UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

Form 10-Q

 

For the quarterly period ended March 31, 2014

OR

 

For the transition period from _______________ to ________________

 

Commission File Number 1-32414

 

W&T OFFSHORE, INC.

(Exact name of registrant as specified in its charter)

 

 

(713) 626-8525

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  

Yes  þ  No  ¨  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  þ  No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company.  Yes  ¨  No  þ  

As of May 5, 2014, there were 75,634,246 shares outstanding of the registrant’s common stock, par value $0.00001.

 

 

 

 

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W&T OFFSHORE, INC. AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

 

 

 

 

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PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

 

See Notes to Condensed Consolidated Financial Statements.

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W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

 

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

 

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W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

 

 

 

 

See Notes to Condensed Consolidated Financial Statements.

 

 

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W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See Notes to Condensed Consolidated Financial Statements.

 

 

 

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

1.  Basis of Presentation

Operations.  W&T Offshore, Inc. and subsidiaries, referred to herein as “W&T” or the “Company,” is an independent oil and natural gas producer focused primarily in the Gulf of Mexico and onshore Texas.  The Company is active in the exploration, development and acquisition of oil and natural gas properties.  Our interest in fields, leases, structures and equipment are primarily owned by W&T Offshore, Inc. (the “Parent Company”) and our wholly-owned subsidiary, W&T Energy VI, LLC (“Energy VI”).

Interim Financial Statements.  The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim periods and the appropriate rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, the condensed consolidated financial statements do not include all of the information and footnote disclosures required by GAAP for complete financial statements for annual periods.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

Operating results for interim periods are not necessarily indicative of the results that may be expected for the entire year.  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Use of Estimates.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  Actual results could differ from those estimates.

Adjustment related to additional volumes.  In January 2014, we identified that we had been receiving an erroneous conversion factor from a third party that had the effect of understating natural gas production at our Viosca Knoll 783 field (Tahoe).  The incorrect conversion factor had been used on all natural gas production from the field since we acquired it in 2011.  The effect of using this incorrect conversion factor did not affect revenues, operating cash flows or royalty payments to the federal government but did impact reported natural gas production and the calculation of depletion expense.  We performed an analysis of the information, assessing both quantitative and qualitative factors, and determined that the impact on our net income reported for quarters in 2013, as well as the impact to our earnings trend, was not material to the previously reported results, thus the adjustment was recognized in the fourth quarter of 2013.  The amounts included in the adjustment recognized in the fourth quarter 2013 period which relate to the first quarter of 2013 were: an increase in natural gas production volumes of 264 million cubic feet (“MMcf”) (with no corresponding increase in revenue); an increase to depreciation, depletion, amortization and accretion expense (“DD&A”) of $0.8 million; and a decrease to net income of $0.5 million.

Recent Accounting Developments.  None.

 

2.  Acquisitions and Divestitures

2013 Acquisition

On October 17, 2013, W&T Offshore, Inc. entered into a purchase and sale agreement to acquire certain oil and natural gas property interests from Callon Petroleum Operating Company (“Callon”).  Pursuant to the purchase and sale agreement, transfers of certain properties that had no preferential rights were consummated on November 5, 2013 and transfers of certain properties subject to preferential rights, of which third-parties declined to exercise their preferential rights, were consummated on December 4, 2013.  The properties acquired from Callon (the “Callon Properties”) consist of a 15% working interest in the Medusa field (deepwater Mississippi Canyon blocks 582 and 583), interest in associated production facilities and various interests in other non-operated fields.  All of the Callon Properties are located in the Gulf of Mexico.  The effective date of the transaction was July 1, 2013.  The transaction included customary adjustments for the effective date, certain closing adjustments and we assumed the related ARO.  A net purchase price adjustment of $0.2 million reduction was recorded during the three months ended March 31, 2014.  The purchase price is expected to be finalized in the second quarter of 2014.  The acquisition was funded from borrowings under our revolving bank credit facility and cash on hand.

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

 

The following table presents the preliminary purchase price allocation, including estimated adjustments, for the acquisition of the Callon Properties (in thousands):

 

 

The acquisition was recorded at fair value, which was determined by applying the market and income approaches using Level 3 inputs.  The Level 3 inputs were: (i) analysis of comparable transactions obtained from various third-parties, (ii) estimates of ultimate recoveries of reserves and (iii) estimates of discounted cash flows based on estimated reserve quantities, reserve categories, timing of production, costs to produce and develop reserves, future prices, ARO and discount rates.  The estimates and assumptions were determined by management and third-parties.  The fair value is based on subjective estimates and assumptions, which are inherently imprecise, and the actual realized values could vary significantly from these estimates.  No goodwill was recorded in connection with the Callon Properties acquisition.

2013 Acquisition — Revenues, Net Income and Pro Forma Financial Information — Unaudited

The Callon Properties were not included in our consolidated results until the respective property transfer dates, which occurred during the fourth quarter of 2013.  For the three months ended March 31, 2014, the Callon Properties accounted for $8.7 million of revenues, $0.9 million of direct operating expenses, $3.5 million of DD&A and $1.5 million of income taxes, resulting in $2.8 million of net income.  The net income attributable to the Callon Properties does not reflect certain expenses, such as general and administrative expenses (“G&A”) and interest expense; therefore, this information is not intended to report results as if these operations were managed on a stand-alone basis.  In addition, the Callon Properties are not recorded in a separate entity for tax purposes; therefore, income tax was estimated using the federal statutory tax rate.  There were no expenses associated with acquisition activities and transition activities related to the acquisition of the Callon Properties for the three months ended March 31, 2013.  

Consistent with the computation of pro forma financial information presented in Item 8, Financial Statements and Supplementary Data, in the Annual Report on Form 10-K for the year end December 31, 2013, the unaudited pro forma financial information was computed as if the acquisition of the Callon Properties had been completed on January 1, 2012.  The financial information was derived from W&T’s audited historical consolidated financial statements for annual periods, W&T’s unaudited historical condensed consolidated financial statements for the interim periods, the Callon Properties’ audited historical financial statement for 2012 and the Callon Properties’ unaudited historical financial statements for the interim periods.

The pro forma adjustments were based on estimates by management and information believed to be directly related to the purchase of the Callon Properties.  The pro forma financial information is not necessarily indicative of the results of operations had the purchase occurred on January 1, 2012.  If the transaction had been in effect for the periods indicated, the results may have been substantially different.  For example, we may have operated the assets differently than Callon; the realized sales prices for oil, natural gas liquids (“NGLs”) and natural gas may have been different; and the costs of operating the Callon Properties may have been different.    

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

 

The following table presents a summary of our pro forma financial information (in thousands except earnings per share):

 

 

For the pro forma financial information, certain information was derived from financial records and certain information was estimated.  

The following table presents incremental items included in the pro forma information reported above for the Callon Properties (in thousands):

 

The sources of information and significant assumptions are described below:

The pro forma adjustments do not include adjustments related to any other acquisitions or divestitures.

2013 Divestitures.   On July 11, 2013, we sold our non-operated working interest in two offshore fields located in the Gulf of Mexico; the Green Canyon 60 field and the Green Canyon 19 field.  The effective date was October 1, 2011 and we retained the deep rights in both fields.  Due to the length of time from the effective date, we paid $4.3 million to sell the properties as revenues exceeded operating expenses and the purchase price for the period between the effective date and the close date.  In connection with the sale, we reversed $15.6 million of our ARO.

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

 

On September 26, 2013, we sold our working interests in the West Delta area block 29 with an effective date of January 1, 2013.  The property is located in the Gulf of Mexico.  Including adjustments for the effective date, the net proceeds were $16.5 million.   The transaction was structured as a like-kind exchange under the Internal Revenue Service Code (“IRC”) Section 1031 and other applicable regulations, with funds held by a qualified intermediary until replacement purchases are made.  Replacement purchases were made in 2013, which were within the replacement periods as defined under the IRC.  In connection with this sale, we reversed $3.9 million of ARO.  

 

3.  Asset Retirement Obligations

Our ARO primarily represents the estimated present value of the amount we will incur to plug, abandon and remediate our producing properties at the end of their productive lives in accordance with applicable laws.  

A summary of the changes to our ARO is as follows (in thousands):  

 

 

 

 

4.  Derivative Financial Instruments

Our market risk exposure relates primarily to commodity prices and interest rates. From time to time, we use various derivative instruments to manage our exposure to commodity price risk from sales of our oil and natural gas and interest rate risk from floating interest rates on our revolving bank credit facility. All of the derivative counterparties are also lenders or affiliates of lenders participating in our revolving bank credit facility.  We are exposed to credit loss in the event of nonperformance by the derivative counterparties; however, we currently anticipate that each of our derivative counterparties will be able to fulfill their contractual obligations. Additional collateral is not required by us due to the derivative counterparties’ collateral rights as lenders and we do not require collateral from our derivative counterparties.

In accordance with GAAP, we record each derivative contract on the balance sheet as an asset or a liability at its fair value.  For additional information about fair value measurements, refer to Note 6.  We have elected not to designate our commodity derivative contracts as hedging instruments; therefore, all changes in the fair value of derivative contracts are recognized currently in earnings.  The cash flows of all of our commodity derivative contracts are included in Net cash provided by operating activities on the statements of cash flows.

Commodity Derivatives.  We have entered into commodity swap contracts to manage a portion of our exposure to commodity price risk from sales of oil through December 2014.  While these contracts are intended to reduce the effects of price volatility, they may also limit future income from favorable price movements.  During the three months ended March 31, 2014 and during 2013, our derivative contracts consisted entirely of crude oil swap contracts.  The crude oil swap contracts are comprised of a portion based on Brent crude oil prices, a portion based on West Texas Intermediate (“WTI”) crude oil prices and a portion based on Light Louisiana Sweet (“LLS”) crude oil prices.  The Brent based swap contracts are priced off the Brent crude oil price quoted on the IntercontinentalExchange, known as ICE.  The WTI based swap contracts are priced off the New York Mercantile Exchange, known as NYMEX.  The LLS based swap contracts are priced from data provided by Argus, an independent media organization.  Although our Gulf of Mexico crude oil is based off the WTI crude oil price plus a premium, the realized prices received for our Gulf of Mexico crude oil, up until October 2013, have been closer to the Brent crude oil price because of competition with foreign supplied crude oil, which is based off the Brent crude oil price.  Therefore, a portion of the swap oil contracts are priced off the Brent crude oil price to mitigate a portion of the price risk associated with our Gulf of Mexico crude oil production.

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

 

As of March 31, 2014, our open commodity derivative contracts were as follows:

 

 

Bbls = barrels

The following balance sheet line items include amounts related to the estimated fair value of our open derivative contracts as indicated in the following table (in thousands):

 

 

Changes in the fair value of our commodity derivative contracts are recognized currently in earnings and were as follows (in thousands):

 

 

Offsetting Commodity Derivatives.  As of March 31, 2014 and December 31, 2013, all of our derivative agreements allowed for netting of derivative gains and losses upon settlement.  In general, the terms of the agreements provide for offsetting of amounts payable or receivable between us and the counterparty, at the election of both parties, for transactions that occur on the same date and in the same currency.  If an event of default were to occur causing an acceleration of payment under our revolving bank credit facility, that event may also trigger an acceleration of settlement of our derivative instruments.  If we were required to settle all of our open derivative instruments, we would be able to net payments and receipts per counterparty pursuant to the derivative agreements.  Although our derivative agreements allow for netting, which would allow for recording assets and liabilities per counterparty on a net basis, we account for our derivative contracts on a gross basis per contract as either an asset or liability.

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

 

The following table provides a reconciliation of the gross assets and liabilities reflected in the balance sheet and the potential effects of master netting agreements on the fair value of open derivative contracts (in thousands):

 

 

 

5.  Long-Term Debt

Our long-term debt was as follows (in thousands):

 

 

At March 31, 2014 and December 31, 2013, the balance outstanding of our senior notes, which bear an annual interest rate of 8.50% and mature on June 15, 2019 (the “8.50% Senior Notes”), was classified as long-term at their carrying value.  Interest on the 8.50% Senior Notes is payable semi-annually in arrears on June 15 and December 15.  The estimated annual effective interest rate on the 8.50% Senior Notes is 8.4%, which includes amortization of debt issuance costs and premiums.  We are subject to various financial and other covenants under the indenture governing the 8.50% Senior Notes and we were in compliance with those covenants as of March 31, 2014.  

The Fifth Amended and Restated Credit Agreement (the “Credit Agreement”) governs our revolving bank credit facility and terminates on November 8, 2018.  Borrowings under our revolving bank credit facility are secured by our oil and natural gas properties.  Availability under such facility is subject to a semi-annual redetermination of our borrowing base that occurs in the spring and fall of each year and is calculated by our lenders based on their evaluation of our proved reserves and their own internal criteria.  

At March 31, 2014 and December 31, 2013, we had $0.4 million of letters of credit outstanding under the revolving bank credit facility.  The estimated annual effective interest rate was 2.8% for the three months ended March 31, 2014 for borrowings under the revolving bank credit facility.  The estimated annual effective interest rate includes amortization of debt issuance costs and excludes commitment fees and other costs.  As of March 31, 2014, our borrowing base was $800.0 million and our borrowing availability was $520.6 million.  See Note 12 for information regarding a change of the borrowing base to $750.0 million subsequent to March 31, 2014.  

Under the Credit Agreement, we are subject to various financial covenants calculated as of the last day of each fiscal quarter, including a minimum current ratio and a maximum leverage ratio, each as defined in the Credit Agreement.  We were in compliance with all applicable covenants of the Credit Agreement as of March 31, 2014.

For information about fair value measurements for our 8.50% Senior Notes and revolving bank credit facility, refer to Note 6.

 

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

 

6.  Fair Value Measurements

We measure the fair value of our derivative financial instruments by applying the income approach, using models with inputs that are classified within Level 2 of the valuation hierarchy.  The inputs used for the fair value measurement of our derivative financial instruments are the exercise price, the expiration date, the settlement date, notional quantities, the implied volatility, the discount curve with spreads and published commodity futures prices.  The fair value of our 8.50% Senior Notes is based on quoted prices and the market is not an active market; therefore, the fair value is classified within Level 2.  The carrying amount of debt under our revolving bank credit facility approximates fair value because the interest rates are variable and reflective of market rates.

The following table presents the fair value of our derivative financial instruments, 8.50% Senior Notes and revolving bank credit facility (in thousands).

 

 

As described in Note 4, our derivative financial instruments are reported in the balance sheet at fair value and changes in fair value are recognized currently in earnings.  The 8.50% Senior Notes and revolving bank credit facility are reported in the balance sheet at their carrying value as described in Note 5.  

 

7.  Share-Based Compensation and Cash-Based Incentive Compensation

In 2010, the W&T Offshore, Inc. Amended and Restated Incentive Compensation Plan (the “Plan”) was approved by our shareholders and amendments to the Plan were approved by our shareholders in May 2013.  As allowed by the Plan, during the three months ended March 31, 2014, and in 2013 and 2012, the Company granted restricted stock units (“RSUs”) to certain of its employees.  RSUs are a long-term compensation component of the Plan, which are granted to only certain employees, and are subject to adjustments at the end of the applicable performance period based on the achievement of certain predetermined criteria.  In addition to share-based compensation, the Company may grant to its employees cash-based incentive awards, which are a short-term component of the Plan and are based on the Company and the employee achieving certain pre-defined performance criteria.

During the three months ended March 31, 2014, RSUs granted were subject to a combination of performance criteria, which was comprised of: (i) net income before income tax expense, net interest expense, depreciation, depletion, amortization, accretion and certain other items (“Adjusted EBITDA”) for 2014 and (ii) Adjusted EBITDA as a percent of total revenue (“Adjusted EBITDA Margin”) for 2014.  Adjustments range from 0% to 100% dependent upon actual results compared against pre-defined performance levels.  

During 2013, RSUs granted were subject to a combination of performance criteria, which was comprised of: (i) Adjusted EBITDA for 2013; (ii) Adjusted EBITDA Margin for 2013; and (iii) the Company’s total shareholder return (“TSR”) ranking against peer companies’ TSR for 2013, 2014 and January 1, 2015 to October 31, 2015.  TSR is determined based upon the change in the entity’s stock price plus dividends for the applicable performance period.  For 2013, the Company exceeded the target for Adjusted EBITDA, was approximately at target for 2013 Adjusted EBITDA Margin and was below target for TSR ranking.  

During 2012, RSUs granted were subject to a combination of performance criteria, which was comprised of: (i) earnings per share for 2012; and (ii) the Company’s TSR ranking against peer companies’ TSR for 2012, 2013 and January 1, 2014 to October 31, 2014.  Pursuant to the Plan, discretionary authority was exercised for certain non-executive employees, which reduced the forfeitures that would have occurred through application of the pre-defined performance measurement.

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

 

All RSUs granted to date are subject to employment-based criteria and vesting occurs in December of the second year after the grant.  For example, the RSUs granted during 2012 will vest in December 2014 to eligible employees.

The compensation related to the 2013 annual incentive plan for the Chief Executive Officer (“CEO”) was determined based on pre-defined company and individual performance measures pursuant to the terms of his award and was settled in shares of common stock in March 2014.  The 2014 annual incentive plan award for the CEO will be settled in shares of common stock based on a price of $14.66 per share, subject to pre-defined performance measures and approval of the Compensation Committee.  As the number of shares cannot be determined and a grant has not yet been made, the CEO’s 2014 award is accounted for as a liability award and adjusted to fair value using the Company’s closing price at the end of each reporting period. The performance measures for the CEO’s award were the same as the performance measures established for the other eligible Company employees for 2014 and 2013, respectively.  

Under the Director Compensation Plan, restricted stock was granted to the Company’s non-employee directors during 2013 and prior years.  The restricted stock is subject to service conditions and vesting occurs at the end of specified service periods.

At March 31, 2014, there were 5,036,436 shares of common stock available for issuance in satisfaction of awards under the Plan and 519,379 shares of common stock available for issuance in satisfaction of awards under the Director Compensation Plan. The shares available for both plans are reduced when restricted stock or common stock is granted.  RSUs will reduce the shares available in the Plan only when RSUs are settled in shares of common stock.  Although the Company has the option to settle RSUs in stock or cash at vesting, only common stock has been used to settle vested RSUs to date.

We recognize compensation cost for share-based payments to employees and non-employee directors over the period during which the recipient is required to provide service in exchange for the award, based on the fair value of the equity instrument on the date of grant.  We are also required to estimate forfeitures, resulting in the recognition of compensation cost only for those awards that are expected to actually vest.

Awards Based on Restricted Stock.  As of March 31, 2014, all of the unvested shares of restricted stock (“Restricted Shares”) outstanding were issued to the non-employee directors.  Restricted Shares are subject to forfeiture until vested and cannot be sold, transferred or disposed of during the restricted period. The holders of Restricted Shares generally have the same rights as a shareholder of the Company with respect to such Restricted Shares, including the right to vote and receive dividends or other distributions paid with respect to the Restricted Shares.  The fair value of Restricted Shares was estimated by using the Company’s closing price on the grant date.

Subject to the satisfaction of service conditions, the outstanding Restricted Shares issued to the non-employee directors as of March 31, 2014 are expected to vest as follows:

 

There were no grants, forfeitures or vesting of Restricted Shares during the three months ended March 31, 2014 and 2013.

Awards Based on Restricted Stock Units.  As of March 31, 2014, the Company had outstanding RSUs issued to certain employees.  As described above, the RSUs granted during the three months ended March 31, 2014 are subject to pre-defined performance measures which cannot be determined at this time; therefore, no portion has been determined to be eligible for vesting as of March 31, 2014.  A portion of the RSUs granted during 2013 and 2012 remains subject to certain pre-defined performance measures of TSR for the defined periods in 2014 and 2015; therefore, this portion may be adjusted upon determination of the respective performance.  These RSU adjustments related to TSR performance will not affect unrecognized expense, as the fair value of the portion related to market-based awards (TSR) was established at the date of grant (described below) and actual performance does not affect expense recognition for this portion.  The portion of RSUs subject to performance measurement and adjustment ranges are disclosed in the second table below.  

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

 

The fair value for the RSUs granted during the three months ended March 31, 2014 was determined using the Company’s closing price on the grant date.  The fair value for the 2013 RSUs was determined separately for the component related to the Company specific performance measures (Adjusted EBITDA and Adjusted EBITDA Margin) and the component related to TSR targets.  The fair value of the 2013 RSUs component related to the Company specific performance measures was determined using the Company’s closing price on the grant date.  The fair value for the 2013 RSUs component related to TSR targets was determined by using a Monte Carlo simulation probabilistic model.  The inputs used in the probabilistic model for the Company and the peer companies were: average closing stock prices during January 2013; risk-free interest rates using the London Interbank Offered Rate (“LIBOR”) ranging from 0.27% to 0.91% over the service period; expected volatilities ranging from 30% to 63%; expected dividend yields ranging from 0.0% to 3.1%; and correlation factors ranging from (84%) to 95%.  The expected volatilities, expected dividends and correlation factors were developed using historical data.

A methodology similar to that employed for the 2013 RSUs was used to determine the fair value for the 2012 RSUs.  The inputs used in the probabilistic model for the Company and the peer companies were: average closing stock prices during January 2012; risk-free interest rates using the LIBOR ranging from 0.15% to 0.72% over the service period; expected volatilities ranging from 33% to 74%; expected dividend yields ranging from 0.0% to 2.5%; and correlation factors ranging from (67%) to 94%.  The expected volatilities, expected dividends and correlation factors were developed using historical data.

All RSUs awarded are subject to forfeiture until vested and cannot be sold, transferred or otherwise disposed of during the restricted period.  Dividend equivalents are earned at the same rate as dividends paid on our common stock after achieving the specified performance requirement for that component of the RSUs.

A summary of activity in 2014 related to RSUs is as follows:

 

 

 

All of the outstanding RSUs are subject to the satisfaction of service conditions and a portion of the outstanding RSUs are also subject to pre-defined performance measurements.  The RSUs outstanding as of March 31, 2014 potentially eligible to vest are listed in the table below:    

 

 

 

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

 

The grant date fair value of RSUs granted during the three months ended March 31, 2014 was $19.4 million.  There were no grants of RSUs during the three months ended March 31, 2013.   During the three months ended March 31, 2014 and 2013, there was no vesting of RSUs.

Awards Based on Common Stock.  A grant and issuance of 42,547 shares of common stock was made in March 2014 to the CEO pursuant to the terms of his 2013 annual incentive compensation award.  The number of shares was determined after deductions for withholding and payroll taxes and the shares were valued at the Company’s closing price as of the date of grant.   

Share-Based Compensation.  A summary of incentive compensation expense under share-based payment arrangements and the related tax benefit is as follows (in thousands):  

 

Unrecognized Share-Based Compensation.  As of March 31, 2014, unrecognized share-based compensation expense related to our awards of Restricted Shares, RSUs and common stock was $0.4 million, $27.0 million and $0.9 million, respectively.   Unrecognized share-based compensation expense will be recognized through April 2016 for Restricted Shares, November 2016 for RSUs and February 2015 for awards based on common shares.

Cash-Based Incentive Compensation. As defined by the Plan, annual incentive awards may be granted to eligible employees and payable in cash.  (In the case of the award to the CEO, the grant for 2013 payable in 2014 was paid in shares of common stock as described above.)  These awards are performance-based awards consisting of one or more business criteria or individual performance criteria and a targeted level or levels of performance with respect to each of such criteria.  Generally, the performance period is the calendar year and determination and payment is made in cash in the first quarter of the following year.

Share-Based Compensation and Cash-Based Incentive Compensation Expense.  A summary of incentive compensation expense is as follows (in thousands):  

 

 

 

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W&T OFFSHORE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

 

8.  Income Taxes  

Income tax expense of $6.6 million and $14.9 million was recorded during the three months ended March 31, 2014 and 2013, respectively.  Our effective tax rate for the three months ended March 31, 2014 was 37.3% and differed from the federal statutory rate of 35.0% primarily as a result of state income taxes and other permanent items.  The effective tax rate for the three months ended March 31, 2013 was 35.9% and differed from the federal statutory rate primarily as a result of state income taxes.

During 2013, we received refunds of $59.1 million, of which $9.5 million of these refunds have been accounted for as unrecognized tax benefits.  We recognize interest and penalties related to unrecognized tax benefits in income tax expense.  During the three months ended March 31, 2014 and 2013, we had less than $0.1 million of accrued interest expense related to our unrecognized tax benefit.  As of March 31, 2014 and December 31, 2013, we had a valuation allowance related to state net operating losses.  The realization of these assets depends on recognition of sufficient future taxable income in specific tax jurisdictions in which those temporary differences or net operating losses are deductible.  The tax years from 2010 through 2013 remain open to examination by the tax jurisdictions to which we are subject.

 

9.  Earnings Per Share

The following table presents the calculation of basic and diluted earnings per common share (in thousands, except per share amounts):

 

 

10.  Dividends

During the three months ended March 31, 2014 and 2013, we paid regular cash dividends per common share of $0.10 and $0.08, respectively.  On May 6, 2014, our board of directors declared a cash dividend of $0.10 per common share, payable on June 4, 2014 to shareholders of record on May 23, 2014.  

 

11.  Contingencies

Notice of Suspension and Debarment.  In November 2013, W&T Offshore, Inc., the Parent Company, received a Notice of Suspension and Proposed Debarment and a Notice of Clean Water Act Listing from the U.S. Environmental Protection Agency (the “EPA”).  The Notices were directed to only the Parent Company and do not name or apply to our wholly-owned subsidiaries.  The first Notice suspends the Parent Company and proposes a three year debarment from participation in future federal contracts, including future federal oil and gas leases, and assistance activities and renders the Parent Company ineligible to receive any federal contracts or approved subcontracts or to act as an agent or representative on behalf of another in such transaction, or receive certain federal benefits.  The second Notice provides a narrower prohibition on federal contracts or benefits for the Parent Company.  The Notices stemmed from the Parent Company’s previously disclosed plea agreement and corporate conviction on two criminal counts as described in Item 8, Financial Statements and Supplementary Data, in our Annual Report on Form 10-K for the year end December 31, 2013.  

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The Notices prevent the Parent Company from obtaining federal oil and gas leases, whether at a future lease sale or an existing lease by assignment.  The Notices do not affect current or future drilling or production operations or the existing lease ownership of the Parent Company.

The Company does not believe that the regulatory requirements for suspension and debarment exist.  The Company has corrected the issues leading to the 2009 offenses that form the basis for suspension and debarment and has been and remains a responsible operator.  Suspension is not necessary to protect the Government’s business interests.  The Company believes the EPA action fails to recognize the Company’s compliance with the plea agreement referenced above, our demonstration that the conditions which gave rise to the violations have been corrected and that the Company is a responsible operator acting under a comprehensive environmental and safety compliance program.  We have had continuing discussions with the EPA Suspension and Debarment Officials and made filings to contest the limitations in both Notices and seek to remove the suspension in a cooperative fashion as soon as practicable.  The timing and ultimate result of these efforts, however, cannot be predicted at this time.

Disqualification of waiver concerning certain supplement bonding requirements from the Bureau of Ocean Energy Management (“BOEM”).  In November and December 2013, W&T Offshore, Inc. received letters from the BOEM claiming that it no longer qualifies for a waiver of certain supplemental bonding requirements for potential offshore decommissioning, plugging, and abandonment liabilities. These letters pertain to the Parent Company’s prior supplemental bonding waiver.  Our wholly-owned subsidiary, Energy VI, is not exempt from supplemental bonding under BOEM’s procedures and therefore such wholly-owned subsidiary provides supplemental bonding for its plugging and abandonment liabilities. The supplemental bonding requirements are separate and distinct from the suspension and debarment issue described above.  The letters notified the Parent Company that it must provide supplemental bonding on certain of its offshore leases, rights of way and easements in the Gulf of Mexico.  We believe that this action is without basis and inconsistent with regulatory requirements.  We have had and continue to have discussions with representatives of the BOEM regarding this decision in an attempt to resolve this issue. We are also discussing potential additional supplemental bonding requirements that may be required to be met in the event that the BOEM’s decision regarding the Parent Company’s supplemental bonding waiver is not modified or reversed. While these discussions remain ongoing, in order to preserve our rights, in January 2014 we filed a Petition for Stay Pending Appeal and Request for Interim Relief with the U.S. Department of Interior’s Board of Land Appeals. The petition seeks a stay of any supplemental bonding requirements pending the appeal and to reverse BOEM’s revocation of W&T Offshore, Inc.’s waiver of supplemental bonding requirements. Initially, we were granted a stay until February 15, 2014 in response to our petition and recently we were granted a stay until June 15, 2014 to facilitate ongoing negotiations.  We continue to believe that the Parent Company qualifies for a supplemental bonding waiver.

The Parent Company has transferred certain assets together with associated ARO liability to our wholly-owned subsidiary, Energy VI.  These actions were taken to assist the Parent Company in its efforts to obtain from the BOEM a continuation of the waiver of supplemental bonding for the Parent Company.   We believe these efforts should result in the BOEM’s continuation of our waiver of supplemental bonding.  These actions have caused us to obtain additional supplemental bonds for Energy VI related to the ARO for the transferred properties, incurring approximately $0.9 million of additional bond fees.  Similar bonds fees will be required every year the bonds are in effect until the properties are plugged and abandoned.  To date, letters of credit have not been required to secure supplemental bonding for Energy VI, but it is possible that letters of credit may be required in the future.  The revolving bank credit facility allows for the issuance of up to $300.0 million of letters of credit.  If we were required to post letters of credit for this purpose, this would utilize a portion of our borrowing capacity available under our revolving bank credit facility.

Notification by ONRR of fine for non-compliance.  In December 2013 and January 2014, we were notified by the Office of Natural Resources Revenue (“ONRR”) of an underpayment of royalties on certain Federal offshore oil and gas leases that cumulatively approximated $30,000 over several years, which represents 0.0045% of royalty payments paid by us during the same period of the underpayment.  In March 2014, we received notice from the ONRR of a statutory fine of $2.3 million relative to such underpayment, which is substantially in excess of the underpayment.  We believe the fine is excessive and extreme considering the circumstances and in relation to the underpayment itself.  On April 23, 2014, we filed a request for a hearing on the record and a general denial of ONRR’s allegations contained in the notice.  We intend to contest the fine to the fullest extent possible.  As no amount has been determined as more likely than any other within the range of possible resolutions, no amount has been accrued as of March 31, 2014 per authoritative guidance.  However, we cannot state with certainty that our estimate of the exposure is accurate concerning this matter.  

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
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Insurance Claims.  During the fourth quarter of 2012, underwriters of W&T’s excess liability policies (“Excess Policies”) (Indemnity Insurance Company of North America, New York Marine & General Insurance Company, Navigators Insurance Company, XL Specialty Insurance Company and Liberty Mutual Insurance Co.) filed declaratory judgment actions in the United States District Court for the Southern District of Texas seeking a determination that our Excess Policies do not cover removal-of-wreck and debris claims arising from Hurricane Ike to the extent we have first exhausted the limits of our Energy Package (defined as certain insurance policies relating to our oil and gas properties which includes named windstorm coverage) with only removal-of-wreck and debris claims.  The court consolidated the various suits filed by the underwriters.  In January 2013, we filed a motion for summary judgment seeking the court’s determination that such Excess Policies do not require us to exhaust the limits of our Energy Package policies with only removal-of-wreck and debris claims.  In July 2013, the District Court ruled in favor of the underwriters, adopting their position that the Excess Policies cover removal-of-wreck and debris claims only to the extent the limits of our Energy Package policies have been exhausted with removal-of-wreck and debris claims.  We disagree with the Court’s ruling and have appealed the decision.  As of March 31, 2014, we had not filed any claims under such Excess Policies; however, claims were filed subsequent to March 31, 2014.  The amount in dispute is estimated at approximately $46.0 million, of which substantially all has been incurred.  Removal-of-wreck costs are recorded in Oil and natural gas properties and equipment on the Condensed Consolidated Balance Sheets.  If we are successful in our appeal, any recoveries from claims made on these Excess Policies will be recorded as reductions in this line item, which will reduce our DD&A rate.

Royalties.  In 2009, the Company recognized $5.3 million in allowable reductions of cash payments for royalties owed to the ONRR for transportation of their deepwater production through our subsea pipeline systems.  In 2010, the ONRR audited the calculations and support related to this usage fee, and in the third quarter of 2010, we were notified that the ONRR had disallowed approximately $4.7 million of the reductions taken.  We recorded a reduction to other revenue of $4.7 million in the third quarter of 2010 to reflect this disallowance; however, we disagree with the position taken by the ONRR and we are pursuing our claim to resolve the matter.

Other Claims.  We are a party to various pending or threatened claims and complaints seeking damages or other remedies concerning our commercial operations and other matters in the ordinary course of our business.  In addition, claims or contingencies may arise related to matters occurring prior to our acquisition of properties or related to matters occurring subsequent to our sale of properties.  In certain cases, we have indemnified the sellers of properties we have acquired, and in other cases, we have indemnified the buyers of properties we have sold.  We are also subject to federal and state administrative proceedings conducted in the ordinary course of business.  Although we can give no assurance about the outcome of pending legal and federal or state administrative proceedings and the effect such an outcome may have on us, we believe that any ultimate liability resulting from the outcome of such proceedings, to the extent not otherwise provided for or covered by insurance, will not have a material adverse effect on our consolidated financial position, results of operations or liquidity.

Contingent Liability Recorded.  There were minimal expenses recognized related to accrued and settled claims, complaints and fines for the three months ended March 31, 2014 and 2013.  As of March 31, 2014 and December 31, 2013, we have recorded $0.1 million and $0.2 million, respectively, which are included in Accrued liabilities on the Condensed Consolidated Balance Sheets, for the loss contingencies matters in the normal course of business.

 

 

12.  Subsequent Events

 

Borrowing Base.  Effective April 17, 2014, the borrowing base and the amount available for borrowing under the revolving bank credit facility was changed to $750.0 million.  There were no changes to the terms of the Credit Agreement, such as the maturity date, interest rates, covenants or collateral.  

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
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13.  Supplemental Guarantor Information

Our payment obligations under the 8.50% Senior Notes and the Credit Agreement (see Note 6) are fully and unconditionally guaranteed by certain of our wholly-owned subsidiaries, including W&T Energy VI, LLC and W&T Energy VII, LLC (together, the “Guarantor Subsidiaries”).  W&T Energy VII, LLC does not currently have any active operations or contain any assets.  Guarantees of the 8.50% Senior Notes will be released under certain circumstances, including:

(1) in connection with any sale or other disposition of all or substantially all of the assets of a Guarantor Subsidiary (including by way of merger or consolidation) to a person that is not (either before or after giving effect to such transaction) the Company or a Restricted Subsidiary (as such term is defined in the indenture governing the 8.50% Senior Notes) of the Company, if the sale or other disposition does not violate the “Asset Sales” provisions of the indenture;

(2) in connection with any sale or other disposition of the capital stock of such Guarantor Subsidiary to a person that is not (either before or after giving effect to such transaction) the Company or a Restricted Subsidiary of the Company, if the sale or other disposition does not violate the “Asset Sales” provisions of the indenture and the Guarantor Subsidiary ceases to be a subsidiary of the Company as a result of such sales or disposition;

(3) if such Guarantor Subsidiary is a Restricted Subsidiary and the Company designates such Guarantor Subsidiary as an Unrestricted Subsidiary in accordance with the applicable provisions of the indenture;

(4) upon Legal Defeasance or Covenant Defeasance (as such terms are defined in the indenture) or upon satisfaction and discharge of the indenture;

(5) upon the liquidation or dissolution of such Guarantor Subsidiary, provided no event of default has occurred and is continuing; or

(6) at such time as such Guarantor Subsidiary is no longer required to be a Guarantor Subsidiary of the 8.50% Senior Notes as described in the indenture, provided no event of default has occurred and is continuing.

The following unaudited condensed consolidating financial information presents the financial condition, results of operations and cash flows of the Parent Company and the Guarantor Subsidiaries, together with consolidating adjustments necessary to present the Company’s results on a consolidated basis.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
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Condensed Consolidating Balance Sheet as of March 31, 2014