Forest Oil Corp. told the U.S. Securities and Exchange Commission (SEC) it will need more time to file its quarterly Form 10-Q after an internal audit found problems with the company's accounting software system and related compensating controls, and "material weakness" in its internal control over financial reporting.
The bad news didn't stop there as Denver-based Forest, which is rolling toward a merger with Sabine Oil & Gas LLC by the end of the year, said delays in well completions and lower-than-expected production from a single well in East Texas resulted in a lower average net sales volume for 2Q2014. The company posted a net loss of $83 million for the quarter. Forest's stock also took a tumble.
In a Form NT 10-Q filing with the SEC on Monday, Forest said the Public Company Accounting Oversight Board (PCAOB) conducted an inspection of audits performed by Ernest & Young LLP (EY) -- Forest's independent public accounting firm -- over the financial statements that were included in the company's annual report on Form 10-K for 2013, as well as internal control over financial reporting for that year.
According to Forest, after the PCAOB inspection, EY wanted to re-evaluate "certain previously-identified deficiencies" with the company's information technology general controls (ITGC). Specifically, the firm "questioned the reliance of the compensating review controls on the accounting software system where the identified ITGC deficiencies originated."
Forest said its management, after consultation with EY and other advisers, had concluded its compensating review controls "were not adequate," and added that the ITGC and problems with its review control deficiencies "each represent a 'material weakness' in internal control over financial reporting."
But in a separate statement to investors and analysts on Monday, the company said that "to the knowledge of Forest's CEO and CFO, these internal control material weaknesses did not result in a material misstatement of Forest's financial statements included in the Form 10-K. Furthermore, EY has not withdrawn its audit report on the financial statements included in the Form 10-K.
"However, EY must conduct additional audit procedures to be sure a misstatement did not occur. This additional testing has prevented EY from conducting a timely review of Forest's Quarterly Report on Form 10-Q for [2Q2014], and until such review is completed, any such Form 10-Q filed with the SEC would be incomplete and not fully compliant with applicable rules."
Last May, Forest and Sabine announced an all-stock merger to create Sabine Oil & Gas Corp., a publicly traded company that will also be one of the biggest players in East Texas (see Shale Daily,May 6). The combined company will also have significant positions in the Eagle Ford Shale and the Arkoma, Granite Wash and Permian basins.
The merger is expected to be completed in 4Q2014. Forest did not hold a conference call to discuss 2Q2014.
On Monday, Forest reported a net loss of $83 million (71 cents/share) for 2Q2014, compared to a net loss of $21 million (18 cents/share) during the preceding quarter, 1Q2014. The net loss included merger-related costs of $10 million, plus ceiling test write-down of oil and gas properties of $77 million and a gain on asset dispositions of $22 million.
Without the aforementioned items, and others, Forest said it would have posted an adjusted net loss of $7 million (6 cents/share) for 2Q2014.
"Our proposed merger with Sabine continues to progress in a timely manner and we are working diligently to complete this transaction during the fourth quarter," said Forest CEO Patrick McDonald. "Our priority for the remainder of the year will be to direct capital to our highest rate-of-return projects to generate increased capital efficiency within our drilling program as we work to optimize capital spending ahead of the merger closing."
Signaling that shift in priorities, Forest slashed capital expenditures (capex) for the full-year 2014. Drilling and completion capital was reduced to $220-230 million, down from a range of $260-270 million. The company said it will run a three-rig drilling program in the Ark-La-Tex and a one-rig program in the Eagle Ford for the remainder of the year. Total capex was cut to $240-250 million, down from $290-310 million.
Forest said it completed two wells in Rusk County, TX, targeting the liquids-rich Cotton Valley formation during the second quarter. The wells had a 30-day average gross production rate of 11 MMcfe/d (40% liquids). A third well that was expected to begin producing in April was deferred until mid-July, due to a mechanical issue that resulted in completion of only 1,000 feet of the well's lateral.
According to Forest, the third well produced about 2 MMcfe/d (52% liquids) during the initial 20 days of production from the short lateral. But when normalized for a type-curve lateral length of about 4,400 feet, production would have been about 10 MMcfe/d.
The company also drilled a well targeting the light sweet crude oil play in Cherokee County, TX, during 2Q2014. Completion operations have been started at the well.
During the quarter, net sales volumes averaged about 85 MMcfe/d in the Ark-La-Tex and 2,500 boe/d in the Eagle Ford. Forest also completed the reprocessing of its 3D seismic surveys in the Eagle Ford in 2Q2014, a move that caused the company's stock to lose 38% of its value when the decision was announced in February (see Shale Daily, Feb. 26).
Forest's stock took another dip this week on the New York Stock Exchange, trading at $1.61/share (down 6.94%, 12 cents/share) in afternoon trading on Thursday. That was a 19.5% decrease from the $2.00/share recorded at Monday's close.