The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.
The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
(Unaudited)
Note 1—Organization and Presentation
Organization and Description
of Business
Falcon Minerals Corporation
(the “Company” or “Falcon” and formerly named Osprey Energy Acquisition Corp.) was a blank check company,
incorporated in Delaware in June 2016. The Company was formed for the purpose of acquiring, through a merger, capital stock exchange,
asset acquisition, stock purchase, reorganization, recapitalization, or other similar business transaction, one or more operating
businesses or assets (a “Business Combination”).
On August 23, 2018
(the “Closing Date”), the Company completed the acquisition of the equity interests ( the “Equity Interests”)
in certain of the subsidiaries (the “Royal Entities”) of Noble Royalties Acquisition Co., LP, (“NRAC”),
Hooks Ranch Holdings LP (“Hooks Holdings”), DGK ORRI Holdings, LP (“DGK”), DGK ORRI GP LLC (“DGK
GP”) and Hooks Holding Company GP, LLC (“Hooks GP”, and collectively with NRAC, Hooks Holdings, DGK, and DGK
GP, the “Contributors”). The acquisition was made pursuant to the Contribution Agreement, dated as of June 3, 2018
(the “Contribution Agreement”), by and among the Company, Royal Resources L.P. (“Royal”), Royal Resources
GP L.L.C. (“Royal GP”) and the Contributors. The acquisition of the Royal Entities pursuant to the Contribution Agreement
is referred to in this Form 10-Q as the “Business Combination” and the Business Combination together with the other transactions contemplated by the Contribution Agreement are referred to herein as the “Transactions.”
Pursuant to the Contribution
Agreement, on the Closing Date, the Company contributed cash to Falcon Minerals Operating Partnership, LP, a Delaware limited partnership
and wholly owned subsidiary of the Company (“Opco”), in exchange for (a) a number of OpCo Common Units representing
limited partnership interests in Opco (the “OpCo Common Units”) equal to the number of shares of the Company’s
Class A common stock, par value $0.0001 per share (the “Class A Common Stock”), outstanding as of the Closing
Date and (b) a number of Opco warrants exercisable for OpCo Common Units equal to the number of the Company’s warrants outstanding
as of the Closing Date. The Company controls Opco through Falcon Minerals GP, LLC, a Delaware limited liability company, wholly
owned subsidiary of the Company and the sole general partner of Opco (“Opco GP”).
On the Closing Date,
Falcon completed the acquisition of the Equity Interests and in return the Contributors received (i) $400 million of cash and (ii)
40 million units OpCo Common Units. The Company also issued to the Contributors 40 million shares of non-economic Class C common
stock of the Company, which entitles each holder to one vote per share. The OpCo Common Units are redeemable on a one-for-one basis
for shares of Class A Common Stock at the option of the Contributors. Upon the redemption by any Contributor of OpCo Common Units
for Class A Common Stock, a corresponding number of shares of Class C Common Stock held by such Contributor will be cancelled.
In connection with
the closing of the Business Combination (the “Closing”), the Company changed its name from “Osprey Energy Acquisition
Corp.” to “Falcon Minerals Corporation”. The Company is now structured as an “Up-C,” meaning that
substantially all the assets of the Company are held by Opco, and the Company’s only operating asset is its equity interest
in Opco. Each OpCo Common Unit, together with one share of Class C Common Stock, is exchangeable for one share of Class A
Common Stock at the option of the holder pursuant to the terms of the Company’s and Opco’s organizational documents,
subject to certain restrictions.
The Company’s
assets, via its controlling interest in OpCo, consist of royalty interests, mineral interests, non-participating royalty interests
and overriding royalty interests, or ORRIs, (“Royalties) underlying approximately 250,000 gross unit acres that are concentrated
in what the Company believes is the “core-of-the-core” of liquids-rich condensate region of the Eagle Ford Share in
Karnes, DeWitt and Gonzales Counties, Texas. The company owns additional assets of approximately 58,000 gross acres in Pennsylvania,
Ohio and West Virginia that is prospective for Marcellus Shale.
These royalties entitle
the holder to a portion of the production of oil and natural gas from the underlying acreage at the sales price received by the
operator, net of any applicable post-production expenses and taxes. The holder of these interests has no obligation to fund exploration
and development costs, lease operating expenses or plugging and abandonment costs at the end of a well’s productive life.
Note 2—Summary of Significant
Accounting Policies
Basis of Presentation
The acquisition of
the Royal Entities has been accounted for as a reverse recapitalization in accordance with GAAP. Under this method of accounting,
Falcon will be treated as the acquired company and Royal will be treated as the acquirer for financial reporting purposes. Therefore,
the consolidated financial results include information regarding Royal as the Company’s predecessor entity, which includes
certain interests in subsidiary companies which were not acquired by the Company in the Transactions. Thus, the financial statements
included in this report reflect (i) the historical operating results of Royal prior to the Transactions: (ii) the combined results
of the Company, OpCo and Royal following the Transactions; (iii) the assets, liabilities and partners’ capital of Royal at
their historical costs; and (iv) the Company’s equity and earnings per share presented for the period from the Closing Date
of the Business Combination. The Royal subsidiaries that were contributed in the Transaction are VickiCristina, LP, DGK ORRI Company,
L.P., Noble EF DLG LP, Noble EF LP and Noble Marcellus LP. The interests in Riverbend Natural Resources, L.P (‘RNR”)
and KGD ORRI, L.P. were not contributed in the Transactions (the “Non-Contributed Entities”). The RNR interests that
were not contributed in the Transactions are classified as held for sale and are presented separately in the December 31, 2017
consolidated balance sheet of the Company. In addition, the amounts attributed to RNR interests related to the Transaction are
included in discontinued operations in the consolidated statements of operations.
The accompanying interim
statements of the Company have been prepared in accordance with GAAP for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X issued by the SEC. Accordingly, they do not include all of the information and footnotes
required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring
adjustments and disclosures necessary for a fair statement of these interim statements have been included. The results reported
in these interim statements are not necessarily indicative of the results that may be reported for the entire year or for any other
period. These interim statements should be read in conjunction with Royal’s audited financial statements for the year ended
December 31, 2017 included in the proxy statement of the Company filed with the SEC on August 3, 2018 (the “Proxy Statement”)
and incorporated by reference in the Current Report on Form 8-K filed with the SEC on August 29, 2018.
Use of Estimates
The preparation of
unaudited condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities; disclosure of contingent assets and liabilities at the date of the
financial statements; the reported amounts of revenues and expenses during the reporting periods; and the quantities and values
of proved oil, natural gas and natural gas liquids (“NGLs”) reserves used in calculating depletion and assessing impairment
of oil and natural gas properties. Actual results could differ significantly from these estimates. Significant estimates made by
management include the quantities of proved oil, natural gas and NGL reserves, related present value estimates of future net cash
flows therefrom, the carrying value of oil and natural gas properties, fair value of the Company’s warrants, estimates of
current and deferred income taxes, and deferred income tax valuation allowances. While management believes these estimates are
reasonable, changes in facts and assumptions or the discovery of new information may result in revised estimates. Actual results
could differ from these estimates and it is reasonably possible these estimates could be revised in the near term, and these revisions
could be material.
Royalty Interests in
Oil and Natural Gas Properties
The Company follows
the successful efforts method of accounting for oil and natural gas operations. Under this method, costs to acquire mineral and
royalty interests in oil and natural gas properties are capitalized when incurred. Acquisitions of royalty interests of oil and
natural gas properties are considered asset acquisitions and are recorded at cost.
Acquisition costs
of proven royalty interests are amortized using the units of production method over the life of the property, which is estimated
using proven reserves. Acquisition costs of royalty interests on exploration stage properties, where there are no proven reserves,
are not amortized. When the associated exploration stage interests are converted to proven reserves, the cost basis is amortized
using the units of production methodology over the life of the property, using proven reserves. For purposes of amortization, interests
in oil and natural gas properties are grouped in a reasonable aggregation of properties with common geological structural features
or stratigraphic condition.
Fair Value of Financial
Instruments
Fair value is defined
as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants
at a specified measurement date. Fair value measurements are derived using inputs and assumptions that market participants would
use in pricing an asset or liability, including assumptions about risk. GAAP establishes a valuation hierarchy for disclosure of
the inputs used to measure fair value. This three-tier hierarchy classifies fair value amounts recognized or disclosed in the condensed
consolidated financial statements based on the observability of inputs used to estimate such fair values. The classification within
the hierarchy of an asset or liability is determined based on the lowest level input that is significant to the fair value measurement.
The hierarchy considers fair value amounts based on observable inputs (Levels 1 and 2) to be more reliable and predictable than
those based primarily on unobservable inputs (Level 3). At each balance sheet reporting date, the Company categorizes its assets
and liabilities recorded at fair value using this hierarchy.
The amounts reported
in the balance sheet for cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair
value because of the short-term maturities of these instruments (Level 1). Because the Credit Facility (as defined in “Note
5 – Debt – Falcon Credit Facility” below) has a market rate of interest, its carrying amount approximated fair
value (Level 2).
Revenue Recognition
The Company’s
oil, natural gas and natural gas liquids sales contracts are generally structured whereby the producer of the properties in which
the Company owns a royalty interest sells the Company’s proportionate share of oil, natural gas and natural gas liquids production
to the purchaser and the Company collects its percentage royalty based upon the revenue generated by the sale of the oil, natural
gas and natural gas liquids. In this scenario, the Company recognizes revenue when control transfers to the purchaser at the wellhead
or at the gas processing facility based on the Company’s percentage ownership share of the revenue.
The Company uses the
entitlement method of accounting for revenues. Under this method, revenues are recognized based on actual production. However,
settlement statements for certain oil, natural gas and natural gas liquids sales may not be received for 30 to 90 days after the
date production is delivered, and as a result, the Company is required to estimate the amount of royalty income to be received
based upon the Company’s interest. The Company records the differences between its estimates and the actual amounts received
for royalties in the month that payment is received from the producer. The Company has existing internal controls for its revenue
estimation process and related accruals, and any identified differences between its revenue estimates and actual revenue received
historically have not been significant. To the extent actual volumes and prices of oil and natural gas are unavailable for a given
reporting period because of timing or information not received from third parties, the royalties related to the expected sales
volume and prices for those properties are estimated and recorded.
Income Taxes
The Company under
ASC 740 uses the asset and liability method of accounting for income taxes, under which deferred tax assets and liabilities are
recognized for the future tax consequences of (i) temporary differences between the financial statement carrying amounts and the
tax bases of existing assets and liabilities and (ii) operating loss and tax credit carryforwards. Deferred income tax assets and
liabilities are based on enacted tax rates applicable to the future period when those temporary differences are expected to be
recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the
period the rate change is enacted. A valuation allowance is provided for deferred tax assets when it is more likely than not the
deferred tax assets will not be realized.
ASC 740 prescribes
a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken
or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be
sustained upon examination by taxing authorities. The Company recognizes accrued interest and penalties related to unrecognized
tax benefits as income tax expense. No amounts were accrued for the payment of interest and penalties at September 30, 2018. The
Company is currently not aware of any issues under review that could result in significant payments, accruals or material deviation
from its position. The Company is subject to income tax examinations by major taxing authorities since inception.
Royal was historically
treated as a partnership for federal income tax purposes, with each partner being separately taxed on its share of taxable income;
therefore, there is no federal income tax expense reflected in Royal’s financial statements.
Derivative Financial
Instruments
Royal used derivative
financial instruments to reduce exposure to fluctuations in commodity prices. The transactions were in the form of crude swaps.
Royal’s derivative instruments were not designated as cash flow hedges for accounting purposes for any of periods presented.
Accordingly, the changes in fair value are recognized in the consolidated statements of operations in the period of change. Gains
and losses from derivatives are included in the cash flows from operating activities. Royal’s derivative financial instruments
were extinguished in connection with the Transaction.
Segment Reporting
The Company derives
revenue from royalty interests, mineral interests, non-participating royalty interests and overriding royalty interests, or ORRIs,
(“Royalties”) in oil and natural gas properties in North America. The Company operates in a single operating and reportable
segment. Operating segments are defined as components of an enterprise for which separate financial information is evaluated regularly
by the chief operating decision maker (“CODM”) in deciding how to allocate resources and assess performance. The Company’s
chief executive officer has been determined to be the CODM and allocates resources and assesses performance based upon financial
information at the consolidated level.
Recently Issued Accounting
Pronouncements
In May 2014, the FASB
issued updated guidance on the reporting and disclosure of revenue recognition. The update requires that an entity recognize revenue
to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects
to be entitled in exchange for those goods or services. This update also requires new qualitative and quantitative disclosures
about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant
judgments and changes in judgments, information about contract balances and performance obligations, and assets recognized from
costs incurred to obtain or fulfill a contract. In April 2015, the FASB proposed a one-year deferral of the effective date, and
therefore, this guidance will be effective for the Company beginning in the first quarter of 2019, with early adoption optional
but not before the original effective date of December 15, 2016. In May and December 2016, the FASB issued certain narrow-scope
improvements and practical expedients to the guidance. The Company plans to adopt this effective January 1, 2019 using the modified
retrospective method. To date, the Company has not identified changes to its revenue recognition policies that would result in
a material adjustment to the opening balance of shareholder’s equity on January 1, 2019; however, it is continuing to evaluate
the effect, if any, adopting this guidance will have on its financial position, results of operations, cash flows and related disclosures.
Adopting this guidance will result in increased disclosures related to revenue recognition policies and disaggregation of revenue.
In February 2016,
the FASB issued new guidance which amends various aspects of existing guidance for leases. The new guidance requires an entity
to recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative
and quantitative disclosures. The main difference between previous GAAP and the new standard is the recognition of lease assets
and lease liabilities by lessees on the balance sheet for those leases classified as operating leases under previous GAAP. As a
result, the Company will have to recognize a liability representing its lease payments and a right-of-use asset representing its
right to use the underlying asset for the lease term on the balance sheet. The new guidance is effective for fiscal years beginning
after December 15, 2019, with early adoption permitted. The Company is currently evaluating the effect this standard will have
on its consolidated financial position or results of operations.
In August 2016, the
FASB issued new guidance which makes eight targeted changes to how certain cash receipts and cash payments are presented and classified
in the statement of cash flows. The update provides specific guidance on cash flow classification issues that are not currently
addressed by GAAP and thereby reduces the current diversity in practice. The standard is effective for the Company’s financial
statements issued for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption
is permitted. The Company does not expect this requirement to have a significant impact on its financial condition, results of
operations, cash flows and related disclosures.
In January 2017,
the FASB issued new guidance which provides clarifications to evaluating when a set of transferred assets and activities (collectively,
the “set”) is a business and provides a screen to determine when a set is not a business. Under the new guidance, when
substantially all of the fair value of gross assets acquired (or disposed of) is concentrated in a single identifiable asset, or
group of similar assets, the assets acquired would not represent a business. Also, to be considered a business, an acquisition
would have to include an input and a substantive process that together significantly contribute to the ability to produce outputs.
The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018,
and should be applied on a prospective basis to any transactions occurring within the period of adoption. Early adoption is permitted
for interim or annual periods in which the financial statements have not been issued. The Company does not expect this requirement
to have a significant impact on its financial condition, results of operations, cash flows and related disclosures.
Note 3 – Transaction
On the Closing Date,
Falcon completed the acquisition of the equity interests in the Royal Entities and in return the Contributors received (i) $400
million of cash and (ii) 40 million units Op Co Common Units. The Company also issued to the Contributors 40 million shares of
non-economic Class C common stock of the Company, which entitles each holder to one vote per share. The OpCo Common Units are redeemable
on a one-for-one basis for shares of Class A Common Stock at the option of the Contributors. Upon the redemption by any Contributor
of OpCo Common Units for Class A Common Stock, a corresponding number of shares of Class C Common Stock held by such Contributor
will be cancelled.
In addition to the
above, pursuant to the Contribution Agreement, Royal is entitled to receive earn-out consideration to be paid in the form of OpCo
Common Units (and a corresponding number of shares of Class C Common Stock) if the 30-day volume-weighted average price (“30-Day
VWAP”) of the Class A Common Stock equals or exceeds certain hurdles set forth in the Contribution Agreement. Royal can potentially
receive up to an additional 20.0 million OpCo Common Units as a part of the earn-out consideration. As of the September 30, 2018,
none of these hurdles have been met. Royal is also entitled to the earn-out consideration described above in connection with certain
liquidity events of the Company, including a merger or sale of all or substantially all of the Company’s assets, if the consideration
paid to holders of the Class A Common Stock in connection with such liquidity event is greater than any of the 30-Day VWAP hurdles.
In connection with
the Company’s entry into the Contribution Agreement, the Company agreed to issue and sell in a private placement an aggregate
of 11,480,000 shares of Class A Common Stock for a purchase price of $10.00 per share, and aggregate consideration of $114.8 million
(the “Private Placement”). The Private Placement was consummated concurrently with the Closing Date and the proceeds
of the Private Placement were used to fund a portion of the cash consideration paid to the Contributors.
Because Royal has
effective control of the combined company after the Transaction through its majority voting interests in both the Company and,
accordingly, Opco, this Transaction was accounted for as a reverse recapitalization. Although the Company was the legal acquirer,
Royal was the accounting acquirer. As a result, the reports filed by the Company subsequent to the Transaction are prepared “as
if” Royal is the predecessor and legal successor to the Company. The historical operations of Royal are deemed to be those
of the Company. Thus, the financial statements included in this report reflect (i) the historical operating results of Royal prior
to the Transaction; (ii) the combined results of the Company, OpCo and Royal following the Transaction; (iii) the assets, liabilities
and partners’ capital of Royal at their historical cost; and (iv) the Company’s equity and earnings per share for the
period from the Closing Date of the Business Combination.
The RNR assets, liabilities
and operations are considered discontinued operations prior to the Closing Date of the Transactions. Below is a reconciliation
of the carrying amounts of the major classes of assets and liabilities of the discontinued operations that are classified as held
for sale and are presented separately in the December 31, 2017 consolidated balance sheet of the Company (in thousands):
|
|
December 31,
|
|
|
|
2017
|
|
Assets:
|
|
|
|
Current assets:
|
|
|
|
Cash and cash equivalents
|
|
$
|
2,152
|
|
Accounts receivable
|
|
|
1,185
|
|
Total current assets
|
|
|
3,337
|
|
Royalty interests in oil and natural gas properties, net
|
|
|
22,253
|
|
Total assets of disposal group classified as held for sale
|
|
$
|
25,590
|
|
Liabilities and shareholder’s equity:
|
|
|
|
|
Current liabilities:
|
|
|
|
|
Accounts payable and accrued expenses
|
|
$
|
152
|
|
Total current liabilities
|
|
|
152
|
|
Credit facility
|
|
|
976
|
|
Asset retirement obligation
|
|
|
182
|
|
Total liabilities of the disposal group classified as held for sale
|
|
$
|
1,310
|
|
Below are amounts attributed to the disposition
of the RNR interests included in discontinued operations in the consolidated statements of operations (in thousands):
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil & gas sales
|
|
$
|
635
|
|
|
$
|
2,819
|
|
|
$
|
5,401
|
|
|
$
|
6,318
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Production and ad valorem taxes
|
|
|
39
|
|
|
|
242
|
|
|
|
484
|
|
|
|
558
|
|
Lease operating expenses
|
|
|
114
|
|
|
|
194
|
|
|
|
510
|
|
|
|
458
|
|
Transportation and marketing
|
|
|
153
|
|
|
|
160
|
|
|
|
332
|
|
|
|
310
|
|
Depreciation, depletion and amortization
|
|
|
181
|
|
|
|
1,472
|
|
|
|
1,574
|
|
|
|
3,103
|
|
General, administrative and other
|
|
|
51
|
|
|
|
49
|
|
|
|
325
|
|
|
|
167
|
|
Total expenses
|
|
|
538
|
|
|
|
2,117
|
|
|
|
3,225
|
|
|
|
4,596
|
|
Operating income
|
|
|
97
|
|
|
|
702
|
|
|
|
2,176
|
|
|
|
1,722
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income
|
|
|
2
|
|
|
|
-
|
|
|
|
2
|
|
|
|
-
|
|
Interest expense
|
|
|
(8
|
)
|
|
|
(14
|
)
|
|
|
(39
|
)
|
|
|
(39
|
)
|
Total other income (expense)
|
|
|
(6
|
)
|
|
|
(14
|
)
|
|
|
(37
|
)
|
|
|
(39
|
)
|
Net income
|
|
$
|
91
|
|
|
$
|
688
|
|
|
$
|
2,139
|
|
|
$
|
1,683
|
|
Below are the amounts attributed to the
disposition of the RNR interests included in the consolidated cash flow statements (in thousands):
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Cash flow from operating activities:
|
|
|
|
|
|
|
Net income
|
|
$
|
2,139
|
|
|
$
|
1,683
|
|
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
Amortization of mineral interests
|
|
|
1,574
|
|
|
|
3,103
|
|
Amortization of debt issuance costs
|
|
|
8
|
|
|
|
9
|
|
Accretion expense
|
|
|
7
|
|
|
|
31
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
534
|
|
|
|
(397
|
)
|
Accounts receivable - related parties
|
|
|
54
|
|
|
|
-
|
|
Accounts payable and accrued expenses
|
|
|
(41
|
)
|
|
|
(20
|
)
|
Accrued expenses to related parties
|
|
|
215
|
|
|
|
96
|
|
Net cash provided by operating activities
|
|
|
4,490
|
|
|
|
4,505
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Additions to oil and natural gas properties
|
|
|
(523
|
)
|
|
|
(2,684
|
)
|
Additions to oil and natural gas properties - change in capital accruals
|
|
|
-
|
|
|
|
(557
|
)
|
Decrease in advances to operators
|
|
|
-
|
|
|
|
225
|
|
Net cash (used in) investing
activities
|
|
|
(523
|
)
|
|
|
(3,016
|
)
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Distributions
|
|
|
(530
|
)
|
|
|
-
|
|
Net cash (used in) financing activities
|
|
|
(530
|
)
|
|
|
-
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
3,437
|
|
|
|
1,489
|
|
Cash and cash equivalents, beginning of period
|
|
|
2,152
|
|
|
|
2,512
|
|
Cash and cash equivalents, end of period
|
|
$
|
5,589
|
|
|
$
|
4,001
|
|
Note 4—Oil and Natural Gas Interests
Oil and natural gas interest include the
following (in thousands):
|
|
As of
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Oil and natural gas interests:
|
|
|
|
|
|
|
Subject to depletion
|
|
$
|
306,359
|
|
|
$
|
463,571
|
|
Not subject to depletion
|
|
|
19,200
|
|
|
|
19,200
|
|
Gross oil and natural gas interests
|
|
|
325,559
|
|
|
|
482,771
|
|
Accumulated depletion and impairment
|
|
|
(113,823
|
)
|
|
|
(155,855
|
)
|
Less: Discontinued operations portion
|
|
|
-
|
|
|
|
(22,253
|
)
|
Oil and natural gas interests, net
|
|
|
211,736
|
|
|
|
304,663
|
|
In
February 2018, Royal completed the sale of its interests in a portion of its oil and natural gas properties to an unaffiliated
third part for cash proceeds of $121.0 million. The sale resulted in a realized gain of $41.3 million.
Note 5—Debt
Royal Credit Facilities
Royal’s historical
primary sources of indebtedness are its first lien credit facility, which it entered into in October 2012, and Royal Natural Resources,
LP (“RNR”) credit facility:
|
·
|
First lien credit facility:
As of December 31, 2017, the borrowing base on the first lien
credit facility was $57 million. The borrowing base is re-determined semi-annually. Borrowings are either at LIBOR or at the Base
Rate, at Royal’s option, plus a variable credit spread. The variable credit spread is based on the percentage of the borrowing
base utilized. In connection with the pre-Transaction sale of a portion of Royal’s interests in certain oil and natural gas
properties, Royal repaid $27.0 million towards the first lien credit facility. The first lien credit facility was extinguished
on the Closing Date.
|
|
·
|
RNR credit facility:
As of December 31, 2017, the borrowing
base on the RNR credit facility was $2 million. Borrowings are between 7% and 9% for LIBOR-based loans, and between 6% and 8% for
Base Rate loans. The interest rate is based on the percentage of the borrowing based utilized. The RNR credit facility was incurred
by Riverbend Natural Resources, LP, which was not contributed in the Transaction.
|
The availability under
each facility was subject to Royal’s compliance with certain customary contractual financial and non-financial covenants
and non-financial covenants and each facility was secured by Royal’s assets.
Falcon Credit
Facility
On the Closing Date,
we entered into a credit facility with Citibank, N.A., as administrative agent and collateral agent for the lenders from time to
time party thereto (the “Credit Facility”). The Credit Facility initially provides for aggregate revolving borrowings
of up to $500.0 million with an initial $115.0 million borrowing base and expires on the fifth anniversary of the Closing Date.
On the Closing Date, $38.0 million was drawn under the Credit Agreement to fund a portion of the purchase price of the Business
Combination, to pay transaction expenses, to fund any original issue discount or upfront fees in connection with the “market
flex” provisions previously agreed upon and to finance working capital needs and other general corporate purposes. As of
September 30, 2018, the Company had borrowings of $38.0 million under the Credit Facility at an interest rate of 4.62%. The Company
incurred $3.2 million in connection with the closing of the Credit Facility. These amounts have been recorded as a deferred asset
and will be amortized over the term of the credit facility.
Principal amounts
borrowed are payable on the maturity date. We have a choice of borrowing at the base rate or LIBOR, with such borrowings bearing
interest, payable quarterly in arrears for base rate loans and one month, two-month, three month or six-month periods for LIBOR
loans. LIBOR loans bear interest at a rate per annum equal to the rate appearing on the Reuters Reference LIBOR01 or LIBOR02 page
as the LIBOR, for deposits in dollars at 12:00 noon (London, England time) for one, two, three, or six months plus an applicable
margin ranging from 200 to 300 basis points. Base rate loans bear interest at a rate per annum equal to the greatest of (i) the
agent bank’s reference rate, (ii) the federal funds effective rate plus 50 basis points and (iii) the rate for one-month
LIBOR loans plus 1%, plus an applicable margin ranging from 100 to 200 basis points. The next scheduled redetermination of our
borrowing base is on April 1, 2019. Based upon the current borrowing base, the Company has $77.0 million of available capacity
under the Credit Facility.
Obligations
under the Credit Facility are guaranteed by us and each of our existing and future, direct and indirect domestic subsidiaries (the
“Credit Parties”) and are secured by all the present and future assets of the Credit Parties, subject to customary
carve-outs.
The Credit Facility
contains certain customary representations and warranties, affirmative covenants, negative covenants and events of default. As
of September 30, 2018, the Company was in compliance with such covenants. The negative covenants include restrictions on the
Company’s ability to incur additional indebtedness, acquire and sell assets, create liens, enter into certain lease agreements,
make investments and make distributions.
Note 6—Shareholder’s Equity
and Dividends
Shares Outstanding
Prior to the Transaction,
Falcon was a shell company with no operations, formed as a vehicle to affect a business combination with one or more operating
businesses. After the Closing of the Transaction, the Company became a holding company whose sole material operating asset consists
of its interest in Royal through its interest in Opco. The following table summarizes the changes in the outstanding stock and
warrants through September 30, 2018.
|
|
Class A Common Stock
|
|
|
Class B Common Stock
|
|
|
Class C Common Stock
|
|
|
Warrants
|
|
Issued at IPO in July 2017
|
|
|
27,500,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
13,750,000
|
|
Issued to founders
|
|
|
-
|
|
|
|
6,875,000
|
|
|
|
-
|
|
|
|
7,500,000
|
|
Issued in connection with private placement
|
|
|
11,480,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Issued in connection with the Transaction
|
|
|
-
|
|
|
|
-
|
|
|
|
40,000,000
|
|
|
|
-
|
|
Class B conversion related to Transaction
|
|
|
6,875,000
|
|
|
|
(6,875,000
|
)
|
|
|
|
|
|
|
|
|
Shares outstanding at September 30, 2018
|
|
|
45,855,000
|
|
|
|
-
|
|
|
|
40,000,000
|
|
|
|
21,250,000
|
|
Preferred stock -
At September 30,
2018 and December 31, 2017, there were no shares of preferred stock issued or outstanding. The Company is authorized to issue 1,000,000
shares of preferred stock with a par value of $0.0001 per share with such designation, rights and preferences as may be determined
from time to time by the Company’s Board of Directors.
Class A Common Stock
- At September
30, 2018 and December 31, 2017, there were 45,855,000 and 1,359,246 shares of Class A Common Stock issued and outstanding (excluding
0 and 26,140,754 shares of common stock subject to possible redemption), respectively. Holders of the Company’s Class A Common
Stock are entitled to one vote for each share. The Company is authorized to issue 240,000,000 shares of Class A Common Stock with
a par value of $0.0001 per share.
Class B Common Stock
- At September
30, 2018 and December 31, 2017, there were 0 and 6,875,000 shares of Class B Common Stock issued and outstanding, respectively.
The shares of Class B Common Stock automatically converted into shares of Class A Common Stock at the time of the Transaction on
a one-for-one basis. The Company is authorized to issue 0 shares of Class B Common Stock with a par value of $0.0001 per share.
Holders of the Company’s Class B Common Stock are entitled to one vote for each share.
Class C Common Stock
– At
September 30, 2018 and December 31, 2017, there were 40,000,000 and 0 shares of Class C Common Stock issued and outstanding, respectively.
Class C common stock was issued to the Contributors in connection with the Transaction and are non-economic but entitled the holder
to one vote per share. The Company is authorized to issue 120,000,000 shares of Class C Common Stock with a par value of $0.0001
per share.
Warrants
– At September 30,
2018 and December 31, 2017, there were 21,250,000 outstanding during each period. Each warrant entitles the holder to purchase
one share of Class A Common Stock at an exercise price of $11.50 per share, subject to adjustment pursuant to the terms of the
warrant agreement. The warrants become exercisable on the later of (a) 30 days after the completion of a business combination or
(b) 12 months from the closing of the Initial Public Offering; provided in each case that the Company has an effective registration
statement under the Securities Act covering the shares of common stock issuable upon of the warrants and a current prospectus relating
to them is available. The exercise price and number of shares of Class A common stock issuable upon exercise of the warrants may
be adjusted in certain circumstances including in the event of a stock dividend, or recapitalization, reorganization, merger or
consolidation. The warrants expire five years from August 23, 2018, the date upon with the Transaction was closed, or earlier upon
redemption or liquidation.
In connection with
the Transaction, the Company issued 40,000,000 OpCo Common Units to the Contributors. The OpCo Common Units are redeemable on a
one-for-one basis for shares of Class A Common Stock at the option of the holder. Upon the redemption by any Contributor of OpCo
Common Units for shares of Class A Common Stock, a corresponding number of shares of Class C Common Stock held by such Contributor
will be cancelled.
In addition to the
above, the Contributors will be entitled to receive earn-out consideration to be paid in the form of OpCo Common Units (with a
corresponding number of shares of Class C common stock) if the volume-weighted average price of the trading days during any thirty
(30) calendar days (the “30-Day VWAP”) of the Class A common stock equals or exceeds certain hurdles set forth in the
Contribution Agreement. If the 30-Day VWAP of the Class A common stock is $12.50 or more per share at any time within the seven
years following the closing, Royal LP will receive (i) an additional 10 million Op Co Common Units (and an equivalent number of
shares of Class C common stock), plus (ii) an amount of OpCo Common Units (and an equivalent number of shares of Class C common
stock) equal to (x) the amount by which annual cash dividends paid on each share of Class A common stock exceeds $0.50 in each
year between the closing and the date the first earn-out is achieved (with any dividends paid in the stub year in which the first
earn-out is achieved annualized for purposes of determining what portion of such dividends would have, on an annual basis, exceeded
$0.50), multiplied by 10 million, (y) divided by $12.50. If the 30-Day VWAP of the Class A common stock is $15.00 or more per share
at any time within the seven years following the closing (which $15.00 threshold will be reduced by the amount by which annual
cash dividends paid on each share of Class A common stock exceeds $0.50 in each year between the closing and the date the earn-out
is achieved, but not below $12.50), the Contributors will receive an additional 10 million OpCo Common Units (and an equivalent
number of Class C common stock).
Noncontrolling
Interest
The Company’s
non-controlling ownership interest in consolidated subsidiaries are presented in the consolidated balance sheet within shareholder’s
equity as a separate component. In addition, consolidated net income includes earnings attributable to both the shareholders and
the non-controlling interests. For the nine months ended September 30, 2018 and 2017, less than $0.1 million of distributions for
each period have been made to non-controlling interest holders of the consolidated subsidiaries.
Long-Term Incentive
Plan
In connection with the Closing, the Falcon
Board of Directors adopted the Falcon Minerals Corporation 2018 Long-Term Incentive Plan (the “Plan”). An aggregate of
8.6 million shares of Class A Common Stock are available for issuance under the Plan. As of September 30, 2018, no grants have
been made under the Plan.
Cash Dividends
The table below summarizes the quarterly
dividends related to the Company’s quarterly financial results (in thousands, except per unit data):
|
|
Total Quarterly Dividend per
|
|
|
Total Cash
|
|
|
Date of
|
|
Class A Shareholders
|
Quarter Ended
|
|
Share
|
|
|
Dividend
|
|
|
Dividend
|
|
Record Date
|
9/30/2018
(1)
|
|
$
|
0.0950
|
|
|
$
|
4,356
|
|
|
November 15, 2018
|
|
November 8, 2018
|
(1)
Initial pro rata dividend, prorated for the period from August 23, 2018 to September 30, 2018.
Note 7—Earnings Per Share
The Transaction was
structured as a reverse capitalization by which the Company issued stock for the net assets of Royal accompanied by a recapitalization.
Earnings per share is calculated for the Company only for periods after the Transaction due to the reverse recapitalization.
Diluted net income
per share includes the effects of potentially dilutive shares of the Class C Common Stock. Diluted net income per share excludes
the effects of warrants to purchase 21,250,000 shares of common stock because there are no assurances that the stock price will
exceed the exercise price.
The following table
sets forth the calculation of basic and diluted earnings per share for the periods indicated (in thousands, except per share data):
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2018
|
|
Net income attributable to Class A shareholders
|
|
$
|
2,529
|
|
|
$
|
2,529
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
|
Basic weighted average common shares outstanding
|
|
|
45,855
|
|
|
|
45,855
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Potential common shares issuable
|
|
|
40,000
|
|
|
|
40,000
|
|
Diluted weighted average common units outstanding
|
|
|
85,855
|
|
|
|
85,855
|
|
Net income per common share, basic
|
|
$
|
0.06
|
|
|
$
|
0.06
|
|
Net income per common share, diluted
|
|
$
|
0.03
|
|
|
$
|
0.03
|
|
Note 8—Income Taxes
The Company uses an
estimated annual effective tax rate, which is based on expected annual income, statutory tax rates and tax planning opportunities
available in the various jurisdictions in which the Company operates, to determine its quarterly provision for income taxes. Certain
significant or unusual items are separately recognized in the quarter in which they occur and can be a source of variability in
the effective tax rates from quarter to quarter.
As of September 30,
2018, the Company recorded an income tax expense of $810,231 and $0 for the three months ended September 30,
2018 and 2017, and income tax expense of $810,231 and $0 for the nine months ended September 30,
2018 and 2017, respectively. Royal was historically treated as a partnership for federal income tax purposes, with each
partner being separately taxed on its share of taxable income; therefore, there is no federal income tax expense reflected in
Royal’s financial statements for the three and nine months ending September 30, 2017 or any period prior to the business
combination on August 23, 2018.
As of September 30,
2018, the Company had $60.6 million of net deferred tax assets net of valuation allowances. Deferred tax assets of $61.1M net
of valuation allowances were recorded as of the August 23, 2018 transaction date. These net deferred tax assets relate to oil
& gas assets and other temporary items where the tax basis differs from the GAAP carrying amounts.
At September
30, 2018 and December 31, 2017, the Company had recorded a prepayment of income taxes of $355,983 and $0 respectively.
The Company
recognizes accrued interest and penalties related to unrecognized tax benefits as income tax expense. No amounts were accrued
for the payment of interest and penalties at September 30, 2018. The Company is currently not aware of any issues under
review that could result in significant payments, accruals or material deviation from its position. The Company is subject to
income tax examinations by major taxing authorities since inception.
On December 22, 2017, the U.S. government enacted
comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act
makes broad and complex changes to the U.S. tax code that will affect our calendar year tax filings for the period ending
December 31, 2018, including, but not limited to, (1) reducing the U.S. federal corporate tax rate from 35 percent to 21
percent; (2) eliminating the corporate alternative minimum tax (AMT) and changing how existing AMT credits can be realized;
(3) creating a new limitation on deductible interest expense; and (4) changing rules related to uses and limitations of NOL
carryforwards created in tax years beginning after December 31, 2017. The impact of the Tax Act on the Company’s
financial statements are recorded in the amounts reported in our income tax provision.
Note 9—Related Party Transactions
Founder Shares
In June 2016, the
Company issued an aggregate of 125,000 shares of Class B Common Stock to Osprey Sponsor, LLC (the “Sponsor”) for an
aggregate purchase price of $25,000 (the “Founder Shares”). In March 2017, the Company effectuated a 57.5-for-1 stock
split resulting in an aggregate of 7,187,500 Founders Shares outstanding and held by the Sponsor. The Founder Shares automatically
converted into Class A Common Stock upon the consummation of the Transaction on a one-for-one basis. Due to the underwriter’s
election not to exercise the remaining portion of the over-allotment option related to the Initial Public Offering, 312,500 Founder
Shares were forfeited resulting in an aggregate of 6,875,000 Founders Shares held by the Sponsor prior to the Transaction.
Promissory Note
Prior to the closing
of the Initial Public Offering, the Sponsor loaned the Company a total of $0.2 million under a promissory note (the “Promissory
Note”) to be used for the payment of costs related to the Initial Public Offering. The Promissory Note was non-interest bearing,
unsecured and due on the earlier of December 31, 2017 or the closing of the Initial Public Offering. The Promissory Note was repaid
upon the consummation of the Initial Public Offering.
Atlas Energy
Group, LLC
Atlas Energy Group,
LLC, which Company officers and directors Edward Cohen, Jonathan Cohen and Daniel Herz are also directors and officers of, and
its affiliates provide the Company with advisory services in connection with potential business opportunities and prospective
targets. For the nine months ended September 30, 2018 and 2017, the Company paid less than $0.1 million and $0 in expenses in
connection with such services. In October 2018, Daniel Herz resigned from any and all director and officer positions within Atlas
Energy Group, LLC and its affiliates.
Hepco Capital
Management, LLC
Hepco Capital Management,
LLC (“Hepco Capital”), which Company officers and directors Edward Cohen, Jonathan Cohen and Jeffrey Brotman are also
directors and officers of, and its affiliates share certain employees and office space and reimburses the Company for a proportionate
amount of the shared expenses on a monthly basis. For the nine months ended September 30, 2018 and 2017, the Company incurred less
than $0.1 million and $0 million, respectively.
Note 10—Major Operators
The following table
presents the percentage of revenues with the Company’s significant operators (those that have accounted for 10% or more of
the Company’s revenues in a given period) for the periods indicated:
|
|
% of Revenues
|
|
|
% of Revenues
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Conoco Phillips
|
|
|
58
|
%
|
|
|
15
|
%
|
|
|
41
|
%
|
|
|
14
|
%
|
EOG
|
|
|
13
|
%
|
|
|
18
|
%
|
|
|
21
|
%
|
|
|
16
|
%
|
Devon
|
|
|
13
|
%
|
|
|
29
|
%
|
|
|
16
|
%
|
|
|
31
|
%
|
BHP Billiton
|
|
|
4
|
%
|
|
|
19
|
%
|
|
|
6
|
%
|
|
|
23
|
%
|
Total
|
|
|
88
|
%
|
|
|
81
|
%
|
|
|
84
|
%
|
|
|
84
|
%
|
Note 11—Commitments
and Contingencies
The Company could
be subject to various possible loss contingencies which arise primarily from interpretation of federal and state laws and regulations
affecting the natural gas and crude oil industry. Such contingencies include differing interpretations as to the prices at which
natural gas and crude oil sales may be made, the prices at which royalty owners may be paid for production from their leases, environmental
issues and other matters. Management believes it has complied with the various laws and regulations, administrative rulings and
interpretations.
Commitments and Contractual Obligations
Future non-cancelable
commitments related to certain contractual obligations as of September 30, 2018 are presented below (in thousands):
|
|
Payments Due by Period
|
|
|
|
Total
|
|
|
Q4 2018
|
|
|
2019
|
|
|
2020
|
|
|
2021
|
|
|
2022
|
|
|
Thereafter
|
|
Long-term debt obligations
|
|
$
|
38,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
38,000
|
|
Operating lease obligations
|
|
|
696
|
|
|
|
52
|
|
|
|
209
|
|
|
|
209
|
|
|
|
209
|
|
|
|
17
|
|
|
|
-
|
|
Total
|
|
$
|
38,696
|
|
|
|
52
|
|
|
|
209
|
|
|
|
209
|
|
|
|
209
|
|
|
|
17
|
|
|
|
38,000
|
|
Note 12—Subsequent Events
Cash Dividends
In October 2018, the
Company declared a partial quarterly cash dividend of $0.095 per share of Class A common stock totaling approximately $4.4 million
for all shares Class A common stock outstanding. The dividend is for the period from August 23, 2018 through September 30, 2018.
The dividend is payable on November 15, 2018 to all Class A shareholders of record on November 8, 2018.
OpCo Distribution
In November 2018,
OpCo made distributions totaling $8.8 million to its unitholders. Of the $8.8 million distributed by OpCo, the Company received
$4.7 million.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING
STATEMENTS
Certain statements
and information in this Quarterly Report on Form 10-Q may constitute “forward-looking statements” within the meaning
of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange
Act”). All statements, other than statements of present or historical fact, included in this prospectus regarding our strategy,
future operations, financial position, estimated revenues, and losses, projected costs, prospects, plans and objectives of management
are forward-looking statements. When used in this report, the words “could,” “should,” “will,”
“may,” “believe,” “anticipate,” “intend,” “estimate,” “expect,”
“project,” the negative of such terms and other similar expressions are intended to identify forward-looking statements,
although not all forward-looking statements contain such identifying words. These forward-looking statements are based on management’s
current expectations and assumptions about future events and are based on currently available information as to the outcome and
timing of future events. Except as otherwise required by applicable law, we disclaim any duty to update any forward-looking statements,
all of which are expressly qualified by the statements in this section, to reflect events or circumstances after the date of this
prospectus. We caution you that these forward-looking statements are subject to all of the risks and uncertainties, most of which
are difficult to predict and many of which are beyond our control, incident to the development, production, gathering and sale
of oil, natural gas and natural gas liquids. Important factors that could cause actual results to differ materially from those
in the forward-looking statements include, but are not limited to, those summarized below:
|
●
|
our ability to execute our business strategies;
|
|
●
|
the volatility of realized oil and natural gas prices;
|
|
●
|
the level of production on our properties;
|
|
●
|
regional supply and demand factors, delays or interruptions of production;
|
|
●
|
our ability to replace our oil and natural gas reserves;
|
|
●
|
our ability to identify, complete and integrate acquisitions of properties or businesses, including our recent and pending acquisitions;
|
|
●
|
general economic, business or industry conditions;
|
|
●
|
competition in the oil and natural gas industry;
|
|
●
|
the ability of our operators to obtain capital or financing needed for development and exploration operations;
|
|
●
|
title defects in the properties in which we invest;
|
|
●
|
uncertainties with respect to identified drilling locations and estimates of reserves;
|
|
●
|
the availability or cost of rigs, equipment, raw materials, supplies, oilfield services or personnel;
|
|
●
|
the availability of transportation facilities;
|
|
●
|
the ability of our operators to comply with applicable governmental laws and regulations and to obtain permits and governmental approvals; and
|
|
●
|
future operating results.
|
For additional information
regarding known material factors that could affect our operating results and performance, please read the section entitled “Risk
Factors” in our proxy statement filed with the SEC on August 3, 2018, as well as all risk factors described in the documents
incorporated by reference herein. Should one or more of the risks or uncertainties described in or incorporated into this report
occur, or should underlying assumptions prove incorrect, actual results and plans could different materially from those expressed
in any forward-looking statements.
Reserve engineering
is a process of estimating underground accumulations of oil, natural gas and natural gas liquids (“NGLs”) that cannot
be measured in an exact way. The accuracy of any reserve estimate depends on the quality of available data, the interpretation
of such data and the price and cost assumptions made by reserve engineers. In addition, the results of drilling, completion and
production activities may justify revisions of estimates that were made previously. If significant, such revisions would change
the schedule of any further production and development drilling. Accordingly, reserve estimates may differ significantly from the
quantities of oil, natural gas and NGLs that are ultimately recovered.