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MPET > SEC Filings for MPET > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for MAGELLAN PETROLEUM CORP /DE/



Quarterly Report


The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and notes thereto contained herein and in our Annual Report on Form 10-K for the year ended June 30, 2012, along with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in such Form 10-K. Any terms used but not defined in the following discussion have the same meaning given to them in the Form 10-K. Unless otherwise indicated, all references in this discussion to Notes are to the Notes to the unaudited condensed consolidated financial statements included in Part I, Item I of this report. Our discussion and analysis includes forward looking information that involves risks and uncertainties and should be read in conjunction with Risk Factors under Item 1A of Part II of this report, along with the forward looking statements discussion at the end of this section for information about the risks and uncertainties that could cause our actual results to be materially different than our forward looking statements.
The Company is an independent energy company engaged in the exploration, development, production, and sale of crude oil and natural gas. The Company conducts its operations through two wholly owned subsidiaries: Nautilus Poplar LLC ("NP"), which owns Poplar, a highly attractive oil field in the Williston Basin; and Magellan Petroleum Australia Limited ("MPAL"), a successful independent oil and gas company in existence since 1964 active in Australia and the United Kingdom.
Magellan was founded in 1957 and incorporated in Delaware in 1967. The Company's common stock has been trading on the NASDAQ since 1972 and trades under the ticker symbol "MPET."
Our strategy is to enhance shareholder value by maximizing the value of our existing assets. Our portfolio of operations includes several early stage oil and gas exploration and development projects, the successful development of which requires significant capital, engineering, and management resources. We are committed to investing the necessary resources in these projects to establish their technical and economic viability. In turn, we will determine the most efficient way to create value and returns for our shareholders.
Revenues for the three months ended September 30, 2012, totaled $1.7 million, compared to $3.7 million in the prior year period, a decrease of 56%. The Company does not anticipate an increase in its revenues until the Company's assets move to the development phase. Operating loss for the three months ended September 30, 2012, totaled $5.9 million, compared to a $0.9 million gain in the prior year period. Net loss for the three months ended September 30, 2012, totaled $5.3 million ($(0.10)/basic share), compared to a $0.9 million gain ($0.02/basic share) in the prior year period. For further information, please refer to the discussion below in this section under Comparison of Results between the Three Months Ended September 30, 2012, and 2011.
During the three months ended September 30, 2012, management articulated a strategy focused on proving up the value of its existing assets as the most economic way of increasing shareholder value. Towards that end, management has begun a number of initiatives to evaluate and determine the potential of its oil and gas properties.
Poplar (Montana, USA)
Magellan 100% operated intervals. During the three months ended September 30, 2012, Magellan sold 18 Mbbls of oil attributable to its net revenue interests in Poplar, compared to 15 Mbbls of oil sold during the same period in 2011. These results represent a 20% increase in average daily sales for the year from 160 boepd to 200 boepd. The increase in production is primarily due to constrained production in the prior year period caused by the temporary suspension of one of Poplar's salt water disposal wells, which resulted in the temporary shut in of several producing wells; greater ownership in Poplar as a result of the Nautilus Restructuring in September 2011; a workover program instituted at Poplar in the summer of 2012; and sales from the EPU 117 well, which produces out of the Amsden Formation, a new pool discovery made in January 2012.
During this period, Magellan focused heavily on advancing its plans for a CO2-enhanced oil recovery project ("CO2-EOR") project in the Charles Formation at Poplar. In August 2012, Core Laboratories, on behalf of Magellan, finalized its analyses of oil samples taken from the Charles Formation, including tests of minimum miscibility pressure, CO2 solubility swelling, and viscosity reduction. The results of these analyses were all supportive of the viability of a CO2-EOR project at Poplar. Subsequent to these findings, Magellan identified a location for, and began the permitting process to drill and implement, a five-well CO2-EOR pilot project to be conducted during fiscal year 2013. The permitting process is ongoing and is expected to be completed in the third quarter of fiscal year 2013, with the drilling of the five wells to follow. In parallel to the permitting process, Magellan has been evaluating

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various options for the CO2 supply for its pilot project. Also during the period, Magellan continued to experiment with and evaluate production enhancing technologies on existing wells at Poplar, including water shut-off and stim-oil treatments. Evaluation of the effectiveness of these treatments is ongoing. VAALCO 65% operated intervals. Under the terms of our Lease Purchase and Sale and Participation Agreement with VAALCO (the "VAALCO PSA"), VAALCO is required to spud and complete three test wells in the deeper Formations at Poplar by December 31, 2012, in order to earn a 65% working interest in these Formations. VAALCO's second test well, EPU 133-H, was completed as a horizontal well in the Bakken/Three Forks Formation in September 2012. This well was found to be water-bearing and is temporarily shut-in while VAALCO evaluates its options. Australia
Palm Valley. The Palm Valley gas field, which is operated by MPAL, produced a gross average of approximately 0.4 MMcf/d of natural gas for sale for the three months ended September 30, 2012, compared to 4.5 MMcf/d during the same period in 2011. Gas sales volumes at Palm Valley decreased due to the termination of the gas sales contract with Northern Territory Power and Water Corporation (the "PWC Contract") during January 2012. Gas volumes during this period were sold under a long-term gas sales contract with Santos. To date, gas volumes sold under this arrangement have been significantly lower than under the PWC Contract, although volumes are expected to increase by fiscal year 2015 to levels similar to, and at prices significantly higher than, those realized under the PWC Contract.
Dingo. During the period ended September 30, 2012, the Company has continued its marketing efforts to identify and attract long-term customers for Dingo's gas resources.
NT/P82. During the three months ended September 30, 2012, Magellan worked to permit and commission a 3-D and 2-D seismic survey over its NT/P82 Exploration Permit in the Bonaparte Basin, offshore Northern Territory, Australia. The permitting process, which included an environmental assessment, was satisfactorily completed in October 2012. Simultaneous with the permitting, Magellan held discussions with several contractors to conduct the seismic survey, and, in October 2012, the Company executed a contract with Seabird Exploration FZ-LLC for the seismic recording vessel Voyager Explorer to undertake a 75 square mile 3-D and an 84 square mile 2-D seismic survey within its NT/P82 permit area. The seismic survey is expected to commence during the second week of December 2012, and to take approximately two weeks to complete. Magellan plans to process and analyze the seismic data over the following three months to assess the presence of hydrocarbons in NT/P82. This is an important milestone in Magellan's strategy to prove up the value of its assets. United Kingdom
Celtique Energie Operated Licenses. In the Weald Basin, Magellan and Celtique Energie each own a 50% working interest in four licenses (PEDL 231, 232, 234, and 243) covering a gross total of approximately 270,000 acres, all expiring on June 30, 2014, unless extended. During the three months ended September 30, 2012, Magellan, in conjunction with Celtique, focused on evaluating the prospects for an exploratory well in one of these licenses. Such a well would serve to assess the hydrocarbon potential of the Kimmeridge and Liassic Formations which are considered to have significant non-conventional hydrocarbon potential.
Northern Petroleum-Operated Licenses. In the Weald and Wessex Basins, Magellan owns working interests of between 23% and 40% in five licenses operated by Northern Petroleum (PEDL 126, 155, 240, and 256 and P1916), which expire between June 2014 and January 2016. During the three months ended September 30, 2012, the Markwells Wood-1 well drilled in 2011 remained temporarily suspended following a long-term production test conducted during fiscal year 2012. During the same period, the Company continued to evaluate the exploration options for its most recently acquired license, P1916, which lies offshore, west of the Isle of Wight, and is prospective for a Wytch Farm extension play.
Magellan Operated Licenses. In the Weald Basin, Magellan owns a 100% interest in two licenses (PEDL 137 and 246), which expire in September 2013 and June 2014, respectively. During the period ended September 30, 2012, the Company allowed PEDL 135 to expire at the end of its term on September 30, 2012. Magellan had previously owned a 100% interest in the license. Magellan acquired PEDL 135 to target similar to those targeted by its licenses co-owned with Celtique, but subsequently determined that the prospectivity of this license had been downgraded and did not warrant further exploration in this area. Also during the period, Magellan renewed its license for PEDL 137, originally set to expire on September 30, 2012, for an additional year.
Withholding Tax Liability
During the third quarter of fiscal year 2012, the Company identified a potential liability of approximately $2.0 million related to the Company's non-payment of required U.S. Federal tax withholding in the course of its initial acquisition of a part of NP. In October 2009, Magellan acquired 83.5% of the membership interests in NP (the "Poplar Acquisition"), from the two majority owners of NP, White Bear LLC ("White Bear") and YEP I, SICAV-FES ("YEP I"). Both of these entities are affiliated with Mr. Bogachev, a Director of Magellan and a foreign national. Due to the status of YEP I as a foreign entity and the members of White Bear as foreign nationals, Magellan was required to make U.S. Federal tax withholdings from the payments to or for the benefit of White Bear and YEP I. Of the

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$2.0 million liability, $1.3 million was estimated to relate to the interest sold by White Bear, $0.6 million to the interest sold by YEP I, and $0.1 million to Magellan's interest on late payment of the U.S. Federal tax withholdings. Upon the filing of U.S. income tax returns in relation to the Poplar Acquisition and payment of corresponding income taxes by White Bear and YEP I, Magellan is deemed to be relieved of its liability for the U.S. Federal tax withholdings as well as related penalties and interest except for Magellan's interest on late payment of the U.S. Federal tax withholdings. With regards to White Bear, Magellan has confirmed that as of the date of this filing, Mr. Bogachev has filed his U.S. income tax return and paid taxes due on the Poplar Acquisition, which were estimated at $0.3 million. Magellan has paid Mr. Bogachev $0.3 million in additional compensation during the quarter ended September 30, 2012. Had Mr. Bogachev not filed and paid his tax return, Magellan's liability in relation to its U.S. Federal tax withholdings requirements was estimated at $1.3 million. With regards to YEP I, Magellan continues to seek from YEP I or, because YEP I is a now defunct entity, from its successor entities, the filing of its U.S. income tax return.
As of September 30, 2012, we have recorded a total liability of $0.7 million under accrued and other liabilities in the consolidated balance sheets related to this matter. That amount is comprised of the $0.6 million in withholdings, penalties, and interest related to YEP I and $0.1 million related to Magellan's interest on its late payment of the U.S. Federal tax withholdings. There was no effect on the unaudited condensed consolidated statements of operations for the three months ended September 30, 2012, related to this transaction. Sopak AG and Glencore International plc
On September 28, 2012, Sopak AG, Glencore International plc, and various related entities (together, "Glencore") filed a Schedule 13D with the SEC stating that Glencore had acquired beneficial ownership of 9,264,637 issued and outstanding shares of Magellan common stock (the "Issued Shares") and beneficial ownership of a warrant to purchase 4,347,826 shares of Magellan common stock (together with the Issued Shares, the "Transferred Shares"). The Transferred Shares were previously pledged by Young Energy Prize ("YEP"), an entity controlled by Nikolay Bogachev, a Director of Magellan, pursuant to the Pledge and Security Agreement dated July 7, 2009, amended as of July 8, 2009, and March 11, 2010 (the "Pledge Agreement"). On September 21, 2012, Sopak AG delivered a letter to the Company instructing the Company to cancel the original certificate for the Transferred Shares and deliver a replacement certificate to Sopak AG. On October 11, 2012, the 9,264,637 Issued Shares were re-registered in the name of Sopak AG.
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES Historically, we have funded our activities from cash from operations and our existing cash balance. Following the recent end of the long term PWC Contract and the completion of the Santos SA, the source of the Company's funds for the implementation of its strategy will come primarily from the Company's existing cash balance. In addition, we may fund our development strategy through a prioritization of assets which may include farmouts, or a partial or total divestiture. The Company has limited capital expenditure obligations related to its leases and licenses, which allow for significant flexibility in the use of its capital resources. Based on its existing cash position and the various alternative sources of funds generally available to the Company, the Company believes it has sufficient financial resources to fund its ongoing operations and to finance projects that will further establish the full value of its assets.
Uses of Funds
Capital Expenditures Plans. At Poplar, the Company does not face significant mandatory capital expenditure requirements to maintain its acreage position. Substantially all of the leases are held by production and contain producing wells with reserves adequate to sustain multi-year production. Approximately 80% of the acreage has been unitized as a Federal Exploratory Unit, which is held by production from any one well. Currently, Poplar contains 35 producing wells. In the shallow intervals, which are 100% owned and operated by the Company, discretionary capital expenditure plans over the next two years will be determined by the results of ongoing engineering and technical analysis. In fiscal year 2013, the Company intends to evaluate the potential of CO2-EOR in the Charles Formation at Poplar by drilling a five-well pilot, including one CO2 injector well and four producing wells. Magellan expects to incur up to $10.0 million in capital drilling costs on these wells. Timing of the drilling of these wells will depend on the permitting process and drilling rig availability. The four producing wells are designed to yield conventional oil production from the Charles Formation in addition to enhanced production as a result of the CO2-EOR. As such, these four wells will constitute a portion of the wells to be drilled in the projections of our proved undeveloped reserves reported at June 30, 2012.
In the deeper intervals, which are operated by VAALCO and in which the Company has a 35% working interest, capital expenditures will be determined by the results of the three test wells that VAALCO is required to spud by the end of calendar year 2012, and for which VAALCO will bear 100% of the capital expenditures. If these test wells are deemed successful, the Company plans to fund its 35% share of the cost of the future drilling program in the deeper formations of Poplar.
At Palm Valley, the Company's interest in the field is governed by Petroleum Lease No. 3, which expires in November 2024 (and is subject to automatic renewal for another 21 years). The Company is not obligated to undertake significant mandatory capital expenditures in order to maintain its position in the lease. The Company's discretionary capital expenditure plans are primarily focused

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on maintaining gas production from the existing facilities to meet the Santos Gas Contract demand while maintaining a safe and efficient operation, conducted in accordance with good oil field practice.
At Dingo, the Company's interest in the field is governed by Retention License No. 2, which expires in February 2014 (and is subject to renewal for a further 5 years). No mandatory capital expenditure is required until new gas sales contracts are secured. Dingo contains two suspended wells which are capable of production. The Company is currently evaluating a number of options for the future development of this field and is in the process of identifying potential new gas customers.
In the Bonaparte Basin, offshore Australia, the Company holds a 100% interest in the NT/P82 Exploration Permit. In October 2012, the Company executed a contract with Seabird Exploration FZ-LLC (the "Seabird Agreement") for the seismic recording vessel Voyager Explorer to undertake a seismic survey within its NT/P82 permit area. The estimated cost of shooting, processing, and analyzing the seismic survey is approximately $4.5 million.
In the United Kingdom, the Company's interests are governed by various Petroleum Exploration and Development Licenses. The majority of these licenses expire in 2014, and all are subject to "drill-or-drop" terms.
Contractual Obligations. As of September 30, 2012, the Company is committed to make future payments for seismic data survey services under the Seabird Agreement of approximately $4.5 million within a twelve month period. Please refer to the contractual obligations table in Part II, Item 7 of our Form 10-K for the fiscal year ended June 30, 2012, for information on all other material contractual obligations.
Sources of Funds
Cash and Cash Equivalents. On a consolidated basis, the Company had approximately $37.9 million of cash and cash equivalents at September 30, 2012, compared to $41.2 million as of June 30, 2012.
The Company considers cash equivalents to be short term, highly liquid investments that are both readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Cash balances totaled $19.3 million as of September 30, 2012, with the remaining $18.6 million held in several Australian banks in time deposit accounts that have terms of 90 days or less. Due to the international nature of its operations, the Company is exposed to certain legal and tax constraints in matching the capital needs of its assets and its cash resources. As of September 30, 2012, $19.3 million of the Company's consolidated cash and cash equivalents, representing 51% of the total, were deposited in accounts held by MPAL. To the extent that the Company repatriates cash amounts from MPAL to the U.S., the Company will potentially be liable for incremental U.S. Federal and state income tax, which may be reduced by the U.S. Federal and state net operating loss and foreign tax credit carry forwards available to the Company at that time.
Existing Credit Facilities. A summary of the Company's existing credit facilities and borrowing base is as follows:

                         September 30,      June 30,
                              2012            2012
                               (In thousands)
Outstanding borrowings:
Term loan               $           738    $     870
Line of credit                      100           50
Total                   $           838    $     920

The Company, through its wholly owned subsidiary NP, maintains its only credit facility with Jonah Bank of Wyoming. As of September 30, 2012, the Company's borrowing capacity under these facilities totaled $2.3 million, consisting of a $1.3 million term loan and a $1.0 million line of credit. Of the $1.0 million line of credit, $0.1 million was drawn, $25 thousand secured business credit cards used by NP, $25 thousand secured a line of credit in favor of the Bureau of Land Management, and $0.8 million remained available to borrow. As of September 30, 2012, NP was in compliance with its financial covenants as set forth in the term loan agreement. The credit facilities are collateralized by a first mortgage and an assignment of production for Poplar and are guaranteed by the Company up to $6.0 million but not to exceed the amount of the principal owed, which was $0.8 million as of September 30, 2012.
Other Sources of Financing. In addition to its cash and existing credit facilities, the Company has various alternatives to fund the development of its assets. These alternatives could potentially include entering into a corporate credit facility, a reserve-based loan facility, a farm-out of a portion of the development program of some of the Company's assets, and an issuance of new shares to equity investors.

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Cash Flows
The following table presents the Company's cash flow information for the three
months ended:
                                                                  September 30,
                                                                2012         2011
                                                                 (In thousands)
Cash (used in) provided by:
Operating activities                                         $ (3,650 )   $ (2,027 )
Investing activities                                             (385 )     11,476
Financing activities                                              (82 )     (2,824 )
Effect of exchange rate changes on cash and cash equivalents      841       (1,319 )
Net decrease in cash and cash equivalents                    $ (3,276 )   $  5,306

Cash used in operating activities during the three months ended September 30, 2012, was $3.7 million, compared to cash used of $2.0 million for the same period in 2011. The increase in cash used in operating activities primarily related to a decrease in revenues of $2.1 million over the same period and a $0.4 million decrease in exploration expense.
Cash used in investing activities during the three months ended September 30, 2012, was $0.4 million, compared to cash provided of $11.5 million for the same period in 2011. For the three months ended September 30, 2012, the cash used in investing activities consisted of expenditures on the development of our assets. For the same period in 2011, $5.0 million in proceeds was received from the VAALCO PSA and a $10.9 million deposit related to the Evans Shoal Asset Sales Deed was refunded both of which were offset by $0.8 million spent on the purchase of non-controlling interests in Poplar, and $1.2 million in expenditures on the development of our assets.
Cash used in financing activities during the three months ended September 30, 2012, was $0.1 million, compared to cash used of $2.8 million for the same period in 2011. The increase in cash provided by financing activities for the three months ended September 30, 2012, related to the Company's $3.4 million purchase of the non-controlling interest in Poplar in the prior year. During the three months ended September 30, 2012, the effect of changes in foreign currency exchange rates positively impacted the translation of our AUD denominated cash and cash equivalent balances into USD and resulted in an increase of $0.8 million in cash and cash equivalents, compared to a decrease of $1.3 million for the same period in 2011.
Adjusted EBITDAX
We define Adjusted EBITDAX as net income (loss) attributable to Magellan, plus
(i) depletion, depreciation, amortization, and accretion expense, (ii) exploration expense, (iii) stock based compensation expense, (iv) foreign transaction loss (gain), (v) impairment expense, (vi) gain on sale of assets,
(vii) net interest income, (viii) other income, (ix) income tax benefit (provision), and net income attributable to non-controlling interest in subsidiaries. Adjusted EBITDAX is not a measure of net income or cash flow as determined by accounting principles generally accepted in the United States ("GAAP"), and excludes certain items that we believe affect the comparability of operating results. Our Adjusted EBITDAX measure provides additional information which may be used to better understand our operations. Adjusted EBITDAX is one of several metrics that we use as a supplemental financial measurement in the evaluation of our business and should not be considered as an alternative to, or more meaningful than, net income (loss) as an indicator of our operating performance. Certain items excluded from Adjusted EBITDAX are significant components in understanding and assessing a company's financial performance, such as the historic cost of depreciable and depletable assets. Adjusted EBITDAX, as used by us, may not be comparable to similarly titled measures reported by other companies. We believe that Adjusted EBITDAX is a widely followed measure of operating performance and is one of many metrics used by our management team and by other users of our consolidated financial statements. For example, Adjusted EBITDAX can be used to assess our operating performance and return on capital in comparison to other independent exploration and production companies without regard to financial or capital structure, and to assess the financial performance of our assets and our company without regard to historical cost basis and items affecting the comparability of period to period operating results.

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The following table provides a reconciliation of net (loss) income to Adjusted EBITDAX for the periods ended:

                                                                 THREE MONTHS ENDED
                                                                   September 30,
                                                                2012            2011
                                                                   (In thousands)
Net (loss) income attributable to Magellan Petroleum
Corporation                                                 $    (5,310 )   $      940
Depletion, depreciation, amortization, and accretion
expense                                                             316            474
Exploration expense                                                 622            987
. . .
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