UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

Form 10-Q

 

For the quarterly period ended September 30, 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  ☑    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  ☑    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  ☑  

As of October 31, 2016, there were 137,082,824 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’ 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, proved reserves 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 nine months of 2016 on an average basis.  Steps taken during 2015 and the first nine months of 2016 to mitigate the effects of these lower prices include: (i) significantly reducing the budgeted capital spending for 2015 and 2016 from historical levels; (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; (vi) consummating the Exchange Transaction, as defined and described below; and (vii) 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 and the Notes herein for additional information.

 

 

    

 

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

On September 7, 2016, we consummated a transaction whereby we exchanged approximately $710.2 million, or 79%, of our 8.500% Senior Notes due 2019 (the “Unsecured Senior Notes”) for new secured notes and common stock.  At the same time, we closed on a new $75.0 million, 11.00% 1.5 Lien Term Loan (the “1.5 Lien Term Loan”), and in conjunction; two amendments were made effective under our Credit Agreement.  See Note 5 for a full description of the transaction, the new debt instruments and the accounting for the transaction.

During 2015, we were notified by the BOEM that the Company was no longer eligible for any exemptions set forth in the regulations and then-current supplemental bonding procedures of the BOEM related to decommissioning obligations.  In February and March 2016, we received several orders from the Bureau of Ocean Energy Management (“BOEM”) ordering the Company to provide additional security in the aggregate of $260.8 million.  We filed appeals with the Interior Board of Land Appeals (“IBLA”) and the IBLA has agreed to stay the effectiveness of the orders.  This is the third stay that we have received from the IBLA, and their latest stay extends the effectiveness to January 31, 2017.  We submitted a proposal for a tailored plan of compliance in May 2016 under the BOEM’s then-current supplemental bonding procedures in NTL #2008-N07. Subsequently, the BOEM issued NTL #2016-N01 to replace NTL #2008-N07, effective September 2016, and we submitted a revised proposed tailored plan of compliance to the BOEM incorporating requirements of the new NTL.  We continue to have discussions with the BOEM regarding these matters.  See Note 11 for additional information.    

We have assessed our financial condition, the current capital markets and options given different scenarios of commodity prices.  We believe we will have adequate liquidity to fund our operations through September 30, 2017, the period of assessment to qualify as a going concern.  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%; plus (ii) the cost of unproved oil and natural gas properties not being amortized; plus (iii) the lower of cost or estimated fair value of unproved oil and natural gas properties included in the amortization base; and less (iv) 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 each of the first three quarters of 2016 and in every quarter of 2015, which are reported as a separate line in the Consolidated Statements of Operations.  The average price using the SEC required methodology at September 30, 2016 was $38.17 per barrel for West Texas Intermediate (“WTI”) crude oil and $2.28 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 September 30, 2016 and 2015 were $57.9 million and $441.7 million, respectively, and for nine months ended September 30, 2016 and 2015 were $279.1 million and $954.9 million, respectively.  The ceiling test write-down for the full year of 2015 was $987.2 million.    

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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 (in thousands):

 

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 fully determined or quantified 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 to 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 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 of ASU 2016-09, but do not anticipate the revised guidance will have a material effect on our financial statements.  

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

In June 2016, the FASB issued Accounting Standards Update No. 2016-13, (“ASU 2016-13”), Financial Instruments – Credit Losses (Subtopic 326).  The new guidance eliminates the probable recognition threshold and broadens the information to consider past events, current conditions and forecasted information in estimating credit losses.  ASU 2016-13 is effective for fiscal years beginning after December 15, 2019 and early adoption is permitted for fiscal years beginning after December 15, 2018.  We have not yet fully determined or quantified the effect ASU 2016-13 will have on our financial statements.

 

In August 2016, the FASB issued Accounting Standards Update No. 2016-15, (“ASU 2016-15”), Statement of Cash Flows (Topic 230) – Classification of Certain Cash Receipts and Cash Payments.  ASU 2016-15 addresses the classification of several items that previously had diversity in practice.  Items identified in the new standard which were incurred by us in the past are (a) debt prepayment or extinguishment costs (b) contingent consideration made after a business acquisition and (c) proceeds from settlement of insurance claims.  The item described in clause (b) would be the only such item changed under our historical classification in the Statement of Cash Flows (financing vs. investing) and the amount of such change would not be material; therefore, we do not anticipate the new standard will have a material effect on our Statement of Cash Flows.   ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 and early adoption is permitted.    

 

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 $370.9 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 $0.9 million for final customary effective date adjustments was recorded during the nine months ended September 30, 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”) equal to a variable percentage 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.        

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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, 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.

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

Commodity Derivatives

As of September 30, 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 collars” consisting 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.    

  

As of September 30, 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):

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

 

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):

 

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.  

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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):

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

 

Exchange Transaction

On September 7, 2016, we consummated a transaction whereby we exchanged approximately $710.2 million in aggregate principal amount, or 79%, of our Unsecured Senior Notes, due June 15, 2019 for: (i) $159.8 million in aggregate principal amount of 9.00%/10.75% Senior Second Lien PIK Toggle Notes, due May 2020, (the “Second Lien PIK Toggle Notes”); (ii) $142.0 million in aggregate principal amount of 8.50%/10.00% Senior Third Lien PIK Toggle Notes, due June 2021, (the “Third Lien PIK Toggle Notes”); and (iii) 60.4 million shares of our common stock (collectively, the “Debt Exchange”).  At the same time on closing on the Debt Exchange, we closed on a $75.0 million, 11.00% 1.5 Lien Term Loan, due November 2019, with the largest holder of our Unsecured Senior Notes (collectively with the Debt Exchange, the “Exchange Transaction”).  We accounted for the Exchange Transaction as a Troubled Debt Restructuring pursuant to the guidance under Accounting Standard Codification 470-60, Troubled Debt Restructuring (“ASC 470-60”).  Under ASC 470-60, the carrying value of the newly issued Second Lien PIK Toggle Notes, Third Lien PIK Toggle Notes and 1.5 Lien Term Loan (the “New Debt”) is measured using all future undiscounted payments (principal and interest); therefore, no interest expense was recorded for the New Debt in the Consolidated Statements of Operations during the three and nine month months ended September 30, 2016.  Additionally, no interest expense related to the New Debt will be recorded in future periods as payments of interest on the New Debt will be recorded as a reduction in the carrying amount; thus, our reported interest expense will be significantly less than the contractual interest payments through the terms of the New Debt.    

A gain of $124.0 million was recognized related to the Exchange Transaction. Under ASC 470-60, a gain was recognized as the sum of (i) the future undiscounted payments (principal and interest) related to the New Debt, (ii) the fair value of the common stock issued and (iii) deal transaction costs of $18.9 million was less than the sum of (iv) the carrying value of the Unsecured Senior Notes exchanged and (v) the funds received from the 1.5 Lien Term Loan.  The shares of common stock issued were valued at $1.76 per share, which was the closing price on September 7, 2016.  Transaction costs related to the Exchange Transaction of approximately $2.8 million previously recorded as General and Administrative expense were reclassified and netted against the Gain on Debt Exchange. When such costs were previously recorded, the Exchange Transaction was dependent on approvals and actions by third parties including the approval of two-thirds of our shareholders.  The effect on basic and diluted earnings per share for the three and nine months ended September 30, 2016 was a $1.33 per share and $1.52 per share, respectively, which assumes the gain would not affect income tax benefit for either time period.   

The funds received from the 1.5 Lien Term Loan were used to pay transaction costs related to the Exchange Transaction and to pay down borrowings on the revolving bank credit facility.  The balance of the borrowings on the revolving bank credit facility was paid down from available cash.

The primary terms of our long-term debt following the Exchange Transaction are described below.   

Credit Agreement

The Fifth Amended and Restated Credit Agreement (as amended, the “Credit Agreement”), provides a revolving bank credit facility.  In conjunction with the Exchange Transaction, two amendments were executed for the Credit Agreement.  The primary items related to the recent amendments are:

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

Availability under our revolving bank credit facility is subject to a semi-annual redetermination of our borrowing base that occurs in the spring and fall of each year (commencing in 2017) and is calculated by our lenders based on their evaluation of our proved reserves and their own internal criteria.  The spring redetermination occurred in March 2016 and the next redetermination will occur in April 2017.  Subsequent to April 2017, the lenders and the Company have the option for an additional redetermination every year.  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 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 substantially all of 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 September 30, 2016 and thereafter are: (i) the First Lien Leverage Ratio must be less than 2.50 to 1.00 with a step down to 2.00 to 1.00 on September 30, 2017; (ii) the Current Ratio must be greater than 1.00 to 1.00; and (iii) the Asset Coverage Ratio must not be less than 1.25x measured on September 30, 2016 and December 31, 2016.  The Asset Coverage Ratio is determined using the present value of proved reserves, discounted at 10%, and using strip forward pricing (PV-10 using strip pricing) compared to the amount of first lien debt outstanding.   As of September 30, 2016, the First Lien Leverage Ratio was 0.01 to 1.00, the Current Ratio was 2.35 to 1.00 and the Asset Coverage Ratio was not meaningful, as only letters of credit were outstanding on September 30, 2016, and was well above the threshold.  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 other long-term debt agreements, and such agreements contain similar cross-default clauses with the Credit Agreement.  We were in compliance with all applicable covenants of the Credit Agreement as of September 30, 2016.

We are required to have deposit accounts only with banks under the Credit Agreement with certain exceptions and may not have unrestricted cash balances above $35 million if outstanding balances on the revolving bank credit facility (including letters of credit) are greater than $5 million.  We are required to maintain minimum liquidity of $15 million, defined as the sum of unrestricted cash and availability under the revolving bank credit facility.

The recent amendments increased some of the margins applied to borrowings under the revolving bank credit facility.  Borrowings under the revolving bank credit facility bear interest at the applicable London Interbank Offered Rate (“LIBOR”) plus a margin that varies from 3.00% to 4.00% depending on the level of total borrowings under the Credit Agreement, or an alternative base rate equal to the greater of (a) Prime Rate, (b) Federal Funds Rate plus 0.50%, and (c) LIBOR plus 1.00%, plus applicable margin ranging from 2.00% to 3.00%.  The unused portion of the borrowing base is subject to a commitment fee of 0.50%.

The borrowing base reduction occurring in the first three months of 2016 resulted in a proportional reduction in the unamortized costs related to the Credit Agreement of $1.4 million for the nine months ended September 30, 2016, which is included in the line Other expense, net on the Condensed Statement of Operations.  

  The estimated annual effective interest rate was 5.6% for the nine months ended September 30, 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.  As of both September 30, 2016 and December 31, 2015, we did not have any borrowings outstanding and had $0.9 million of letters of credit outstanding under the revolving bank credit facility at both dates.  Availability as of September 30, 2016 was $149.1 million.  

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

1.5 Lien Term Loan

As part of the Exchange Transaction, we entered into the 1.5 Lien Term Loan on September 7, 2016 with a maturity date of November 15, 2019.    The maturity date will accelerate to February 28, 2019 if the remaining Unsecured Senior Notes have not been extended, renewed, refunded, defeased, discharged, replaced or refinanced by February 28, 2019. Interest accrues at 11.00% per annum and is payable quarterly in cash.  The holder of the 1.5 Lien Term Loan was the largest holder of our Unsecured Senior Notes prior to the Exchange Transaction.  The 1.5 Lien Term Loan is secured by a 1.5 priority lien on all of our assets pledged under the Credit Agreement.  The lien securing the 1.5 Lien Term Loan is subordinate to the liens securing the Credit Agreement and has priority above the liens securing the Second Lien Term Loan, the Second Lien PIK Toggle Notes and the Third Lien PIK Toggle Notes.  All future undiscounted cash flows have been included in the carrying value under ASC 470-60.  Current maturities of long-term debt represent the cash interest payable for the 1.5 Lien Term Loan payable in the next 12 months.  The 1.5 Lien Term Loan contains various covenants that limit, among other things, our ability to: (i) pay cash dividends; (ii) repurchase our common stock; (iii) sell our assets; (iv) make certain loans or investments; (v) merge or consolidate; (vi) enter into certain liens; and (vii) enter into transactions with affiliates.  We were in compliance with those covenants as of September 30, 2016.

Second Lien Term Loan

At September 30, 2016 and December 31, 2015, our Second Lien Term Loan, which bears an annual interest rate of 9.00% and matures on May 15, 2020 (the “Second Lien Term Loan”), was recorded at its carrying value consisting of principal, unamortized discount and unamortized debt issuance costs.  Interest on the  Second Lien Term Loan is payable in arrears semi-annually on May 15 and November 15.  The estimated annual effective interest rate on the Second Lien Term Loan is 9.7%, which includes amortization of debt issuance costs and discounts.  The Second Lien Term Loan is secured by a second-priority lien on all of our assets that are secured under the Credit Agreement.  The Second Lien Term Loan is effectively subordinate to the Credit Agreement and the 1.5 Lien Term Loans (discussed above) and is effectively pari passu with the Second Lien PIK Toggle Notes (discussed below).  We are subject to various covenants under the terms governing the Second Lien 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 September 30, 2016.

Second Lien PIK Toggle Notes

As part of the Exchange Transaction, we issued Second Lien PIK Toggle Notes on September 7, 2016, with a maturity date of May 15, 2020.  Cash interest accrues at 9.00% per annum and is payable on May 15 and November 15 of each year.  The Second Lien PIK Toggle Notes contain payment-in-kind (“PIK”) interest provisions, where certain semi-annual interest is added to the principal amount instead of being paid in cash in the then current semi-annual period.  We have the option for the first 18 months to pay all or a portion of interest in kind at a rate of 10.75% per annum, except that the initial interest payment on November 15, 2016 is to be paid solely in kind.  The Second Lien PIK Toggle Notes are secured by a second-priority lien on all of our assets that are pledged under the Credit Agreement.  The Second Lien PIK Toggle Notes are effectively subordinate to the Credit Agreement and the 1.5 Lien Term Loan (discussed above) and is effectively pari passu with the Second Lien Term Loan.  For purposes of determining the gain from the Exchange Transaction under ASC 470-60, we assumed the Company will elect full use of the PIK option and these amounts will increase the principal amount.  All future undiscounted cash flows have been included in the carrying value under ASC 470-60.  The Second Lien PIK Toggle Notes contain covenants that restrict our ability and the ability of certain of our subsidiaries to: (i) incur additional debt; (ii) make payments or distributions on account of our or our restricted subsidiaries’ capital stock; (iii) sell assets; (iv) restrict dividends or other payments of our restricted subsidiaries; (v) create liens that secure debt; (vi) enter into transactions with affiliates and (vii) merge or consolidate with another company.  We were in compliance with those covenants as of September 30, 2016.      

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

Third Lien PIK Toggle Notes

As part of the Exchange Transaction, we issued Third Lien PIK Toggle Notes on September 7, 2016, with a maturity date of June 15, 2021.  The maturity date will accelerate to February 28, 2019 if the remaining Unsecured Senior Notes have not been extended, renewed, refunded, defeased, discharged, replaced or refinanced by February 28, 2019.  Cash interest accrues at 8.50% per annum and is payable on June 15 and December 15 of each year.  The Third Lien PIK Toggle Notes contain PIK interest provisions, where certain semi-annual interest is added to the principal amount instead of being paid in cash in the then current semi-annual period.  We have the option for the first 24 months to pay all or a portion of interest in kind at a rate of 10.00% per annum, except that the initial interest payment on December 15, 2016 is to be paid solely in kind.  The Third Lien PIK Toggle Notes are secured by a third-priority lien on all of our assets that are secured under the Credit Agreement.  The Third Lien PIK Toggle Notes are effectively subordinate to the Second Lien Term Loan and the Second Lien PIK Toggle Notes. For purposes of determining the gain from the Exchange Transaction under ASC 470-60, we assumed the Company will elect full use of the PIK option and these amounts will increase the principal amount.  All future undiscounted cash flows have been included in the carrying value under ASC 470-60.  The Third Lien PIK Toggle Notes contain covenants that restrict our ability and the ability of certain of our subsidiaries to: (i) incur additional debt; (ii) make payments or distributions on account of our or our restricted subsidiaries’ capital stock; (iii) sell assets; (iv) restrict dividends or other payments of our restricted subsidiaries; (v) create liens that secure debt; (vi) enter into transactions with affiliates and (vii) merge or consolidate with another company.  We were in compliance with those covenants as of September 30, 2016.

Unsecured Senior Notes

At September 30, 2016 and December 31, 2015, our outstanding Unsecured Senior Notes, which bear an annual interest rate of 8.50% and mature on June 15, 2019, were recorded at their carrying value consisting of principal, unamortized premium and unamortized debt issuance costs.  For the Exchange Transaction, unamortized debt premium and unamortized debt issuance costs were allocated based on the principal values of the Unsecured Senior Notes exchanged and those not exchanged.  The Unsecured Senior Notes are effectively subordinate to all our secured debt.  Interest on the Unsecured Senior Notes is payable semi-annually in arrears on June 15 and December 15.  The estimated annual effective interest rate on the Unsecured 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 Unsecured Senior Notes, and we were in compliance with those covenants as of September 30, 2016.  

For information about fair value measurements for our long-term debt, 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 value of the 1.5 Lien Term Loan was estimated using the carrying value of the principal as no market has initially developed and the loan was recently consummated.  The fair values of our Second Lien Term Loan, Second Lien PIK Toggle Notes, Third Lien PIK Toggle Notes and Unsecured Senior Notes were based on quoted prices, although the market is not an active market; therefore, the fair value is classified within Level 2.  

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

The following table presents the fair value of our open derivatives and long-term debt, all of which are classified as Level 2 within the valuation hierarchy (in thousands):

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

Awards to Employees.  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 and in May 2016.  The May 2016 amendment increased the number of shares available in the Plan by 3,300,000 shares.  As allowed by the Plan, during 2016, 2015 and 2014, the Company granted restricted stock units (“RSUs”) to certain of its employees.  RSUs are a long-term compensation component of the Plan, which are granted to only certain employees, and are subject to adjustments at the end of the applicable performance period based on the results 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.

As of September 30, 2016, there were 7,532,938 shares of common stock available for issuance in satisfaction of awards under the Plan.   The shares available for issuance are reduced when RSUs are settled in shares of common stock, net of withholding tax.  Although the Company has the option at vesting to settle RSUs in stock or cash, or a combination of stock and cash, only common stock has been used to settle vested RSUs to date.

RSUs currently outstanding have been adjusted for performance achieved against predetermined criteria for the applicable performance year.  The RSUs outstanding continue to be subject to employment-based criteria and vesting occurs in December of the second year after the grant.  See the second table below for potential vesting by year.

We recognize compensation cost for share-based payments to employees over the period during which the recipient is required to provide service in exchange for the award.  Compensation cost is based on the fair value of the equity instrument on the date of grant.  The fair values for the RSUs granted during 2016, 2015 and 2014 were determined using the Company’s closing price on the grant date.  We are also required to estimate forfeitures, resulting in the recognition of compensation cost only for those awards that are expected to actually vest.

All RSUs awarded are subject to forfeiture until vested and cannot be sold, transferred or otherwise disposed of during the restricted period.  

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W&T OFFSHORE, INC. AND SUBSIDIARIES
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 September 30, 2016, vesting is expected to occur as follows:  

 

Restricted Stock Units fair value at grant date and vested date:  The fair value of Restricted Stock Units granted during the nine months ended September 30, 2016 was $9.3 million based on the Company’s closing price on the date of grant.  The fair value of Restricted Stock Units that vested during the nine months ended September 30, 2016 was minimal and was based on the Company’s closing price on the date of vesting.

Awards to Non-Employee Directors.  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 2016, 2015 and 2014.  As of September 30, 2016, there were 317,896 shares of common stock available for issuance in satisfaction of awards under the Director Compensation Plan.  The shares available are reduced when Restricted Shares are granted.  

We recognize compensation cost for share-based payments to non-employee directors over the period during which the recipient is required to provide service in exchange for the award.  Compensation cost is based on the fair value of the equity instrument on the date of grant.  The fair values for the Restricted Shares granted were determined using the Company’s closing price on the grant date.   No forfeitures were estimated for the non-employee directors’ awards.

The Restricted Shares are subject to service conditions and vesting occurs at the end of specified service periods unless approved by the Board.  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.  

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

 

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

Restricted Shares fair value at grant date and vested date:  The fair value of Restricted Shares granted during the nine months ended September 30, 2016 was $0.3 million based on the Company’s closing price on the date of grant.  The fair value of Restricted Shares that vested during the nine months ended September 30, 2016 was $0.1 million based on the Company’s closing price on the date of vesting.  

For the outstanding Restricted Shares issued to the non-employee directors as of September 30, 2016, vesting is expected to occur as follows:

 

  Share-Based Compensation.  Share-based compensation expense is recorded in the line General and administrative expenses in the Condensed Statements of Operations.  A summary of incentive compensation expense under share-based payment arrangements and the related tax benefit is as follows (in thousands):