, 2012 in connection with the execution of the Amendment. Deferred financing costs of $2.1 million as of August 8, 2012 related to the Credit Agreement prior to the Amendment were fully amortized upon execution of the Amendment due to the significant change in the terms of the amended Credit Agreement.

 

Current Business Plan

 

Our current business plan is not significantly altered as a result of the Amendment to our Credit Agreement.  Our focus remains on the reduction of costs and the optimization of production volumes to maintain maximum cash flow and liquidity. We plan to continue taking the following steps during the remainder of 2012, while remaining in accordance with the provisions of our Credit Agreement, as amended:

 

·                  limit capital spending to amounts we deem appropriate to maintain our leases and properties,

 

·                  reduce operating and administrative costs with particular attention to the properties acquired in November of 2011,

 

·                  apply excess cash flows to reduce bank debt,

 

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