UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

Form 10-Q

 

For the quarterly period ended March 31, 2016

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 2, 2016, there were 76,508,829 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

(In thousands, except share data)

 

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W&T OFFSHORE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

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 (DEFICIT)

 

 

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. (with subsidiaries referred to herein as “W&T,” “we,” “us,” “our,” or the “Company”) is an independent oil and natural gas producer with operations offshore in the Gulf of Mexico.  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 its 100%-owned subsidiary, W & T Energy VI, LLC (“Energy VI”).  On October 15, 2015, a substantial amount of our interest in onshore acreage was sold, which is described in Note 2.  

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, 2015.

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.

Recent Events.  The price we receive for our crude 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 in the second half of 2014, continued to generally decline in 2015 and declined further in the first quarter of 2016.   Steps taken  during 2015 and 2016 to mitigate the effects of these lower prices include: (i) significantly reducing the budgeted capital spending for 2016; (ii) continuing the suspension of our drilling and completion activities at several locations; (iii) continued suspension of the regular quarterly common stock dividend; (iv) selling our interests in the Yellow Rose field in the fourth quarter of 2015; (v) reducing our headcount of employees and contractors; and (vi) continuing the implementation of numerous projects to reduce our operating costs.  See our Annual Report on Form 10-K for the year ended December 31, 2015 concerning risks related to our business and events occurring during 2015 and other information.  

In February 2016, we borrowed $340.0 million under the Fifth Amended and Restated Credit Agreement (as amended, the “Credit Agreement”).  On March 23, 2016, the banks reduced our borrowing base to $150.0 million from $350.0 million in connection with the spring borrowing base redetermination.  We are required to repay borrowings outstanding in excess of the redetermined borrowing base pursuant to the terms of the Credit Agreement.  On March 31, 2016, we repaid $52.0 million leaving an outstanding balance under the Credit Agreement of $288.0 million as of March 31, 2016.  We also had approximately $1.0 million of letters of credit outstanding as of March 31, 2016.  On May 2, 2016, we repaid an additional $12.0 million.  Additional payments are required of $64.0 million on May 30, 2016 and $64.0 million on June 30, 2016, in addition to interest payments on our long-term debt, which will bring total borrowings outstanding under the credit agreement in conformity with the borrowing base limitation.  See Note 5 for additional information.

    

 

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

In February and March 2016, we received several orders from the Bureau of Ocean Energy Management (“BOEM”) demanding that we provide additional supplemental bonding on certain Federal offshore oil and gas leases, rights of way and rights of use and easement owned and/or operated by the Company.  One order was rescinded and re-issued and another one was rescinded. The outstanding orders total approximately $260.8 million.  We have filed appeals with the Interior Board of Land Appeals (“IBLA”) regarding three of the BOEM orders - specifically the February order that required W&T to post a total of $159.8 million in supplemental bonding and two March orders requiring $68.0 million in supplemental bonding.  We have had discussions with the BOEM and its sister agency, the Bureau of Safety and Environmental Enforcement (“BSEE”), since receiving the orders.  The objective of the Company remains to reach a mutual agreement on the financial assurance requirements of the demands.  The issuance of any additional surety bonds to satisfy the BOEM orders or any future BOEM orders may require the posting of cash collateral, which may be significant, and the creation of escrow accounts.  We continue to have discussions with the BOEM regarding these matters.  See Notes 11 and 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, 2017; however, we cannot predict how an extended period of low commodity prices or the impact of future bonding requirements will affect our operations, liquidity levels and compliance with debt covenants.

Ceiling Test Write-Down.  Under the full cost method of accounting, each quarter we are required to 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 asset retirement obligations (“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 for each product, 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 primarily to declines in the unweighted rolling 12-month average of first-day-of-the-month commodity prices for oil and natural gas, we recorded ceiling test write-downs in the first quarter of 2016 and 2015, which are reported as a separate line in the Statements of Operations.  The average price using the SEC required methodology at March 31, 2016 was $42.77 per barrel for West Texas Intermediate (“WTI”) crude oil and $2.40 per million British Thermal Unit  (“MMBtu”) for Henry Hub natural gas before adjustments.  Ceiling test write-downs of the carrying value of our oil and natural gas properties for the three months ended March 31, 2016 and 2015 were $116.6 million and $260.4 million, respectively.  The ceiling test write-down for the full year of 2015 was $987.2 million.  If crude oil and natural gas prices remain or decrease from current levels, it is probable that a ceiling test write-down will be recorded in the second quarter of 2016 and possibly in subsequent quarters during 2016.  

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

Prepaid Expenses and Other.  Amounts recorded in Prepaid expenses and other on the Condensed Consolidated Balance Sheets are expected to be realized within one year.  Major categories are disclosed in the following table:

 

Recent Accounting Developments.  In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-09 (“ASU 2014-09”), Summary and Amendments That Create Revenue from Contracts and Customers (Subtopic 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.

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 February 2016, the FASB issued Accounting Standards Update No. 2016-02 (“ASU 2016-02”), Leases (Subtopic 842).  Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current GAAP, the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease.  However, unlike current GAAP, which requires only capital leases to be recognized on the balance sheet, ASU 2016-02 will require both types of leases to be recognized on the balance sheet.  ASU 2016-02 also will require disclosures to help investors and other financial statement users to better understand the amount, timing and uncertainty of cash flows arising from leases.  These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements.  ASU 2016-02 does not apply for leases for oil and gas properties, but does apply to equipment used to explore and develop oil and gas resources.  Our current operating leases that will be impacted by ASU 2016-02 when it is effective are leases for office space in Houston and New Orleans, although ASU 2016-02 may impact the accounting for leases related to operations equipment depending on the term of the lease.  We currently do not have any leases classified as financing leases.  ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018 and is to be applied using the modified retrospective approach.  We have not yet fully determined or quantified the effect ASU 2016-02 will have on our financial statements.

In March 2016, the FASB issued Accounting Standards Update No. 2016-09 (“ASU 2016-09”), Compensation – Stock Compensation (Subtopic 718).  The objective of ASU 2016-09 is for simplification involving several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows.  ASU 2016-09 is effective for annual and interim periods beginning after December 15, 2016 and early adoption is permitted.  We have not yet fully determined or quantified the effect ASU 2016-09 will have on our financial statements. 

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

2.  Divestitures

2015 Divestiture

On October 15, 2015, we sold certain onshore oil and natural gas property interests to Ajax Resources, LLC (“Ajax”) for approximately $370.8 million in cash, which includes certain customary post effective date price adjustments, and Ajax assumed responsibility for the related ARO and other associated liabilities.  The effective date of the sale was January 1, 2015.  A net purchase price adjustment of $1.0 million was recorded during the three months ended March 31, 2016.  Ajax acquired all of our interest in the Yellow Rose field in the Permian Basin, covering approximately 25,800 net acres in Andrews, Martin, Gaines and Dawson counties in West Texas.  We retained a non-expense bearing overriding royalty interest (“ORRI”) in production from the working interests assigned to Ajax, which percentage varies on a sliding scale from one percent for each month that the New York Mercantile Exchange (“NYMEX”) prompt month contract trading price for light sweet crude oil is at or below $70.00 per barrel to a maximum of four percent for each month that such NYMEX trading price is greater than $90.00 per barrel.  

Under the full cost method, sales or abandonments of oil and natural gas properties, whether or not being amortized, are accounted for as adjustments of capitalized costs, with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and natural gas attributable to the cost center.  The sale to Ajax did not represent greater than 25% of the Company’s proved reserves of oil and natural gas attributable to the full cost pool.  As a result, alteration in the relationship between capitalized costs and proved reserves of oil and natural gas attributable to the full cost pool was not deemed significant and no gain or loss was recognized from the sale.        

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):  

 

 

 

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

 

4.  Derivative Financial Instruments

Our market risk exposure relates primarily to commodity prices and, from time to time, we use various derivative instruments to manage our exposure to this commodity price risk from sales of our oil and natural gas.  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.

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 periods presented.  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.

For information about fair value measurements, refer to Note 6.

Commodity Derivatives

As of March 31, 2016, we have open crude oil and natural gas derivative contracts for a portion of our anticipated future production for the remainder of 2016.  These contracts were entered into during the second quarter of 2015.  The open oil derivative contracts are known as “two-way”, “costless” collars, which consist of a purchased put option and a sold call option.  These two-way collars provide price risk protection if crude oil prices fall below certain levels, but may limit incremental income from favorable price movements above certain limits.  The oil contracts are based on WTI crude oil prices as quoted off the NYMEX.  The open natural gas derivative contracts are known as “three-way collars” consisting of a purchased put option, a sold call option and a purchased call option, each at varying strike prices.  The three-way collar contracts are structured to provide price risk protection if the commodity price falls below the strike price of the put option and provides us the opportunity to benefit if the commodity price rises above the strike price of the purchased call option.  These contracts may have the effect of reducing some of our incremental income from favorable price movements if the commodity price is above certain levels, but have unlimited upside potential if prices rise above those levels.  The natural gas contracts are based on Henry Hub natural gas prices as quoted off the NYMEX.  The strike prices of both the oil and natural gas contracts were set so that the contracts were premium neutral (“costless”), which means no net premium was paid to or received from a counterparty.    

During the three months ended March 31, 2015, we did not have any open derivative contracts or any contracts that closed during the period.  

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

As of March 31, 2016, our open commodity derivative contracts were as follows:

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

 

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

 

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

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

 

Offsetting Commodity Derivatives

During 2016 and 2015, all our commodity derivative contracts permit netting of derivative gains and losses upon settlement.  In general, the terms of the contracts 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 commodity.  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 contracts, we would be able to net payments and receipts per counterparty pursuant to the derivative contracts.  Although our derivative contracts allow for netting, which would allow for recording assets and liabilities per counterparty on a net basis, we have historically accounted for our derivative contracts on a gross basis per contract as either an asset or liability.  For the open derivative contracts as of March 31, 2016 and December 31, 2015, there would have been no difference if the contracts were presented on net basis.

5.  Long-Term Debt

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

 

8.5% Senior Notes

At March 31, 2016 and December 31, 2015, our outstanding senior notes, which bear an annual interest rate of 8.50% and mature on June 15, 2019 (the “8.50% Senior Notes”), were 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, 2016.  

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

9.00% Term Loan

At March 31, 2016 and December 31, 2015, our outstanding term loan, which bears an annual interest rate of 9.00% and matures on May 15, 2020 (the “9.00% Term Loan”), was classified as long-term at its carrying value.  Interest on the 9.00% Term Loan is payable in arrears semi-annually on May 15 and November 15.  The estimated annual effective interest rate on the 9.00% Term Loan is 9.7%, which includes amortization of debt issuance costs and discounts.  The 9.00% Term Loan is secured by a second priority lien covering our oil and gas properties to the extent such properties secure first priority liens granted to secure indebtedness under our Credit Agreement.  We are subject to various covenants under the terms governing the 9.00% Term Loan including, without limitation, covenants that limit our ability to incur other debt, pay dividends or distributions on our equity, merge or consolidate with other entities and make certain investments in other entities.  We were in compliance with those covenants as of March 31, 2016.  

Credit Agreement

The Credit Agreement provides a revolving bank credit facility.  Availability under the Credit Agreement is subject to a semi-annual borrowing base determination set at the discretion of our lenders, and the Company and the lenders may each request one additional determination per year.  The amount of the borrowing base is calculated by our lenders based on their evaluation of our proved reserves and their own internal criteria.  Any determination by our lenders to change our borrowing base will result in a similar change in the availability under our revolving bank credit facility.  To the extent borrowings and letters of credit outstanding exceed the redetermined borrowing base, such excess or deficiency is required to be repaid within 90 days in three equal monthly payments.  Letters of credit may be issued in amounts up to $150.0 million, provided availability under the revolving bank credit facility exists.  The revolving bank credit facility is secured and is collateralized by our oil and natural gas properties.  The Credit Agreement terminates on November 8, 2018.

The Credit Agreement contains various customary covenants for certain financial tests, as defined in the Credit Agreement and measured as of the end of each quarter, and for customary events of default.  These financial test ratios and limits as of March 31, 2016 and thereafter are: (i) the First Lien leverage Ratio must be less than 1.50 to 1.00; (ii) the Current Ratio must be greater than 1.00 to 1.00; and (iii) the Secured Debt Leverage Ratio must be less than 3.50 to 1.00.   As of March 31, 2016, our the First Lien Ratio was  1.48 to 1.00, the Current Ratio was 2.84 to 1.00 and the Secured Debt Leverage Ratio was 3.02 to 1.00.  The customary events of default include: (i) nonpayment of principal when due or nonpayment of interest or other amounts within three business days of when due; (ii) bankruptcy or insolvency with respect to the Company or any of its subsidiaries guaranteeing borrowings under the revolving bank credit facility; or (iii) a change of control.  The Credit Agreement contains cross-default clauses with the 8.50% Senior Notes and the 9.00% Term Loan, and these agreements contain similar cross-default clauses with the Credit Agreement.  We were in compliance with all applicable covenants of the Credit Agreement as of March 31, 2016.

In February 2016, we borrowed $340.0 million under the Credit Agreement.  On March 23, 2016, the banks reduced our borrowing base to $150.0 million from $350.0 million in connection with the spring borrowing base redetermination.  We are required to repay borrowings outstanding in excess of the redetermined borrowing base pursuant to the terms of the Credit Agreement.  On March 31, 2016, we repaid $52.0 million leaving an outstanding balance under the Credit Agreement of $288.0 million as of March 31, 2016.  On May 2, 2016, we repaid an additional $12.0 million.  Additional payments are required of $64.0 million on May 31, 2016 and $64.0 million on June 30, 2016, in addition to interest payments on our long-term debt, which will bring total borrowings outstanding under the Credit Agreement in conformity with the borrowing base limitation.  The Company has sufficient available cash to make these payments.  The reduction in the borrowing base resulted in a proportional reduction in the unamortized costs related to the Credit Agreement of $1.4 million, which is included in the line Other (income) expense, net on the Condensed Statement of Operations.  

As of March 31, 2016 and December 31, 2015, we had $1.0 million and $0.9 million, respectively, of letters of credit outstanding under the revolving bank credit facility.  The estimated annual effective interest rate was 4.7% for the three months ended March 31, 2016 for average daily borrowings outstanding 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.  

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

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

For information about fair value measurements for our 8.50% Senior Notes, 9.00% Term Loan and revolving bank credit facility, refer to Note 6.

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, credit risk and published commodity futures prices.  The fair values of our 8.50% Senior Notes and 9.00% Term Loan were 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 open derivatives and long-term debt, as reported in the Condensed Consolidated Balance Sheets (in thousands):

 

 

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 2015 and in 2014, the Company granted restricted stock units (“RSUs”) to certain of its employees. During the three months ended March 31, 2016, 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 typical 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 typically based on the Company and the employee achieving certain pre-defined performance criteria.

During 2015, RSUs granted were subject to adjustments based on achievement of multiple 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 2015 and (ii) Adjusted EBITDA as a percent of total revenues (“Adjusted EBITDA Margin”) for 2015.  For 2015, the Company was below target for Adjusted EBITDA and achieved the target for Adjusted EBITDA Margin.

During 2014, RSUs granted were subject to adjustments based on achievement of a combination of performance criteria, which was comprised of: (i)  Adjusted EBITDA for 2014 and (ii) Adjusted EBITDA Margin for 2014.  For 2014, the Company achieved the target for Adjusted EBITDA and was slightly below target for Adjusted EBITDA Margin.    

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

All RSUs  that are currently outstanding under the Plan are subject to employment-based criteria and vesting occurs in December of the second year after the grant.  For example, the RSUs granted during 2014, adjusted for 2014 performance described above, will vest in December 2016 to eligible employees assuming employment-based criteria are also satisfied.  

Under the Director Compensation Plan, shares of restricted stock (“Restricted Shares”) have been granted to the Company’s non-employee directors.  Grants to non-employee directors were made during 2015, 2014 and 2013.  The Restricted Shares are subject to service conditions and vesting occurs at the end of specified service periods unless approved by the Board.  

At March 31, 2016, there were 4,239,548 shares of common stock available for issuance in satisfaction of awards under the Plan and 444,024 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, 2016, all of the unvested shares of Restricted Shares outstanding were issued to the non-employee directors.  Restricted Shares 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.

For the outstanding Restricted Shares issued to the non-employee directors as of March 31, 2016, vesting is expected to occur as follows:

 

There were no grants, forfeitures or vesting of Restricted Shares during the first quarter of 2016 or the first quarter of 2015.  

Awards Based on Restricted Stock Units.  As of March 31, 2016, the Company had outstanding RSUs issued to certain employees.  As described above, the RSUs granted during 2015 and 2014 were 100% performance based and were subject to pre-defined performance measures and employment-based criteria.  The fair values for the RSUs granted during 2015 and 2014 were 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 are paid on our common stock after achieving the specified performance requirement for that component of the RSUs.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

A summary of activity in 2016 related to RSUs is as follows:

 

For the outstanding RSUs issued to the eligible employees as of March 31, 2016, vesting is expected to occur as follows:  

 

 

  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, 2016, unrecognized share-based compensation expense related to our awards of Restricted Shares and RSUs was $0.4 million and $10.3 million, respectively.  Unrecognized share-based compensation expense will be recognized through April 2018 for Restricted Shares and November 2017 for RSUs.

Cash-Based Incentive Compensation. As defined by the Plan, annual incentive awards may be granted to eligible employees and are typically payable in cash.  These awards are performance-based awards consisting of one or more business or individual performance criteria and a targeted level or levels of performance with respect to each such criterion.  Generally, the performance period is the calendar year and determination and payment is made in cash in the first quarter of the following year.  

During 2015, the Company issued cash-based incentive awards for 2015 that, in addition to being performance-based awards related to 2015 criteria, the payment of such awards is contingent on the Company achieving the following financial condition on or before December 31, 2017:  Adjusted EBITDA less Interest Expense, as reported by the Company in its announced Earnings Release with respect to the end of any fiscal quarter plus three preceding quarters, exceeds $300.0 million.  As the Company did not achieve this financial condition up through March 31, 2016, no amounts have been recognized to date related to the 2015 cash-based incentive awards.  Amounts recorded during the three months ended March 31, 2015 relate to the 2014 cash-based awards, for which costs were recognized from the award date through February 2015 (the service period), and adjustments were recorded to true up previous estimates to actual payments.    

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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Share-Based Compensation and Cash-Based Incentive Compensation Expense.  A summary of incentive compensation expense is as follows (in thousands):  

 

 

8.  Income Taxes  

Our income tax benefit for the three months ended March 31, 2016 and 2015 was $4.9 million and $103.6 million, respectively.  Our annualized effective tax rate for the three months ended March 31, 2016 and 2015 was 2.5% and 28.9%, respectively.  Both of these percentages differ from the federal statutory rate of 35.0% primarily due to recording and adjusting a valuation allowance for our deferred tax assets.     

 During the three months ended March 31, 2016 and 2015, we recorded a valuation allowance of $60.0 million and $22.5 million, respectively, related to federal and state deferred tax assets.  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 addition, the realization depends on the ability to carryback certain items to prior years for refunds of taxes previously paid.  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.  As of March 31, 2016 and December 31, 2015, we had a valuation allowance related to Federal, Louisiana and Alabama net operating losses and other deferred taxes.  The tax years 2012 through 2015 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, 2016 and 2015, 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 loss per common share (in thousands, except per share amounts):

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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10.  Dividends

During the three months ended March 31, 2016 and the full year of 2015, we did not pay any dividends and a suspension of dividends remains in effect.    

 

11.  Contingencies

Supplemental Bonding Requirements by the BOEM.  The significant reductions in crude oil and natural gas pricing since the middle of 2014 have adversely impacted our financial strength and have resulted in our inability to meet the relevant financial strength and reliability criteria set forth in the BOEM Notice To Lessee #2008-N07, Supplemental Bond Procedures, (“NTL #2008-N07”).  Both W&T Offshore, Inc. and its subsidiary are now subject to supplemental bonding.  In February and March 2016, we received several orders from the BOEM demanding that we provide additional supplemental bonding on certain Federal offshore oil and gas leases, rights of way and rights of use and easement owned and/or operated by the Company.  One order was rescinded and re-issued and another one was rescinded.  The outstanding orders total approximately $260.8 million.  We have had discussions with the BOEM and its sister agency, the BSEE, since receiving the orders.  See Note 12 for information on events occurring subsequent to March 31, 2016 for this item.

The issuers of such surety bonds may request, and in some cases, have requested, collateral, which could be significant and could impact our liquidity.  In addition, pursuant to the terms of our agreements with various sureties under our existing bonds or under any additional bonds we may obtain, we are required to post collateral at any time, on demand, at the surety’s discretion.    

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.  A hearing on this matter is scheduled with an Administrative Law Judge on June 21, 2016 in Houston, Texas.  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, 2016 or December 31, 2015.        

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.  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. 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

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 $43 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 its portion of the settlement (approximately $5 million), in addition to a portion of interest owed.  The other underwriters have not paid, 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, Liberty Mutual Insurance Co. paid additional interest and Starr Marine has paid its portion ($5 million) of the first excess liability policy without interest.  The lawsuit includes interest not paid by Starr Marine. The revised estimate of potential reimbursement is approximately $31 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 depreciation, depletion, amortization and accretion (“DD&A”) rate.

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 IBLA.  W&T’s brief was filed in November 2014 and we expect the briefing before the IBLA to be completed in 2016.

The ONRR has publicly announced an “unbundling” initiative to review the methodology employed by producers in determining the appropriate allowances for transportation and processing costs that are permitted to be deducted in determining royalties under Federal oil and gas leases.  In the second quarter of 2015, pursuant to the initiative, the Company received requests from the ONRR for additional data regarding the Company’s transportation and processing allowances on natural gas production that is processed through a specific processing plant.  The Company also received a preliminary determination notice from the ONRR asserting its preliminary determination that the Company’s allocation of certain processing costs and plant fuel use at another processing plant were impermissibly allowed as deductions in the determination of royalties owed under Federal oil and gas leases.  The Company intends to submit a response to the preliminary determination asserting the reasonableness of its own allocation methodology of such costs.  These open ONRR unbundling reviews, and any further similar reviews, could ultimately result in an order for payment of additional royalties under the Company’s Federal oil and gas leases for current and prior periods.  The Company is not able to determine the likelihood or range of any additional royalties or, if and when assessed, whether such amounts would be material.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)

Notices of Proposed Civil Penalty Assessment.  The Company currently has three open Incidents of Noncompliance (“INCs”) issued by the BSEE, which have not been settled as of the filing of this Form 10-Q.  The INC’s were issued during 2015 and relate to three separate offshore locations with occurrence dates ranging from July 2012 to June 2014.  The proposed civil penalties for these INCs total $7.1 million.  The Company has accrued approximately $1.0 million, which is the Company’s best estimate of the final settlement once all appeals have been exhausted.  The Company’s position is that the proposed civil penalties are excessive given the specific facts and circumstances related to these INCs.      

Iberville School Board Lawsuit.  In August, 2013, a citation was issued on behalf of plaintiffs, the State of Louisiana and the Iberville Parish School Board, in their suit against the Company (among others) in the 18^th Judicial District Court for the Parish of Iberville, State of Louisiana.  This case involves claims by the Iberville Parish School Board that this property has allegedly been contaminated or otherwise damaged by certain defendants’ oil and gas exploration and production activities.  The plaintiff’s claims include assessment costs, restoration costs, diminution of property value, punitive damages, and attorney fees and expenses, of which were not quantified in the claim.  We cannot currently estimate our potential exposure, if any, related to this lawsuit.  We are currently, and intend to continue, vigorously defending this litigation.

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.  In addition, the BOEM considers all owners of record title and/or operating rights interest in an Outer Continental Shelf (“OCS”) lease to be jointly and severally liable for the satisfaction of the supplemental bonding obligations and/or decommissioning obligations.  Accordingly, we may be required to satisfy supplemental bonding obligations or decommissioning obligations of a defaulting owner of record title and/or operating rights interest in an OCS lease in which we are (or in some cases were) an owner of record title and/or operating rights interest in the same OCS lease.  We are also subject to federal and state administrative proceedings conducted in the ordinary course of business including matters related to alleged royalty underpayments on certain federal-owned properties.  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, 2016 and 2015.  As of March 31, 2016 and December 31, 2015, we had no material amounts recorded in liabilities for claims, complaints and fines.  

 

12.  Subsequent Events  

Supplemental Bonding Requirements by the BOEM.  Subsequent to March 31, 2016, we have filed appeals with the IBLA regarding three of the BOEM orders - specifically the February order that required W&T to post a total of $159.8 million in supplemental bonding and two March orders requiring $68.0 million in supplemental bonding.  The objective of the Company remains to reach a mutual agreement on the financial assurance requirements of the demands.  The issuance of any additional surety bonds to satisfy the BOEM orders or any future BOEM orders may require the posting of cash collateral, which may be significant, and the creation of escrow accounts.  We continue to have discussions with the BOEM regarding these matters.

 

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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, the 9.00% Term Loan and the Credit Agreement (see Note 5) are fully and unconditionally guaranteed by certain of our 100%-owned subsidiaries, including Energy VI 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, if the sale or other disposition does not violate the Asset Sales provisions (as such terms are define in certain debt documents);

(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 certain debt documents;

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

(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 certain debt documents, 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 were made from the Parent Company to the Guarantor Subsidiaries.  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.  None of the adjustments had any effect on the consolidated results for the current or prior periods presented.  

 

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

Condensed Consolidating Balance Sheet as of March 31, 2016