2. Acquisitions

On May 11, 2011, we completed the acquisition of approximately 21,900 gross acres (21,500 net acres) of oil and gas leasehold interests in the West Texas Permian Basin (the "Permian Basin Properties") from Opal Resources LLC and Opal Resources Operating Company LLC ("Opal"). The stated purchase price was $366.3 million, subject to certain adjustments, including adjustments from an effective date of January 1, 2011. Taking into account adjustments through June 30, 2011, the purchase price was $399.5 million. The increase of $33.2 million primarily reflects drilling costs in excess of cash flow from the effective date of January 1, 2011 to the closing date of May 11, 2011. The purchase price is subject to further adjustments and we expect final settlement could occur as early as the third quarter of 2011. We acquired estimated proved reserves of approximately 30 million barrels of oil equivalent (182 Bcfe) (using a 6 to 1 Mcf to barrel equivalency) as of December 31, 2010, comprised of approximately 91% oil and natural gas liquids and which are approximately 78% proved undeveloped. The acquisition was funded from cash on hand and borrowings under our revolving bank credit facility.

During 2010, we closed on two major acquisition transactions. On April 30, 2010, through our wholly-owned subsidiary, W&T Energy VI, LLC ("Energy VI"), we acquired all of Total E&P USA's ("Total") interest, including production platforms and facilities, in three federal offshore lease blocks located in the Gulf of Mexico and assumed the asset retirement obligations ("ARO") for plugging and abandonment of the acquired interest. The purchase price was $121.3 million. The properties acquired from Total are producing interests and include a 100% working interest in the Matterhorn field (Mississippi Canyon block 243) and a 64% working interest in the Virgo field (Viosca Knoll blocks 822 and 823).

 

On November 4, 2010, through Energy VI, we acquired all of Shell Offshore Inc.'s ("Shell") interests, including production platforms and facilities, in three federal offshore lease blocks located in the Gulf of Mexico and assumed the ARO for plugging and abandonment of the acquired interest. The purchase price was $139.9 million. The properties acquired from Shell are producing interests and include a 70% working interest in the Tahoe field (Viosca Knoll 783), 100% working interest in the Southeast Tahoe field (Viosca Knoll 784) and a 6.25% of 8/8ths overriding royalty interest in the Droshky field (Green Canyon 244).

The Permian Basin Properties accounted for $11.1 million of revenue, $1.4 million of direct operating expenses, $2.4 million of depreciation, depletion, amortization and accretion ("DD&A") and $2.6 million of income taxes, resulting in $4.8 million of net income for the three and six months ended June 30, 2011. The net income attributable to these properties does not reflect certain expenses, such as general and administrative expenses and interest expense; therefore this information is not intended to report results as if these operations were managed on a stand-alone basis. In addition, the Permian Basin Properties are not recorded in a separate entity for tax purposes; therefore income tax was estimated using the federal statutory tax rate.

Pro forma financial statements have been prepared due to the acquisition being significant to us. The unaudited pro forma financial information was computed as if the acquisition of the Permian Basin Properties had been completed on January 1, 2010. The historical financial information is derived from the unaudited historical consolidated financial statements of W&T and the unaudited historical statements of revenues and direct operating expenses of the Permian Basin Properties (which were based on information provided by Opal). The adjustments noted below assume the entire transaction was financed with borrowings because the cash and cash equivalents balances for the assumed acquisition date was less than the cash and cash equivalents on hand used on the actual closing date of May 11, 2011.

The pro forma adjustments were based on information and estimates by management to be directly related to the purchase of the Permian Basin Properties. The pro forma financial information is not necessarily indicative of the results of operations had the purchase occurred on January 1, 2010. If the transaction had been in effect for the periods indicated, the results may have been substantially different. For example, we may have operated the assets differently than Opal, realized sales prices may have been different and costs of operating the properties may have been different. The following tables present a summary of our pro forma consolidated statement of income (loss) for the six months ended June 30, 2011 and 2010 (in thousands except earnings per share):

 

		Six Months Ended June 30, 2011
		Historical				Permian Basin Properties				Pro Forma Adjustments				Pro Forma
Revenues		$	463,777			$	23,801	(a)		$	—			$	487,578
Operating costs and expenses:
Lease operating expenses			101,002				5,261	(a)			—				106,263
Production taxes			1,133				1,352	(a)			—				2,485
Gathering and transportation			8,350				10	(a)			—				8,360
Depreciation, depletion and amortization			141,618				—				9,263	(b)			150,881
Asset retirement obligation accretion			15,844				—				10	(c)			15,854
General and administrative expenses			36,131				—				(282	)(d)			35,849
Derivative loss			6,508				—				—				6,508
Total costs and expenses			310,586				6,623				8,991				326,200
Operating income/(loss)			153,191				17,178				(8,991	)			161,378
Interest expense:
Incurred			22,192				—				3,865	(e)			26,057
Capitalized			(3,491	)			—				(1,165	)(f)			(4,656	)
Loss on extinguishment of debt			20,663				—				—				20,663
Other income			16				—				—				16
Income/(loss) before income tax expense			113,843				17,178				(11,691	)			119,330
Income tax expense			40,019				—				1,920	(g)			41,939
Net income/(loss)		$	73,824			$	17,178			$	(13,611	)		$	77,391
Basic and diluted earnings per common share		$	0.98											$	1.02

 

		Six Months Ended June 30, 2010
		Historical				Permian Basin Properties				Pro Forma Adjustments				Pro Forma
Revenues		$	349,252			$	12,043	(a)		$	—			$	361,295
Operating costs and expenses:
Lease operating expenses			87,823				1,695	(a)			—				89,518
Production taxes			512				575	(a)			—				1,087
Gathering and transportation			8,313				4	(a)			—				8,317
Depreciation, depletion and amortization			132,819				—				13,857	(b)			146,676
Asset retirement obligation accretion			12,412				—				15	(c)			12,427
General and administrative expenses			24,754				—				—				24,754
Derivative (gain)			(13,270	)			—				—				(13,270	)
Total costs and expenses			253,363				2,274				13,872				269,509
Operating income/(loss)			95,889				9,769				(13,872	)			91,786
Interest expense:
Incurred			21,834				—				5,489	(e)			27,323
Capitalized			(2,745	)			—				(1,548	)(f)			(4,293	)
Other income			482				—				—				482
Income/(loss) before income tax expense			77,282				9,769				(17,813	)			69,238
Income tax expense/(benefit)			7,097				—				(2,815	)(g)			4,282
Net income/(loss)		$	70,185			$	9,769			$	(14,998	)		$	64,956
Basic and diluted earnings per common share		$	0.94											$	0.87

The purchase price is subject to further adjustments and we expect final settlement could occur as early as the third quarter of 2011. For these pro forma financial statements, the cash consideration is assumed to be funded entirely from borrowings from the revolving bank credit facility. The following table presents the purchase price allocation for the Permian Basin Properties as of June 30, 2011 (in thousands):

 

Oil and natural gas properties and equipment (full cost method, $84,720 excluded from amortization)		$	399,501
Asset retirement obligation			(382	)
Long-term liability			(2,143	)
Total cash paid		$	396,976

The following adjustments were made in the preparation of the condensed combined financial statements:

 

(a)

Revenues and direct operating expenses for the Permian Basin Properties were derived from the historical records of Opal up to the closing date of May 11, 2011.

 

(b)

Depreciation, depletion and amortization ("DD&A") was estimated using the full-cost method and determined as the incremental DD&A expense due to adding the Permian Basin costs, reserves and production into the computation. The purchase price allocation included $84.7 million allocated to the pool of unevaluated properties for oil and gas interests. Accordingly, no DD&A expense was estimated for the unevaluated properties.

 

(c)

Asset retirement obligations and related accretion were estimated by the management of W&T.

 

(d)

Incremental transaction expenses related to the purchase of Permian Basin Properties were $0.3 million and were assumed to be funded from cash on hand.

 

(e)

Interest expense was computed using interest rates that were in effect during the applicable time period and it was assumed that six-month LIBOR borrowings were made as allowed under the revolving bank credit facility. The assumed interest rates ranged from 3.1% to 3.5%. A reduction in the revolving bank credit facility commitment fee related to the assumed borrowings was netted against the computed incremental interest expense.

 

(f)

Incremental capitalized interest was computed for the addition of $84.7 million allocated to the pool of unevaluated properties and the capitalization interest rate was adjusted for the assumed borrowings.

 

(g)

Income tax was computed using the 35% federal statutory rate.