STTH.. $0.228
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and notes thereto included in Item 1 in this Quarterly Report on Form 10-Q. This item contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those indicated in such forward-looking statements.
Overview
Stratum Holdings, Inc. (“we” or the “Company”) is a holding company whose operations are presently focused on the domestic Exploration & Production business. In that business, our wholly-owned subsidiaries, CYMRI, L.L.C. and Triumph Energy, Inc., own working interests in approximately 60 producing oil and gas wells in Texas and Louisiana, with net production of approximately 700 MCF equivalent per day. We seek to increase shareholder value through an approach focused on growth and transaction opportunities in the energy industry.
Through June 3, 2011, we also operated in the Canadian Energy Services business via two wholly-owned subsidiaries, Decca Consulting, Ltd. and Decca Consulting, Inc. (collectively referred to as “Decca”). On that date, we sold the outstanding capital stock of Decca to a private company for a total sales price of $4.6 million (subject to certain adjustments), payable in a combination of: (a) Cash; (b) Non-interest bearing notes, which are payable out of the post-closing collection of Decca’s accounts receivable; and (c) Interest bearing notes, payable in 48 monthly installments of principal and interest, commencing on October 1, 2011 (see Note 2).
As a result of the sale of Decca, we are treating the revenues and expenses of the Canadian Energy Services segment as discontinued operations in this report, with our domestic Exploration & Production segment being reported as continuing operations.
Results of Operations
The following discussion reflects the revenues and expenses for the three month and nine month periods ended September 30, 2011 and 2010, as reported in our consolidated financial statements and notes thereto included in Item 1.
Three months ended September 30, 2011 versus three months ended September 30, 2010 — Total revenues from continuing operations for the three months ended September 30, 2011 were $739,000 compared to $690,000 for the three months ended September 30, 2010.
Revenues from CYMRI’s and Triumph’s oil and gas sales for the three months ended September 30, 2011 were $739,000 compared to $690,000 for the three months ended September 30, 2010. In the three months ended September 30, 2011, revenues from oil production were $642,000, reflecting volumes of 6,916 barrels at an average price of $92.83 per barrel, while gas revenues were $97,000, reflecting volumes of 19,418 Mcf at an average price of $5.00 per Mcf. On an overall basis, these amounts reflect a 17% increase in average oil and gas prices which was partially offset by a 9% decline in production volumes. The Company believes that continuing declines in CYMRI’s and Triumph’s production volumes are likely in the foreseeable future.
Lease operating expenses (“LOE”), including production taxes, were $348,000 for the three months ended September 30, 2011 versus $320,000 for the three months ended September 30, 2010, representing LOE of CYMRI’s and Triumph’s oil and gas production operations. This increase was largely due to a change in the relative timing of certain lease operating expenses between the two quarterly periods.
Depreciation, depletion and amortization (“DD&A”) expense for the three months ended September 30, 2011 was $125,000 versus $216,000 for the three months ended September 30, 2010, representing DD&A of CYMRI’s and Triumph’s oil and gas properties. This decrease was due to a significant decline in depletion rates as well as a decrease in production volumes.
Workover expenses for the three months ended September 30, 2011 were $37,000 versus $93,000 for the three months ended September 30, 2010, representing workovers on CYMRI’s and Triumph’s oil and gas properties. This decrease was largely experienced in CYMRI’s Burnell Field.
Selling, general and administrative (“SG&A”) expenses from continuing operations for the three months ended September 30, 2011 were $299,000 compared to $202,000 for the three months ended September 30, 2010. This increase primarily reflected a reduction in administrative expenses recovered from third parties under contract operating agreements.
Interest expense from continuing operations for the three months ended September 30, 2011 was $78,000 versus $52,000 for the three months ended September 30, 2010. This increase was substantially due to a higher interest rate on outstanding borrowings secured by CYMRI’s and Triumph’s oil and gas properties.
Gain on oil and gas derivatives for the three months ended September 30, 2011 was $16,000 versus nil for the three months ended September 30, 2010. This fluctuation was largely due to the change in fair value of CYMRI’s outstanding oil and gas derivative contracts (see Note 4).
Income taxes from continuing operations were a benefit of $31,000 for the three months ended September 30, 2011 compared to a benefit of $66,000 for the three months ended September 30, 2010. These benefit amounts reflected consolidated income tax rates from continuing operations of 24% and 34%, respectively.
Income from discontinued operations, net of income taxes, was zero for the three months ended September 30, 2011 versus a net loss $2,000 for the three months ended September 30, 2010. As further described in Note 2, we sold the outstanding capital stock of our Canadian Energy Services subsidiary, Decca, to a private company on June 3, 2011. The results of operations of our Canadian Energy Services business have been classified as discontinued operations in the Consolidated Statement of Operations, net of applicable income tax expense.
Nine months ended September 30, 2011 versus nine months ended September 30, 2010 — Total revenues from continuing operations for the nine months ended September 30, 2011 were $2,324,000 compared to $2,063,000 for the nine months ended September 30, 2010.
Revenues from CYMRI’s and Triumph’s oil and gas sales for the nine months ended September 30, 2011 were $2,324,000 compared to $2,062,000 for the nine months ended September 30, 2010. In the nine months ended September 30, 2011, revenues from oil production were $2,078,000, reflecting volumes of 21,677 barrels at an average price of $95.86 per barrel, while gas revenues were $246,000, reflecting volumes of 51,123 Mcf at an average price of $4.81 per Mcf. On an overall basis, these amounts reflect a 24% increase in average oil and gas prices which was partially offset by a 9% decline in production volumes. The Company believes that continuing declines in CYMRI’s and Triumph’s production volumes are likely in the foreseeable future.
Lease operating expenses (“LOE”), including production taxes, were $1,172,000 for the nine months ended September 30, 2011 versus $1,151,000 for the nine months ended September 30, 2010, representing LOE of CYMRI’s and Triumph’s oil and gas production operations. This slight increase between the two quarterly periods was not considered to be significant.
Depreciation, depletion and amortization (“DD&A”) expense for the nine months ended September 30, 2011 was $371,000 versus $626,000 for the nine months ended September 30, 2010, representing DD&A of CYMRI’s and Triumph’s oil and gas properties. This decrease was due to a significant decline in depletion rates as well as a decrease in production volumes.
Workover expenses for the nine months ended September 30, 2011 were $207,000 versus $311,000 for the nine months ended September 30, 2010, representing workovers on CYMRI’s South Texas oil and gas properties. This decrease was largely experienced in CYMRI’s Burnell Field.
Selling, general and administrative (“SG&A”) expenses from continuing operations for the nine months ended September 30, 2011 were $870,000 compared to $677,000 for the nine months ended September 30, 2010. This increase primarily reflected a reduction in administrative expenses recovered from third parties under contract operating agreements.
Interest expense from continuing operations for the nine months ended September 30, 2011 was $207,000 versus $289,000 for the nine months ended September 30, 2010. This decrease was due in large part to interest no longer being incurred on the Company’s unsecured notes payable that were repaid in March 2010 (see Note 5).
Gain on debt extinguishment for the nine months ended September 30, 2011 was zero compared to $439,000 for the nine months ended September 30, 2010. This decrease was due to the forgiveness of a portion of the principal and all of the accrued interest on unsecured notes payable to certain unrelated parties in March 2010 (see Note 5).
Gain on oil and gas derivatives for the nine months ended September 30, 2011 was $34,000 versus $83,000 for the nine months ended September 30, 2010. This fluctuation was largely due to the change in fair value of CYMRI’s outstanding oil and gas derivative contracts (see Note 4).
Income taxes from continuing operations were a benefit of $144,000 for the nine months ended September 30, 2011 compared to a benefit of $159,000 for the nine months ended September 30, 2010. These benefit amounts reflected consolidated income tax rates from continuing operations of 31% and 34%, respectively.
Income from discontinued operations, net of income taxes, was $3,098,000 for the nine months ended September 30, 2011 versus $225,000 for the nine months ended September 30, 2010. As further described in Note 2, we sold the outstanding capital stock of our Canadian Energy Services subsidiary, Decca, to a private company on June 3, 2011. The results of operations of our Canadian Energy Services business, including the pre-tax gain in the estimated amount of $2,766,000 recognized from the sale, have been classified as discontinued operations in the Consolidated Statement of Operations, net of applicable income tax expense reflecting the sales gain as a permanent tax difference in the 2011 period.
Liquidity and Capital Resources
Operating activities. Net cash used in operating activities from continuing operations for the nine months ended September 30, 2011 was $89,000 compared to $266,000 for the nine months ended September 30, 2010. This comparative difference in net operating cash flows reflected a relative improvement in the level of cash usage in our domestic Exploration & Production segment, primarily due to the effect of higher average oil and gas prices.
Investing activities. Net cash provided by investing activities, after deducting capital expenditures, was $1,305,000 for the nine months ended September 30, 2011 compared to $1,466,000 for the nine months ended September 30, 2010. In the nine months ended September 30, 2011, the Company received proceeds from the sale of Decca in the amount of $350,000 of cash paid at closing and $1,133,000 from the post-closing collection of notes receivable from the purchaser. In the nine months ended September 30, 2010, the Company converted approximately $1.6 million of restricted cash arising from the March 2008 sale of a former subsidiary into unrestricted cash.
Financing activities. Net cash used in financing activities from continuing operations for the nine months ended September 30, 2011 was $468,000 compared to $1,442,000 for the nine months ended September 30, 2010. This relative increase in net financing cash flows was primarily due to the liquidation of the Company’s unsecured notes payable that were repaid in March 2010 (see Note 5).
As disclosed in Note 5, a substantial portion of our existing long term debt is in the form of a bank credit facility secured by CYMRI/Triumph’s producing oil and gas properties. Borrowings under the bank credit agreement amounted to $2,886,000 as of September 30, 2011 and are subject to a borrowing base, which is periodically redetermined, based on oil and gas reserves. The bank credit agreement does not require monthly principal payments so long as outstanding borrowings are less than a declining borrowing base. As of September 30, 2011, there was no available borrowing base and the maturity was scheduled in October 2011, however, the bank has informally agreed to extend the maturity on a month-to-month basis until a more permanent arrangement can be made. The Company is currently seeking commitments from its current bank and other financial institutions for a new credit facility to replace the maturing credit agreement.
CYMRI did not fully meet certain financial covenants under the credit agreement as of September 30, 2011 and December 31, 2010. The bank is aware of these covenant violations, however, it has not requested, nor does the Company expect it to request, accelerated payment of this debt, which is classified in our current liabilities, as a result of both the covenant violations and the near term maturity.
Our ongoing capital expenditures are in the Exploration & Production segment, which can be highly capital intensive. In this business, expenditures for CYMRI/Triumph’s drilling and equipping of oil and gas wells are typically required to maintain or increase existing production levels. We normally attempt to finance CYMRI/Triumph’s capital expenditure requirements through a combination of cash flow from operations and secured bank borrowings and we expect that these sources will be sufficient to meet our capital expenditures in 2011. We presently have relatively low capital expenditure requirements relating to CYMRI/Triumph’s oil and gas properties as evidenced by a total of only $177,000 being spent as of September 30, 2011. We believe that our capital expenditures for the remainder of 2011 can be financed largely through our traditional sources.
Going Concern
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The Company has reported net losses from continuing operations in the last two years and presently has a working capital deficit in the amount of $2,460,000. These factors, among others, indicate that the Company may be unable to continue as a going concern for a reasonable period of time. The consolidated financial statements do not contain any adjustments to reflect the possible future effects on the classification of assets or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern.
We believe that the June 2011 sale of Decca, on the terms summarized in Note 2, potentially improves our financial condition. It should be noted, however, that we received only a relatively small portion of the sales price in cash at closing and our realization of the remaining sales price will depend on the purchaser making scheduled payments of principal and interest to us in accordance with the terms of our notes receivable. Assuming that the purchaser makes the note payments to us in accordance with their terms, we believe that such note payments will provide an enhanced source of liquidity for our continuing operations.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based on consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We believe that certain accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. See our Annual Report on Form 10-K for the year ended December 31, 2010 for a further description of our critical accounting policies and estimates.
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in the Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal controls over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
