FIRST QUARTER REPORT 2014
HIGHLIGHTS ($ thousands, except per share and per unit amounts) 2014 2013 % Change Operating Petroleum and natural gas sales 40,893 32,201 27 Production: Oil (bbl/d) 1,337 1,727 (23) Natural gas (mcf/d) 34,601 36,086 (4) Natural gas liquids (bbl/d) 1,794 1,630 10 Total production (boe/d @ 6:1) 8,898 9,371 (5) Average prices Oil ($/bbl) 93.46 84.70 10 Natural gas ($/mcf) 5.97 3.47 72 Natural gas liquids ($/bbl) 68.44 52.99 29 Average realized price 51.06 38.18 34 Operating netback ($/boe) 25.85 24.47 6 Cash flow netback ($/boe) 22.31 21.65 3 Financial Funds flow from operations 1 17,878 18,355 (3) Per share - basic 0.46 0.48 (4) Per share - diluted 0.46 0.48 (4) Net loss (833) (3,045) (73) Per share - basic (0.02) (0.08) (75) Per share - diluted (0.02) (0.08) (75) Weighted average common shares outstanding (000's) Basic 38,609 38,609 - Diluted 38,609 38,609 - Total securities outstanding (000's) Common shares 38,609 38,609 - Fixed price options 2 2,272 2,272 - Time vesting options 2 3,722 3,722 - Performance vesting options 2 9,355 9,355 - Total securities outstanding 53,958 53,958 - Total assets 613,064 541,497 13 Net debt 1 56,946 25,156 126 Shareholders' equity 444,855 428,682 4 Undeveloped land (end of period) Gross (acres) 187,297 194,767 (4) Net (acres) 144,485 150,244 (4) 1 Funds flow from operations and net debt are non-ifrs terms. Please refer to the advisory on non-ifrs measures. 2 Maximum number of securities available for issue at end of period. 2014 First Quarter Report Mosaic Energy Ltd. Page 2
MANAGEMENT S DISCUSSION AND ANALYSIS ADVISORIES The following Management s Discussion and Analysis ( MD&A ), dated June 10, 2014, outlines Mosaic Energy Ltd. s ( Mosaic or the Company ) operating and financial results for the three months ended March 31, 2014 compared with the corresponding period in the prior year. This discussion should be read in conjunction with the March 31, 2014 unaudited condensed interim financial statements and notes thereto as well as the audited financial statements for the year ended December 31, 2013, together with accompanying notes. Additional information relating to Mosaic is available on the Company s website at www.mosaicenergy.ca. The reader should be aware that historical results are not necessarily indicative of future performance. Forward-looking statements This MD&A contains forward-looking statements and forward-looking information (collectively, forward-looking statements ) within the meaning of applicable securities laws. The use of any of the words will, expects, believe, plans, potential and similar expressions are intended to identify forward-looking statements. More particularly and without limitation, this MD&A contains forward looking statements, including management's assessment of: Mosaic s future focus, strategy, plans, opportunities and operations; financial risk management strategy; forecast production, production mix, drilling, development, completion and tie-in plans and results; Mosaic s planned capital budget; targeted debt level; the timing, allocation and efficiency of Mosaic s capital program and the results therefrom; Mosaic s planned divesture program; the anticipated potential and growth opportunities associated with Mosaic s asset base; forecast funds from operations; expectations regarding the review of Mosaic s borrowing base; the source of funding of capital expenditures; the objectives and focus of Mosaic s capital program and the allocation thereof; asset retirement obligations and the amount and timing of expenditures and the source of funding thereof; estimated tax pools; expectations regarding future commodity prices and netbacks; industry conditions; the costs to settle asset retirement obligations; anticipated accounting changes and the impact on Mosaic s operations and financial position. Statements relating to reserves are also deemed to be forward-looking statements, as they involve the implied assessment, based on certain estimates and assumptions that the reserves described exist in the quantities predicted or estimated and that the reserves can be profitably produced in the future. By their nature, forward-looking statements are based upon certain assumptions and are subject to numerous risks and uncertainties, some of which are beyond Mosaic s control, including the impact of general economic conditions, industry conditions, current and future commodity prices, currency and interest rates, anticipated production rates, borrowing, operating and other costs and funds from operations, the timing, allocation and amount of capital expenditures and the results therefrom, anticipated reserves and the imprecision of reserve estimates, the performance of existing wells, the success obtained in drilling new wells, the sufficiency of budgeted capital expenditures in carrying out planned activities, competition from other industry participants, availability of qualified personnel or services and drilling and related equipment, effects of regulation by governmental agencies including changes in environmental regulations, tax laws and royalties; the ability to access sufficient capital from internal sources and bank and equity markets. We have included this summary of assumptions and risks related to forward-looking statements provided in this MD&A in order to provide investors with a more complete perspective on our current and future operations and such information may not be appropriate for other purposes. Readers are cautioned that the assumptions used in the preparation of such information, although considered reasonable at the time of preparation, may prove to be imprecise and, as such, undue reliance should not be placed on forward-looking statements. Mosaic s actual results, performance or achievement could differ materially from those expressed in, or implied by, these forward-looking statements. Mosaic disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. 2014 First Quarter Report Mosaic Energy Ltd. Page 3
MANAGEMENT S DISCUSSION AND ANALYSIS BASIS OF PRESENTATION The reporting and the measurement currency of the Company is the Canadian dollar. For the purpose of calculating unit costs, natural gas is converted to a barrel of oil equivalent ( boe ) using six thousand cubic feet of natural gas equal to one barrel of oil unless otherwise stated. The term boe may be misleading, particularly if used in isolation. A boe conversion ratio for gas of 6 Mcf: 1 boe is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. DESCRIPTION OF BUSINESS Mosaic is a private oil and natural gas company engaged in the exploration for and the development, production and acquisition of, petroleum and natural gas reserves in Western Canada. The Company is primarily focused on multi zone horizons in the deep basin of the Western Canadian Sedimentary Basin. NON-IFRS MEASUREMENTS Within the MD&A references are made to terms commonly used in the oil and gas industry, including operating netback, net debt and working capital (deficiency) and funds from operations. These non-ifrs financial measures do not have any standardized meaning and therefore are unlikely to be comparable to similar measures presented by other companies. However they are included in this report as they are key measurement tools used by management to analyze operating and financial performance. Funds from operations represent funds from operating activities before adjustments for decommissioning liability expenditures and net changes in non-cash working capital. The Company evaluates its performance based on earnings and funds from operations and considers funds from operations a key measure in demonstrating its ability to generate the funds necessary to fund future growth through capital investment and to repay debt. Funds from operations per share is calculated using the same weighted average number of shares outstanding used in the calculation of net income per share. The following table reconciles Mosaic s cash provided by operating activities to funds from operations: ($ thousands) 2014 2013 % Change Cash provided by operating activities 14,633 19,965 (27) Add back: Change in non-cash working capital 3,245 (1,610) (302) Funds from operations 17,878 18,355 (3) Net debt and working capital deficiency is calculated as cash and net working capital including commodity contract assets and liabilities and demand credit facilities. Management uses net debt and working capital deficiency as a means of estimating Mosaic s assets and obligations expected to be settled in cash. The following table outlines Mosaic s calculation of net debt and working capital deficiency: ($ thousands) March 31, 2014 December 31, 2013 Demand credit facility (31,419) (16,458) Accounts payable and accrued liabilities (31,008) (42,041) Accounts receivable 15,788 13,731 Commodity contracts (13,195) (7,762) Prepaid expenses and other 2,888 2,998 Net debt and working capital deficiency (56,946) (49,532) As at As at 2014 First Quarter Report Mosaic Energy Ltd. Page 4
MANAGEMENT S DISCUSSION AND ANALYSIS Operating Netback equals total revenue less royalties, operating costs and transportation costs which management utilizes to measure and analyze operating performance relative to commodity prices. This benchmark as presented does not have any standardized meaning prescribed by IFRS and therefore may not be comparable with the calculations of similar measures for other entities. The calculation of Mosaic s netbacks can be seen below in the Operating Netbacks section. PRODUCTION Product 2014 2013 % Change Oil (bbl/d) 1,337 1,727 (23) Natural gas (mcf/d) 34,601 36,086 (4) Natural gas liquids (bbl/d) 1,794 1,630 10 Total Production (boe/d) 8,898 9,371 (5) Total cumulative production (boe) 800,860 843,418 (5) % Oil and liquids production 35% 36% (3) Overall corporate production for the three months ended March 31, 2014 decreased 5 percent compared to the same period in the prior year. This decrease is mainly a result of the disposition of the Company s Redwater property in December 2013 and natural decline on producing properties. Major area 2014 2013 % Change Northern 2,404 2,028 19 West-Central 6,070 6,021 1 East-Central 62 652 (90) Other 362 670 (46) Total Production (boe/d) 8,898 9,371 (5) During the first quarter, production in the Company s Northern area increased 19 percent compared to first quarter 2013, mainly as a result of the Company s 2013 drilling program which primarily focused on the Northern area. Production volumes in the East-Central area decreased 90 percent as a result of the Redwater disposition in December of 2013. The Company s first quarter production increased 1 percent from 8,800 boe per day in the fourth quarter of 2013. Production in the Northern area increased 21 percent compared to fourth quarter 2013 production of 1,981 boe per day, as a result of two wells brought on at the end of December 2013 combined with the Company s ability to restart wells previously shut-in due to capacity constraints on third party infrastructure in the Jayar area. East-Central production decreased 87 percent when compared to the fourth quarter 2013 as a result of the Redwater area disposition in December 2013. 2014 First Quarter Report Mosaic Energy Ltd. Page 5
MANAGEMENT S DISCUSSION AND ANALYSIS REVENUE ($ thousands except per unit amounts) 2014 2013 % Change Sales revenue Oil 11,245 13,164 (15) Natural gas 18,594 11,264 65 Natural gas liquids 11,054 7,773 42 Total sales revenue 40,893 32,201 27 Realized gain (loss) on commodity contracts (5,670) 984 (676) Other income 784 967 (19) Total revenue before royalties 36,007 34,152 5 Average prices Oil ($/bbl) 93.46 84.70 10 Natural gas ($/mcf) 5.97 3.47 72 Natural gas liquids ($/bbl) 68.44 52.99 29 Average price 51.06 38.18 34 Average price including commodity contracts 43.98 39.35 12 Benchmark pricing (CDN$) WTI crude oil ($US/bbl) 98.62 94.37 5 Edmonton MSW ($/bbl) 100.03 88.55 13 NYMEX Henry Hub ($US/mmbtu) 5.72 3.45 66 AECO 5A Daily Spot ($/mcf) 5.65 3.20 77 Exchange rate (US$/CDN$) 0.90 0.99 (9) The Company s production is predominately sold on the spot market and as a result, sales prices received fluctuate in tandem with prevailing market prices. Overall corporate revenue for the first quarter 2014 is up from the same period last year mainly due to increases in realized prices for all products and increased natural gas liquids production. First quarter 2014 oil price increased 10 percent from the first quarter 2013, while total oil revenue decreased 15 percent due to the decrease in oil production as a result of the Redwater disposition. The corporate gas price increased 72 percent compared to first quarter 2013 which resulted in a 65 percent increase in natural gas revenue when combined with the decrease in gas production. Mosaic s liquids price for the first quarter 2014 increased 29 percent from the same period last year, which combined with the increase in liquids production, resulted in the 42 percent increase in natural gas liquids revenue. Total sales revenue for the first quarter increased 27 percent from the same period last year, mainly as a result of the increased realized prices for all products and increase in liquids production which contributes to a higher average realized price. Total sales revenue for the first quarter 2014 increased 31 percent compared to the fourth quarter 2013 mainly as a result of the 32 percent increase in the average realized price. Oil revenue for the first quarter 2014 increased 18 percent mainly as a result of the 17 percent increase in average oil prices. A 54 percent increase in natural gas prices in the first quarter of 2014 resulted in a corresponding 53 percent increase in natural gas revenue over the previous quarter. Natural gas liquids revenue for the first quarter 2014 increased 15 percent compared to fourth quarter 2013 as a result of a 19 percent increase in natural gas liquids prices. 2014 First Quarter Report Mosaic Energy Ltd. Page 6
MANAGEMENT S DISCUSSION AND ANALYSIS COMMODITY PRICE RISK MANAGEMENT Gain (loss) on commodity contracts ($ thousands) 2014 2013 % Change Realized (5,670) 984 (676) Unrealized (5,433) (8,111) (33) Total (11,103) (7,127) 56 The Company has adopted a risk management program designed to reduce volatility in financial results and to ensure a certain level of cash flow to fund planned capital expenditure programs. The Company recognized a realized loss on commodity contracts of $5.7 million (2013 $1.0 million gain) for the three months ended March 31, 2014. The Company recognized an unrealized loss on commodity contracts of $5.4 million (2013 $8.1 million loss) for the three months ended March 31, 2014. The fair value, or mark-to-market value, of these contracts is based on the estimated amount that would have been received or paid to settle the contracts as at March 31, 2014 and may be different from what will eventually be realized. The unrealized loss for the three months ended March 31, 2014 is a result of higher forecasted future oil and gas prices at March 31, 2014 compared to December 31, 2013 on the Company s commodity contracts that were outstanding at December 31, 2013 and March 31, 2014. The fair value of the commodity contracts outstanding at March 31, 2014 is reflected as a liability of $13.2 million (December 31, 2013 a net liability of $7.8 million). Mosaic has hedged approximately 55 percent of current production for 2014. As new production is brought on, management will continue to monitor the Company s level of hedged production as part of its risk management strategy. The following is a summary of commodity contracts outstanding at March 31, 2014: Crude oil Term Type Volume Price Basis January 1, 2014 to December 31, 2014 Swap 900 bbls/d $91.24 WTI converted to CDN$ January 1, 2014 to December 31, 2014 Call 250 bbls/d $90.00 WTI - US$ January 1, 2015 to June 30, 2015 Swap 600 bbls/d $89.82 WTI converted to CDN$ July 1, 2015 to December 31, 2015 Swap 600 bbls/d $89.35 WTI converted to CDN$ Natural gas Term Type Volume Price Basis January 1, 2013 to December 31, 2014 Swap 8,000 gj/d $3.23 AECO January 1, 2013 to December 31, 2014 Swap 8,000 gj/d $3.34 AECO January 1, 2015 to December 31, 2015 Swap 5,000 gj/d $3.85 AECO January 1, 2015 to March 31, 2015 Swap 5,000 gj/d $3.73 AECO January 1, 2015 to March 31, 2015 Swap 5,000 gj/d $3.76 AECO 2014 First Quarter Report Mosaic Energy Ltd. Page 7
MANAGEMENT S DISCUSSION AND ANALYSIS OTHER INCOME ($ thousands) 2014 2013 % Change Royalty income 70 112 (38) Processing income 714 855 (16) Total other income 784 967 (19) Other income is primarily derived from third parties processing their natural gas through Company owned facilities. The largest contributor of gas gathering and processing revenue is generated from the Gilby gas plant. For the three months ended March 31, 2014, processing income decreased 16 percent compared to the same period in 2013 as a result of a decrease in third party volumes processed. Royalty income decreased 38 percent as a result of the Redwater disposition, in December 2013. Processing income for the first quarter 2014 remained consistent with fourth quarter 2013 processing income of $0.7 million, while royalty income decreased from the fourth quarter 2013 as a result of the Redwater disposition, in December 2013. ROYALTIES ($ thousands) 2014 2013 % Change Royalties 6,083 4,333 40 Gas cost allowance (1,295) (1,173) 10 Net royalties 4,788 3,160 52 % of revenue 12% 10% 20 Royalty rates are dependent on a number of factors including product type, product prices, production rates, well types and depths and ownership of the reserves being produced. Generally, the greatest impact on the movement in Mosaic s royalty rates is related to pricing. In addition, there are specific new oil and gas wells drilled in Alberta that receive a royalty rate reduction ( royalty holiday ) on all volumes produced to a certain threshold. For the three months ended March 31, 2014, net royalties increased 52 percent to $4.8 million from $3.2 million for the same period in 2013. The Company s average royalty rate for the three months ended March 31, 2014 was 12 percent of revenue compared to 10 percent for the same period in 2013. Royalties increased for the three months ended March 31, 2014 compared to the same period in 2013 as a result of the increase in commodity prices combined with one of the Company s Northern wells coming off royalty holiday during the first quarter of 2014. Royalties increased 87 percent during the first quarter of 2014 compared to the fourth quarter of 2013 at $2.6 million and 8 percent of total revenue for the three month periods for the same reasons as mentioned above. 2014 First Quarter Report Mosaic Energy Ltd. Page 8
MANAGEMENT S DISCUSSION AND ANALYSIS OPERATING AND TRANSPORTATION COSTS ($ thousands, except per boe amounts) 2014 2013 % Change Operating costs 9,761 9,679 1 $ per boe 12.19 11.48 6 Transportation costs 752 672 12 $ per boe 0.94 0.80 18 Total production expense 10,513 10,351 2 $ per boe 13.13 12.28 7 Operating expenses totaled $9.8 million or $12.19 per boe for the three months ended March 31, 2014 as compared to $9.7 million or $11.48 per boe in the first quarter of 2013. Transportation expenses totaled $0.8 million or $0.94 per boe for the three months ended March 31, 2014 as compared to $0.7 million or $0.80 per boe in the first quarter of 2013. Operating expenses increased on a total and per boe basis mainly due to the higher cost of trucking oil and natural gas liquids volumes. The Company also continues to bring on oil and liquids production which has higher associated operating and transportation costs per boe. Lower production during the quarter has also contributed to the increased per boe costs when compared to the prior period. Operating expenses for the first quarter 2014 were 6 percent lower than fourth quarter 2013 levels of $10.4 million or $12.87 per boe. The decrease is due to the increase in production and the Company s focus on reducing operating costs in its core areas and the sale of the Company s Redwater area which contributed to higher operating expenses. The Company expects to continue to invest in earlier stage opportunities in the near term which typically results in higher operating costs, which are expected to be offset by higher sales revenue. Management anticipates operating costs (including transportation) will likely remain at current levels on a per boe basis throughout 2014. OPERATING NETBACK ($ per boe) 2014 2013 % Change Sales revenue¹ 43.98 39.35 12 Other income 0.98 1.15 (15) Royalties (5.98) (3.75) 59 Operating costs (12.19) (11.48) 6 Transportation (0.94) (0.80) 18 Operating netback 25.85 24.47 6 Operating netback ex. realized commodity contracts 32.93 23.30 41 ¹ Sales revenue includes realized gain (loss) on commodity contracts Operating income expressed on a unit of production basis was $25.85 for the first quarter 2014, which represents an increase of 6 percent from the same period last year. The higher average sales prices were offset by increased royalties, operating and transportation costs. For the first quarter 2014 the Company s risk management program reduced operating income by $7.08 per barrel of oil equivalent, largely due to the increasing commodity prices. 2014 First Quarter Report Mosaic Energy Ltd. Page 9
MANAGEMENT S DISCUSSION AND ANALYSIS The Company s operating netback for the first quarter of 2014 increased 13 percent compared to the fourth quarter 2013 operating netback of $22.94 per boe, largely due to the increase in commodity prices. GENERAL AND ADMINISTRATIVE ("G&A") ($ thousands, except per boe amounts) 2014 2013 % Change Gross G&A expense 3,530 3,083 14 Overhead recoveries and capitalized G&A (1,011) (708) 43 Net G&A costs 2,519 2,375 6 $ per boe 3.15 2.82 12 For the first quarter of 2014, G&A, net of capitalized and overhead recovery amounts, was $2.5 million or $3.15 per boe as compared to the quarter ended March 31, 2013 where G&A expenses were $2.4 million or $2.82 per boe. G&A expenses increased as a result of higher staffing levels that were brought on throughout 2013 combined with one time payments made for the purpose of reducing staffing levels during the first quarter of 2014. First quarter 2014 overhead recoveries and capitalized G&A costs are 43 percent higher than the same period of 2013, mainly due to higher capitalization rates for directly attributable G&A. During the second half of 2013 the Company performed a review the items being capitalized and concluded an increased capitalization rate was appropriate given the increase in capital spending throughout 2013 and anticipated for 2014. Gross G&A expense for the first quarter 2014 decreased 13 percent compared to the fourth quarter 2013 as a result of fees associated with the year-end financial statement audit, independent reserve evaluation and transaction fees for the disposition of the Redwater properties that were incurred during the fourth quarter 2013. FINANCE COSTS ($ thousands, except per boe amounts) 2014 2013 % Change Interest and bank charges 309-100 Accretion expense 289 121 139 Total finance costs 598 121 394 Finance costs $ per boe 0.75 0.14 436 Interest costs $ per boe 0.39-100 Interest expense includes interest on outstanding debt, stand-by fees on unused credit lines and the cost of setting up the credit facility. Total interest charges for the first quarter have increased 100 percent from the first quarter 2013 as the Company had increased debt in connection with the 2013 and 2014 capital programs. For the first quarter 2013 the Company had no outstanding debt as a result of the $122.9 million financing completed in November of 2012, and therefore no interest expense was incurred. Total finance costs for the first quarter 2014 decreased 16 percent compared to the fourth quarter 2013, due to lower debt levels as the Company incurred lower capital expenditures combined with the proceeds from the Redwater disposition in December 2013. 2014 First Quarter Report Mosaic Energy Ltd. Page 10
MANAGEMENT S DISCUSSION AND ANALYSIS EXPLORATION AND EVALUATION ( E&E ) ($ thousands, except per boe amounts) 2014 2013 % Change E&E expense 1,220-100 $ per boe 1.52-100 Under IFRS, the Company accumulates costs related to E&E assets pending determination of technical feasibility and commercial viability of the asset. E&E costs are primarily for seismic data and undeveloped land. Costs related to undeveloped land that is no longer intended for development, as well as costs of undeveloped land expiries are expensed as they occur. During the first quarter of 2014, the Company recorded E&E expense of $1.2 million or $1.52 per boe, which related to lease expiries in several of the Company s areas, versus nil in the same period of 2013. E&E expenses for the first quarter 2014 increased 37 percent compared to fourth quarter 2013 as a result of a higher number of expiries in the first quarter 2014. STOCK-BASED COMPENSATION ($ thousands, except per boe amounts) 2014 2013 % Change Stock-based compensation 691 1,212 (43) $ per boe 0.86 1.44 (40) Stock-based compensation expense of $0.7 million was recognized for the first quarter of 2014 decreasing 43 percent from the $1.2 million in first quarter 2013 largely due to the 2.0 million stock options granted in the fourth quarter of 2012 and 0.5 million granted in the first three months of 2013. The graded vesting schedule for calculating stock-based compensation attributes a higher percentage of expense to the years immediately following the grant. Stock-based compensation expense for the first quarter 2014 decreased 42 percent compared to the fourth quarter 2013 expense of $1.2 million or $1.46 per boe, as a result of a larger portion of the stock-based compensation is being capitalized. DEPLETION AND DEPRECIATION ($ thousands, except per boe amounts) 2014 2013 % Change Depletion of oil and gas assets 10,799 12,552 (14) Depreciation of fixed assets 44 15 193 Total depletion and depreciation 10,843 12,567 (14) $ per boe 13.54 14.90 (9) For the first quarter of 2014, depletion and depreciation expense was $10.9 million or $13.54 per boe as compared to the quarter ended March 31, 2013 in which the expense was $12.6 million or $14.90 per boe. The decrease in depletion and depreciation expense is largely due to a significant increase in reserves as at December 31, 2013 and a further increase as at March 31, 2014 related to the Company s Northern area. Depletion and depreciation expense for the first quarter 2014 decreased 9 percent compared to the fourth quarter 2013 expense of $11.8 million or $14.63 per boe, for the same reasons as mentioned above. 2014 First Quarter Report Mosaic Energy Ltd. Page 11
MANAGEMENT S DISCUSSION AND ANALYSIS TAXES ($ thousands, except per boe amounts) 2014 2013 % Change Deferred income tax recovery (46) (611) (92) $ per boe (0.06) (0.72) (92) Deferred income tax recovery totaled $0.1 million for the three months ended March 31, 2014. The decrease for the three month period relates to higher pre-tax losses during the three months ended March 31, 2013. Deferred income tax recovery for the first quarter 2014 increased 226 percent compared to the fourth quarter 2013 expense of $1.8 million or $2.26 per boe. The increase was largely the result of an impairment reversal recognized during the fourth quarter of 2013. ESTIMATED TAX POOLS ($ thousands) March 31, 2014 December 31, 2013 CEE 1,460 1,407 CDE 147,396 142,841 COGPE 64,565 69,519 UCC 61,629 59,417 Loss carry forwards 35,266 34,691 Other 935 1,104 Total tax pools 311,251 308,979 CASH AND FUNDS FROM OPERATIONS & NET LOSS ($ thousands except per share amounts) 2014 2013 % Change Cash provided by operating activities 14,633 19,965 (27) Funds from operations 17,878 18,355 (3) Per share basic 0.46 0.48 (4) Per share diluted 0.46 0.48 (4) Net loss (833) (3,045) (73) Per share basic (0.02) (0.08) (75) Per share diluted (0.02) (0.08) (75) Weighted average shares outstanding (000's) Basic 38,609 38,609 - Diluted 38,609 38,609 - For the three months ended March 31, 2014, funds flow from operations decreased by 3 percent to $17.9 million compared to $18.4 million during the same period of 2013. Basic and diluted funds flow from operations per share for the quarter was $0.46 per share compared to $0.48 per basic and diluted share during the same period of 2013. This decrease is mainly the result of the realized losses on derivative contracts during the first quarter of 2014. For the three months ended March 31, 2014, the Company recorded a net loss of $0.8 million or $0.02 per basic and diluted share compared to a net loss of $3.0 million or $0.08 per basic and diluted share in the same period of 2013. The Company s net loss for the quarter decreased primarily due to the increase in petroleum and natural gas revenues. 2014 First Quarter Report Mosaic Energy Ltd. Page 12
MANAGEMENT S DISCUSSION AND ANALYSIS For the three months ended March 31, 2014, funds flow from operations increased by 18 percent compared to the fourth quarter of 2013 with funds flow of $15.2 million or $0.39 per basic and diluted share. This increase is mainly due to increased sales revenues as a result of increased commodity prices. For the three months ended March 31, 2014, net loss increased 120 percent compared to the fourth quarter 2013 net income of $4.4 million or $0.11 per basic and diluted share. This increase is mainly the result of an impairment reversal that was recorded on assets in the Company s Northern area in the fourth quarter of 2013. CAPITAL EXPENDITURES ($ thousands) 2014 2013 % Change Land - 3,008 (100) Geological and geophysical 53 29 83 Drilling and completions 16,329 18,595 (12) Equipment and facilities 6,773 9,678 (30) Other 926 611 52 Exploration and development 24,081 31,921 (25) Property acquisitions - 1,004 (100) Property dispositions¹ (4,222) - 100 Net capital expenditures 19,859 32,925 (40) ¹ Represents the cash proceeds from the sale of assets. Total exploration and development expenditures for the three months ended March 31, 2014 were $24.1 million compared to $31.9 million for the same period in 2013. The decrease in capital expenditures for the three months ended March 31, 2014 is mainly due to lower land acquisition costs combined with slightly lower drilling activities during the quarter. Management expects capital spending to increase following the spring break-up period. Net capital expenditures for the three months ended March 31, 2014 were $19.9 million compared to $32.9 million for the same period in 2013. The Company disposed of all its petroleum and natural gas properties and related facilities in the Hanna area of Alberta during the first quarter of 2014 for total consideration of $4.2 million. First quarter exploration and development expenditures were $17.3 million lower than fourth quarter 2013 mainly due to lower drilling and completion activities. Net capital expenditures were $19.9 million compared to net proceeds of $4.5 million, mainly as a result of the proceeds from the Redwater disposition in December 2013. The Company s net drilling, completion and equipping activity for the three months ended March 31, 2014 is summarized below:, 2014 Net wells by Area Spud RR Comp Equip Northern - 1.0 3.0 2.0 West-Central - - - - East-Central - - - - Other - - - - Totals - 1.0 3.0 2.0 During the first quarter of 2014, the Company drilled 1 gross (1 net) well in its Northern Area. The Company completed and brought on stream 2 gross (2 net) wells in the first quarter of 2014, both were drilled in the fourth quarter of 2013. 2014 First Quarter Report Mosaic Energy Ltd. Page 13
MANAGEMENT S DISCUSSION AND ANALYSIS LIQUIDITY AND CAPITAL RESOURCES Capital funding At March 31, 2014, Mosaic had available a $150 million syndicated revolving demand credit facility. The credit facility bears interest at prime plus a range of 0.75 percent to 2.50 percent depending on Mosaic s debt to cash flow ratio (as defined by the lender) and is secured by a $275 million fixed and floating charge debenture on the assets of the Company. Under the terms of the credit facility, Mosaic is required to meet certain financial and engineering reporting requirements and maintain an adjusted working capital ratio of not less than 1.0:1.0 at all times. The working capital ratio is defined under the credit facility as cash-based current assets, including the undrawn portion of the facility, to cash-based current liabilities, excluding any current bank indebtedness. Mosaic is compliant with all its credit facility covenants at March 31, 2014. As at March 31, 2014, the Company had $31.4 million (December 31, 2013 - $16.5 million) drawn on the facility. Working capital The capital intensive nature of the Company s activities generally results in the Company carrying a working capital deficit. Working capital deficit includes cash, accounts receivable, prepaid expenses less accounts payable and accrued liabilities and commodity contracts. The Company maintains sufficient unused bank credit lines to satisfy working capital deficits. At March 31, 2014, the Company s working capital deficiency totaled $25.5 million which, when combined with the drawings on its bank line at March 31, 2014, represented approximately 38 percent of its $150 million bank facility. Share capital Mosaic is authorized to issue an unlimited number of voting common shares, an unlimited number of non-voting common shares, and an unlimited number of class A and B preferred shares, issuable in series. As at March 31, 2014, Mosaic had 38,608,658 Common Shares and options to acquire 14,749,616 Common Shares of the Company issued and outstanding. No non-voting common shares or preferred shares have been issued. Contractual obligations Throughout the course of its ongoing business, the Company enters into various contractual obligations such as firm transportation agreements and lease obligations for office space. All such contractual obligations reflect market conditions prevailing at the time of contract. The Company believes it has adequate sources of capital to fund all contractual obligations as they come due. The following table lists the Company s obligations as at March 31, 2014: ($ thousands) 2015 2016 2017 2018+ Total Firm transportation agreement - 1,344 2,666 22,663 26,673 Total commitments - 1,344 2,666 22,663 26,673 The firm transportation agreement is a commitment to a third party to transport petroleum products in the Company s Northern area. The agreement has a term of ten years, with an anticipated start date of July 2016. 2014 First Quarter Report Mosaic Energy Ltd. Page 14
MANAGEMENT S DISCUSSION AND ANALYSIS Capital structure The Company s policy is to maintain a strong capital structure for the objectives of maintaining financial flexibility, creditor and investor confidence, and to execute on strategies throughout the business cycle. The Company considers its capital structure to include equity, bank debt and working capital. The Company manages its capital structure and makes adjustments to it in light of changes in economic conditions and the risk characteristics of the underlying petroleum and natural gas assets. In order to maintain or adjust the capital structure, the Company may from time to time issue new shares, adjust its capital spending, hedge future revenue, issue new debt or replace existing debt. The Company monitors net debt to annualized funds from operations as one measure of the Company's ability to manage its debt levels under current operating conditions. The ratio represents the time period it would require to pay off debt if no further capital expenditures were incurred and if funds from operations remained constant. The Company monitors this ratio and endeavours to keep long term levels below 2.0 to 1. The ratio may fluctuate as a result of acquisitions or low commodity prices. As shown below, as at March 31, 2014, the Company s ratio of net debt to annualized funds from operations was 0.80 to 1 (December 31, 2013 0.82 to 1). The Company plans to continue its strategy of divesting of noncore properties, will adjust its annual capital expenditure program if necessary or may consider other forms of financing in order to maintain its financial flexibility. ($ thousands) March 31, 2014 December 31, 2013 Net debt and working capital deficiency 56,946 49,532 Quarterly funds from operations 17,878 15,173 Annualized 71,512 60,692 Net debt to annualized funds from operations 0.80 0.82 APPLICATION OF CRITICAL ACCOUNTING ESTIMATES The reader is advised that the critical accounting estimates, policies, and practices described in the Company s Management Discussion and Analysis for the year ended December 31, 2013 continue to be critical in determining Mosaic s unaudited financial results as of March 31, 2014. There were no changes in accounting policies during the three months ended March 31, 2014, except as noted below. CHANGES IN ACCOUNTING POLICIES AND NEW ACCOUNTING STANDARDS On January 1, 2014, the Company adopted International Financial Reporting Interpretations Committee ( IFRIC ) Interpretation 21 Levies, which addresses payments to government bodies. There was no impact on the Company as a result of adopting the new standard. On January 1, 2014, the Company adopted Amendments to Offsetting Financial Assets and Financial Liabilities addressed within IAS 32 - Financial Instruments: Presentation, which provides guidance regarding when it is appropriate and permissible for an entity to disclose offsetting financial assets and financial liabilities on a net basis. There was no impact on the Company as a result of adopting the amendments to the standard. There are currently no new accounting pronouncements issued or outstanding that are expected to have an impact on the Company s financial statements. BUSINESS RISKS The reader is advised that Mosaic continues to be subject to various types of business risks and uncertainties as described in the Company s Management s Discussion and Analysis for the year ended December 31, 2013. As at As at 2014 First Quarter Report Mosaic Energy Ltd. Page 15
CONDENSED INTERIM STATEMENTS OF FINANCIAL POSITION (Cdn $ thousands, unaudited) As at March 31, 2014 December 31, 2013 Assets Current assets Accounts receivable 15,788 13,731 Prepaid expenses and other 2,888 2,998 18,676 16,729 Property, plant and equipment (note 4) 529,391 514,865 Exploration and evaluation assets (note 5) 30,846 32,878 Goodwill 34,151 34,151 Total assets 613,064 598,623 Liabilities Current liabilities Accounts payable and accrued liabilities 31,008 42,041 Bank debt (note 6) 31,419 16,458 Fair value of commodity contracts (note 11) 11,679 6,968 74,106 65,467 Decommissioning liability (note 7) 40,752 36,345 Deferred income taxes 51,835 51,881 Fair value of commodity contracts (note 11) 1,516 794 Total liabilities 168,209 154,487 Shareholders equity Share capital (note 8) 384,010 384,010 Contributed surplus 21,061 19,509 Merger reserve (34,817) (34,817) Retained earnings 74,601 75,434 Total shareholders' equity 444,855 444,136 Total liabilities and shareholders' equity 613,064 598,623 Commitments (note 12) Subsequent events (note 13) See accompanying notes to the financial statements 2014 First Quarter Report Mosaic Energy Ltd. Page 16
CONDENSED INTERIM STATEMENTS OF LOSS AND COMPREHENSIVE LOSS (Cdn $ thousands, except per share amounts, unaudited) For the three months ended March 31, 2014 2013 Revenue Petroleum and natural gas sales 40,893 32,201 Royalties (4,788) (3,160) Other income 784 967 36,889 30,008 Realized gain (loss) on commodity contracts (note 11) (5,670) 984 Unrealized loss on commodity contracts (note 11) (5,433) (8,111) (11,103) (7,127) 25,786 22,881 Expenses Operating 9,761 9,679 Transportation 752 672 General and administrative 2,519 2,375 Finance expense 598 122 Exploration and evaluation costs (note 5) 1,220 - Stock-based compensation (note 9) 691 1,212 Loss (gain) on property dispositions (note 4) 281 (90) Depletion, depreciation and impairment (note 4) 10,843 12,567 26,665 26,537 Loss before taxes (879) (3,656) Income taxes Deferred (46) (611) Net and comprehensive loss (833) (3,045) Net loss per share (note 8) Basic Diluted See accompanying notes to the financial statements (0.02) (0.08) (0.02) (0.08) 2014 First Quarter Report Mosaic Energy Ltd. Page 17
CONDENSED INTERIM STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY (Cdn $ thousands, unaudited) For the three months ended March 31, 2014 2013 Share capital Balance, beginning of period 384,010 384,010 Balance, end of period 384,010 384,010 Contributed surplus Balance, beginning of period 19,509 11,319 Stock-based compensation 1,552 1,772 Balance, end of period 21,061 13,091 Merger reserve Balance, beginning of period (34,817) (34,817) Balance, end of period (34,817) (34,817) Retained earnings Balance, beginning of period 75,434 69,444 Net loss (833) (3,045) Balance, end of period 74,601 66,399 Total shareholders' equity 444,855 428,683 See accompanying notes to the financial statements 2014 First Quarter Report Mosaic Energy Ltd. Page 18
CONDENSED INTERIM STATEMENTS OF CASH FLOWS (Cdn $ thousands, unaudited) For the three months ended March 31, 2014 2013 Operating activities Net loss (833) (3,045) Items not affecting cash: Depletion, depreciation and impairment (note 4) 10,843 12,567 Stock-based compensation (note 9) 691 1,212 Deferred income tax (46) (611) Unrealized loss on commodity contracts (note 11) 5,433 8,111 Accretion (note 7) 289 121 Exploration and evaluation expenses (note 5) 1,220 - Loss on disposition (note 4) 281 - Changes in non-cash working capital (note 10) (3,245) 1,610 Net cash from operations 14,633 19,965 Financing activities Change in bank debt 14,961 - Net cash from financing activities 14,961 - Investing activities Expenditures on property, plant and equipment (note 4) (24,029) (28,901) Expenditures on property acquisitions - (1,004) Exploration and evaluation expenditures (note 5) (52) (3,020) Proceeds from property dispositions (note 4) 4,222 - Changes in non-cash working capital (note 10) (9,735) 4,829 Net cash used in investing activities (29,594) (28,096) Net change in cash and cash equivalents - (8,131) Cash and cash equivalents, beginning of period - 8,235 Cash and cash equivalents, end of period - 104 See accompanying notes to the financial statements 2014 First Quarter Report Mosaic Energy Ltd. Page 19
NOTES TO THE CONDENSED INTERIM FINANCIAL STATEMENTS As at and for the three months ended March 31, 2014 and 2013 (Dollar amounts in thousands of Canadian, except as noted, unaudited) 1. Reporting entity Mosaic Energy Ltd. (the Company ) is a privately owned company incorporated under the laws of the Province of Alberta and under the Canada Business Corporations Act on July 13, 2004. The Company is engaged in the exploration for and development and production of oil and natural gas in Western Canada. The Company s address of its registered office is 900, 606 4st Street S.W., Calgary, Alberta, T2P 1T1. On January 1, 2013, the Company and its wholly owned subsidiary, 1141523 Alberta Ltd. were amalgamated and the combined entity has carried on business as Mosaic Energy Ltd. 2. Basis of preparation Statement of compliance These condensed interim financial statements have been prepared in accordance with International Accounting Standard ( IAS ) 34 Interim Financial Reporting using accounting policies consistent with International Financial Reporting Standards ( IFRS ). These condensed interim financial statements do not include all of the information required for full annual financial statements. The financial statements should be read in conjunction with the Company s annual financial statements for the year ended December 31, 2013. These condensed interim financial statements were authorized for issue by the Board of Directors on June 10, 2014. Basis of measurement The financial statements have been prepared on the historical cost basis except for certain commodity financial instruments which are measured at fair value. Functional and presentation currency These financial statements are presented in Canadian dollars, which is the Company s functional currency. All financial information is rounded to the nearest thousands, except per unit amounts and where otherwise indicated. Use of estimates and judgments The preparation of financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, revenues and expenses. Actual results may differ from these estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future years affected. Information about significant areas of estimation uncertainty and critical judgments in applying accounting policies that have the most significant effect on the amounts recognized in the condensed interim financial statements are outlined in the Company s annual financial statements for the year ended December 31, 2013. 3. Summary of significant accounting policies These condensed interim financial statements should be read in conjunction with the annual financial statements and accompanying notes for the year ended December 31, 2013. These condensed interim financial statements have been prepared following the same accounting policies as described in note 3 of the Company s annual financial statements for the year ended December 31, 2013, except as noted below. On January 1, 2014, the Company adopted International Financial Reporting Interpretations Committee ( IFRIC ) Interpretation 21 Levies, which addresses payments to government bodies. There was no impact on the Company as a result of adopting the new standard. 2014 First Quarter Report Mosaic Energy Ltd. Page 20
NOTES TO THE CONDENSED INTERIM FINANCIAL STATEMENTS As at and for the three months ended March 31, 2014 and 2013 (Dollar amounts in thousands of Canadian, except as noted, unaudited) On January 1, 2014, the Company adopted Amendments to Offsetting Financial Assets and Financial Liabilities addressed within IAS 32 - Financial Instruments: Presentation, which provides guidance regarding when it is appropriate and permissible for an entity to disclose offsetting financial assets and financial liabilities on a net basis. There was no impact on the Company as a result of adopting the amendments to the standard. 4. Property, plant and equipment Oil and natural gas assets Other assets Total Cost Balance at December 31, 2012 576,277 510 576,787 Additions 110,464 431 110,895 Acquisitions 27,368-27,368 Transfer from exploration and evaluation assets 1,511-1,511 Decommissioning liability 16,330-16,330 Dispositions (56,738) - (56,738) Balance at December 31, 2013 675,212 941 676,153 Additions 24,886 3 24,889 Transfer from exploration and evaluation assets 744-744 Decommissioning liability 4,738-4,738 Dispositions (8,223) - (8,223) Balance at March 31, 2014 697,357 944 698,301 Accumulated depletion, depreciation and impairment Balance at December 31, 2012 131,884 354 132,238 Depletion and depreciation 48,136 149 48,285 Impairment 1,864-1,864 Reversal of previously recognized impairment (9,743) - (9,743) Dispositions (11,356) - (11,356) Balance at December 31, 2013 160,785 503 161,288 Depletion and depreciation 10,799 44 10,843 Dispositions (3,221) - (3,221) Balance at March 31, 2014 168,363 547 168,910 Carrying amounts At December 31, 2013 514,427 438 514,865 At March 31, 2014 528,994 397 529,391 Capitalization of general and administrative and stock-based compensation expenses During the period ended March 31, 2014, approximately $1.0 million (December 31, 2013 - $4.2 million) of directly attributable G&A costs and $0.9 million (December 31, 2013 - $3.7 million) of stock-based compensation were capitalized as expenditures on property, plant and equipment. Future development costs and salvage value At March 31, 2014, future development costs of $1,186.6 million (December 31, 2013 - $861.3 million) associated with proved plus probable reserves were included in costs subject to depletion. An estimated $9.0 million (December 31, 2013 - $9.0 million) in salvage value on production equipment was excluded from costs subject to depletion. 2014 First Quarter Report Mosaic Energy Ltd. Page 21
NOTES TO THE CONDENSED INTERIM FINANCIAL STATEMENTS As at and for the three months ended March 31, 2014 and 2013 (Dollar amounts in thousands of Canadian, except as noted, unaudited) Dispositions During the period ended March 31, 2014 the Company disposed its Hanna properties for proceeds of $4.1 million, resulting in a loss of $0.3 million. Deletion, depreciation and impairment At March 31, 2014, property, plant and equipment includes $5.6 million (December 31, 2013 $2.6 million) of assets under construction pertaining to infrastructure projects that are not yet in use and therefore not subject to depletion and depreciation. For the period ended March 31, 2014, management determined that no impairment indicators were present and as such, did not perform an impairment test. 5. Exploration and evaluation assets Three months ended March 31, 2014 Year ended December 31, 2013 Balance, beginning of period 32,878 22,961 Additions 52 14,497 Transfer to property, plant and equipment (744) (1,511) Dispositions (120) (1,391) Lease expiries and other expenses (1,220) (1,678) Balance, end of period 30,846 32,878 Exploration and evaluation assets consist of the Company s exploration projects which are pending the determination of proven and/or probable reserves. Additions primarily represent the acquisition of undeveloped land during the year. 6. Bank debt At March 31, 2014, the Company had available a $150 million syndicated revolving demand credit facility. The credit facility bears interest at prime plus a range of 0.75 percent to 2.50 percent depending on the Company s debt to cash flow ratio (as defined by the lender) and is secured by a $275 million fixed and floating charge debenture on the assets of the Company. Under the terms of the credit facility, the Company is required to meet certain financial and engineering reporting requirements and maintain an adjusted working capital ratio of not less than 1.0:1.0 at all times. The working capital ratio is defined under the credit facility as cash-based current assets, including the undrawn portion of the facility, to cash-based current liabilities, excluding any current bank indebtedness. The Company is fully compliant with all of its covenants at March 31, 2014. As at March 31, 2014, the Company had $31.4 million (December 31, 2013 - $16.5 million) drawn on the facility. The amount of the facility is subject to a borrowing base test performed on a periodic basis by the lenders, based primarily on reserves and using commodity prices estimated by the lenders as well as other factors. The borrowing base of the credit facility is subject to review at least semi-annually with the next review to take place not later than June 19, 2014. Any decrease in the borrowing base could result in a reduction to the credit facility. 2014 First Quarter Report Mosaic Energy Ltd. Page 22
NOTES TO THE CONDENSED INTERIM FINANCIAL STATEMENTS As at and for the three months ended March 31, 2014 and 2013 (Dollar amounts in thousands of Canadian, except as noted, unaudited) 7. Decommissioning liability The decommissioning obligations result from its ownership interest in oil and natural gas assets including well sites, gathering systems and processing facilities. The Company estimates the total undiscounted future amount of cash flows required to settle its decommissioning obligations to be approximately $56.5 million at March 31, 2014 (December 31, 2013 $57.2 million), which are expected to be incurred between 2024 and 2064. A risk-free rate of 2.82 percent (December 31, 2013 3.13 percent) and an inflation rate of 2 percent (December 31, 2013 2 percent) were used to calculate the fair value of the decommissioning liability at March 31, 2014. A reconciliation of the decommissioning liability is provided below: Three months ended March 31, 2014 Year ended December 31, 2013 Balance, beginning of period 36,345 20,719 Liabilities incurred 79 701 Liabilities acquired - 2,543 Revision in estimate 4,659 13,098 Liabilities disposed (620) (1,296) Accretion 289 580 Balance, end of period 40,752 36,345 8. Share capital Authorized The Company is authorized to issue an unlimited number of voting common shares, an unlimited number of non-voting common shares, and an unlimited number of class A and B preferred shares, issuable in series. No non-voting common shares or preferred shares have been issued. Per share amounts Per share amounts were calculated on the weighted-average number of shares outstanding. The basic and diluted shares outstanding were as follows: 2014 2013 Net loss (833) (3,045) Weighted average shares outstanding (000 s) Basic 38,609 38,609 Diluted 38,609 38,609 Net income per weighted average common share Basic (0.02) (0.08) Diluted (0.02) (0.08) In computing the diluted loss per share for the period ended March 31, 2014, nil (March 31, 2013 nil) shares were added to the weighted average shares outstanding to account for the dilution of stock options. There were 494,549 (March 31, 2013 486,547) stock options that were not included in the diluted loss per share calculation because they were antidilutive. The company used an estimated fair market value of $12.00 per share (March 31, 2013 - $12.00) for the purposes of calculating the diluted net income per share. 2014 First Quarter Report Mosaic Energy Ltd. Page 23
NOTES TO THE CONDENSED INTERIM FINANCIAL STATEMENTS As at and for the three months ended March 31, 2014 and 2013 (Dollar amounts in thousands of Canadian, except as noted, unaudited) 9. Stock-based compensation The Company has established stock option plans whereby directors, officers and employees may be granted options to purchase common shares. The options vest over a period of three years and all but 390,000 of them expire on November 13, 2015. The plans comprise of fixed price options, time vesting options and performance vesting options. Given the vesting conditions related to the performance vesting options, they are not included in the determination of diluted shares. The maximum number of options available for grant is as follows: Option type Maximum available Fixed price stock options 2,272,000 Time vesting stock options¹ ² 3,721,523 Performance vesting options 9,354,517 Total 15,348,040 ¹The initial exercise price of $12.00 per option escalates at a rate of 8 percent per year effective November 13, 2012. ²The escalated exercise price at March 31, 2014 is $13.32. The number and weighted average exercise price of time vesting and fixed price stock options outstanding at March 31, 2014 are as follows: Time vesting and fixed price stock options Number of Options Weighted Average Exercise Price ($) Balance December 31, 2012 4,155,737 10.60 Granted 747,000 13.09 Forfeited (43,444) 11.20 Balance December 31, 2013 4,859,293 11.42 Granted 1,429,689 13.01 Forfeited (403,835) 13.15 Balance March 31, 2014 5,885,147 11.78 The following table summarizes additional information about the fixed price and time vesting stock options outstanding at March 31, 2014: Exercise price ($) Number Weighted average remaining life Weighted average exercise price ($) Number exercisable at March 31, 2014 Weighted average exercise Price ($) 2.79 60,000 1.6 2.79 60,000 2.79 6.50 309,500 1.7 6.50 309,500 6.50 10.00 1,902,500 1.8 10.00 1,793,103 10.00 13.32 3,613,147 1.6 13.32 1,371,235 13.32 Total 5,885,147 1.7 11.78 3,533,838 10.86 2014 First Quarter Report Mosaic Energy Ltd. Page 24
NOTES TO THE CONDENSED INTERIM FINANCIAL STATEMENTS As at and for the three months ended March 31, 2014 and 2013 (Dollar amounts in thousands of Canadian, except as noted, unaudited) Performance vesting options Under the Company s stock option plan, the Company may grant performance vesting options to its directors, officers and employees. These options are performance-vested whereby the holder of the option has the right to exercise once the realized cash proceeds generated in the course of a liquidity event equals or exceeds the performance threshold (i.e. the exercise price). All performance vesting options expire on November 13, 2015. There were 2,491,771 performance vesting options granted during the period ended March 31, 2014 with exercise prices ranging from $16 to $48 per option which vest subject to meeting certain performance conditions. The plan allows for 9.4 million performance vesting options to be granted and outstanding at any given time. At March 31, 2014 there were 8.9 million options outstanding at various exercise prices as detailed below: Performance option type Exercise price ($) Performance options outstanding Maximum number available 2009 Performance I Vesting Options 16.00 1,129,859 1,184,859 2009 Performance II Vesting Options 24.00 1,270,750 1,335,756 2009 Performance III Vesting Options 32.00 1,437,441 1,517,441 2012 Performance I Vesting Options 24.00 1,473,689 1,550,634 2012 Performance II Vesting Options 36.00 1,668,469 1,757,386 2012 Performance III Vesting Options 48.00 1,884,261 2,008,441 Total 8,864,469 9,354,517 Stock-based compensation The Company uses the Black-Scholes option pricing model to calculate the estimated fair value of the stock options issued during the period. The following weighted average assumptions were used to arrive at the estimated fair value on the date of grant: Three months ended March 31, 2014 Year ended December 31, 2013 Risk-free interest rate (%) 1.0 1.2 Expected life (years) 1.75 3 Expected volatility (%) 80 80 Expected dividend yield (%) - - Forfeiture rate (%) 3 3 Fair value per option ($/option) 4.87 5.82 In estimating the fair value of time-vesting stock options granted during the period, the Company assumed an exercise price of $15.12 per option (in conjunction with the escalating nature) as these options vest over 3 years and expire November 13, 2015. Stock-based compensation of $0.7 million (2013 - $1.2 million) was expensed during the three months ended March 31, 2014 while $0.9 million (2013 - $0.6 million) in stock-based compensation was capitalized during three months ended March 31, 2014. No amount of stock-based compensation related to the performance vesting options has been recognized in the three months ended March 31, 2014 (2013 - $nil) given the vesting conditions are not currently determinable. 2014 First Quarter Report Mosaic Energy Ltd. Page 25
NOTES TO THE CONDENSED INTERIM FINANCIAL STATEMENTS As at and for the three months ended March 31, 2014 and 2013 (Dollar amounts in thousands of Canadian, except as noted, unaudited) 10. Supplemental cash flow information Changes in non-cash working capital is comprised of: For the three months ended March 31, 2014 2013 Accounts receivable (2,057) 1,906 Prepaids and other 110 71 Accounts payable and accrued liabilities (11,033) 4,462 Change in non-cash working capital (12,980) 6,439 Related to operating activities (3,245) 1,610 Related to investing activities (9,735) 4,829 Change in non-cash working capital (12,980) 6,439 11. Financial instruments and risk management The Company s financial instruments recognized on the statement of financial position consist of cash and cash equivalents, accounts receivables, accounts payable and accrued liabilities, bank debt and commodity contracts. The Company classifies the fair value of derivative contracts according to the following hierarchy based on the amount of observable inputs used to value the instrument. Level 1 Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions occur in sufficient frequency and volume to provide pricing information on an ongoing basis. Level 2 Pricing inputs are other than quoted prices in active markets included in Level 1. Prices are either directly or indirectly observable as of the reporting date. Level 2 valuations are based on inputs, including quoted forward rates for interest rate, time value and volatility factors, each of which can be substantially observed or corroborated in the marketplace. Level 3 Valuations in this level are those with inputs for the asset or liability that are not based on observable market data. The Company s commodity contracts have been assessed on the fair value hierarchy described above. The commodity contracts are classified as Level 2. Assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the placement within the fair value hierarchy level. The Company s activities expose it to credit, liquidity and market risks that arise as a result of its exploration, development, production, and financing activities. The Company employs risk management strategies and policies to ensure that any exposure to risk is in compliance with the Company s business objectives and risk tolerance levels. Risk management is ultimately established by the board of directors and is implemented by management. The fair value of forward contracts and swaps is determined by discounting the difference between the contracted prices and published forward price curves at the period end date using remaining contracted oil and natural gas volumes. The fair value of options is based on option models that use published information with respect to volatility, prices, and interest rates. 2014 First Quarter Report Mosaic Energy Ltd. Page 26
NOTES TO THE CONDENSED INTERIM FINANCIAL STATEMENTS As at and for the three months ended March 31, 2014 and 2013 (Dollar amounts in thousands of Canadian, except as noted, unaudited) As at March 31, 2014, the Company had the following commodity contracts in place: Crude oil Term Type Volume (bbls/d) Price Basis Fair Value ($ millions) Jan. 1, 2014 to Dec. 31, 2014 Call 250 $90.00 WTI - US$ (0.7) Jan. 1, 2014 to Dec. 31, 2014 Swap 900 $91.24 WTI converted to CDN$ (4.3) Jan. 1, 2015 to Jun. 30, 2015 Swap 600 $89.82 WTI converted to CDN$ (1.3) Jul. 1, 2015 to Dec. 31, 2015 Swap 600 $89.35 WTI converted to CDN$ (1.0) Natural gas Term Type Volume (gj/d) Price Basis Fair Value ($ millions) Jan. 1, 2013 to Dec. 31, 2014 Swap 8,000 $3.23 AECO (2.6) Jan. 1, 2013 to Dec. 31, 2014 Swap 8,000 $3.34 AECO (2.4) Jan. 1, 2015 to Dec. 31, 2015 Swap 5,000 $3.85 AECO (0.2) Jan. 1, 2015 to Mar. 31, 2015 Swap 5,000 $3.73 AECO (0.3) Jan. 1, 2015 to Mar. 31, 2015 Swap 5,000 $3.76 AECO (0.4) Net crude oil and natural gas commodity contract liability (13.2) The fair value of commodity contracts at March 31, 2014 was a net liability of $13.2 million (December 31, 2013 a net liability of $7.8 million) and has been included on the statement of financial position with changes in the fair value reported on the statement of income and comprehensive income as an unrealized gain/loss. 12. Commitments The Company had the following commitments as at March 31, 2014: 2015 2016 2017 2018+ Total Firm transportation agreement - 1,344 2,666 22,663 26,673 Total commitments - 1,344 2,666 22,663 26,673 The firm transportation agreement is a commitment to a third party to transport petroleum products in the Company s northern area. The agreement has a term of ten years, with an anticipated start date of July 2016. 13. Subsequent events On May 9, 2014, the Company closed the disposition of certain non-core petroleum and natural gas properties for proceeds of approximately $6.1 million. 2014 First Quarter Report Mosaic Energy Ltd. Page 27
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Corporate information HEAD OFFICE Suite 900, 606 4 th Street SW Calgary, Alberta, T2P 1T1 Email: info@mosaicenergy.ca Phone: 403 699-7650 Fax: 403 699-7651 AUDITORS KPMG LLP BANKERS National Bank of Canada Union Bank CIBC LEGAL COUNSEL Blake, Cassels & Graydon LLP RESERVE ENGINEER Sproule Associates Ltd. WEBSITE www.mosaicenergy.ca BOARD OF DIRECTORS Independent Directors George Marquardt, Chairman Tomas Ackerman Cameron Dunn Craig Glick Brian Minnehan Members from Management Steve Fagan Peter Sticksl OFFICERS Steve Fagan President and CEO David Ambedian Sr. Vice President, CFO Peter Sticksl Sr. Vice President, Business Development Ben Elgert Vice President, Development Rick Kunimoto Vice President, Geology Greg Kaiser Vice President, Capital Projects Scott Seipert Controller 2014 First Quarter Report Mosaic Energy Ltd. Page 29
Suite 900, 606 4th Street SW Calgary, Alberta, T2P 1T1 Email: info@mosaicenergy.ca Phone: 403 699-7650 Fax: 403 699-7651 www.mosaicenergy.ca