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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 the Company and its 100%-owned subsidiary, W & T Energy VI, LLC, and through our proportionately consolidated interest in Monza Energy LLC (“Monza”), as described in more detail in Note 4.

 

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, 2018.

 

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.

 

Leases.  In February 2016, Accounting Standards Update 2016-02, Leases (Topic 842) (“ASU 2016-02”) was issued requiring an entity to recognize a right-of-use (“ROU”) asset and lease liability for all leases.  The classification of leases as either a finance or operating lease determines the recognition, measurement and presentation of expenses.  ASU 2016-02 also requires certain quantitative and qualitative disclosures about leasing arrangements.  Leases acquired to explore for or extract oil or natural gas resources, including the right to explore for those natural resources and rights to use the land in which those natural resources are contained, are not within the scope of this standard’s update.  ASU 2016-02 was effective for us in the first quarter of 2019 and we adopted the new standard using a modified retrospective approach, with the date of initial application on January 1,2019.  Consequently, upon transition, we recognized an ROU asset and a lease liability with no retained earnings impact.  See Note 8 for additional information.

 

 

 

 

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

 

 

 

Revenue Recognition.  We recognize revenue from the sale of crude oil, natural gas liquids ("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.

 

Reclassifications.  Certain reclassifications have been made to the prior period financial statements to conform to the current presentation as follows: In the Condensed Consolidated Statements of Operations, interest income was reclassified from Other expense, net to Interest expense, net, which did not change Income (loss) before income tax (benefit) expense.  In the Condensed Consolidated Statements of Cash Flows, adjustments were made to certain line items within the Net cash provided by operating activities and Net cash used in investing activities sections, of which did not change the total amounts previous reported.  The adjustments did not affect the Condensed Consolidated Balance Sheets.

 

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):

 

		September 30,				December 31,
		2019				2018
Derivative assets (1)		$	23,150			$	60,687
Unamortized bond/insurance premiums			5,497				5,197
Prepaid deposits related to royalties			8,794				8,872
Other			2,780				1,650
Prepaid expenses and other assets		$	40,221			$	76,406

 

 

(1)

Includes closed contracts which have not yet settled.

 

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):

 

		September 30,				December 31,
		2019				2018
Oil and natural gas properties and equipment		$	8,471,973			$	8,169,871
Furniture, fixtures and other			20,247				20,228
Total property and equipment			8,492,220				8,190,099
Less accumulated depreciation, depletion and amortization			7,771,269				7,674,678
Oil and natural gas properties and other, net		$	720,951			$	515,421

 

 

 

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

 

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

 

		September 30,				December 31,
		2019				2018
Appeal bond deposits		$	6,925			$	6,925
Unamortized debt issuance costs			4,138				4,773
Investment in White Cap, LLC			2,885				2,586
Unamortized brokerage fee for Monza			4,131				2,277
Proportional consolidation of Monza's other assets (Note 4)			3,660				3,275
Right-of Use (Note 8)			10,239				—
Escrow deposit - Apache lawsuit (Note 12)			—				49,500
Derivative assets			—				21,275
Other			886				936
Total other assets (long-term)		$	32,864			$	91,547

 

 

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

 

		September 30,				December 31,
		2019				2018
Accrued interest		$	25,414			$	12,385
Accrued salaries/payroll taxes/benefits			2,267				2,320
Incentive compensation plans			3,667				10,817
Litigation accruals			3,673				3,673
Lease liability (Note 8)			1,877				—
Other			356				416
Total accrued liabilities		$	37,254			$	29,611

 

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

 

		September 30,				December 31,
		2019				2018
Dispute related to royalty deductions		$	4,687			$	4,687
Dispute related to royalty-in-kind			2,231				2,135
Apache lawsuit (Note 12)			—				49,500
Uncertain tax positions including interest/penalties			—				11,523
Lease liability (Note 8)			7,883				—
Other			1,466				845
Total other liabilities (long-term)		$	16,267			$	68,690

 

 

Recent Accounting Developments.

 

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-13, Financial Instruments – Credit Losses (Topic 326) (“ASU 2016-13”) and subsequently issued additional guidance on this topic.  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.  Our assessment is this amendment will not have a material impact on our financial statements.

 

In August 2017, the FASB issued Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815) – Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”) and subsequently issued additional guidance on this topic.  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 instruments 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.

 

In August 2018, the SEC issued Final Rule Release No. 33-10532, Disclosure Update and Simplification, which revised Regulation S-X, Rule 3-04, Changes in Stockholders’ Equity and Noncontrolling Interests.  The new requirement for registrants is to include a reconciliation of changes in stockholders’ equity (deficit) in interim periods for each period that for which a statement of operations is required to be filed.  The new requirement became effective for us for the quarter ended March 31, 2019.

 

 

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

 

 

2.	Long-Term Debt

 

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

 

		September 30,				December 31,
		2019				2018
Credit Agreement borrowings		$	105,000			$	21,000
Senior Second Lien Notes:
Principal			625,000				625,000
Unamortized debt issuance costs			(11,051	)			(12,465	)
Total Senior Second Lien Notes			613,949				612,535
Total long-term debt		$	718,949			$	633,535

 

 

Credit Agreement

 

On October 18, 2018, we entered into the Sixth Amended and Restated Credit Agreement (the “Credit Agreement”), which matures on October 18, 2022.  The primary terms and covenants associated with the Credit Agreement are as follows, with capitalized terms defined under the Credit Agreement:

 

•

The borrowing base and lending commitment was $250.0 million as of the filing date of this Form 10-Q.

 

•

Letters of credit may be issued in amounts up to $30.0 million, provided availability under the Credit Agreement exists.  As of September 30, 2019 and December 31, 2018, we had $7.2 million and $9.6 million, respectively, of letters of credit issued and outstanding under the Credit Agreement.

 

•

The Leverage Ratio is limited to 3.25 to 1.00 for the quarter ending September 30, 2019; and 3.00 to 1.00 for the quarters ending December 31, 2019 and thereafter.  In the event of a Material Acquisition (which includes our August 2019 acquisition of the Mobile Bay properties described in Note 7), the Leverage Ratio limit is 3.50 to 1.00 for the two quarters following a Material Acquisition.

 

•

The Current Ratio must be maintained at greater than 1.00 to 1.00.

 

Availability under the Credit Agreement is subject to semi-annual redeterminations of our borrowing base to occur on or before May 15 and November 14 each calendar year, and certain additional redeterminations that may be requested at the discretion of either the lenders or the Company.  The borrowing base has not changed from the initial amount.  The borrowing base is calculated by our lenders based on their evaluation of our proved reserves and their own internal criteria.  Any redetermination by our lenders to change our borrowing base will result in a similar change in the availability under the Credit Agreement.  The Credit Agreement’s security is collateralized by a first priority lien on properties constituting at least 85% of the total proved reserves of the Company as set forth on reserve reports required to be delivered under the Credit Agreement and certain personal property.  The annualized interest rate on borrowings outstanding for the nine months ended September 30, 2019 was 5.1%, which excludes debt issuance costs, commitment fees and other fees.

 

9.75% Senior Second Lien Notes Due 2023

 

On October 18, 2018, we issued $625.0 million of 9.75% Senior Second Lien Notes due 2023 (the “Senior Second Lien Notes”), which were issued at par with an interest rate of 9.75% per annum and mature on November 1, 2023, and are governed under the terms of the Indenture of the Senior Second Lien Notes (the “Indenture”).  The estimated annual effective interest rate on the Senior Second Lien Notes is 10.3%, which includes amortization of debt issuance costs.  Interest on the Senior Second Lien Notes is payable in arrears on May 1 and November 1 of each year.

 

The Senior Second Lien Notes are secured by a second-priority lien on all of our assets that are secured under the Credit Agreement.  The Senior Second Lien Notes contain covenants that limit or prohibit our ability and the ability of certain of our subsidiaries to: (i) make investments; (ii) incur additional indebtedness or issue certain types of preferred stock; (iii) create certain liens; (iv) sell assets; (v) enter into agreements that restrict dividends or other payments from the Company’s subsidiaries to the Company; (vi) consolidate, merge or transfer all or substantially all of the assets of the Company; (vii) engage in transactions with affiliates; (viii) pay dividends or make other distributions on capital stock or subordinated indebtedness; and (ix) create subsidiaries that would not be restricted by the covenants of the Indenture.  These covenants are subject to exceptions and qualifications set forth in the Indenture.  In addition, most of the above described covenants will terminate if both S&P Global Ratings, a division of S&P Global Inc., and Moody’s Investors Service, Inc. assign the Senior Second Lien Notes an investment grade rating and no default exists with respect to the Senior Second Lien Notes.

 

Covenants 

 

As of September 30, 2019, we were in compliance with all applicable covenants of the Credit Agreement and the Indenture.

 

Fair Value Measurements 

 

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

 

 

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

 

 

3.	Fair Value Measurements

 

Derivative Financial Instruments

 

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 open derivative financial instruments are the exercise price, the expiration date, the settlement date, notional quantities, the implied volatility, the discount curve with spreads and published commodity future prices.  Our open derivative financial instruments are reported in the Condensed Consolidated Balance Sheets using fair value.  See Note 6, Derivative Financial Instruments, for additional information on our derivative financial instruments.

 

The following table presents the fair value of our open derivative financial instruments (in thousands):

 

		September 30,				December 31,
		2019				2018
Assets:
Derivatives instruments - open contracts		$	21,965			$	74,580

 

Long-Term Debt

 

We believe the carrying value of our debt under the Credit Agreement approximates fair value because the interest rates are variable and reflective of current market rates. The fair value of our Senior Second Lien Notes was measured using quoted prices, although the market is not a very active market. The fair value of our long-term debt was classified as Level 2 within the valuation hierarchy.  See Note 2, Long-Term Debt for additional information on our long-term debt.

 

The following table presents the carrying value and fair value of our long-term debt (in thousands):

 

		September 30, 2019								December 31, 2018
		Carrying Value				Fair Value				Carrying Value				Fair Value
Liabilities:
Credit Agreement		$	105,000			$	105,000			$	21,000			$	21,000
Senior Second Lien Notes			613,949				610,225				612,535				546,875

 

 

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

 

 

4.	Joint Venture Drilling Program

 

On March 12, 2018, W&T and two other initial members formed and initially funded Monza, which jointly participates with us in the exploration, drilling and development of certain drilling projects (the “JV Drilling Program”) in the Gulf of Mexico.  The projects are expected to be completed through 2020, but some projects may possibly extend into years beyond 2020.  W&T initially contributed 88.94% of its working interest in 14 identified undeveloped drilling projects to Monza and retained 11.06% of its working interest.  Subsequent to the initial closing, additional investors joined as members of Monza during 2018 and total commitments by all members, including W&T, are $361.4 million.  The JV Drilling Program is structured so that we initially receive an aggregate of 30.0% of the revenues less expenses, 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.  Any exceptions are approved by the Monza board.  W&T is or will be the operator of each well in the JV Drilling Program unless there is a designated third-party operator.

 

Monza is an entity separate from any other entity with its own separate creditors who will be entitled, upon its liquidation, to be satisfied out of Monza’s assets prior to any value in Monza becoming available to holders of its equity.  The assets of Monza are not available to pay creditors of the Company and its affiliates.

 

The members of Monza are made up of third-party investors, 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 the third-party investors 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 $14.5 million.

 

As of September 30, 2019, members of Monza made partner capital contributions, including our initial contributions of working interest in the drilling projects, to Monza totaling $282.2 million, of which $125.5 million was contributed during the nine months ended September 30, 2019.  Our net contribution to Monza, reduced by distributions received, as of September 30, 2019 was $61.4 million.  W&T is obligated to fund certain cost overruns to the extent they occur, subject to certain exceptions, for the JV Drilling Program wells above budgeted and contingency amounts, of which the total exposure cannot be estimated at this time.

 

Consolidation and Carrying Amounts. Our interest in Monza is considered to be a variable interest that we account for using proportional consolidation.  Through September 30, 2019, there have not been any events or changes that would cause a redetermination of the variable interest status.  We do not fully consolidate Monza because we are not considered the primary beneficiary and we utilize proportional consolidation to account for our interests in the Monza properties.  As of September 30, 2019, in the Condensed Consolidated Balance Sheet, we recorded $16.8 million, net, in Oil and natural gas properties and other, net, $3.7 million in Other assets and $3.6 million, net, increase in working capital in connection with our proportional interest in Monza’s assets and liabilities.  As of December 31, 2018, in the Condensed Consolidated Balance Sheet, we recorded $8.8 million, net, in Oil and natural gas properties and other, net, $3.3 million in Other assets and $0.7 million, net, increase in working capital in connection with our proportional interest in Monza’s assets and liabilities.  For the nine months ended September 30, 2019, we recorded $7.4 million in Total revenues and $4.6 million in Operating costs and expenses in connection with our proportional interest in Monza’s operations.  For the nine months ended September 30, 2018, we recorded $2.2 million in Total revenues, $1.1 million in Operating costs and expenses and $0.3 million, net, in Other (income) expense, net in connection with our proportional interest in Monza’s operations.

 

Additionally, during the nine months ended September 30, 2019, we called on Monza to provide, and received, $123.5 million to fund JV Drilling Program projects, of which $36.5 million is included in the Condensed Consolidated Balance Sheet in Advances from joint interest partners as of September 30, 2019.

 

 

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

 

 

5.	Asset Retirement Obligations

 

Our asset retirement obligations (“ARO”) represent the estimated present value of the amount incurred to plug, abandon and remediate our properties at the end of their productive lives.

 

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

 

Balances, December 31, 2018		$	310,137
Liabilities settled			(7,740	)
Accretion of discount			14,086
Liabilities assumed through purchase			21,619
Liabilities incurred			426
Revisions of estimated liabilities			5,967
Balances, September 30, 2019			344,495
Less current portion			23,095
Long-term		$	321,400

 

 

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 crude oil and natural gas.  All of the present derivative counterparties are also lenders or affiliates of lenders participating in our Credit Agreement. 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.  We are not required to provide additional collateral to the derivative counterparties 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.

 

During 2018, we entered into commodity contracts for crude oil and natural gas which related to a portion of our expected future production.  The crude oil contracts are based on West Texas Intermediate (“WTI”) crude oil prices as quoted off the New York Mercantile Exchange (“NYMEX”).  The natural gas contracts were based on Henry Hub natural gas prices as quoted off the NYMEX and expired during the second quarter of 2019.  The open contracts as of September 30, 2019 are presented in the following tables:

 

 

(1)

Bbls = Barrels

 

 

(1)

Bbls = Barrels

 

 

 

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

 

The following amounts were recorded in the Condensed Consolidated Balance Sheets in the categories presented and include the fair value of open contracts, and closed contracts which had not yet settled (in thousands):

 

		September 30,				December 31,
		2019				2018
Prepaid expenses and other assets		$	23,150			$	60,687
Other assets (non-current)			—				21,275

 

The amounts recorded on the Condensed Consolidated Balance Sheets are on a gross basis. If these were recorded on a net settlement basis, it would not have resulted in any differences in reported amounts.

 

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

 

 

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

 

 

 

7.	Oil and Gas Property Acquisitions and Divestiture

 

Mobile Bay Acquisition

 

On June 26, 2019, we entered into a purchase and sale agreement with ExxonMobil Corporation and certain of their subsidiaries (collectively "ExxonMobil") to acquire their interests in and operatorship of oil and gas producing properties in the eastern region of the Gulf of Mexico offshore Alabama and a related processing facility for $200.0 million.  On August 30, 2019, we closed on the purchase with ExxonMobil, and after taking into account customary closing adjustments and an effective date of January 1, 2019, cash consideration paid by us was $167.6 million, including a previously-funded $10.0 million deposit.  The transaction is referred to as the "Mobile Bay Acquisition".  The acquisition was funded from cash on hand and borrowings under the Credit Agreement, which was previously undrawn.  We also assumed the related ARO and certain other obligations associated with these assets.  The properties include working interests in nine Gulf of Mexico offshore producing fields and an onshore treatment facility that are adjacent to existing properties owned and operated by us. 

 

We determined that the assets acquired did not meet the definition of a business under GAAP; therefore, the transaction was accounted for as an asset acquisition.  The recorded values were determined using the cash paid to the seller and expenses incurred related to the transaction.  Values for the liabilities assumed for ARO and certain other obligations were determined using the same methodology used to estimate other similar obligations of the Company.  The components of the cash paid to the seller at closing and the amounts recorded on the Condensed Consolidated Balance Sheet for the purchase price allocation and liabilities assumed are presented in the following tables (in thousands):

 

 

 

 

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

 

Heidelberg Field

 

On April 5, 2018, we closed on the purchase from Cobalt International Energy, Inc. of a 9.375% non-operated working interest in the Heidelberg field located in Green Canyon blocks 859, 903 and 904.  The gross purchase price was $31.1 million which was adjusted for certain closing items and an effective date of January 1, 2018.  Cash flows generated by the acquired interest between the effective date and the closing date reduced the net purchase price to $16.8 million.  We determined that the assets acquired did not meet the definition of a business; therefore, the transaction was accounted for as an asset acquisition.  

 

Permian Basin

 

 On September 28, 2018, we closed on the divestiture of substantially all of our ownership in an overriding royalty interests in the Permian Basin.  The net proceeds received were $56.6 million, which was recorded as a reduction to our full-cost pool.

 

 

8.

Leases

 

ASU 2016-02 was effective for us on January 1, 2019 and we adopted the new standard using a modified retrospective approach.  Consequently, upon transition, we recognized an ROU asset and a lease liability with no retained earnings impact.

 

As provided for in subsequent accounting standards updates related to ASU 2016-02, we are applying the following practical expedients which provide elections to:

 

•

not apply the recognition requirements to short-term leases (a lease that at commencement date has a lease term of 12 months or less and does not contain a purchase option);

 

•

not reassess whether a contract contains a lease, lease classifications between operating and financing and accounting for initial direct costs related to leases;

 

•

not reassess certain land easements in existence prior to January 1, 2019;

 

•

use hindsight in determining the lease term and assessing impairment; and

 

•

not separate non-lease and lease components.

 

Based on the results of our implementation process, we identified one operating lease in existence at January 1, 2019 subject to ASU 2016-02, which is our real estate lease for office space in Houston, Texas that terminates in December 2022.  We identified no finance leases.  The implementation  of ASU 2016-02 resulted in establishing an ROU asset and lease liability of $5.0 million during the first quarter of 2019.  The adoption of the new standard did not impact our Condensed Consolidated Statements of Operations, Condensed Consolidated Statements of Cash Flows or Condensed Consolidated Statements of Changes in Shareholders’ Deficit.  

 

During the nine months ended September 30, 2019, various pipeline rights-of-way contracts and a land lease were acquired, assumed, renewed or otherwise entered into, primarily in conjunction with the Mobile Bay Acquisition.  For these contracts, an ROU asset and a corresponding lease liability was calculated based on our assumptions of the term, inflation rates and incremental borrowing rates.  The term of each pipeline right-of-way contract is 10 years with various effective dates, and each has an option to renew for up to another ten years.  It is expected renewals beyond 10 years can be obtained as renewals were granted to the previous lessees.  The land lease has an option to renew every five years extending to 2085.  The expected term of the rights-of way and land leases was estimated to approximate the life of the related reserves.  

 

Minimum future lease payments were estimated assuming expected terms of the leases and estimated inflation escalations of payments for certain leases.  Undiscounted future minimum payments as of September 30, 2019 are as follows: 2019 - $0.8 million; 2020 - $1.9 million; 2021 - $1.9 million; 2022 - $2.0 million; 2023 - $0.5 million; and 2024 and beyond - $13.2 million.  During the nine months ended September 30, 2019 and 2018, expense recognized related to these leases was $2.0 million for each period.    

 

As of September 30, 2019, we recorded ROU assets and lease liabilities using a discount rate of 9.75% for the Houston office lease and 10.75% for the other leases.  The discount rate (or incremental borrowing rate) was determined using the interest rate of recently issued debt instruments that were issued at par and for a similar term as the term of our Houston office lease.  For the other lease contracts, a higher discount rate was used as the incremental borrowing rate due to longer expected termination dates.  The expected terms of the leases ranged between three and 20 years, with no early terminations assumed.

 

 

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

 

Amounts related to leases recorded within our Condensed Consolidated Balance Sheet are as follows (in thousands):

 

 

 During the nine months ended September 30, 2019, we incurred short-term lease costs related to drilling rigs of $13.3 million, net to our interest, of which the majority of such costs were recorded within Oil and natural gas properties, net, on the Condensed Consolidated Balance Sheet.  In exercising the practical expedient, we did not separate non-lease and lease components for these short-term leases.  

 

 

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

 

Awards to Employees. In 2010, the W&T Offshore, Inc. Amended and Restated Incentive Compensation Plan (as amended from time to time, the “Plan”) was approved by our shareholders.  During 2019, 2018 and 2017, the Company granted restricted stock units (“RSUs”) under the Plan to certain of its employees.  RSUs are a long-term compensation component, and are subject to satisfaction of certain predetermined performance criteria and adjustments at the end of the applicable performance period based on the results achieved.  In addition to share-based awards, the Company may grant to its employees cash-based incentive awards under the Plan, which may be used as short-term and long-term compensation components of the awards, and are subject to satisfaction of certain predetermined performance criteria.

 

As of September 30, 2019, there were 11,852,592 shares of common stock available for issuance in satisfaction of awards under the Plan.  The shares available for issuance are reduced on a one-for-one basis when RSUs are settled in shares of common stock, which shares of common stock are issued net of withholding tax through the withholding of shares.  The Company has the option following vesting to settle RSUs in stock or cash, or a combination of stock and cash. The Company expects to settle RSUs that vest in the future using shares of common stock.

 

RSUs currently outstanding relate to the 2019, 2018 and 2017 grants.  The 2019 grants are subject to pre-determined performance criteria which will be measured using 2019 performance results.  The 2018 and 2017 grants were subject to predetermined performance criteria applied against the applicable performance period.  All the RSUs currently outstanding are subject to employment-based criteria and vesting generally occurs in December of the second year after the grant.  See the table below for anticipated 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 2019, 2018 and 2017 were determined using the Company’s closing price on the grant date. We also 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.

 

A summary of activity related to RSUs during the nine months ended September 30, 2019 is as follows:

 

		Restricted Stock Units
						Weighted Average
						Grant Date Fair
		Units				Value Per Unit
Nonvested, December 31, 2018			3,355,917			$	3.90
Granted			990,608				4.51
Forfeited (1)			(1,075,864	)			3.12
Nonvested, September 30, 2019			3,270,661				4.34

 

(1)

Primarily related to former executives' forfeitures.

 

For the outstanding RSUs issued to the eligible employees as of September 30, 2019, vesting is expected to occur as follows (subject to forfeitures): 

 

 

 

 

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

 

Awards to Non-Employee Directors.  Under the W&T Offshore, Inc. 2004 Directors Compensation Plan (as amended from time to time, 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 2019, 2018 and 2017.  As of September 30, 2019, there were 82,620 shares of common stock available for issuance in satisfaction of awards under the Director Compensation Plan.  The shares available are reduced on a one-to-one basis 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 otherwise 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.

 

A summary of activity related to Restricted Shares during the nine months ended September 30, 2019 is as follows:

 

		Restricted Shares
						Weighted Average
						Grant Date Fair
		Shares				Value Per Share
Nonvested, December 31, 2018			181,832			$	3.08
Granted			46,360				6.04
Vested			(105,012	)			2.67
Nonvested, September 30, 2019			123,180				4.55

 

For the Restricted Shares vested during the nine months ended September 30, 2019, the grant date value was $0.3 million and the vested date value, as determined on the vesting dates, was $0.5 million.

 

For the outstanding Restricted Shares issued to the non-employee directors as of September 30, 2019, vesting is expected to occur as follows (subject to any forfeitures):

 

 

Share-Based Compensation.  Share-based compensation expense is recorded in the line General and administrative expenses in the Condensed Consolidated Statements of Operations.  The tax benefit related to compensation expense recognized under share-based payment arrangements was not meaningful and was minimal due to our income tax situation.  A summary of incentive compensation expense under share-based payment arrangements is as follows (in thousands):

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2019				2018				2019				2018
Share-based compensation expense from:
Restricted stock units (1)		$	1,178			$	1,303			$	2,219			$	3,598
Restricted Shares			70				70				210				210
Total		$	1,248			$	1,373			$	2,429			$	3,808

 

(1)

For the nine months ended September 30, 2019, share-based compensation expense includes adjustments for former executives' forfeitures.

 

Unrecognized Share-Based Compensation.  As of September 30, 2019, unrecognized share-based compensation expense related to our awards of RSUs and Restricted Shares was $5.9 million and $0.4 million, respectively.  Unrecognized share-based compensation expense will be recognized through November 2021 for RSUs and April 2022 for Restricted Shares.

 

 

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

 

Cash-Based Incentive Compensation.  In addition to share-based awards, cash-based awards were granted under the Plan to eligible employees in 2019, 2018 and 2017.  For 2018, there were two cash-based awards consisting of a long-term award and a short-term award.  All cash-based awards are performance-based awards consisting of predetermined performance criteria applied against the applicable performance period.  Expense for each award is recognized over the service period once the applicable financial condition is expected to be met, and the business criteria and individual performance criteria can be reasonably estimated for the applicable period.

 

•

For the 2019 short-term, cash-based awards, incentive compensation expense was determined based on estimates of the Company achieving certain performance metrics for 2019 and is being recognized over the May 2019 to February 2020 period.  The 2019 short-term, cash-based awards will be eligible for payment during March 2020, subject to participants meeting certain employment-based criteria.

 

•

For the 2018 long-term, cash-based awards, incentive compensation expense was determined based on the Company achieving certain performance metrics for 2018 and is being recognized over the September 2018 to November 2020 period.  The 2018 long-term, cash-based awards will be eligible for payment on December 14, 2020 subject to participants meeting certain employment-based criteria.

 

•

For the 2018 short-term, cash-based awards, incentive compensation expense was determined based on the Company achieving certain performance metrics for 2018 combined with individual performance criteria for 2018 and was recognized over the January 2018 to February 2019 period.  The 2018 short-term, cash-based awards were paid during March 2019.

 

•

For the 2017 short-term, cash-based awards, incentive compensation expense was determined based on the Company achieving certain performance metrics for 2017 combined with individual performance criteria for 2017 and was recognized over the January 2017 to February 2018 period.  The 2017 short term, cash-based awards were paid during March 2018.

 

A summary of compensation expense related to share-based awards and cash-based awards is as follows (in thousands):

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2019				2018				2019				2018
Share-based compensation included in:
General and administrative expenses		$	1,248			$	1,373			$	2,429			$	3,808
Cash-based incentive compensation included in:
Lease operating expense (1)			672				837				951				2,240
General and administrative expenses (1)			1,679				1,534				5,017				5,597
Total charged to operating income		$	3,599			$	3,744			$	8,397			$	11,645

 

(1)

Includes adjustments of accruals to actual payments.

 

 

10.	Income Taxes

 

Tax Benefit and Tax Rate.  We recorded an income tax benefit of $55.5 million and $67.0 million for the three and nine months ended September 30, 2019, respectively.  During the three months ended September 30, 2019, we released a portion of the valuation allowance on our net deferred tax assets based on the Company’s quarterly assessment of the realizability of net deferred tax assets, resulting in an income tax benefit of $55.8 million.  During the nine months ended September 30, 2019, we reversed a liability related to an uncertain tax position that was effectively settled with the Internal Revenue Service ("IRS"), resulting in an income tax benefit of $11.5 million.  Our effective tax rate was not meaningful for the periods presented due to these changes.

 

Valuation Allowance.  Net deferred tax assets relate to net operating loss carryforwards, interest expense carryforwards and other temporary differences expected to produce tax deductions in future periods.  The realization of these assets depends on recognition of sufficient future taxable income in specific federal and state tax jurisdictions in which those temporary differences 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 our deferred tax assets will not be realized.  At December 31, 2018, our valuation allowance was $117.8 million, which offset substantially all net deferred tax assets as of such date. 

 

Throughout 2019, the Company has been in a cumulative three year pre-tax income position and has been assessing the realizeability of our deferred tax assets.  During the quarter ended September 30, 2019, the Company’s assessment included consideration of the Company’s operating history and our forecasted taxable income using all available information.  Based on the assessment, we determined that the Company’s ability to maintain long-term profitability despite near-term changes in commodity prices and capital and operating costs demonstrated that a portion of the Company’s net deferred tax assets would more likely than not be realized.  We released $55.8 million of the valuation allowance, resulting in an income tax benefit in the quarter ended September 30, 2019.  As of September 30, 2019, the Company’s valuation allowance was $62.9 million.

 

 

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

 

Income Taxes Receivable.  As of September 30, 2019 and December 31, 2018, we had current income taxes receivable of $36.9 million and $54.1 million, respectively, related primarily to net operating loss carryback claims for the years 2012, 2013 and 2014 that were carried back to prior years.  These carryback claims were made pursuant to IRC Section 172(f) (related to rules regarding “specified liability losses”), which permits certain platform dismantlement, well abandonment and site clearance costs to be carried back 10 years.  During the three and nine months ended September 30, 2019, we received $16.9 million in income tax refunds.  During the same periods, we recorded interest income of $0.5 million and $4.5 million related to these income tax claims, respectively.  During October 2019, we received $34.9 million in additional income tax refunds in addition to the $4.5 million in interest income and we expect to receive the remaining balance of claims of approximately $2.0 million in the first half of 2020. 

 

During the three and nine months ended September 30, 2018, we did not receive any income tax claims or make any income tax payments of significance.

 

The tax years 2013 through 2018 remain open to examination by the tax jurisdictions to which we are subject.

 

 

11.	Earnings Per Share

 

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

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2019				2018				2019				2018
Net income		$	75,899			$	46,260			$	64,527			$	109,983
Less portion allocated to nonvested shares			1,345				1,860				1,272				4,489
Net income allocated to common shares		$	74,554			$	44,400			$	63,255			$	105,494
Weighted average common shares outstanding			140,567				138,972				140,520				138,917
Basic and diluted earnings per common share		$	0.53			$	0.32			$	0.45			$	0.76

 

 

12.	Contingencies

 

Apache Lawsuit.  On December 15, 2014, Apache filed a lawsuit against the Company, Apache Deepwater, L.L.C. vs. W&T Offshore, Inc., alleging that W&T breached the joint operating agreement related to, among other things, the abandonment of three deepwater wells in the Mississippi Canyon 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 and provided oral arguments in December 2018.  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.  On July 16, 2019, a panel of the U.S. Court of Appeals for the Fifth Circuit rendered its opinion that affirmed the trial court's judgment against the Company.  Requests for rehearing and rehearing en banc subsequently were denied. The deposit with the registry of the court was distributed during the third quarter of 2019 pursuant to an agreement with Apache, which does not hinder the Company's continuing right to seek United States Supreme Court review.  The Company intends to pursue vigorously all available legal recourse.  

 

As funds were distributed during the third quarter of 2019, no amounts were recorded on the Condensed Consolidated Balance Sheet as of September 30, 2019 related to this matter.  Interest income of $1.9 million was recorded in Interest expense, net on the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2019.  The deposit of $49.5 million made with the registry of the court was recorded in Other assets (long-term) and $49.5 million was recorded in Other liabilities (long-term) on the Condensed Consolidated Balance Sheet as of December 31, 2018. 

 

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 with the offset to a liability reserve; 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 a motion for reconsideration of the IBLA decision on March 27, 2017.  Based on a statutory deadline, 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.  On December 4, 2018, the IBLA denied our motion for reconsideration.  On February 4, 2019, we filed our first amended complaint, and the government has filed its Answer in the Administrative Record.  On July 9, 2019, we filed an Objection to the Administrative Record and Motion to Supplement the Administrative Record, asking the court to order the government to file a complete privilege log with the record.  Following a hearing on July 31, 2019, the Court ordered the government to file a complete privilege log.  The government recently provided that privilege log and we are evaluating whether to move to compel production of any of the documents listed on the log.  After these issues concerning the record are resolved, the parties will file cross-motions for summary judgment.

 

 

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

 

Royalties-In-Kind (“RIK”).  Under a program of the Minerals Management Service (“MMS”) (a Department of Interior agency and predecessor to the ONRR), royalties must be paid “in-kind” rather than in value from federal leases in the program. The MMS added to the RIK program our lease at the East Cameron 373 field beginning in November 2001, where in some months we over delivered volumes of natural gas and under delivered volumes of natural gas in other months for royalties owed.  The MMS elected to terminate receiving royalties in-kind in October 2008, causing the imbalance to become fixed for accounting purposes.  The MMS ordered us to pay an amount based on its interpretation of the program and its calculations of amounts owed. We disagreed with MMS’s interpretations and calculations and filed an appeal with the IBLA, of which the IBLA ruled in MMS’ favor.  We filed an appeal with the District Court of the Western District of Louisiana, who assigned the case to a magistrate to review and issue a ruling, and the District Court upheld the magistrate’s ruling on May 29, 2018.  We filed an appeal on July 24, 2018. Part of the ruling was in favor of our position and part was in favor of MMS’ position.  Based solely on the District Court’s ruling, we recorded a liability reserve of $2.2 million and $2.1 million as of September 30, 2019 and December 31, 2018, respectively.  We have appealed the ruling to the U.S. Fifth Circuit Court of Appeals and the government filed a cross-appeal.  Briefing has now been completed oral argument was held on October 9, 2019, and we are awaiting a final ruling from the Fifth Circuit.  Based on the briefs filed, W&T has asserted that the government has waived its claim for interest for the period prior to the MMS’s issuance of its order in 2010 requiring W&T to make a cash payment to resolve delivery imbalances (MMS quantified this interest amount as approximately $0.7 million); the government has not disputed W&T’s assertion on this issue.

 

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 nine months ended September 30, 2019 and 2018, we paid $0.4 million and $0.6 million, respectively, of additional royalties and expect to pay more in the future.  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 nine months ended September 30, 2019 and 2018, 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 nine 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 INCs underlying these open civil penalties cite alleged non-compliance with various safety-related requirements and procedures occurring at separate offshore locations on various dates ranging from July 2012 to January 2018.  The proposed civil penalties for these INCs total $7.7 million.  As of September 30, 2019 and December 31, 2018, we have accrued approximately $3.5 million, which is our best estimate of the final settlements once all appeals have been exhausted.  Our position is that the proposed civil penalties are excessive given the specific facts and circumstances related to these INCs.

 

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