California Resources Corporation - 10-Q quarterly report FY2017 Q2

California Resources Corporation and Subsidiaries

Table of Contents

PART I    FINANCIAL INFORMATION

CALIFORNIA RESOURCES CORPORATION AND SUBSIDIARIES

(in millions, except share data)

CALIFORNIA RESOURCES CORPORATION AND SUBSIDIARIES

(in millions, except share data)

CALIFORNIA RESOURCES CORPORATION AND SUBSIDIARIES

(in millions)

CALIFORNIA RESOURCES CORPORATION AND SUBSIDIARIES

(in millions)

CALIFORNIA RESOURCES CORPORATION AND SUBSIDIARIES

We are an independent oil and natural gas exploration and production company operating properties within California. We were incorporated in Delaware as a wholly owned subsidiary of Occidental Petroleum Corporation (Occidental) on April 23, 2014, and remained a wholly owned subsidiary of Occidental until November 30, 2014. On November 30, 2014, Occidental distributed shares of our common stock on a pro-rata basis to Occidental stockholders and we became an independent, publicly traded company (the Spin-off). Occidental initially retained approximately 18.5% of our outstanding shares of common stock, which it distributed to Occidental stockholders on March 24, 2016.

Except when the context otherwise requires or where otherwise indicated, all references to ‘‘CRC,’’ the ‘‘company,’’ ‘‘we,’’ ‘‘us’’ and ‘‘our’’ refer to California Resources Corporation and its subsidiaries, and all references to ‘‘Occidental’’ refer to Occidental Petroleum Corporation, our former parent, and its subsidiaries.

Certain prior year amounts have been reclassified to conform to the 2017 presentation. On the statements of operations, we reclassified net gains on early extinguishment of debt, gains on asset divestitures and other non-operating expense out of other (income) expenses, net. On the statements of cash flows, we reclassified net gains on early extinguishment of debt, amortization of deferred gain and issuance costs and gains on asset divestitures out of other non-cash (gains) losses in income, net. We also reclassified debt repurchases and debt transaction costs into their own line items from debt repurchase and amendment costs.

In 2016, the Financial Accounting Standards Board (FASB) issued rules clarifying the revenue recognition standard issued in 2014. Under the new rules, an entity will recognize revenue when it transfers promised 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 and services. The new rules also require more detailed disclosures related to the nature, timing, amount and uncertainty of revenue and cash flows arising from contracts with customers. We are currently reviewing the provisions of these rules, analyzing the impact on our revenue contracts, reviewing current accounting policies and practices to identify potential differences that would result from applying these rules to our revenue contracts and assessing their potential impact on our financial statements and disclosures. Based on our assessment to date, we have not identified any changes to the timing of revenue recognition based on the requirements of the new rules. We will adopt these rules in the first quarter of 2018 and expect to apply the modified retrospective approach upon adoption with the cumulative effect of applying the rules, if any, recognized as of the date of initial application.

In January 2017, the FASB issued rules that changed the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. The rules are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We do not expect the adoption of these rules to have a significant impact on our financial statements.

In March 2017, the FASB issued rules requiring employers that sponsor defined benefit plans for pensions and postretirement benefits to present the service cost component of net periodic benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period. Only the service cost component will be eligible for capitalization in assets. Employers will present the other components of the net periodic benefit cost separately from the line item that includes the service cost and outside of any subtotal of operating income. The rules are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We do not expect the adoption of these rules to have a significant impact on our financial statements.

In May 2017, the FASB issued rules to simplify the guidance on the modification of share-based payment awards. The amendments provide clarity on which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting prospectively. The rules are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. The new guidance will be applied prospectively to any awards modified on or after the adoption date.

In July 2015, the FASB issued rules requiring entities to measure inventory at the lower of cost or net

realizable value. We adopted these rules in the first quarter of 2017 with no changes to our financial statements.

The carrying amounts of cash and other on-balance sheet financial instruments, other than debt, approximate fair value.

The lenders under the 2014 First-Out Credit Facilities have a first-priority lien in a substantial majority of our assets, including our Elk Hills power plant and midstream assets. We also granted a lien in the same assets to the lenders under our first-lien, second-out term loan credit facility (2016 Second-Out Credit Agreement) and the holders of our 8% senior secured second-lien notes due December 15, 2022 (2022 notes).

Borrowings under the 2014 First-Out Credit Facilities bear interest, at our election, at either a LIBOR rate or an alternate base rate (ABR) (equal to the highest of (i) the federal funds effective rate plus 0.50%, (ii) the administrative agent’s prime rate and (iii) the one-month LIBOR rate plus 1.00%), in each case plus an applicable margin. This applicable margin is based, while our total leverage ratio exceeds 3.00:1.00, on our borrowing base utilization and will vary from (a) in the case of LIBOR loans, 2.50% to 3.50% and (b) in the case of ABR loans, 1.50% to 2.50%. The unused portion of the Revolving Credit Facility commitments is subject to a commitment fee equal to 0.50% per annum. We also pay customary fees and expenses under the 2014 First-Out Credit Facilities. Interest on ABR loans is payable quarterly in arrears.  Interest on LIBOR loans is payable at the end of each LIBOR period, but not less than quarterly.

We must generally apply 100% of the net cash proceeds from asset sales (other than permitted development joint ventures) to repay loans outstanding under the 2014 First-Out Credit Facilities, except that we are permitted to use up to 50% of net cash proceeds from non-borrowing base asset sales or monetizations (i) to repurchase our notes to the extent available at a significant minimum discount to par, (ii) to purchase up to $140 million of certain of our unsecured notes at a discount, (iii) for general corporate purposes or (iv) for oil and gas expenditures. At least 75% of asset sale proceeds must be in cash (50% for sales of non-borrowing base assets unless our leverage ratio is less than 4:00 to 1:00 at which time the requirement falls to 40%), other than permitted development joint ventures and certain other transactions. The 2014 First-Out Credit Facilities also permit us to incur up to an additional $50 million of non-facility indebtedness, which may be secured by non-borrowing base assets, subject to compliance with our financial covenants and indentures, the proceeds of which must be applied to repay the Term Loan Facility. We must apply cash on hand in excess of $150 million daily to repay amounts outstanding under our Revolving Credit Facility. Further, we are restricted from paying dividends or making other distributions to common stockholders.

Our borrowing base under the 2014 First-Out Credit Facilities is redetermined each May 1 and November 1. The borrowing base is based upon a number of factors, including commodity prices and reserves, declines in which could cause our borrowing base to be reduced. Increases in our borrowing base require approval of at least 80% of our revolving lenders, as measured by exposure, while decreases or affirmations require a two-thirds approval. We and the lenders (requiring a request from the lenders holding two-thirds of the revolving commitments and outstanding loans) each may request a special redetermination once in any period between three consecutive scheduled redeterminations. We will be permitted to have collateral released when both (i) our credit ratings are at least Baa3 from Moody's and BBB- from S&P, in each case with a stable or better outlook, and (ii) certain permitted liens securing other debt are released.

In August 2016, we entered into a $1 billion 2016 Second-Out Credit Agreement. The net borrowings under the 2016 Second-Out Credit Agreement were used to (i) prepay $250 million of the Term Loan Facility and (ii) reduce our Revolving Credit Facility by $740 million. The proceeds received were net of a $10 million original issue discount. The loan under the 2016 Second-Out Credit Agreement bears interest at a floating rate per annum equal to LIBOR plus 10.375%, subject to a 1.00% LIBOR floor, determined for the applicable interest period (or ABR rates plus 9.375% in certain circumstances). Interest on LIBOR loans is payable at the end of each LIBOR period, but not less than quarterly. Interest on ABR loans is payable quarterly in arrears.

The 2016 Second-Out Credit Agreement provides for customary covenants and events of default consistent with, or generally less restrictive than, the covenants in the 2014 First-Out Credit Facilities, including limitations on additional indebtedness, liens, asset dispositions, investments and restricted payments and other negative covenants, in each case subject to certain limitations and exceptions. Additionally, the 2016 Second-Out Credit Agreement requires us to maintain a first-lien asset coverage ratio of 1.20 to 1.00 as of any June 30 and December 31, consistent with the 2014 First-Out Credit Facilities.

In October 2014, we issued $5 billion in aggregate principal amount of our senior unsecured notes, including $1 billion of 2020 notes, $1.75 billion of 2021 notes and $2.25 billion of 6% senior unsecured notes due November 15, 2024 (2024 notes, and collectively, the unsecured notes). We used the net proceeds from the issuance of the unsecured notes to make a $4.95 billion cash distribution to Occidental in October 2014.

In December 2015, we issued $2.25 billion in aggregate principal amount of our 2022 notes which we exchanged for $2.8 billion of our outstanding unsecured notes. We recorded a deferred gain of approximately $560 million on the debt exchange, which will be amortized using the effective interest rate method over the term of the 2022 notes. Our 2022 notes are secured on a second-priority basis, subject to the terms of an intercreditor agreement and collateral trust agreement, by a lien on the same collateral used to secure our obligations under the 2014 First-Out Credit Facilities and 2016 Second-Out Credit Agreement (collectively, the Credit Facilities).

In 2015, we repurchased approximately $33 million in principal amount of the 2020 notes for $13 million in cash.

In 2016, we repurchased over $1.5 billion of our outstanding unsecured notes, primarily using drawings of $750 million on our Revolving Credit Facility and cash from operations. We also exchanged approximately 3.4 million shares of our common stock for unsecured notes in an aggregate principal amount of over $100 million.

In the first quarter of 2017, we purchased $28 million in aggregate principal amount of our 2020 notes for $24 million in cash.

We pay interest semiannually in cash in arrears on January 15 and July 15 for the 2020 notes, on March 15 and September 15 for the 2021 notes, on June 15 and December 15 for the 2022 notes and on May 15 and November 15 for the 2024 notes.

The indentures governing the unsecured notes and the 2022 notes each include covenants that, among other things, limit our and our subsidiaries’ ability to incur debt secured by liens. The indentures also restrict our ability to merge or consolidate with, or transfer all or substantially all of our assets to, another entity. The covenants are not, however, directly linked to measures of our financial performance. In addition, if we experience a “change of control triggering event” (as defined in the indentures) with respect to a series of notes, we will be required, unless we have exercised our right to redeem the notes of such series, to offer to purchase the notes of such series at a purchase price equal to 101% of their principal amount, plus accrued and unpaid interest. The indenture governing the 2022 notes also restricts our ability to sell certain assets and to release collateral from liens securing the 2022 notes, unless the collateral is released in compliance with the 2014 First-Out Credit Facilities.

We may redeem the unsecured notes prior to their maturity dates, in whole or in part, at a redemption price equal to 100% of the principal amount redeemed plus a make-whole amount and accrued and unpaid interest.

We may redeem the 2022 notes (i) prior to December 15, 2017 from the proceeds of certain equity offerings, in an amount up to 35% of the initial aggregate principal amount of the notes initially issued plus any additional notes issued, at a redemption price equal to 108% of the principal amount redeemed, plus accrued and unpaid interest, (ii) prior to December 15, 2018, in whole or in part at a redemption price equal to 100% of the principal amount redeemed plus a make-whole amount and accrued and unpaid interest and (iii) on or after December 15, 2018, in whole or in part at a fixed redemption price during 2018, 2019 and thereafter of 104%, 102% and 100% of the principal amount redeemed, respectively, plus accrued and unpaid interest.

All obligations under the Credit Facilities and the notes are guaranteed both fully and unconditionally and jointly and severally by all of our material wholly owned subsidiaries.

The terms and conditions of all of our indebtedness are subject to additional qualifications and limitations that are set forth in the relevant governing documents.

In February 2017, we divested non-core assets resulting in $32 million of proceeds and a $21 million gain.

In February 2017, we entered into a joint venture with Benefit Street Partners (BSP) under which BSP will invest up to $250 million, subject to agreement of the parties, to be used to develop certain of our oil and gas properties in exchange for our contribution of a net profits interest (NPI) in existing and future production from such properties. If BSP receives cash distributions equal to a predetermined threshold return, the NPI reverts to us in its entirety. BSP contributed $50 million in the first quarter of 2017 and $50 million in July 2017. Approximately $2 million is included in cash and cash equivalents at June 30, 2017, which was designated for distribution to BSP. Our consolidated financial statements reflect the full operations of this joint venture, with the net income of the joint venture being reported as a noncontrolling interest.

In April 2017, we entered into a joint venture with Macquarie Infrastructure and Real Assets Inc. (MIRA) under which MIRA will invest up to $300 million, subject to agreement of the parties, to develop certain of our oil and gas properties in exchange for a 90% working interest in the related properties. MIRA will fund 100% of the development cost of such properties. Our 10% working interest reverts to 75% if MIRA receives cash distributions equal to a predetermined threshold return. MIRA initially committed $160 million, which is intended to be invested over two years. Of the committed amount, MIRA contributed $8 million for drilling projects in the second quarter of 2017, with additional funding expected during the course of the year and in 2018. Our consolidated financial statements reflect only our working interest share in this joint venture.

We, or certain of our subsidiaries, are involved, in the normal course of business, in lawsuits, environmental and other claims and other contingencies that seek, among other things, compensation for alleged personal injury, breach of contract, property damage or other losses, punitive damages, civil penalties, or injunctive or declaratory relief.

We are currently under examination by the Internal Revenue Service for our U.S. federal income tax return for the post-Spin-off period in 2014 and calendar year 2015. No significant issues have been raised to date. State returns for these years remain subject to examination.

We use a variety of derivative instruments to protect our cash flows, margins and capital investment program from the cyclical nature of commodity prices and to improve our ability to comply with the covenants of our credit facilities in case of price deterioration. We will continue to be strategic and opportunistic in implementing our hedging program as market conditions permit. Derivatives are carried at fair value and on a net basis when a legal right of offset exists with the same counterparty.

For purchased puts, we would receive settlement payments for prices below the indicated weighted-average price per barrel. For sold puts, we would make settlement payments for prices below the indicated weighted-average price per barrel. From time to time, we use puts in conjunction with other derivatives to increase the efficacy of our hedging activities.

Some of our fourth quarter 2017 swaps grant our counterparties the option to increase volumes by up to 10,000 barrels per day at a weighted-average Brent price of $55.46. As of June 30, 2017 our counterparties also have options to further increase swap volumes for the first half of 2018 by up to 10,000 barrels per day at a weighted-average Brent price of $60.00.

Additional hedges for 2018 were put in place after June 30, 2017 that are not included in the table above.

We compute basic and diluted earnings per share (EPS) using the two-class method required for participating securities. Certain restricted and performance stock awards are considered participating securities when such shares have non-forfeitable dividend rights at the same rate as common stock.

Under the two-class method, undistributed earnings allocated to participating securities are subtracted from net income attributable to common stock in determining net income available to common stockholders. In loss periods, no allocation is made to participating securities because they do not share in losses. For basic EPS, the weighted-average number of common shares outstanding excludes outstanding shares related to unvested stock awards. For diluted EPS, the basic shares outstanding are adjusted by adding potentially dilutive securities.

The following table sets forth the components of the net periodic benefit costs for our defined benefit pension and postretirement benefit plans:

For the three and six months ended June 30, 2017, we did not provide any current or deferred tax provision or benefit. The difference between our expected tax rate and our effective tax rate for the periods is primarily related to changes in our valuation allowance. Given our recent and anticipated future earnings trends, we have recorded a full valuation allowance against our net deferred tax asset and do not believe any of our valuation allowance as of June 30, 2017 will be released within the next 12 months. The amount of the net deferred tax assets considered realizable could however be adjusted if estimates change. In the first quarter of 2016, we had a deferred tax benefit of $78 million resulting from a change in valuation allowance.

Our Credit Facilities and Senior Notes (Note 5 - Debt) are guaranteed both fully and unconditionally and jointly and severally by our material wholly owned subsidiaries (Guarantor Subsidiaries). Certain of our subsidiaries do not guarantee our Credit Facilities and Senior Notes (Non-Guarantor Subsidiaries). The following condensed consolidating balance sheets at June 30, 2017 and December 31, 2016, condensed consolidating statements of operations for the three and six months ended June 30, 2017 and 2016 and condensed consolidating statements of cash flows for the six months ended June 30, 2017 and 2016 reflect the condensed consolidating financial information of our parent company, CRC (Parent), our combined Guarantor Subsidiaries, our combined Non-Guarantor Subsidiaries and the consolidation and elimination entries necessary to arrive at the information for CRC on a consolidated basis.

The financial information may not necessarily be indicative of results of operations, cash flows or financial position had the Guarantor Subsidiaries operated as independent entities.