News Column

EQUAL ENERGY LTD. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

May 8, 2014

Forward-Looking Statements

The information discussed in this quarterly report on Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). All statements, other than statements of historical facts, included herein concerning, among other things, planned capital expenditures, changes in oil and gas production, the number of anticipated wells to be drilled after the date hereof, future cash flows and borrowings, pursuit of potential acquisition opportunities, our financial position, business strategy and other plans and objectives for future operations, are forward-looking statements. These forward-looking statements are identified by their use of terms and phrases such as "may," "expect," "estimate," "project," "plan," "believe," "intend," "achievable," "anticipate," "will," "continue," "potential," "should," "could," and similar terms and phrases. Although we believe that the expectations reflected in these forward-looking statements are reasonable, they do involve certain assumptions, risks and uncertainties. Our results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, among others:

• the pending sale of the company to Petroflow; • risks associated with drilling oil and natural gas wells; • the volatility of oil and natural gas prices; • uncertainties in estimating oil and natural gas reserves; • the need to replace the oil and natural gas the Company produces; • the Company's ability to execute its growth strategy by drilling wells as planned; • risks and liabilities associated with acquired properties and risks related to the integration of acquired businesses; • amount, nature and timing of capital expenditures, including future development costs, required to develop the Company's undeveloped areas; • concentration of operations in Central Oklahoma; • inability to retain drilling rigs and other services; • risk of currency fluctuations; • the potential adverse effect of commodity price declines on the carrying value of the Company's oil and natural gas properties; • severe or unseasonable weather that may adversely affect production and drilling; • availability of satisfactory oil and natural gas marketing and transportation; • availability and terms of capital to fund capital expenditures; • amount and timing of proceeds of asset sales and asset monetization; • ability to fund ongoing dividends; • limitations on operations resulting from debt restrictions and financial covenants; • potential financial losses or earnings reductions from commodity derivatives; • potential elimination or limitation of tax incentives; • competition in the oil and natural gas industry; • risks associated with consent solicitations and proxy contests conducted by dissident stockholders; • general economic conditions, either internationally or domestically or in the areas where the Company operates; • inability to obtain required regulatory approvals for development activities; • costs to comply with current and future governmental regulation of the oil and natural gas industry, including environmental, health and safety laws and regulations, and regulations with respect to water disposal and hydraulic fracturing; • the need to maintain adequate internal control over financial reporting.



Finally, our future results will depend upon various other risks and uncertainties, including, but not limited to, those detailed in the section entitled "Risk Factors" included in our 2013 Annual Report on Form 10-K. All forward-looking

Page 13 of 28



--------------------------------------------------------------------------------

Table of Contents

statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements in this section and elsewhere in this report. Other than as required under securities laws, we do not assume a duty to update these forward-looking statements, whether as a result of new information, subsequent events or circumstances, changes in expectations or otherwise.

The following discussion and analysis addresses material changes in our results of operations and capital resources and uses for the three months ended March 31, 2014, compared to the three months ended March 31, 2013, and in our financial condition and liquidity since December 31, 2013, and should be read in conjunction with "Item 1. Consolidated Financial Statements" of this report and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2013 Annual Report on Form 10-K.

In addition, the following discussion is for our continuing operations (U.S. operations) for the three months ended March 31, 2014.

Overview

Equal Energy Ltd. is a Calgary, Alberta based company headquartered in Oklahoma City, Oklahoma, engaged in the exploration, acquisition, development and production of petroleum and natural gas in Oklahoma. The Company also reviews new drilling opportunities and potential acquisitions in Oklahoma to supplement its exploration and development activities.

The Company averaged approximately 7,000 boe/d of production for the three months ended March 31, 2014, which was comprised of approximately 48% natural gas, 49% NGLs and 3% crude oil. At March 31, 2014, the Company had 142 gross (119 net) producing wells, virtually all of which it operates, and approximately 90,000 gross (59,000 net) acres under lease or held by production.

Arrangement to Sell all Issued and Outstanding Shares of the Company

On December 6, 2013, Equal, Petroflow Energy Corporation, a Delaware corporation ("Petroflow"), and Petroflow Canada Acquisition Corp., an Alberta, Canada corporation and wholly-owned subsidiary of Petroflow ("PetroflowSub"), entered into an Arrangement Agreement (the "Arrangement Agreement"), pursuant to which Petroflow has agreed to acquire, indirectly through PetroflowSub, all of the outstanding common shares of Equal for $5.43 per share in cash, without interest, and pursuant to which Equal will become an indirect wholly-owned subsidiary of Petroflow (the "Arrangement"). On May 1, 2014, the Arrangement Agreement was amended (the "Amendment") subsequent to Petroflow securing debt financing commitment letters in order to (a) extend the outside termination date contained therein from May 1, 2014 to July 31, 2014, (b) permit Equal to declare and pay on or after May 1, 2014, and prior to the effective date of the Arrangement, a cash dividend of $0.05 per common share, (c) permit Equal to declare and pay to its common shareholders who are entitled to receive Arrangement consideration upon completion of the Arrangement a cash dividend of $0.05 cents per common share (the "Arrangement Dividend") and (d) amend the approved budget for Equal agreed to by the parties in the Arrangement Agreement.

On the terms of and subject to the conditions set forth in the Arrangement Agreement, which has been unanimously approved by the Board of Directors of Equal, at the effective time of the Arrangement (the "Effective Time"), and as a result thereof, each common share of Equal that is issued and outstanding immediately prior to the Effective Time (other than Equal common shares for which dissenter's rights have been validly exercised and not withdrawn) will be converted at the Effective Time into the right to receive $5.43 in cash (the "Consideration"), without interest, less any applicable withholding taxes as described in the Arrangement Agreement and the Plan of Arrangement included in our proxy statement in connection with the Arrangement. Each stock option outstanding immediately prior to the Effective Time (whether vested or unvested), shall be transferred from the option holder to Equal. Upon the transfer, if the Consideration, expressed in Canadian dollars in respect of each stock option, exceeds the exercise price per common share of such stock option, the option holder will receive cash consideration equal to such difference, subject to applicable withholding taxes and deductions. Where the Consideration, expressed in Canadian dollars, in respect of each stock option, does not exceed the exercise price per common share of such option, the option holder will not receive any payment in respect of such option. All options will be cancelled immediately after the transfer to Equal. Pursuant to the Arrangement Agreement, Equal has agreed to take all steps necessary or desirable to give effect to the foregoing, including entering into option cancellation agreements ("Option Agreements") with each option holder in respect of all options and to obtain necessary consents from option holders to the transfer and cancellation of the options as described above. At the Effective Time, the Arrangement Dividend will be paid.

At the Effective Time, all Equal common shares issuable pursuant to Equal's restricted share and performance share incentive plan will be issued and those Equal common shares will be converted into the right to receive the Consideration, less any applicable withholding taxes.

Page 14 of 28



--------------------------------------------------------------------------------

Table of Contents

Equal and Petroflow have made customary representations, warranties and covenants in the Arrangement Agreement, including, among others, covenants by Equal that: (i) subject to certain provisions in the Arrangement Agreement relating to the conduct of business up to the Effective Time, Equal will conduct its business in the normal and ordinary course of business and consistent with past practice, during the interim period between the execution of the Arrangement Agreement and the Effective Time; (ii) Equal will not engage in certain kinds of transactions during such period; (iii) Equal will cause a meeting of the Equal shareholders to be held to consider approval of the Arrangement Agreement; and (iv) subject to certain customary exceptions, that the Board of Directors of Equal will recommend approval by its shareholders of the Arrangement Agreement. Petroflow and Equal have agreed to cooperate to make any required filings, applications and submissions with governmental authorities, and to obtain any required consents, waivers and approvals from those authorities. Equal has also made certain additional customary covenants, including, among others, covenants not to (i) solicit proposals relating to alternative business combination transactions or (ii) subject to certain exceptions, enter into discussions concerning or provide confidential information in connection with any proposals for alternative business combination transactions. Petroflow has agreed to use commercially reasonable efforts to fulfill, or cause to be fulfilled, the conditions that are within its control for funding and closing of the financing necessary for Petroflow to pay the Consideration in connection with the consummation of the Arrangement, and Equal has agreed to provide, and to cause its officers, employees and advisors to provide, upon the reasonable request of Petroflow, all reasonable cooperation in connection with the arrangement of the financing for Petroflow's consummation of the Arrangement.

Consummation of the Arrangement is subject to customary conditions, including, among others: (i) approval of the holders of a majority of the votes cast by shareholders at the meeting of Equal shareholders to be held to consider approval of the Arrangement, excluding any Equal common shares held by the President and Chief Executive Officer of Equal; (ii) approval of the holders of 66 2/3% of the votes cast by shareholders at the meeting of Equal shareholders to be held to consider approval of the Arrangement; (iii) the absence of any law or order prohibiting the consummation of the Arrangement; (iv) the granting of an interim and final court order under Alberta law approving the Arrangement; (v) the absence of a material adverse effect with respect to Equal; (vi) the obtaining by Petroflow of financing necessary to consummate the Arrangement; (vii) no make-whole premium be payable in respect of Equal's outstanding convertible debentures; (viii) Option Agreements must be in place with the holders of Equal's stock options; and (ix) dissent rights shall not have been exercised with respect to more than 5% of the Equal common shares, calculated on a fully diluted basis. Many of the conditions to consummation have not yet been satisfied.

The Arrangement Agreement contains certain termination rights for both Petroflow and Equal, and further provides that, upon termination of the Arrangement Agreement under certain specified circumstances, Equal would be required to pay Petroflow a termination fee of $2,000,000 or Petroflow would be required to pay Equal a reverse termination fee of $2,000,000.

In connection with the parties' entry into the Arrangement Agreement, the directors and officers of Equal (the "Locked-Up Parties") have entered into a Lock-Up and Support Agreement (the "Lock-Up Agreement") with respect to a total of 847,477 common shares of Equal legally or beneficially owned by the Locked-Up Parties (the "Locked-Up Shares"), which represent approximately 2.35% of Equal's outstanding common shares, as of May 5, 2014. Any of Equal's common shares acquired after the date of the Lock-Up Agreement (including, without limitation, pursuant to the exercise of options or other convertible securities or restricted stock) will also become subject to the Lock-Up Agreement as provided in the Lock-Up Agreement. Under the Lock-Up Agreement, each Locked-Up Party has agreed to vote its Locked-Up Shares in favor of the Arrangement and has also agreed to certain restrictions on the disposition of such Locked-Up Shares, subject to the terms and conditions set forth in the Lock-Up Agreement. The Lock-Up Agreement provides that it will terminate concurrently with any termination of the Arrangement Agreement.

Petroflow has agreed that following the Effective Date, Petroflow will satisfy or cause Equal to satisfy, all of Equal's obligations regarding our convertible debentures, including that Petroflow will cause Equal to make an offer to purchase all of Equal's outstanding CAD $45 million of convertible debentures within 30 days. In accordance with the terms of the indenture governing the convertible debentures, cash consideration equal to 101% of the face value, plus accrued and unpaid interest, will be offered to holders of the convertible debentures.

The foregoing descriptions of the Arrangement, the Arrangement Agreement, the Amendment, the Option Agreement and the Lock-Up Agreement do not purport to be complete and are subject to, and qualified in their entirety by reference to, the full text of the Arrangement Agreement, the full text of the Lock-Up Agreement, and the full text of the Option Agreement, which are incorporated herein by reference as filed in the Company's Form 8-K on December 9, 2013 as Exhibits No. 2.1, 2.2 and 2.3, respectively. The Amendment is incorporated herein by reference as filed in the Company's Form 8-K on May 1, 2014 as Exhibit 2.1.

Page 15 of 28



--------------------------------------------------------------------------------

Table of Contents

As described above, the Arrangement Agreement contains representations and warranties by Petroflow and Equal. These representations and warranties have been made solely for the benefit of the other parties to the Arrangement Agreement and (i) may be intended not as statements of fact, but rather as a way of allocating the risk to Petroflow or Equal if those statements prove to be inaccurate, (ii) have been qualified by disclosures that were made to the other party in connection with the negotiation of the Arrangement Agreement, (iii) may apply materiality standards different from what may be viewed as material to investors, and (iv) were made only as of the date of the Arrangement Agreement or such other dates as may be specified in the Arrangement Agreement and are subject to more recent developments. Accordingly, these representations and warranties should not be relied on as characterizations of the actual state of facts or for any other purpose either at the time they were made or at any other time.

Equal's Properties

The Company's production comes from its Oklahoma based operations. The core area assets are located in Lincoln and Logan counties of Oklahoma. The Company also has an inventory of minor producing assets, minor royalty interests and various exploration and exploitation prospects on undeveloped lands in Oklahoma.

[[Image Removed: LOGO]]



In Oklahoma, the key producing horizon is the Hunton formation. The Hunton is a carbonate rock formation which has been largely ignored by the industry in areas with high water/hydrocarbon production ratios. Over the last decade, new drilling and production techniques have enabled profitable development of the Hunton formation. Extensive dewatering lowers reservoir pressure, allowing the liberation and mobilization of oil, natural gas and NGLs from smaller rock pores. Typical peak wellhead hydrocarbon production rates average 150 boe/d per horizontal well and are generally observed within six months of production commencement.

Average Hunton production for the three months ended March 31, 2014, was approximately 19.9 MMcf/d of natural gas, 3.4 Mbbls/d of NGLs and 0.2 Mbbls/d of oil. At December 31, 2013, the reserve report attributed proved reserves of 280 Mbbls of crude oil, 66 Bcf of natural gas and 12,993 Mbbls of NGLs.

As of March 31, 2014, the Company had approximately 32,000 gross (12,000 net) undeveloped acres of land under leasehold, primarily located in Lincoln and Logan counties of Oklahoma comprising of interests in 86 sections.

Market Conditions

Prices of natural gas, NGLs, and oil that we produce can vary significantly, which impacts our revenues and cash flows. The following table lists average New York Mercantile Exchange ("NYMEX") prices for natural gas, West Texas Intermediate ("WTI") prices for crude oil, and propane prices at Conway, KS for the three months ended March 31, 2014 and 2013.

Page 16 of 28



--------------------------------------------------------------------------------

Table of Contents Three months ended March 31, 2014 2013 Propane, Conway, KS (US$ per bbl) $ 41.08$ 34.32 NYMEX natural gas (US$ per mcf) $ 4.73$ 3.61 WTI (US$ per bbl) $ 98.68$ 94.34



Results of Operations for the three months ended March 31, 2014, and March 31, 2013

For the three months ended March 31, 2014, Equal Energy's production was from the Central Oklahoma properties.

The following table sets forth selected operating data for the periods indicated. Three months ended March 31, (in thousands, except for boe/d) Central Oklahoma Q1 2014 Q1 2013 Change % Change Net Production per Day: Oil (Bbl) 241 157 84 54 % NGL (Bbl) 3,411 3,084 327 11 % Natural Gas (Mcf) 19,925 18,232 1,693 9 % Total (Boe/d) 6,973 6,280 693 11 % Net Production: Oil (MBbl) 22 14 8 57 % NGL (MBbl) 307 278 29 10 % Natural Gas (MMcf) 1,793 1,641 152 9 % Total (MBoe) 628 566 62 11 % Net Sales: Oil Sales $ 2,090$ 1,305$ 785 60 % NGL Sales 12,477 9,146 3,331 36 % Natural Gas Sales 7,579 4,354 3,225 74 % $ 22,146$ 14,805$ 7,341 50 % Average Sales Prices: Oil (per Bbl) $ 95$ 92.12$ 2.88 3 % NGL (per Bbl) 40.64 32.95 7.69 23 % Natural Gas (per Mcf) 4.23 2.65 1.58 60 % Per Boe $ 35.29$ 26.19$ 9.10 35 % Operating Expenses: Production Expenses $ 4,061$ 3,455$ 606 18 % Production Taxes 753 926 (173 ) -19 % Expenses (per Boe): Production Expenses $ 6.47$ 6.12$ 0.35 6 % Production Taxes 1.20 1.64 (0.44 ) -27 % Net Producing Wells at Period End 119 132 -13 -10 % Page 17 of 28



--------------------------------------------------------------------------------

Table of Contents

The following table sets forth selected operating data as reported for the periods indicated. Q1 2014 Q1 2013 Change % Change Operating Expenses: General and Administrative Expense (Including Share Based Compensation) $ 3,312$ 3,154$ 158 5 % Interest 879 949 (70 ) -7 % Depletion of Oil and Gas Properties 4,508 4,793 (285 ) -6 % Costs and Expenses (per Boe): General and Administrative Expense (Including Share Based Compensation) $ 5.28$ 5.58$ (0.99 ) -18 % Interest 1.40 1.68 (0.28 ) -17 % Depletion of Oil and Gas Properties 7.18 8.48 (1.30 ) -15 %



Oil, Natural Gas and NGL Sales:

Sales in all categories benefited from higher production, as compared to the prior year's quarter. After drilling only three wells in early 2012, Equal initiated a one-rig program in January 2013 which was originally budgeted to drill 10 wells during the year. Better than anticipated efficiencies allowed the rig to drill 12 wells during the year. Nine of these wells were completed in 2013 and the final three wells were completed in January 2014. All 12 wells proved very successful, and with several being drilled in oilier parts of the play, we saw a significant jump in oil production as compared to the first quarter of 2013.

Oil Sales

Oil revenue was $2.1 million for the first quarter of 2014 as compared to $1.3 million for the same period last year. The $0.8 million increase was primarily a result of a 54% increase in daily production attributable to successful drilling in 2013.

Gas Sales

Gas revenue for the first quarter of 2014 was $7.6 million as compared to $4.4 million for the same period last year. The $3.2 million increase was primarily due to a 60% increase in average price, excluding commodity contracts, in addition to a 9% increase in daily production attributable to successful drilling in 2013. Price increases were largely consistent with the broad improvement of gas prices in the North American market.

NGL Sales

NGL revenue for the first quarter of 2014 was $12.5 million as compared to $9.1 million for the same period last year. The $3.3 million increase was a result of a 23% increase in average price, excluding commodity contracts, and an 11% increase in daily production. The higher realized prices were largely due to increases in NGL index prices at the Conway, KS hub. The increase in NGL production was attributable to successful drilling in 2013.

Production Expenses

Production expenses were $4.1 million for the first quarter of 2014 compared to $3.5 million for the same period last year. The $0.6 million increase was due primarily to an increase in workover expenses attributable, in part, to weather-related costs. On a per unit-of-production basis, production expenses per boe increased from $6.12 in the first quarter of 2013 to $6.47 in the first quarter of 2014.

Production Taxes

The company normally pays a base rate of 7% in production taxes based on realized oil, NGL and natural gas sales. Production taxes were $0.8 million for the first quarter of 2014 compared to $0.9 million for the same period last year. As a percentage of net sales, our production tax rates averaged 3.4% and 6.3% in the first quarter of 2014 and 2013, respectively. The average production tax rate for the first quarter of 2014 was lower than the same period last year due to new horizontal wells drilled in 2013 qualifying for a 48-month six percent Oklahoma production tax rate reduction. During the three months ended December 31, 2013, prior period errors were identified relating to the recording of tax rebates from the Oklahoma Tax Commission for production activities in 2009, 2010 and 2011, together with the related recognition of deferred income tax assets and expenses. The estimate for the impact related to the prior period tax rebates was decreased by $0.4 million in the first quarter of 2014, which reduced first quarter 2014 production tax expense. Excluding this $0.4 million adjustment, production taxes would have been 5.2% of realized oil, NGL and natural gas sales.

Page 18 of 28



--------------------------------------------------------------------------------

Table of Contents

Commodity Contracts

For the first quarter of 2014, Equal had a net loss on commodity contracts of $2.1 million as compared to a net loss of $3.3 million for the same period last year. Equal made cash payments on settled derivatives of $1.2 million in the first quarter of 2014, as compared to cash receipts of $0.5 million for the same period last year. At March 31, 2014, all the derivative contracts were recorded at their fair value, which was a net liability of $1.2 million, an increase of $0.9 million from the $0.3 million of net liability recorded at December 31, 2013.

General and Administrative Expense

General and administrative expense was $3.3 million for the first quarter of 2014 as compared to $3.2 million for the same period last year, excluding discontinued operations. The $0.1 million increase was due to increases in professional fees of $0.4 million, offset partially by a decrease in compensation costs of $0.3 million. On a per unit-of production basis, the general and administrative expense per boe was $5.28 for the first quarter of 2014 compared to $5.58 for the first quarter of 2013. This reduction in costs per boe is due to increased production, more than offsetting higher costs associated with the arrangement agreement with Petroflow, as disclosed in Part 1, in Form 10-K for the year ended December 31, 2013, filed with the SEC on March 17, 2014. The extension of this agreement is discussed earlier in Item 2 of this quarterly report on Form 10-Q.

Depletion of Oil and Gas Properties

Depletion was $4.5 million, in the first quarter of 2014 as compared to $4.8 million for the same period last year. The $0.3 million decrease in depletion expense was attributable to the proved reserves increasing at a higher rate as compared to costs in the depletion base. On a per unit-of production basis, the depletion expense per boe was $7.18 for the first quarter of 2014 compared to $8.48 for the first quarter of 2013.

Interest Expense

Interest expense was $0.9 million for the first quarter of 2014 and for the same period last year, and is comprised of interest on the CAD $45 million, 6.75% convertible debentures and fees associated with the unused CAD $125 million credit facility.

Income Tax Provision

The provision for income tax expense was $1.8 million in the first quarter of 2014 as compared to a $0.8 million income tax benefit for the same period last year. The increase in income tax expense relates primarily to increased earnings during the current period compared to the same period in the previous year. The effective income tax rate differs from the statutory rate of 35% due to permanent differences, the change in valuation allowance, and AMT credits.

NON-GAAP FINANCIAL MEASURES

Management uses certain industry benchmarks to analyze financial performance. Management feels that these benchmarks are key measures of profitability and overall sustainability for Equal. These benchmarks as presented do not have any standardized meanings prescribed by GAAP and therefore may not be comparable with the calculation of similar measures presented by other entities.

We believe the use of these non-GAAP financial measures provides useful information to investors to gain an overall understanding of our current financial performance. Specifically, we believe the non-GAAP financial measures included herein provide useful information to both management and investors by excluding certain expenses and gains and losses that our management believes are not indicative of our core operating results. In addition, these non-GAAP financial measures are used by management for budgeting and forecasting as well as subsequently measuring our performance, and we believe that we are providing investors with financial measures that most closely align to our internal measurement processes. We consider these non-GAAP measures to be useful in evaluating our core operating results as they more closely reflect our essential revenue generating activities and direct operating expenses (resulting in cash expenditures) needed to perform these revenue generating activities. Our management also believes, based on feedback provided by the investment community, that the non-GAAP financial measures are necessary to allow the investment community to construct its valuation models to better compare our results with our competitors and market sector.

The non-GAAP financial information is presented using consistent methodology from year to year. These measures should be considered in addition to results prepared in accordance with GAAP. In addition, these non-GAAP financial measures are not based on any comprehensive set of accounting rules or principles. We believe that non-GAAP financial measures have limitations in that they do not reflect all of the amounts associated with our results of operations as determined in accordance with GAAP and that these measures should only be used to evaluate our results of operations and financial position in conjunction with the corresponding GAAP financial measures. The adjustment factors are described more fully in the tables below.

Page 19 of 28



--------------------------------------------------------------------------------

Table of Contents ADJUSTED WORKING CAPITAL (in thousands) March 31, 2014 December 31, 2013 Cash $ 17,477 $ 15,631 Accounts receivable, net 15,234 13,581 Prepaid expenses, deposits and other 715 1,051 Accounts payable and accrued liabilities (10,841 ) (17,134 ) Asset retirement obligation (284 ) (278 ) Adjusted working capital $ 22,301 $ 12,851


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters