Top Five SEC Disclosure Issues for E&P Companies’ 2016 Annual Reports; Get Your DUCs in Order
by William Nelson, Judithe Little, Kristina Trauger, Marc Folladori
Published: February, 2017
Submission: February, 2017
Haynes and Boone, LLP Press
Comment letters issued in 2016 by the staff of the Division of Corporation Finance of the Securities and Exchange Commission (SEC) to reporting E&P companies relating to their 2015 annual reports continue, as in past years, to focus on disclosure issues such as the effects of low commodity prices and proved undeveloped reserves (PUD) conversion rates. However, several new focus areas have emerged in SEC comments that E&P companies should consider when preparing their 2016 year-end annual reports. In particular, the staff of the SEC has asked companies to:
SEC focus on DUC wells
While the staff continued to ask questions regarding material changes in PUD reserves, PUD conversion rates, the impact of reduced capital budgets on PUD conversion, and whether or not PUDs have been on the books for more than five years, the staff seemed particularly interested in how companies are characterizing DUC wells. Examples of staff comments include:
Projected PUD development costs and related financing
Notably, it appears that in 2016, the staff did not issue comments as it had in 2014 and 2015 questioning whether companies with successive year-to-year changes in their PUD development plans had, when booking those PUD reserves, met the required standard of reasonable certainty and final investment decision.
With respect to several E&P companies, the staff flagged lower projected total development costs per unit as compared to historical per unit development costs. The staff questioned plans to fund PUD development that appeared inconsistent with other statements in the annual report as well as actual cash flow from operations. Examples of staff comments include:
Material trends in commodity prices and impairments
Comment letters issued in 2015 focused in depth on the impact of lower commodity prices on E&P companies’ proved reserve estimates and potential future impairments, asking companies to quantify possible future effects. Where companies did quantify possible future effects in their 2015 annual reports, the staff in 2016 appeared to be digging deeper, asking if these were the company’s actual expectations regarding future commodity prices (perhaps considering the disclosed hypotheticals as boilerplate) as well as for more discussion of the assumptions used in quantifying estimated impairments and reductions in proved reserves.
While the commodity price environment is currently not as gloomy as it was in 2015 and the first half of 2016, companies should still consider including a robust discussion in their Management's Discussion & Analysis of Financial Condition and Results of Operations (MD&A) on material trends in commodity prices and how these trends are expected to affect their future operations, financial condition and liquidity, and if appropriate, the quantities and values of their reserves. The discussion should include any anticipated impact on the company’s future borrowing base redeterminations, access to capital, or capital expenditures. Examples of staff comments include:
SEC focus on calculation of the standardized measure of discounted future net cash flows
Comment letters issued in 2016 show an increased staff interest in how E&P companies are calculating the standardized measure. Staff comments have focused on line items that are incorrectly excluded or aggregated and apparent inconsistencies in line items compared with other financial measures. Examples of staff comments include:
Focus on non-GAAP financial measures
In May 2016, the SEC issued new Compliance & Disclosure Interpretations on non-GAAP financial measures to address concerns over public companies’ increasing use of non-GAAP financial measures in their filings and press releases, on websites and at investor conferences. Subsequently, numerous E&P companies received comments from the staff addressing their presentation of non-GAAP financial measures, particularly in their earnings releases. For an analysis of this guidance and the staff’s comments, please see “Falling out of the GAAP: Recent SEC Staff Comments on Energy Companies’ Non-GAAP Financial Measures Disclosures."
Of course, companies should ensure that any use of non-GAAP financial measures in their annual report complies with the SEC guidance. Companies should also be aware, however, that the SEC will likely look at their earnings releases when reviewing their annual report. In conjunction with its review of annual reports in 2016, the staff took the opportunity to simultaneously review earnings releases filed or furnished on Form 8-K for compliance with its non-GAAP financial measures guidance. In many cases, where a Form 8-K with an earnings release was filed after the first round of SEC comments, the SEC added a review of the earnings release and any other earnings releases filed in the interim in the staff’s second or third round of comments.
If you have any questions about this topic, please contact a member of our Capital Markets and Securities Practice Group.
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