UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

Form 10-Q

 

For the quarterly period ended March 31, 2018

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, smaller reporting company or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company.    Yes  ☐    No  ☑  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐

As of April 30, 2018, there were 139,091,289 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)

 

See Notes to Condensed Consolidated Financial Statements.

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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 substantially all of its operations offshore in the Gulf of Mexico.  The Company is active in the exploration, development and acquisition of oil and natural gas properties.  Our interests 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”) and through our proportionately consolidated interest in Monza Energy LLC, as described in more detail below under the subheading “-Recent Events” in this Note and in Note 4 herein.  

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, 2017.

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 average realized prices of these commodities improved during the three months ended March 31, 2018 compared to the average realized prices in the three months ended March 31, 2017.  Operating costs were lower for the three months ended March 31, 2018 on an absolute basis compared to the three months ended March 31, 2017.  

Our Fifth Amended and Restated Credit Agreement (as amended, the “Credit Agreement”) provides our revolver bank credit facility and matures on November 8, 2018.  As of March 31, 2018, we had $0.3 million of letters of credit outstanding and no amounts borrowed on our revolving bank credit facility.  Our 8.500% Senior Notes (the “Unsecured Senior Notes”) mature on June 15, 2019.  If the Unsecured Senior Notes have not been extended, refunded, defeased, discharged, replaced or refinanced by February 28, 2019, then the 11.00% 1.5 Lien Term Loan, due November 15, 2019 (the “1.5 Lien Term Loan”) and the 8.50%/10.00% Third Lien Payment-In-Kind (“PIK”) Toggle Notes, due June 15, 2021, (the “Third Lien PIK Toggle Notes”) will both accelerate their maturity to February 28, 2019.  During the remainder of 2018, we plan to address the issues of the potential maturity acceleration of these two debt instruments and to extend or replace the revolving bank credit facility.  We expect to build sufficient cash balances in 2018 to be able to redeem, repurchase or refinance the Unsecured Senior Notes.  Certain amendments under the Credit Agreement and the 1.5 Lien Term Loan will likely be required in the event we redeem or repurchase the Unsecured Senior Notes, which we anticipate would be granted if requested.  Assuming we can also repay or refinance the 1.5 Lien Term Loan, then we believe that we would amend our revolving bank credit facility in such a manner that will permit an extension of the maturity of such facility.  There can be no assurance that lenders will extend our revolving bank credit facility maturity, but under current market conditions and based on the outlook of our cash position in 2018 and further, we believe our lenders or replacement lenders will be amenable to participating in a refinancing or other corporate financing transaction.

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

On March 12, 2018, W&T and two initial members formed and initially funded a limited liability company, Monza Energy LLC, a Delaware limited liability company (“Monza”), that will jointly participate with us in the exploration, drilling and development of up to 14 identified drilling projects (the “JV Drilling Program”) in the Gulf of Mexico over the next three years.  W&T contributed 88.94% of its working interest in the 14 identified projects to Monza and retained an 11.06% working interest.  Since the initial closing, additional investors have joined in Monza and as of April 27, 2018, total commitments by all investors are $297.6 million.  We anticipate additional investors will join in the program.            

In summary, W&T owns a direct interest in the 14 drilling projects as well as an indirect interest via its interest in Monza.  The JV Drilling Program is structured so that we initially receive an aggregate of 30.0% of the net revenues, through both our direct ownership of our working interest in the projects and our indirect interest through our interest in Monza, for contributing 20.0% of the estimated total well costs plus associated leases and providing access to available infrastructure at agreed upon rates.  See Note 4 and 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 available liquidity to fund our operations through May 2019, the period of assessment to qualify as a going concern.  However, we cannot predict the potential changes in commodity prices or future Bureau of Ocean Energy Management (“BOEM”) bonding requirements, either of which could affect our operations, liquidity levels and compliance with debt covenants.

See our Annual Report on Form 10-K for the year ended December 31, 2017 concerning risks related to our business and events occurring during 2017 and other information and the Notes herein for additional information.  

Accounting Standard Updates Effective January 1, 2018.  Accounting Standards Update No. 2016-18, (“ASU 2016-18”), Statement of Cash Flows (Topic 230) – Restricted Cash became effective for us in the period ending March 31, 2018.  As we did not have any amounts recorded as restricted cash in the three months ended March 31, 2018, or any amounts recorded as restricted cash during 2017, ASU 2016-18 did not affect the Condensed Consolidated Statement of Cash Flows.        

Accounting Standard Update No. 2014-09, (“ASU 2014-09”) Revenue from Customers (Topic 606), became effective for us in the period ending March 31, 2018.  We reviewed our contracts using the five-step revenue recognition model, which did not identify any changes required as to the amount or timing of revenue recognition.  We adopted the new standard using the modified retrospective approach which did not result in any cumulative-effect adjustment on the date of adoption.  The implementation of ASU 2014-09 resulted in a change in our reporting in the Condensed Consolidated Statement of Operations so that we now report revenue streams separately for oil, NGLs, natural gas and other revenues in compliance with the new standard.    

Revenue Recognition.  We recognize revenue from the sale of crude oil, NGLs, and natural gas when our performance obligations are satisfied.  Our contracts with customers are primarily short-term (less than 12 months).  Our responsibilities to deliver a unit of crude oil, NGL, and natural gas under these contracts represent separate, distinct performance obligations.  These performance obligations are satisfied at the point in time control of each unit is transferred to the customer.  Pricing is primarily determined utilizing a particular pricing or market index, plus or minus adjustments reflecting quality or location differentials.  

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

Reclassification.  Certain reclassifications have been made to prior periods’ financial statements to conform to the current presentation as follows:  Within the Net Cash Provided by Operating Activities of the Condensed Consolidated Statements of Cash Flows, adjustments were made to certain line items, of which did not change the total amount previous reported.  The adjustments did not affect the Condensed Consolidated Balance Sheets or the Condensed Consolidated Statements of Operations.

Prepaid Expenses and Other Assets.  The amounts recorded are expected to be realized within one year and the major categories are presented in the following table (in thousands):

 

 

Oil and Natural Gas Properties and Other, Net – at cost.  Oil and natural gas properties and equipment are recorded at cost using the full cost method.  There were no amounts excluded from amortization as of the dates presented in the following table (in thousands):

 

Accrued Liabilities.  The major categories are presented in the following table (in thousands):

 

 

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

Other Assets (long-term).  The major categories are presented in the following table (in thousands):

 

Other Liabilities (long-term).  The major categories are presented in the following table (in thousands):

 

Recent Accounting Developments.  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 financing or operating lease.  However, unlike current GAAP, which requires only capital or financing 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.  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.  Our current operating leases that will be impacted by ASU 2016-02 are leases for office space, which is primarily in Houston, Texas, although ASU 2016-02 may impact the accounting for leases related to equipment depending on the term of the lease.  We currently do not have any leases classified as financing leases nor do we have any leases recorded on the Condensed Consolidated Balance Sheets.  We have not yet fully determined or quantified the effect ASU 2016-02 will have on our financial statements.

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.

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

In August 2017, the FASB issued Accounting Standards Update No. 2017-12, (“ASU 2017-12”), Derivatives and Hedging (Topic 815) – Targeted Improvements to Accounting for Hedging Activities.  The amendments in ASU 2017-12 require an entity to present the earnings effect of the hedging instrument in the same income statement line in which the earning effect of the hedged item is reported.  This presentation enables users of financial statements to better understand the results and costs of an entity’s hedging program.  Also, relative to current GAAP, this approach simplifies the financial statement reporting for qualifying hedging relationships.  ASU 2017-12 is effective for fiscal years beginning after December 15, 2019 and interim periods within fiscal years beginning after December 15, 2020.  Early adoption is permitted, including adoption in an interim period.  As we do not designate our commodity derivative positions as qualifying hedging instruments, our assessment is this amendment will not impact the presentation of the changes in fair values of our commodity derivative instruments on our financial statements.      

 

 

 

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

2.  Long-Term Debt

The components of our long-term debt are presented in the following table (in thousands):

 

 

 

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

Accounting for Certain Debt Instruments

We accounted for a transaction executed on September 7, 2016 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 9.00/ 10.75% Second Lien PIK Toggle Notes, due May 15, 2020, (the “Second Lien PIK Toggle Notes”); the Third Lien PIK Toggle Notes and 1.5 Lien Term Loan (the “New Debt”) are measured using all future undiscounted payments (principal and interest); therefore, no interest expense has been recorded for the New Debt in the Condensed Consolidated Statements of Operations for the periods presented.  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.  Under ASC 470-60, payments related to the New Debt are reported in the financing section of the Condensed Consolidated Statements of Cash Flows.

The primary terms of our long-term debt are described below:    

Credit Agreement.  The Credit Agreement provides a revolving bank credit facility and expires by its term on November 8, 2018.  The primary items of the Credit Agreement are as follows, with certain terms defined under the Credit Agreement:

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 and is calculated by our lenders based on their evaluation of our proved reserves and their own internal criteria.  The 2017 fall redetermination reaffirmed the borrowing base amount of $150.0 million.  Any redetermination by our lenders to change our borrowing base will result in a similar change in the availability under our revolving bank credit facility.  The revolving bank credit facility is secured and is collateralized by a first priority lien on substantially all of our oil and natural gas properties.

The Credit Agreement contains various customary covenants for certain financial tests, as defined in the Credit Agreement and are measured as of the end of each quarter, and for customary events of default.  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.  

  As of March 31, 2018 and December 31, 2017, we did not have any borrowings outstanding on the revolving bank credit facility and had $0.3 million of letters of credit outstanding.  Thus, available credit as of March 31, 2018 was $149.7 million.

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

1.5 Lien Term Loan.  In September 2016, we entered into the 1.5 Lien Term Loan 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 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 (defined below), 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.  The 1.5 Lien Term Loan contains various covenants that limit, among other things, our ability to: (i) pay cash dividends; (ii) repurchase the Unsecured Senior Notes at a price greater than 65% of par and limited to a basket of $35 million; (iii) repurchase our common stock; (iv) sell our assets; (v) make certain loans or investments; (vi) merge or consolidate; (vii) enter into certain liens; (viii) create liens that secure debt; and (ix) enter into transactions with affiliates.  

Second Lien Term Loan.  In May 2015, we entered into the 9.00% Term Loan (the “Second Lien Term Loan”), which bears an annual interest rate of 9.00%.  The Second Lien Term Loan was issued at a 1.0% discount to par, matures on May 15, 2020 and is 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 9.6%, 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 Loan (discussed above) and is effectively pari passu with the Second Lien PIK Toggle Notes (discussed below).  The Second Lien Term Loan contains covenants that limit or prohibit 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 to us; (v) create liens that secure debt; (vi) enter into transactions with affiliates and (vii) merge or consolidate with another company.  

Second Lien PIK Toggle Notes.  In September 2016, we issued Second Lien PIK Toggle Notes with a maturity date of May 15, 2020.  Interest is payable on May 15 and November 15 of each year.  The Second Lien PIK Toggle Notes contain provisions whereby certain semi-annual interest is added to the principal amount through payment-in-kind instead of being paid in cash in the then current semi-annual period.  For the interest period from November 15, 2017 up to and including March 6, 2018, we elected the option to pay that portion of interest in kind at the rate of 10.75% per annum.  After March 7, 2018, interest is payable in cash at the rate of 9.00% per annum.  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 and are effectively pari passu with the Second Lien Term Loan.  The Second Lien PIK Toggle Notes contain covenants that limit or prohibit 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 to us; (v) create liens that secure debt; (vi) enter into transactions with affiliates and (vii) merge or consolidate with another company.  

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

Third Lien PIK Toggle Notes.  In September 2016, we issued Third Lien PIK Toggle Notes 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.  Interest is payable on June 15 and December 15 of each year.  The Third Lien PIK Toggle Notes contain interest provisions whereby certain semi-annual interest is added to the principal amount through payment-in-kind instead of being paid in cash in the then current semi-annual period.  For interest periods up to and including September 6, 2018, if we so elect, we have the option to pay all or a portion of interest in kind at a rate of 10.00% per annum.  After September 7, 2018, interest is payable in cash at the rate of 8.50% per annum.  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.  The Third Lien PIK Toggle Notes contain covenants that limit or prohibit 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 to us; (v) create liens that secure debt; (vi) enter into transactions with affiliates and (vii) merge or consolidate with another company.

Unsecured Senior Notes.  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, which includes unamortized debt premium and unamortized debt issuance costs.  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 premiums and debt issuance costs.  The Unsecured Senior Notes contain covenants that limit or prohibit 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 to us; (v) create liens that secure debt; (vi) enter into transactions with affiliates and (vii) merge or consolidate with another company.  

Covenants.  We were in compliance with all applicable covenants for all of our debt instruments as of March 31, 2018.

For information about fair value measurements for our long-term debt, refer to Note 3.

3.  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 fair value of the 1.5 Lien Term Loan was estimated using the carrying value of the principal as only one entity has been the holder of the 1.5 Lien Term Loan.  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 a very active market; therefore, the fair value is classified within Level 2.  

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

The long-term debt items are reported on the Condensed Consolidated Balance Sheets at their carrying value as described in Note 2.  

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

4.  JV Drilling Program

On March 12, 2018, W&T and two other initial members formed and initially funded a limited liability company, Monza, which will jointly participate with us in the exploration, drilling and development of up to 14 identified drilling projects in the Gulf of Mexico over the next three years.  W&T contributed 88.94% of its working interest in the 14 identified projects to Monza and retained an 11.06% working interest.  The projected cost to Monza to fully develop the 14 projects is estimated to be $298.6 million, excluding contingencies.  Since the initial closing on March 12, 2018, additional investors have joined in Monza and as of April 27, 2018, total commitments by all investors are $297.6 million.  We anticipate additional investors will join in the program.  If we experience cost overruns on every project, which is unlikely, then the total cost of all projects could be as high as approximately $373 million, of which W&T would have an indirect (through Monza) cash commitment of approximately $37.5 million.  See Note 11 for additional information.  W&T will be the operator of all the drilling projects unless there is already a designated third-party operator.

One of the initial members of Monza is an entity owned and controlled by Harbourvest Partners, a Boston based private equity fund.  The other initial members are W&T and an entity owned and controlled by Mr. Tracy W. Krohn, our Chairman and Chief Executive Officer.  The Krohn entity invested as a minority investor on the same terms and conditions as Harbourvest Partners and its investment is limited to 4.5% of total invested capital within Monza.  The entity affiliated with Mr. Krohn has made a capital commitment to Monza of $13.4 million, which commitment will be increased as and when additional investors join the JV Drilling Program up to an amount not to exceed $16.8 million.  

In summary, W&T owns a direct interest in the 14 drilling projects as well as an indirect interest via its interest in Monza.  The JV Drilling Program is structured so that we initially receive an aggregate of 30.0% of the net revenues, through both our direct ownership of our working interest in the projects and our indirect interest through our interest in Monza, for contributing 20.0% of the estimated total well costs plus associated leases and providing access to available infrastructure at agreed upon rates.  

At the inception of Monza, W&T received a net reimbursement of approximately $20 million for the capital expenditures incurred prior to the close date for projects in the JV Drilling Program.  W&T may fund certain cost overruns, subject to certain exceptions, on JV Drilling Program wells above budgeted amounts.

We hold a variable interest in Monza, which is a variable interest entity which we account for utilizing proportional consolidation.  We do not fully consolidate Monza because we are not considered the primary beneficiary.  Information on the structure and relationship follows:

Board Structure and Authority.  Under the limited liability agreement, the business and affairs of Monza are managed by a board of five directors, which consists of three directors selected by Harbourvest and other investors, Mr. Krohn, and an additional independent director that will be selected by a majority of the investors in Monza subject to consent by W&T.  The day-to-day operations of Monza are being managed by W&T, under the direction of the Monza board, pursuant to a services agreement.  W&T has no control over the decisions of the Monza board.  W&T has veto rights for certain decisions, but does not have the ability to unilaterally make decisions for Monza, except for day-to-day decisions as permitted under the services agreement.  The Monza board is responsible for the management of Monza and for making decisions with respect to its interest in the 14 drilling projects, including approval of the budgets.    

Accounting Methodology and Carrying Amounts.  As we are not the primary beneficiary and we do not have control of Monza, we are utilizing proportional consolidation for our interest in Monza.  As of March 31, 2018 in the Condensed Consolidated Statement of Financial Position, we recorded $2.4 million in prepaid assets, $44.9 million in oil and natural gas properties, $2.4 million in other assets and $1.0 million in accounts payable in connection with our proportional interest in Monza’s assets and liabilities.

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

Maximum Exposure. Our maximum  exposure within Monza as of March 31, 2018 is $48.7 million, which consists of $6.7 million cash contributed to Monza and $42.0 million of fair value for the conveyance of the 88.94% of the Company’s working interest in the 14 projects.  We may also take responsibility for certain drilling and completion cost overruns, subject to certain limitations and certain exceptions.  

5.  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.  

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

 

 

6.  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.

As of March 31, 2018, we did not have any open commodity derivative contracts and did not enter into any derivative contracts during the three months ended March 31, 2018.   During the three months ended March 31, 2017, we entered into commodity contracts for crude oil and natural gas and did not have any open commodity derivative contracts as of December 31, 2017.  

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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, May 2016 and May 2017.  The May 2017 amendment increased the number of shares available in the Plan by 7,700,000 shares.  As allowed by the Plan, during 2017 and 2016, 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 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 March 31, 2018, there were 13,363,792 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.  The Company has the option at vesting to settle RSUs in stock or cash, or a combination of stock and cash.  The Company plans to settle RSUs that vest in the future using shares of common stock.  

RSUs currently outstanding related to the 2017 and 2016 grants have been adjusted for performance achieved against predetermined criteria for the applicable performance year.  These RSUs continue to be subject to employment-based criteria and vesting occurs in December of the second year after the grant.  See the 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 2017 and 2016 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.  

There were no grants or vesting of RSUs during the three months ended March 31, 2018.  For the outstanding RSUs issued to the eligible employees as of March 31, 2018, vesting is expected to occur as follows:  

 

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 2017, 2016 and 2015.  As of March 31, 2018, there were 170,524 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 of 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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There were no grants or vesting of Restricted Shares during the three months ended March 31, 2018.  For the outstanding Restricted Shares issued to the non-employee directors as of March 31, 2018, 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 Consolidated Statements of Operations.  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, 2018, unrecognized share-based compensation expense related to our awards of RSUs and Restricted Shares was $5.0 million and $0.3 million, respectively.  Unrecognized share-based compensation expense will be recognized through November 2019 for RSUs and April 2020 for Restricted Shares.

Cash-Based Incentive Compensation. In addition to share-based compensation, cash-based awards were granted under the Plan to substantially all eligible employees in 2017 and 2016.  The cash-based awards, which are a short-term component of the Plan, are performance-based awards consisting of one or more business criteria or individual performance criteria and a targeted level or levels of performance with respect to each such criterion.  In addition, these cash-based awards included an additional financial condition requiring Adjusted EBITDA less reported Interest Expense Incurred (as defined in the awards) for any fiscal quarter plus the three preceding quarters to exceed defined levels measured over defined time periods for each cash-based award.  Expense is recognized over the service period once the business criteria, individual performance criteria and financial condition are met.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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A summary of compensation expense related to share-based awards and cash-based awards is as follows (in thousands):

 

8.  Income Taxes  

Our income tax expense for the three months ended March 31, 2018 was $0.1 million and our income tax benefit for the three months ended March 31, 2017 was $7.6 million.  Our effective tax rate was not meaningful for either period presented.  The income tax expense in the three months ended March 31, 2018 represents the interest on uncertain tax positions.  Excluding this adjustment, tax expense would have been zero for the three months ended March 31, 2018.  Our current full-year forecast for 2018 has a net operating loss for tax purposes; therefore, no current tax expense is recorded.  In addition, no deferred income tax expense is recorded due to dollar-for-dollar offsets by our valuation allowance.  The income tax benefit for the three months ended March 31, 2017 relates to net operating loss carryback claims made pursuant to Internal Revenue Code (“IRC”) Section 172(f) (related to rules for “specified liability losses”), which permit certain platform dismantlement, well abandonment and site clearance costs to be carried back 10 years.

During the three months ended March 31, 2018 and 2017, we did not receive any income tax refunds and made no income tax payments of significance.          

As of March 31, 2018, we recorded current income taxes receivable of $65.1 million.  As of December 31, 2017, the balance sheet reflects current income taxes receivable of $13.0 million and non-current income taxes receivable of $52.1 million.  The receivables primarily relate to a net operating loss claim carried back for 2017 and net operating loss claims for the years 2012, 2013 and 2014 that were carried back to prior years. These carryback claims are made pursuant to IRC Section 172(f) described above.  The refund claims for the years 2012, 2013 and 2014 require a review by the Congressional Joint Committee on Taxation.

As of March 31, 2018 and December 31, 2017, our valuation allowance was $165.7 million and $171.5 million, respectively, related to federal and state deferred tax assets.  Net deferred tax assets were recorded related to NOLs and temporary differences between the book and tax basis of assets and liabilities expected to produce tax deductions in future periods.  The realization of these assets depends on recognition of sufficient future taxable income in specific tax jurisdictions in which those temporary differences or net operating losses are deductible.  In assessing the need for a valuation allowance on our deferred tax assets, we consider whether it is more likely than not that some portion or all of them will not be realized.  Although our net deferred tax assets and the related valuation allowance reflect the provisions of the Tax Cuts and Jobs Act (“TCJA”), due to the timing and the complexity of the provisions of the TCJA, further adjustments may be required during 2018 in determination of the final effect in our financial statements.  

We recognize interest and penalties related to unrecognized tax benefits in income tax expense.  During the three months ended March 31, 2018 and 2017, we recorded immaterial amounts of accrued interest expense related to our unrecognized tax benefits.  For the first quarter of 2018, the amount reported as income tax expense is entirely attributable to this accrued interest.

The tax years 2013 through 2017 remain open to examination by the tax jurisdictions to which we are subject.   

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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9.  Earnings Per Share

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

 

10.  Contingencies  

Apache Lawsuit.   On December 15, 2014, Apache filed a lawsuit against the Company alleging that W&T breached the joint operating agreement related to, among other things, the abandonment of three deepwater wells in the Mississippi Canyon (“MC”) area of the Gulf of Mexico.  A trial court judgment was rendered from the U.S. District Court for the Southern District of Texas on May 31, 2017 directing the Company to pay Apache $43.2 million, plus $6.3 million in prejudgment interest, attorney's fees and costs assessed in the judgment.  We filed an appeal of the trial court judgment in the U.S. Court of Appeals for the Fifth Circuit.  Prior to filing the appeal, in order to stay execution of the judgment, we deposited $49.5 million with the registry of the court in June 2017.  

The deposit of $49.5 million with the registry of the court is recorded in Other assets (long-term) on the Condensed Consolidated Balance Sheets as of March 31, 2018 and December 31, 2017.  Although we are appealing the decision, based solely on the decision rendered, we have recorded $49.5 million in Other liabilities (long-term) as of March 31, 2018 and December 31, 2017.

Appeal with the Office of Natural Resources Revenue (“ONRR”). In 2009, we 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 our 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 Interior Board of Land Appeals (“IBLA”) under the Department of the Interior.  On January 27, 2017, the IBLA affirmed the decision of the ONRR requiring W&T to pay approximately $4.7 million in additional royalties.  We filed an appeal of the IBLA decision on July 25, 2017 in the U.S. District Court for the Eastern District of Louisiana.  We were required to post a bond in the amount of $7.2 million and cash collateral of $6.9 million in order to appeal the IBLA decision.  

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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Royalties – “Unbundling” Initiative.  The ONRR has publicly announced an “unbundling” initiative to revise 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.  The ONRR’s initiative requires re-computing allowable transportation and processing costs using revised guidance from the ONRR going back 84 months for every gas processing plant that processed our gas.  In the second quarter of 2015, pursuant to the initiative, we received requests from the ONRR for additional data regarding our transportation and processing allowances on natural gas production related to a specific processing plant.  We also received a preliminary determination notice from the ONRR asserting that our allocation of certain processing costs and plant fuel use at another processing plant was not allowed as deductions in the determination of royalties owed under Federal oil and gas leases.  We have submitted revised calculations covering certain plants and time periods to the ONRR.  As of the filing date of this Form 10-Q, we have not received a response from the ONRR related to our submissions.  These open ONRR unbundling reviews, and any further similar reviews, could ultimately result in an order for payment of additional royalties under our Federal oil and gas leases for current and prior periods.  For the three months ended March 31, 2018 and 2017, we paid additional royalty payments of less than $0.1 million and $0.7 million, respectively.  We are not able to determine the range of any additional royalties or, if and when assessed, whether such amounts would be material.

Notices of Proposed Civil Penalty Assessment.  During the three months ended March 31, 2018 and 2017, we did not pay any civil penalties to the Bureau of Safety and Environmental Enforcement (“BSEE”) related to Incidents of Noncompliance (“INCs”) at various offshore locations.  We currently have five open civil penalties issued by the BSEE from INCs, which have not been settled as of the filing date of this Form 10-Q.  The INC’s underlying t