LINNCO, LLC - 10-K - Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with the
financial statements and related notes, which are included in this Annual Report
on Form 10-K in Item 8. "Financial Statements and Supplementary Data." The
following discussion contains forward-looking statements based on expectations,
estimates and assumptions. Actual results may differ materially from those
discussed in the forward-looking statements. Factors that could cause or
contribute to such differences include, but are not limited to, those factors
set forth in "Cautionary Statement Regarding Forward-Looking Statements" in
Item 1. "Business" and in Item 1A. "Risk Factors."
The reference to a "Note" herein refers to the accompanying Notes to Financial
Statements contained in Item 8. "Financial Statements and Supplementary Data."
General
LinnCo, LLC ("LinnCo" or the "Company") is a
Delaware
limited liability company
formed on April 30, 2012, under the Delaware Limited Liability Company Act, that
has elected to be treated as a corporation for
United States
("U.S.") federal
income tax purposes. Linn Energy, LLC ("LINN Energy"), an independent oil and
natural gas company that trades on the NASDAQ Global Select Market ("NASDAQ")
under the symbol "LINE," owns LinnCo's sole voting share.
LinnCo's success is dependent upon the operations and management of LINN Energy
and its resulting performance. Therefore, LINN Energy's Annual Report on Form
10-K for the year ended December 31, 2015, has been included in this filing as
Exhibit 99.1 and incorporated herein by reference.
Business
At no time after LinnCo's formation and prior to the initial public offering
("IPO") did LinnCo have any operations or own any interest in LINN Energy. After
the IPO, LinnCo's initial sole purpose was to own units representing limited
liability company interests ("units") in its affiliate, LINN Energy. In
connection with the acquisition of Berry Petroleum Company, now Berry Petroleum
Company, LLC ("Berry") (see Note 2), LinnCo amended its limited liability
company agreement to permit, among other things, the acquisition and subsequent
transfer of assets to LINN Energy for consideration received. As of December 31,
2015, LinnCo had no significant assets or operations other than those related to
its interest in LINN Energy.
Berry Acquisition
On December 16, 2013, the Company completed the transactions contemplated by the
merger agreement between the Company, LINN Energy and Berry under which LinnCo
acquired all of the outstanding common shares of Berry and the contribution
agreement between the Company and LINN Energy under which the Company
transferred Berry to LINN Energy in exchange for LINN Energy units. Under the
merger agreement, as amended, Berry's shareholders received 1.68 LinnCo common
shares for each Berry common share they owned, totaling 93,756,674 LinnCo common
shares valued at approximately $2.7 billion. Under the contribution agreement,
LinnCo transferred Berry to LINN Energy after which Berry became an indirect
wholly owned subsidiary of LINN Energy. As consideration for the transfer of
Berry to LINN Energy, the Company acquired 93,756,674 newly issued LINN Energy
units, valued at approximately $2.8 billion and equal to the number of LinnCo
shares issued as consideration for Berry.
Recent Developments
Going Concern Uncertainty
As of December 31, 2015, the Company had income taxes payable of approximately
$30 million and cash of approximately $11 million. The Company's only
significant asset is its interest in LINN Energy units and the Company's cash
flow, which was historically used to pay dividends to the Company's
shareholders, is completely dependent upon the ability of LINN Energy to make
distributions to its unitholders. In October 2015, LINN Energy suspended the
payment of its distribution. Accordingly, the uncertainty associated with the
Company's ability to meet its obligations as they become due raises substantial
doubt about its ability to continue as a going concern. The report of the
Company's independent registered public accounting firm that accompanies its
audited financial statements in this Annual Report on Form 10-K contains an
explanatory paragraph regarding the substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not include
any adjustments that might result from the outcome of the going concern
uncertainty.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
The Company estimates that the income taxes will become due later in 2016, but
cannot be certain of the exact timing of payment, or of the final amount that
will ultimately be owed. If the income taxes owed are greater than the cash on
hand at such time, the payment will require some form of liquidity to satisfy
it. As of March 15, 2016, LINN Energy had not agreed to provide any cash
contribution to the Company.
In addition, LINN Energy does not expect to remain in compliance with all of the
restrictive covenants contained in its credit facilities throughout 2016 unless
those requirements are waived or amended. As a result of this and other factors,
the uncertainty associated with LINN Energy's ability to meet its obligations as
they become due raises substantial doubt about its ability to continue as a
going concern. LINN Energy's auditors' opinion issued in connection with its
consolidated financial statements also includes a going concern explanation. If
lenders, and subsequently noteholders, accelerate LINN Energy's outstanding
indebtedness, it will become immediately due and payable and LINN Energy will
not have sufficient liquidity to repay those amounts. If LINN Energy is unable
to reach an agreement with its creditors prior to any accelerations, it could be
required to immediately file for protection under Chapter 11 of the
U.S.
Bankruptcy Code, and as a result, may result in LinnCo immediately filing for
protection under Chapter 11 of the
U.S.
Bankruptcy Code.
LINN Energy is currently in discussions with various stakeholders and is
pursuing or considering a number of actions, but there can be no assurance that
sufficient liquidity can be obtained from one or more of these actions or that
these actions can be consummated within the period needed.
Reduction and Suspension of Dividend
In October 2015, LINN Energy suspended the payment of its distribution. Since
LinnCo pays its dividend from the receipt of cash distributions from LINN
Energy, LinnCo will not pay a dividend while LINN Energy's distributions are
suspended.
In January 2015, LINN Energy reduced its distribution to $1.25 per unit, from
the previous level of $2.90 per unit, on an annualized basis. Monthly
distributions were paid by LINN Energy through September 2015. LinnCo also
reduced its dividend to $1.25 per share in January 2015, and paid a monthly
dividend through September 2015.
Results of Operations
Equity Loss from Investment in Linn Energy, LLC
The Company uses the equity method of accounting for its investment in LINN
Energy. The Company's equity loss consists of its share of LINN Energy's losses
attributed to the units the Company owns, the amortization of the difference
between the Company's investment in LINN Energy and LINN Energy's underlying net
assets attributable to certain assets and liabilities, and impairments of its
investment in LINN Energy. As a result of LINN Energy completing a public
offering of some of its units in May 2015, the Company's ownership of LINN
Energy's outstanding units decreased from approximately 39% to approximately
37%. As a result of acquiring additional LINN Energy units in exchange for the
transfer of Berry in December 2013, the Company's ownership of LINN Energy's
outstanding units increased from approximately 15% to approximately 39% (see
Berry Acquisition above). The percentage ownership in LINN Energy could continue
to change if the Company acquires additional units or if LINN Energy issues or
repurchases additional units.
Impairment testing on the Company's investment in LINN Energy is performed when
events or circumstances warrant such testing and considers whether there is an
inability to recover the carrying value of the investment that is other than
temporary. At September 30, 2015, and December 31, 2014, declines in the quoted
market price of LINN Energy units, when considering the reduction and later
suspension of LINN Energy's distribution and continued low commodity prices,
were determined by the Company to be other than temporary. Accordingly, the
Company reduced the carrying value of its investment to fair value by recording
a charge in excess of what would otherwise be recognized by the application of
the equity method. The carrying value was reduced to fair value using LINN
Energy's quoted market price of $2.69 per unit and $10.13 per unit at
September 30, 2015, and December 31, 2014, respectively, which is characteristic
of a Level 1 fair value measurement. Impairment charges of approximately $326
million and $2.2 billion are included in "equity loss from investment in Linn
Energy, LLC" on the statements of operations for the years ended December 31,
2015, and December 31, 2014, respectively. No impairment had occurred with
respect to the Company's investment in LINN Energy for the year ended
December 31, 2013.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Primarily as a result of cumulative losses recognized by the Company, its investment in LINN Energy was reduced to zero as of December 31, 2015, at which time the Company discontinued applying the equity method. The amount of excess losses incurred was approximately $490 million as of December 31, 2015. Following are summarized statements of operations information for LINN Energy. Additional information on LINN Energy's results of operations and financial position are contained in its Annual Report on Form 10-K for the year ended December 31, 2015, which is included in this filing as Exhibit 99.1 and incorporated herein by reference.
Summarized Linn Energy, LLC Statements of Operations Information
Year Ended December 31,
2015 2014 2013
(in thousands)
Revenues and other $ 2,883,334 $ 4,983,303 $ 2,331,655
Expenses (7,805,186 ) (4,826,624 ) (2,590,273 )
Other income and (expenses) 155,580 (604,051 ) (434,918 ) Income tax (expense) benefit 6,461 (4,437 ) 2,199 Net loss
$ (4,759,811 ) $ (451,809 ) $ (691,337 )
General and Administrative Expenses
The Company's general and administrative expenses are associated with managing
the business and affairs of LinnCo and include services provided by LINN Energy
necessary for the conduct of LinnCo's business, such as accounting, legal, tax,
information technology and other expenses. For the year ended December 31, 2015,
LinnCo incurred total general and administrative expenses of approximately $3
million, including approximately $2 million related to services provided by LINN
Energy. All expenses incurred during the year had been paid by LINN Energy on
LinnCo's behalf as of December 31, 2015.
For the year ended December 31, 2014, LinnCo incurred total general and
administrative expenses of approximately $3 million, including approximately $2
million related to services provided by LINN Energy. All expenses incurred
during the year had been paid by LINN Energy on LinnCo's behalf as of
December 31, 2014. In addition, during the year ended December 31, 2014, LINN
Energy paid approximately $11 million on LinnCo's behalf for general and
administrative expenses incurred by LinnCo in 2013.
For the year ended December 31, 2013, LinnCo incurred total general and
administrative expenses of approximately $42 million, including approximately
$40 million of transaction costs related to the Berry acquisition (see Note 2),
of which approximately $9 million related to noncash share-based compensation
expense, and approximately $2 million related to services provided by LINN
Energy. Approximately $22 million of expenses had been paid by LINN Energy on
LinnCo's behalf as of December 31, 2013.
Because all general and administrative expenses are actually paid by LINN Energy
on LinnCo's behalf, no cash is disbursed by LinnCo for these expenses.
Gain (Loss) on Transfer of Berry
The gain on transfer of Berry for the year ended December 31, 2014, reflects
acquisition accounting adjustments to the fair value of the assets acquired and
liabilities assumed from Berry that were subsequently transferred to LINN
Energy. The loss on transfer of Berry for the year ended December 31, 2013, is
primarily due to deferred income taxes assumed by LinnCo in the Berry
acquisition that were not transferred to LINN Energy and reflects the difference
between the fair value of the assets acquired and liabilities assumed from Berry
and the fair value of the LINN Energy units received in connection with the
transfer. Components of the gain (loss) are as follows (in millions):
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Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Year Ended December 31,
2014 2013
Deferred income taxes, net $ 14 $ (835 )
Consideration difference between LinnCo and LINN Energy - 113
Other taxes - 4
$ 14 $ (718 )
The loss due to deferred income taxes assumed by LinnCo in the Berry acquisition
for the year ended December 31, 2013, was partially offset by a gain related to
the difference between the value of consideration exchanged between LinnCo and
Berry and LINN Energy and LinnCo. LINN Energy's unit price of $29.47 per unit
exceeded LinnCo's share price of $28.36 per share on the date of acquisition and
both companies issued an equal number of shares or units in the acquisition and
subsequent transfer. The loss for the year ended December 31, 2013, was also
partially offset by a gain of approximately $4 million which consisted of an
income taxes receivable of approximately $13 million and an income taxes
liability of approximately $9 million assumed by LinnCo in the Berry acquisition
but not transferred to LINN Energy.
Income Tax Benefit
The income tax benefits of approximately $11 million, $735 million and $92
million for the years ended December 31, 2015, December 31, 2014, and
December 31, 2013, respectively, are based on the Company's losses, primarily
associated with the equity losses from its investment in LINN Energy. During
2015, the tax benefit was offset by a valuation allowance. The amount of
deferred tax assets considered realizable could be reduced in the future if
estimates of future taxable income during the carryforward and carryback periods
are reduced. These estimates of future taxable income are significantly affected
by changes in commodity prices, the timing and amount of future production and
future operating and capital costs.
Liquidity and Capital Resources
The Company's authorized capital structure consists of two classes of interests:
(1) shares with limited voting rights, which were issued in the IPO and in
connection with the Berry acquisition and (2) voting shares, 100% of which are
held by LINN Energy. At December 31, 2015, LinnCo's issued capitalization
consisted of approximately $3.9 billion in common shares representing limited
liability company interests ("shares") and $1,000 contributed by LINN Energy in
connection with LinnCo's formation and in exchange for its voting share.
Additional classes of equity interests may be created upon approval by the Board
of Directors ("Board") and the holders of a majority of the outstanding shares
and voting shares, voting as separate classes.
LINN Energy has agreed to provide to LinnCo, or to pay on LinnCo's behalf, any
financial, legal, accounting, tax advisory, financial advisory and engineering
fees, and other administrative and out-of-pocket expenses incurred by LinnCo,
along with any other expenses incurred in connection with any public offering of
LinnCo shares or incurred as a result of being a publicly traded entity. These
expenses include costs associated with annual, quarterly and other reports to
holders of LinnCo shares, tax return and Form 1099 preparation and distribution,
NASDAQ listing fees, printing costs, independent auditor fees and expenses,
legal counsel fees and expenses, limited liability company governance and
compliance expenses, and registrar and transfer agent fees.
The Company expects neither to generate nor to require significant cash in its
ongoing business. Any cash received from the sale of additional shares will be
immediately used to purchase LINN Energy units. Accordingly, the Company does
not anticipate any other sources or needs for additional liquidity, other than
if the Company had a tax obligation. Such tax obligation would require some form
of liquidity to satisfy it, including a cash contribution from LINN Energy,
which LINN Energy is not required to provide.
As of December 31, 2015, the Company had income taxes payable of approximately
$30 million and cash of approximately $11 million. The Company's only
significant asset is its interest in LINN Energy units and the Company's cash
flow, which was historically used to pay dividends to the Company's
shareholders, is completely dependent upon the ability of LINN Energy to make
distributions to its unitholders. In October 2015, LINN Energy suspended the
payment of its distribution.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Accordingly, the uncertainty associated with the Company's ability to meet its
obligations as they become due raises substantial doubt about its ability to
continue as a going concern. The report of the Company's independent registered
public accounting firm that accompanies its audited financial statements in this
Annual Report on Form 10-K contains an explanatory paragraph regarding the
substantial doubt about the Company's ability to continue as a going concern.
The Company estimates that the income taxes will become due later in 2016, but
cannot be certain of the exact timing of payment, or of the final amount that
will ultimately be owed. If the income taxes owed are greater than the cash on
hand at such time, the payment will require some form of liquidity to satisfy
it. As of March 15, 2016, LINN Energy had not agreed to provide any cash
contribution to the Company.
In addition, LINN Energy does not expect to remain in compliance with all of the
restrictive covenants contained in its credit facilities throughout 2016 unless
those requirements are waived or amended. As a result of this and other factors,
the uncertainty associated with LINN Energy's ability to meet its obligations as
they become due raises substantial doubt about its ability to continue as a
going concern. LINN Energy's auditors' opinion issued in connection with its
consolidated financial statements also includes a going concern explanation. If
lenders, and subsequently noteholders, accelerate LINN Energy's outstanding
indebtedness, it will become immediately due and payable and LINN Energy will
not have sufficient liquidity to repay those amounts. If LINN Energy is unable
to reach an agreement with its creditors prior to any accelerations, it could be
required to immediately file for protection under Chapter 11 of the
U.S.
Bankruptcy Code, and as a result, may result in LinnCo immediately filing for
protection under Chapter 11 of the
U.S.
Bankruptcy Code.
LINN Energy is currently in discussions with various stakeholders and is
pursuing or considering a number of actions, but there can be no assurance that
sufficient liquidity can be obtained from one or more of these actions or that
these actions can be consummated within the period needed.
At-the-Market Offering Program
The Company's Board has authorized the sale of up to $500 million of shares
under an at-the-market offering program. Sales of shares, if any, will be made
under an equity distribution agreement by means of ordinary brokers'
transactions, through the facilities of the NASDAQ, any other national
securities exchange or facility thereof, a trading facility of a national
securities association or an alternate trading system, to or through a market
maker or directly on or through an electronic communication network, a "dark
pool" or any similar market venue, at market prices, in block transactions, or
as otherwise agreed with a sales agent. The Company expects to use the net
proceeds from any sale of shares to purchase additional LINN Energy units. As of
December 31, 2015, no shares had been sold under the program.
Distributions and Dividends
Within five business days after receiving a cash distribution related to its
interest in LINN Energy units, LinnCo is required to pay the cash received, net
of reserves for its income taxes liability, if any, as dividends to its
shareholders. The following provides a summary of dividends paid by the Company
during the year ended December 31, 2015:
Date Paid Dividends Per Share Total Dividends
(in millions)
September 2015 $ 0.1042 $ 13
August 2015 $ 0.1042 $ 13
July 2015 $ 0.1042 $ 13
June 2015 $ 0.1042 $ 13
May 2015 $ 0.1042 $ 13
April 2015 $ 0.1042 $ 13
March 2015 $ 0.1042 $ 15
February 2015 $ 0.1042 $ 13
January 2015 $ 0.1042 $ 13
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Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
In October 2015, LINN Energy suspended the payment of its distribution. Since
LinnCo pays its dividend from the receipt of cash distributions from LINN
Energy, LinnCo will not pay a dividend while LINN Energy's distributions are
suspended.
Critical Accounting Policies and Estimates
The discussion and analysis of the Company's financial condition and results of
operations is based on the financial statements, which have been prepared in
accordance with
U.S.
generally accepted accounting principles. The preparation
of these financial statements requires management of the Company to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, income and expenses, and related disclosures of contingent assets
and liabilities. These estimates and assumptions are based on management's best
estimates and judgment. Management evaluates its estimates and assumptions on an
ongoing basis using historical experience and other factors that are believed to
be reasonable under the circumstances. Such estimates and assumptions are
adjusted when facts and circumstances dictate. Actual results may differ from
these estimates and assumptions used in the preparation of the financial
statements.
Below are expanded discussions of the Company's more significant accounting
policies. See Note 1 for details about additional accounting policies and
estimates made by Company management.
Recently Issued Accounting Standards
For a discussion of recently issued accounting standards, see Note 1.
Accounting for Investment in Linn Energy, LLC
The Company uses the equity method of accounting for its investment in LINN
Energy. The Company records its share of LINN Energy's net income (loss) in the
period in which it is earned. If the Company's share of LINN Energy's losses
reduces its investment in LINN Energy to zero, the Company temporarily
discontinues applying the equity method. At December 31, 2015, the Company owned
approximately 37% of LINN Energy's outstanding units. The Company's ownership
percentage could change if the Company acquires additional units or if LINN
Energy issues or repurchases additional units. Changes in the Company's
ownership percentage affect its net income (loss).
At December 31, 2015, the carrying amount of the Company's investment in LINN
Energy was greater than the Company's ownership interest in LINN Energy's
underlying net assets by approximately $85 million. The difference is
attributable to proved and unproved oil and natural gas properties and senior
notes, and is included in "investment in Linn Energy, LLC" on the balance sheets
and amortized over the lives of the related assets and liabilities. Such
amortization is included in the equity income (loss) from the Company's
investment in LINN Energy.
Income Taxes
The Company is a limited liability company that has elected to be treated as a
corporation for
U.S.
federal income tax purposes. Deferred income tax assets and
liabilities are recognized for temporary differences between the basis of the
Company's assets and liabilities for financial and tax reporting purposes. At
December 31, 2015, and December 31, 2014, the majority of the Company's
temporary differences and associated deferred taxes result from its investment
in LINN Energy.
The Company routinely assesses the realizability of the deferred tax assets by
considering whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized and records a valuation allowance
against the deferred tax assets that will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. The Company considers the scheduled reversal of deferred tax
liabilities, projected future taxable income and tax planning strategies in
making the assessment. The Company recognizes only the impact of income tax
positions that, based on their merits, are more likely than not to be sustained
upon audit by a taxing authority. For the year ended December 31, 2015, the
Company's established valuation allowances increased by approximately $433
million due to losses recorded in 2015 which generated additional deferred tax
assets that are not expected to be realized. For the year ended December 31,
2014, the Company's established valuation allowances increased by approximately
$3 million due to acquisition accounting adjustments related to the 2013 Berry
acquisition.
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