UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

Form 10-Q

 

For the quarterly period ended March 31, 2015

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 4, 2015, there were 75,936,731 shares outstanding of the registrant’s common stock, par value $0.00001.

 

 

 

 

---

W&T OFFSHORE, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

 

 

 

 

 

---

PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements

W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

See Notes to Condensed Consolidated Financial Statements.

1

---

W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See Notes to Condensed Consolidated Financial Statements.

 

 

2

---

 

W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

 

 

See Notes to Condensed Consolidated Financial Statements.

 

 

3

---

 

W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See Notes to Condensed Consolidated Financial Statements.

 

 

 

4

---

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,” “we,” “us,” “our,” 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. (on a stand-alone basis, the “Parent Company”) and our 100%-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, 2014.

Transactions between Entities under Common Control.  The prior period financial information for the three months ended March 31, 2014 presented in Note 13, Supplemental Guarantor Information, has been retrospectively adjusted due to transactions between entities under common control, as required under authoritative guidance.

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.

Ceiling Test Write-Down.  Under the full cost method of accounting, we are required to periodically perform a “ceiling test,” which determines a limit on the book value of our oil and natural gas properties.  If the net capitalized cost of oil and natural gas properties (including capitalized ARO) net of related deferred income taxes, exceeds the ceiling test limit, the excess is charged to expense on a pre-tax basis and separately disclosed.  Any such write downs are not recoverable or reversible in future periods.  The ceiling test limit is calculated as: (i) the present value of estimated future net revenues from proved reserves, less estimated future development costs, discounted at 10%; (ii) plus the cost of unproved oil and natural gas properties not being amortized; (iii) plus the lower of cost or estimated fair value of unproved oil and natural gas properties included in the amortization base; and (iv) less related income tax effects.  Estimated future net revenues used in the ceiling test for each period are based on current prices, defined by the SEC as the unweighted average of first-day-of-the-month commodity prices over the prior twelve months for that period. All prices are adjusted by field for quality, transportation fees, energy content and regional price differentials.

Due to declines in the unweighted rolling average of first-day-of-the-month commodity prices in oil and natural gas prices, for the three months ended March 31, 2015, we recorded a ceiling test write-down which is reported as a separate line in the Statement of Operations.   We did not have a ceiling test write-down for the three months ended March 31, 2014.  Assuming oil and natural gas prices that we realized during the three months ended March 31, 2015 continue, we will likely have additional ceiling test write-downs during 2015.  The magnitude of these write-downs cannot be estimated at this time.

 

5

---

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

 

Recent Events.  The price we receive for our oil, natural gas liquids (“NGLs”) and natural gas production directly affects our revenues, profitability, cash flows, liquidity, access to capital and future rate of growth.  The prices of these commodities began falling beginning in the second half of 2014 and were significantly lower in the three months ended March 31, 2015 compared to the last few years.  

We have taken several steps to mitigate the effects of these lower prices including: (i) significantly reducing the 2015 capital budget from the previous year; (ii) suspending our drilling and completion activities at several locations; (iii) suspending the regular quarterly common stock dividend and (iv) implementing numerous cost reduction projects to reduce our operating costs.  

In April 2015, we entered into the First Amendment to the Fifth Amended and Restated Credit Agreement (the “Amendment”), which (i) set the borrowing base under our revolving credit facility at $600.0 million, (ii) provided that the borrowing base be reduced by $0.33 for every $1.00 of unsecured indebtedness, or debt which is subordinate in security compared to the lien securing borrowings under our revolving credit facility, in excess of the $900.0 million aggregate principal amount of existing notes, until such time as the borrowing base has been redetermined by the lenders, and (iii) amended certain existing covenants.  See Note 12 for additional information regarding the Amendment.  

In May 2015, we announced the pricing and marketing of a $300.0 million five-year second-lien term loan.  The transaction did not close prior to the filing of this Form 10-Q and there is no assurance the term loan will be finalized and made.  See Note 12 for additional information.  

We have assessed our financial condition, the current capital markets and options given different scenarios of commodity prices and believe we will have adequate liquidity to fund our operations through March 31, 2016; however, we cannot predict how an extended period of low commodity prices will affect our operations and liquidity levels.

 

Recent Accounting Developments.  In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2015-03 (“ASU 2015-03”), Interest – Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs.  The guidance seeks to simplify the presentation of debt issuance costs.  The amendment would require debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of debt liability, consistent with debt discounts or premiums.  The recognition and measurement guidance for debt issuance costs would not be affected by the amendment.  ASU 2015-03 is effective in 2016 and should be applied on a retrospective basis.  Early adoption is permitted.  We do not expect the revised guidance to materially affect our balance sheet as amounts will be reclassified from long-term assets to partial offsets to long-term debt.  The revised guidance will not affect the statements of operations or the statements of cash flows.  

In August 2014, the FASB issued Accounting Standards Update No. 2014-15 (“ASU 2014-15”), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (Subtopic 205-40).  The guidance addresses management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures.  ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter.  We do not expect the revised guidance to materially affect our evaluation as to being a going concern, or have an effect on our financial statements or related disclosures.  

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (“ASU 2014-09”), Summary and Amendments that Create Revenue from Contracts and Customers (Topic 606).  ASU 2014-09 amends and replaces current revenue recognition requirements, including most industry-specific guidance.  The revised guidance establishes a five step approach to be utilized in determining when, and if, revenue should be recognized.  ASU 2014-09 is effective for annual and interim periods beginning after December 15, 2017.  Upon application, an entity may elect one of two methods, either restatement of prior periods presented or recording a cumulative adjustment in the initial period of application.  We have not determined the effect ASU 2014-09 will have on the recognition of our revenue, if any, nor have we determined the method we will utilize upon adoption, which would be in the first quarter of 2018.

    

6

---

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

 

    

2.  Acquisitions and Divestitures

2014 Acquisitions

Fairway  

On September 15, 2014, the Parent Company entered into an asset purchase agreement with a third party to increase its ownership interest from 64.3% to 100% in the Mobile Bay blocks 113 and 132 (the “Fairway Field”) and the associated Yellowhammer gas processing plant (collectively, “Fairway”).  The Fairway Field is located in the state waters of Alabama and the Yellowhammer gas processing plant is located in the state of Alabama.  The effective date of the transaction was July 1, 2014.  The transaction included customary adjustments for the effective date, certain closing adjustments and our assumption of the related asset retirement obligations (“ARO”).  A net purchase price increase of $1.3 million for customary final closing adjustments was recorded in 2015.  The acquisition was funded from borrowings under our revolving bank credit facility and cash on hand.

The following table presents the purchase price allocation, including adjustments, for the increased ownership interest in Fairway (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 this acquisition of an additional working interest in Fairway.

Woodside Properties  

On May 20, 2014, Energy VI entered into a purchase and sale agreement to acquire certain oil and natural gas property interests from Woodside Energy (USA) Inc. (“Woodside”).  The properties acquired from Woodside (the “Woodside Properties”) consisted of a 20% non-operated working interest in the producing Neptune field (deepwater Atwater Valley blocks 574, 575 and 618), along with an interest in the Neptune tension-leg platform, associated production facilities and various interests in 24 other deepwater lease blocks.  All of the Woodside Properties are located in the Gulf of Mexico.  The effective date of the transaction was November 1, 2013.  The transaction included customary adjustments for the effective date, certain closing adjustments and our assumption of the related ARO.  The acquisition was funded from borrowings under our revolving bank credit facility and cash on hand.

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

 

 

7

---

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

 

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 Woodside Properties acquisition.

2014 Acquisitions — Revenues, Net Income and Pro Forma Financial Information  

The increase in working interest ownership for Fairway was not included in our consolidated results until the property transfer date, which occurred in September 2014 and the incremental revenue and operating expenses were immaterial for the three month period ended March 31, 2015.  Unaudited pro forma information is not presented as the pro forma information is not materially different from the reported results presented for the three months ended March 31, 2014.  

The Woodside Properties were not included in our consolidated results until the property transfer date, which occurred in May 2014.  For the three months ended March 31, 2015, the Woodside Properties accounted for $5.5 million of revenues, $3.2 million of direct operating expenses, $4.1 million of depreciation, depletion, amortization and accretion (“DD&A”) and $0.6 million of income tax benefit, resulting in $1.2 million of net loss.  The net loss attributable to the Woodside 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 Woodside Properties are not recorded in a separate entity for tax purposes; therefore, income tax was estimated using the federal statutory tax rate.    

In accordance with the applicable accounting guidance, the unaudited pro forma financial information was computed as if the acquisition of the Woodside Properties had been completed on January 1, 2013.  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 interim periods, and the Woodside Properties’ unaudited historical financial statements for the annual and interim periods.

The pro forma adjustments were based on estimates by management and information believed to be directly related to the purchase of the Woodside Properties.  The pro forma financial information is not necessarily indicative of the results of operations had the purchase occurred on January 1, 2013.  Had we owned the Woodside Properties during the periods indicated, the results may have been substantially different.  For example, we may have operated the assets differently than Woodside; the realized sales prices for oil, NGLs and natural gas may have been different; and the costs of operating the Woodside Properties may have been different.

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 our financial records, Woodside’s financial records and certain information was estimated.  

8

---

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

 

The following table presents incremental items included in the pro forma information reported above for the Woodside 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.

 

9

---

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

 

 

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. As of March 31, 2015 and December 31, 2014, we did not have any open derivative contracts.  During 2014, we used crude oil swap contracts and have used various derivative instruments in recent years to manage our exposure to commodity price risk from sales of our oil and natural gas. While these contracts were intended to reduce the effects of price volatility, they may have limited income from favorable price movements.

We have elected not to designate our commodity derivative contracts as hedging instruments; therefore, all changes in the fair value of derivative contracts were recognized currently in earnings during the three months ended March 31, 2014.  The cash flows of all of our commodity derivative contracts are included in Net cash provided by operating activities on the Condensed Consolidated Statements of Cash Flows.

Changes in the fair value of our oil derivative contracts were as follows (in thousands):

 

 

Cash payments on derivative settlements, net, are included within Net cash provided by operating activities on the Condensed Consolidated Statements of Cash Flows and were as follows (in thousands):

 

10

---

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

 

 

5.  Long-Term Debt

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

 

 

At March 31, 2015 and December 31, 2014, 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, 2015.  

As of March 31, 2015, the Fifth Amended and Restated Credit Agreement (the “Original Credit Agreement”) governed our revolving bank credit facility and matures 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 both March 31, 2015 and December 31, 2014, we had $0.6 million of letters of credit outstanding under the revolving bank credit facility.  The estimated annual effective interest rate was 3.2% for the three months ended March 31, 2015 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, 2015, our borrowing base was $750.0 million and our borrowing availability was $235.4 million.  

In April 2015, we entered into the Amendment to the Original Credit Agreement (collectively, the “Credit Agreement”).  The maturity date of the Original Credit Agreement was not changed by the Amendment and remains at November 8, 2018.  The Amendment lowered the borrowing base to $600.0 million, revised the financial covenant tests and obligated us to certain additional restrictions and conditions.  In addition, the Amendment modified certain financial ratio covenants retroactively to the reporting period for March 31, 2015.  See Note 12 for information on the Amendment, the Credit Agreement and a pending term loan transaction.

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, a maximum leverage ratio, a maximum first lien leverage ratio, a maximum secured debt leverage ratio and a minimum interest coverage ratio.  We were in compliance with all applicable covenants of the Credit Agreement as of March 31, 2015.  

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

11

---

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 open 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, although 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 8.50% Senior Notes and revolving bank credit facility, both of which are reported as liabilities (in thousands):

 

 

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 2014 and in 2013, the Company granted restricted stock units (“RSUs”) to certain of its employees.  During the three months ended March 31, 2015, no RSUs were granted. 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 2014, RSUs granted were subject to adjustments based on achievement of 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.  For 2014, the Company was above target for Adjusted EBITDA and was slightly below target for Adjusted EBITDA Margin.    

During 2013, RSUs granted were also subject to adjustments based on achievement of 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 and was approximately at target for 2013 Adjusted EBITDA Margin.  For 2014 and 2013, the Company was below target for the TSR rankings for each period.  

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 2013 will vest in December 2015 to eligible employees assuming the requisite performance goals are also satisfied.

12

---

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

 

The 2014 annual incentive award for the Chief Executive Officer (“CEO”) was settled in shares of common stock based on a pre-determined price of $14.66 per share, pursuant to the terms of his award.  In March 2015, after reductions for employee payroll and withholding taxes, the net amount of the CEO’s 2014 award resulted in 37,316 shares of common stock issued to the CEO.  The 2013 annual incentive award for the CEO was settled in shares of common stock based at the price of $14.84, which was the Company’s closing price the day prior to the settlement date.  In March 2014, after reductions for employee payroll and withholding taxes, the net amount of the CEO’s 2013 award resulted in 42,547 shares of common stock issued to the CEO.  The CEO awards for both years were 100% performance based and were subject to pre-defined performance measures, which were the same pre-defined performance measures established for the other eligible Company employees, and were subject to approval of the Compensation Committee.  

Under the Director Compensation Plan, shares of restricted stock (“Restricted Shares”) have been granted to the Company’s non-employee directors.  No grants to non-employee directors were made during the three months ended March 31, 2015 but grants were made during 2014 and 2013.  The Restricted Shares are subject to service conditions and vesting occurs at the end of specified service periods.  

At March 31, 2015, there were 4,752,766 shares of common stock available for issuance in satisfaction of awards under the Plan and 500,564 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 Shares or shares of common stock are granted.  RSUs reduce the shares available in the Plan when the RSUs are settled in shares of common stock, net of withholding tax.  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 to Non-Employee Directors.  As of March 31, 2015, all of the unvested shares of 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, 2015 are expected to vest as follows:

 

 

There were no grants, forfeitures or vesting of Restricted Shares during the first quarter of 2015 or the first quarter of 2014.  

Awards Based on Restricted Stock Units.  As of March 31, 2015, the Company had outstanding RSUs issued to certain employees.  As described above, the RSUs granted during 2014 and 2013 were 100% performance based and were subject to pre-defined performance measures.  A portion of the RSUs granted during 2013 remains subject to the performance measure of TSR for the defined period in 2015; therefore, the number of RSUs may be adjusted upon determination of the performance.  The RSUs subject to performance measurement which has not yet been determined are disclosed in the table below for RSUs potentially eligible to vest.  

13

---

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

 

The fair value for the RSUs granted during 2014 was determined using the Company’s closing price on the grant date as the performance measures were all Company-specific performance measures comprised of Adjusted EBITDA and Adjusted EBITDA Margin.  The fair value for the 2013 RSUs was determined separately for the components related to the TSR targets and the Company specific performance measures (Adjusted EBITDA and Adjusted EBITDA Margin).  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 a negative 84% to a positive 95%.  The expected volatilities, expected dividends and correlation factors were developed using historical data.  The fair value of all other 2013 RSUs components was determined using the Company’s closing price on the grant date.  

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 2015 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, 2015 potentially eligible to vest are listed in the table below:    

 

 

 

The grant date fair value of RSUs granted during the three months ended March 31, 2014 was $19.4 million.  During the first quarter of 2015 and the first quarter of 2014, no RSUs vested.  

  

14

---

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

 

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, 2015, unrecognized share-based compensation expense related to our awards of Restricted Shares and RSUs was $0.4 million and $13.7 million, respectively.   Unrecognized share-based compensation expense will be recognized through April 2017 for Restricted Shares and November 2016 for RSUs.

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 awards for 2014 and 2013 were 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.  As of March 31, 2015, the Company did not issue any cash-based incentive awards for 2015.

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

 

 

 

15

---

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

 

8.  Income Taxes  

Income tax benefit was $103.6 million and income tax expense was $6.6 million for the three months ended March 31, 2015 and 2014, respectively.  Our annualized effective tax rate of 28.9% for the three months ended March 31, 2015 differs from the federal statutory rate of 35% due to the effect of a valuation allowance for our deferred tax assets.  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.  

During the quarter ended March 31, 2015, we recorded a valuation allowance of $22.5 million related to federal deferred tax assets and net operating losses. Additionally, as of March 31, 2015 and December 31, 2014, we had a valuation allowance related to Louisiana state net operating losses. Deferred tax assets are recorded related to net operating losses and temporary differences between the book and tax basis of assets and liabilities expected to produce tax deductions in future periods. 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.  In assessing the need for a valuation allowance on our deferred tax assets, we consider whether it is more likely than not that some portion or all of them will not be realized.  The tax years from 2010 through 2014 remain open to examination by the tax jurisdictions to which we are subject.  

We recognize interest and penalties related to unrecognized tax benefits in income tax expense.  During the three months ended March 31, 2015 and 2014, we recorded immaterial amounts of accrued interest expense related to our unrecognized tax benefit.

 

9.  Earnings Per Share

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

 

 

 

 

10.  Dividends

During the three months ended March 31, 2015, we did not declare or pay any dividends.  During the three months ended March 31, 2014, we paid regular cash dividends per common share of $0.10.  Pursuant to the Credit Agreement, the regular quarterly dividend is suspended until June 2016, and may be suspended further depending on certain financial covenants.  See Note 12 for additional information.  

16

---

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

 

 

11.  Contingencies

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.  We believe the fine is excessive and extreme considering the circumstances and in relation to the amount of underpayment.  On April 23, 2014, we filed a request for a hearing on the record and a general denial of the ONRR’s allegations contained in the notice.  We intend to contest the fine to the fullest extent possible.  The ultimate resolution may result in a waiver of the fine, a reduction of the fine, or payment of the full amount plus interest covering several years.  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, 2015 or December 31, 2014 per authoritative guidance.  However, we cannot state with certainty that our estimate of the exposure is accurate concerning this matter.      

Apache Lawsuit.   On December 15, 2014, Apache Corporation (“Apache”) filed a lawsuit against W&T Offshore, Inc., alleging that W&T breached the joint operating agreement (“JOA”) related to deepwater wells in the Mississippi Canyon area of the Gulf of Mexico.  That lawsuit, styled Apache Corporation v. W&T Offshore, Inc., is currently pending in the United States District Court for the Southern District of Texas.  Apache contends that W&T has failed to pay its proportional share of the costs associated with plugging and abandoning three wells that are subject to the JOA.  We contend that the costs incurred by Apache are excessive and unreasonable.  Apache seeks an award of unspecified actual damages, interest, court costs, and attorneys’ fees.  In February 2015, we made a payment to Apache for our net share of the amounts that we believe are reasonable to plug and abandon the three wells, all of which was originally recorded as an asset retirement obligation and was accrued on our balance sheet as of December 31, 2014.  Our estimate of the potential exposure ranges from zero to $32 million related to this matter, which excludes potential interest, court costs and attorneys’ fees. 

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, National Liability & Fire Insurance Company (“Starr Marine”)  and Liberty Mutual Insurance Co.) filed declaratory judgment actions in the United States District Court for the Southern District of Texas (the “District Court”) seeking a determination that our Excess Policies do not cover removal-of-wreck and debris claims arising from Hurricane Ike except 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 appealed the decision in the United States Court of Appeals for the Fifth Circuit (the “Fifth Circuit”) and, in June 2014, the Fifth Circuit reversed the District Court’s ruling and ruled in our favor.  The underwriters filed three separate briefs requesting a rehearing or a certification to the Texas Supreme Court, all of which the Court denied.  A brief was subsequently filed by one underwriter requesting a rehearing to the District Court of the Fifth Circuit’s decision, which the District Court denied.  Claims of approximately $42 million were filed, of which approximately $1 million was paid under the Energy Package and of which approximately $1 million was paid under our Comprehensive General Liability policy.  One of the underwriters, Liberty Mutual Insurance Co., paid their portion of the settlement (approximately $5 million), in addition to a portion of interest owed.  The other underwriters have not paid in accordance with the Fifth Circuit ruling, and we filed a lawsuit in September 2014 against these underwriters for amounts owed, interest, attorney fees and damages.  Subsequent to the filing of that lawsuit, Starr Marine has paid their portion ($5 million) of the first excess liability policy without interest.  The lawsuit includes claims for interest underpaid by Liberty Mutual Insurance Co. and interest not paid by Starr Marine. The revised estimate of potential reimbursement is approximately $30 million, plus interest, attorney fees and damages, if any.  Removal-of-wreck costs are recorded in Oil and natural gas properties and equipment on the Condensed Consolidated Balance Sheets and recoveries from claims made on these Excess Policies will be recorded as reductions in this line item, which will reduce our future DD&A rate.

17

---

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

 

Royalties.  In 2009, the Company recognized 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 2010, we were notified that the ONRR had disallowed approximately $4.7 million of the reductions taken.  We recorded a reduction to other revenue in 2010 to reflect this disallowance; however, we disagree with the position taken by the ONRR.  We filed an appeal with the ONRR, which was denied in May 2014.  On June 17, 2014, we filed an appeal with the Board of Land Appeals (the “BLA”) under the Department of the Interior.  W&T’s brief was filed in November 2014 and we expect the briefing before BLA to be completed in the first half of 2015.

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 no material expenses recognized related to accrued and settled claims, complaints and fines for the three months ended March 31, 2015 and 2014.  As of March 31, 2015 and December 31, 2014, we have recorded in liabilities no material amounts for claims, complaints and fines.  

 

 

12.  Subsequent Events

Amendment to the Credit Agreement. On April 23, 2015, the Company entered into the Amendment among the Company, as the borrower, Toronto Dominion (Texas) LLC, as the administrative agent, the lenders and other parties thereto.  The Credit Agreement, as amended, provides a secured revolving bank credit facility that matures on November 8, 2018.  The Amendment set the borrowing base as of the date of the Amendment at $600.0 million, subject to adjustments as described below.  

The Amendment increased the applicable margin applied to borrowings under the Credit Agreement by 50 basis points (0.5%) on an annual basis such that the LIBOR borrowings are subject to applicable margins ranging from 2.25% to 3.25% and alternate base rate borrowings are subject to applicable margins ranging from 1.25% to 2.25%.  

The Amendment permits the Company to issue additional unsecured indebtedness, or indebtedness which is subordinate in security compared to the lien securing the indebtedness under the Credit Agreement, above its current $900.0 million in aggregate principal amount of outstanding senior notes, provided that, among other things, (A) no event of default has occurred or would result from such incurrence, (B) the Company is in compliance with its current ratio, leverage ratio, secured debt leverage ratio and interest coverage ratio after giving pro forma effect to the incurrence of the additional  indebtedness, and (C) such additional indebtedness matures at least six months after the maturity date of the Credit Agreement and is not subject to covenants and events of default that are, taken as a whole, materially more onerous than those provided for in the Credit Agreement.  

Following the Amendment, if the Company issues additional unsecured indebtedness in excess of the $900.0 million in aggregate principal amount of existing senior notes or if the Company issues debt that is subordinated in security to the indebtedness secured under the Credit Agreement, the borrowing base then in effect will be reduced by $0.33 for each dollar of such excess until the borrowing base is redetermined.  In addition, the borrowing base will be reduced to $550.0 million effective October 1, 2015 irrespective of whether any additional indebtedness is issued.  The Amendment also restricts the ability of the Company to make distributions or repurchase the existing senior notes or other permitted indebtedness (i)  until June 30, 2016, (ii) if an event of default is continuing or would result from such distribution or (iii) if a borrowing base deficiency is continuing or would result therefrom; provided that the restriction in clause (i) of this sentence does not apply to (A) scheduled payments of interest, principal or redemptions on the Company’s existing senior notes or other permitted additional debt and (B) the redemption or repurchase by the Company of  its outstanding senior notes in an aggregate principal amount equal to the aggregate principal amount of any new issuance of senior unsecured notes, provided that any such new notes are not subject to covenants and events of default that are, taken as a whole, materially more restrictive on the Company than its outstanding senior notes and such new notes mature at least six months after the maturity date of the Credit Agreement.

18

---

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

 

The Amendment revised the financial covenants, with definitions of capitalized terms contained in the Credit Agreement, as follows:  

The Amendment increases the mortgaged collateral requirement from 80% to 90% of the total value of both the (i) total proved oil and gas reserves of the loan parties and (ii) the proved developed producing reserves of the loan parties.  The Amendment requires the Company to establish and maintain minimum hedge positions by June 1, 2015 of 25% of estimated oil and gas production for the period of June 1 to December 31, 2015 and 35% of estimated oil and gas production for 2016.  

The foregoing description of the Credit Agreement does not purport to be complete and is qualified in its entirety by reference to the Amendment and the Original Credit Agreement.

 

Second Lien Term Loan.  On May 5, 2015, we announced the pricing and marketing of a $300.0 million five-year second-lien term loan.  The term loan is expected to be made subject to a 1.0% discount to principal bearing interest at an annual rate of 9.0%.  It is expected that the CEO, or an entity controlled by the CEO, will participate in the term loan for a $5.0 million principal commitment on the same terms as the other lenders.  Net borrowings under the term loan will be used to repay a portion of the outstanding borrowings under the revolver bank credit facility.  Upon issuance of the term loan, the borrowing base of the revolving bank credit facility will be reduced from $600.0 million to $500.0 million pursuant to the terms of the Credit Agreement, as amended.  

The lender commitments and making of the term loan are subject to the negotiation, approval and execution of definitive loan documentation, which includes an intercreditor agreement to be approved by the lenders under the Credit Agreement, as amended.  The transaction did not close prior to the filing of this Form 10-Q.  While the transaction is expected to close during May 2015, there is no assurance the term loan will be finalized and made.

 

19

---

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

 

 

13.  Supplemental Guarantor Information

Our payment obligations under the 8.50% Senior Notes and the Credit Agreement (see Note 5 and Note 12) are fully and unconditionally guaranteed by certain of our 100%-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 as described in the indenture, provided no event of default has occurred and is continuing.

 

The following 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.  Transfers of property, including related ARO and deferred income tax liabilities, were made during 2014 from the Parent Company to the Guarantor Subsidiaries to assist the Parent Company to continue to qualify for a waiver of certain supplemental bonding requirements from the Bureau of Ocean Energy Management.  As these transfers were transactions between entities under common control, the prior period financial information has been retrospectively adjusted for comparability purposes, as prescribed under authoritative guidance.  The condensed consolidating financial information for the prior period ended March 31, 2014 was adjusted as if all transfers occurred at the beginning of the period presented.  None of the above adjustments had any effect on the consolidated results for the current or prior periods presented.

 

 

 

20

---

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

 

Condensed Consolidating Balance Sheet as of March 31, 2015

 

 

 

21

---

 

Condensed Consolidating Balance Sheet as of December 31, 2014