2. Acquisitions and Divestitures

2012 Acquisitions

On October 5, 2012, we acquired from Newfield Exploration Company and its subsidiary, Newfield Exploration Gulf Coast LLC (together, “Newfield”) certain oil and gas leasehold interests (the “Newfield Properties”). The adjusted purchase price was $205.6 million, which was subject to certain adjustments, including adjustments from an effective date of July 1, 2012 until the closing date, and the assumption of future ARO. The purchase price may be subject to further adjustments. The properties consisted of leases covering 78 offshore blocks on approximately 416,000 gross acres (268,000 net acres) (excluding overriding royalty interests), comprised of 65 blocks in the deepwater, six of which are producing, 10 blocks on the conventional shelf, four of which are producing, and an overriding royalty interest in three deepwater blocks, two of which are producing. The acquisition was funded from borrowings under our revolving bank credit facility and cash on hand. Subsequently in the same month, the amounts borrowed under our revolving bank credit facility were paid down with funds provided from the issuance of $300.0 million of 8.50% Senior Notes (see Note 7).

The following table presents the preliminary purchase price allocation, including estimated adjustments, for the acquisition of the Newfield Properties (in thousands):

 

Oil and natural gas properties and equipment		$	237,214
Asset retirement obligations – current			(7,250	)
Asset retirement obligations – non-current			(24,414	)
Total cash paid		$	205,550

Expenses associated with acquisition activities and transition activities related to the acquisition of the Newfield Properties for the year ended December 31, 2012 were $0.6 million and are included in general and administrative expenses (“G&A”). The acquisition was recorded at fair value, which was determined using both the market and income approaches and Level 3 inputs were used to determine fair value. See Note 1 for a description of the Level 3 inputs.

Revenue, Net Income and Pro Forma Financial Information – Unaudited

The Newfield Properties were not included in our consolidated results until the closing date of October 5, 2012. For the period of October 5, 2012 to December 31, 2012, the Newfield Properties accounted for $29.6 million of revenue, $5.4 million of direct operating expenses, $11.9 million of depreciation, depletion, amortization and accretion (“DD&A”) and $4.3 million of income taxes, resulting in $8.0 million of net income. The net income attributable to these properties does not reflect certain expenses, such as G&A 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 Newfield Properties are not recorded in a separate entity for tax purposes; therefore, income tax was estimated using the federal statutory tax rate.

The unaudited pro forma financial information was computed as if the acquisition of the Newfield Properties had been completed on January 1, 2011. The financial information was derived from W&T’s audited historical consolidated financial statements, the Newfield Properties’ audited historical financial statements for 2011 and the Newfield Properties’ unaudited historical financial statement for 2012 interim period.

 

The pro forma adjustments were based on estimates by management and information believed to be directly related to the purchase of the Newfield Properties. The pro forma financial information is not necessarily indicative of the results of operations had the purchase occurred on January 1, 2011. 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 Newfield. Realized sales prices for oil, NGLs and natural gas may have been different and costs of operating the Newfield Properties may have been different. The following table presents a summary of our pro forma financial information (in thousands except earnings per share):

 

		(unaudited)
		Year Ended December 31,
		2012				2011
Revenue		$	980,196			$	1,187,808
Net income			77,059				220,875
Basic and diluted earnings per common share			1.01				2.92

For the pro forma financial information, certain information was derived from financial records and certain information was estimated. The sources of information and significant assumptions are described below:

 

(a)

Revenues and direct operating expenses for the Newfield Properties were derived from the historical financial records of Newfield. Incremental revenue adjustments were $105.7 million and $216.8 million for 2012 and 2011, respectively. Incremental operating costs were $33.2 million and $24.6 million for 2012 and 2011, respectively.

 

(b)

Incremental costs for insurance were estimated at $0.6 million annually, which were the incremental costs to add the Newfield Properties to W&T’s insurance programs. The direct operating costs for the Newfield Properties described above excluded insurance costs.

 

(c)

DD&A was estimated using the full-cost method and determined as the incremental DD&A expense due to adding the Newfield Properties’ costs, reserves and production into our currently existing full cost pool in order to compute such amounts. The purchase price allocation included $13.1 million that was allocated to the pool of unevaluated properties for oil and natural gas interests. Accordingly, no DD&A expense was estimated for the unevaluated properties. ARO were estimated by W&T management. Incremental DD&A was estimated at $53.4 million and $102.7 million for 2012 and 2011, respectively.

 

(d)

Incremental transaction expenses related to the acquisition were $0.6 million and were assumed to be funded from cash on hand.

 

(e)

The acquisition was assumed to be funded entirely with borrowed funds. Interest expense was computed using assumed borrowings of $205.6 million, which equates to the cash component of the transaction, and an interest rate of 7.7%, which equates to the effective yield on net proceeds for the additional senior notes issued shortly after the acquisition closed. Incremental interest expense was estimate at $12.0 million and $15.8 million for 2012 and 2011, respectively.

 

(f)

Incremental capitalized interest was computed for the addition to the pool of unevaluated properties and the capitalization interest rate was adjusted for the assumed borrowings. Incremental capitalized interest was estimate at $0.6 million and $0.9 million for 2012 and 2011, respectively.

 

(g)

Income tax expense was computed using the 35% federal statutory rate. Incremental income tax expense was estimated at $2.7 million and $25.9 million for 2012 and 2011, respectively.

 

(h)

The 2011 period does not include any pro forma adjustments related to the 2011 acquisitions as described below.

 

2011 Acquisitions

On May 11, 2011, we acquired from Opal Resources LLC and Opal Resources Operating Company LLC (collectively, “Opal”) certain oil and gas leasehold interests (the “Yellow Rose Properties”). The adjusted purchase price was $394.4 million, which was subject to certain adjustments, including adjustments from an effective date of January 1, 2011 until the closing date, and we assumed the future ARO and a certain long-term liability. The properties consisted of approximately 24,500 gross acres (21,900 net acres) of oil and gas leasehold interests in the West Texas Permian Basin. The acquisition was funded from cash on hand and borrowings under our revolving bank credit facility.

The following table presents the purchase price allocation for the acquisition of the Yellow Rose Properties (in thousands):

 

Oil and natural gas properties and equipment		$	396,902
Asset retirement obligations – non-current			(382	)
Long-term liability			(2,143	)
Total cash paid		$	394,377

On August 10, 2011, we acquired from Shell Offshore Inc. (“Shell”) certain oil and gas leasehold and property interests (the “Fairway Properties”). The adjusted purchase price was $42.9 million, which was subject to certain adjustments, including adjustments from an effective date of September 1, 2010 until the closing date, and we assumed the future ARO. The properties consisted of Shell’s 64.3% interest in the Fairway Field along with a like interest in the associated Yellowhammer gas treatment plant. The acquisition was funded from borrowings under our revolving bank credit facility.

The following table presents the purchase price allocation for the acquisition of the Fairway Properties (in thousands):

 

Oil and natural gas properties and equipment		$	50,682
Asset retirement obligations – non-current			(7,812	)
Total cash paid		$	42,870

Expenses associated with acquisition activities and transition activities related to the Yellow Rose Properties and Fairway Properties for the year 2011 were $1.6 million and are included in G&A. The acquisitions were recorded at fair value, which was determined using both the market and income approaches and Level 3 inputs were used to determine fair value. See Note 1 for a description of the Level 3 inputs.

Revenue, Net Income and Pro Forma Financial Information – Unaudited

The Yellow Rose Properties and the Fairway Properties were not included in our consolidated results until their respective close dates. For the period of May 11, 2011 to December 31, 2011 for the Yellow Rose Properties and the period of August 10, 2011 to December 31, 2011 for the Fairway Properties, these two acquisitions accounted for $64.0 million of revenue, $25.5 million of direct operating expenses, $20.5 million of DD&A and $6.3 million of income taxes, resulting in $11.7 million of net income. The net income attributable to these properties does not reflect certain expenses, such as G&A 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 Yellow Rose Properties and the Fairway Properties were not recorded in a separate entity for tax purposes; therefore, income tax was estimated using the federal statutory tax rate.

 

The unaudited pro forma financial information was computed as if these two acquisitions had been completed on January 1, 2010. The historical financial information is derived from W&T’s audited historical consolidated financial statements, the Yellow Rose Properties’ audited historical financial statement for 2010, the Fairway Properties’ unaudited historical statement for 2010 and the unaudited historical statement of the sellers for the 2011 interim periods.

The pro forma adjustments were based on estimates by management and information believed to be directly related to the purchase of the Yellow Rose Properties and the Fairway Properties. The pro forma financial information is not necessarily indicative of the results of operations had the respective purchases occurred on January 1, 2010. If the transactions 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 the sellers. Realized sales prices for oil, NGLs and natural gas may have been different and costs of operating the properties may have been different. The following table presents a summary of our pro forma financial information (in thousands except earnings per share):

 

		(unaudited) Year Ended December 31,
		2011				2010
Revenue		$	1,023,430			$	784,964
Net income			180,779				113,783
Basic and diluted earnings per common share			2.39				1.52

For the pro forma financial information, certain information was derived from financial records and certain information was estimated. The sources of information and significant assumptions are described below:

 

(a)

Revenues and direct operating expenses for the Yellow Rose Properties and the Fairway Properties were derived from the historical records of the sellers up to the respective closing dates. Incremental revenue adjustments were $52.4 million and $79.2 million for 2011 and 2010, respectively. Incremental operating costs were $16.4 million and $25.3 million for 2011 and 2010, respectively.

 

(b)

DD&A was estimated using the full-cost method and determined as the incremental DD&A expense due to adding the Yellow Rose Properties and Fairway Properties’ costs, reserves and production into our currently existing full cost pool in order to compute such amounts. The purchase price allocation included $81.2 million that was allocated to the pool of unevaluated properties for oil and gas interests. Accordingly, no DD&A expense was estimated for the unevaluated properties. ARO were estimated by W&T management. Incremental DD&A was estimated at $21.9 million and $50.4 million for 2011 and 2010, respectively.

 

(c)

Incremental transaction expenses related to the acquisitions completed during 2011 were $1.6 million and were assumed to be funded from cash on hand. These were adjusted from 2011 results.

 

(d)

The acquisitions were assumed to be funded with borrowed funds and that borrow capacity would have been available on the revolving bank credit facility due to the increase in reserves. Interest expense was computed using interest rates that were in effect during the applicable time period and we assumed that six-month London Interbank Offered Rate (“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. Incremental interest expense was estimate at $4.6 million and $12.9 million for 2011 and 2010, respectively.

 

(e)

Incremental capitalized interest was computed for the addition to the pool of unevaluated properties and the capitalization interest rate was adjusted for the assumed borrowings. Incremental capitalized interest was estimate at $1.1 million and $3.0 million for 2011 and 2010, respectively.

 

(f)

Income tax expense was computed using the 35% federal statutory rate. Incremental income tax expense was estimated at $4.3 million for 2011 and an income tax benefit was estimated at $2.2 million for 2010.

 

(g)

The 2011 period does not included any pro forma adjustments related to the 2012 acquisition described above. The 2010 period does not include any pro forma adjustments related to the 2010 acquisitions as described below.

2010 Acquisitions

On April 30, 2010, we acquired from Total E&P USA (“Total E&P”) certain oil and gas leasehold interest (the “Total Properties”). The acquisition was made through our wholly-owned subsidiary, W&T Energy VI, LLC (“Energy VI”). The adjusted purchase price was $115.0 million, which was subject to certain adjustments, including adjustments from an effective date of January 1, 2010 until the closing date, and we assumed the future ARO. The properties acquired were Total E&P’s interest, including production platforms and facilities, in three federal offshore lease blocks located in the Gulf of Mexico. The properties included 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). The acquisition was funded with cash on hand. In accordance with the Purchase and Sale Agreement, Energy VI obtained unsecured surety bonds in favor of the Bureau of Ocean Energy Management (the “BOEM”) to secure the ARO with respect to these assets. The Purchase and Sale Agreement provides for annual increases in the required security for the ARO. To help satisfy the annual increases, Energy VI has agreed to make periodic payments from production of the acquired properties to an escrow agent. As long as the required security amount then in effect is met, the payments will be promptly released to us by the escrow agent. As of December 31, 2012, we were in compliance with the required security amount.

The following table presents the purchase price allocation for the acquisition of the Total Properties (in thousands):

 

Oil and natural gas properties and equipment		$	121,301
Asset retirement obligations – non-current			(6,289	)
Total cash paid		$	115,012

On November 4, 2010, through Energy VI, we acquired from Shell certain oil and gas leasehold interest (the “Tahoe Properties”). The adjusted purchase price was $116.2 million, subject to certain adjustments, including adjustments from an effective date of September 1, 2010, and we assumed the future ARO. The properties acquired were Shell’s interest, including production platforms and facilities, in three federal offshore lease blocks located in the Gulf of Mexico. The properties included 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 acquisition was funded with cash on hand. In accordance with the Purchase and Sale Agreement, Energy VI obtained unsecured surety bonds to secure the ARO with respect to these assets.

 

The following table presents the purchase price allocation for the acquisition of the Tahoe Properties (in thousands):

 

Oil and natural gas properties and equipment		$	134,189
Asset retirement obligations – non-current			(17,956	)
Total cash paid		$	116,233

Expenses associated with acquisition activities and transition activities related to the Total Properties and Tahoe Properties for the year 2010 were $0.5 million and are included in G&A. The acquisitions were recorded at fair value, which was determined using both the market and income approaches and Level 3 inputs were used to determine fair value. See Note 1 for a description of the Level 3 inputs.

Revenue, Net Income and Pro Forma Financial Information – Unaudited

The Total Properties and the Tahoe Properties were not included in our consolidated results until their respective close dates. For the period of April 30, 2010 to December 31, 2010 for the Total Properties and the period of November 4, 2010 to December 31, 2010 for the Tahoe Properties, these two acquisitions accounted for $97.2 million of revenue, $19.9 million of direct operating expenses, $27.9 million of DD&A and $17.3 million of income taxes, resulting in $32.1 million of net income. The net income attributable to these properties does not reflect certain expenses, such as G&A and interest expense; therefore, this information is not intended to report results as if these operations were managed on a stand-alone basis.

The unaudited pro forma financial information was computed as if these two acquisitions had been completed on January 1, 2009. The historical financial information is derived from W&T’s audited historical consolidated financial statements and the unaudited historical statements of the sellers.

The pro forma adjustments were based on estimates by management and information believed to be directly related to the purchase of the Total Properties and the Tahoe Properties. The pro forma financial information is not necessarily indicative of the results of operations had the respective purchases occurred on January 1, 2009. If the transactions 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 the sellers. Realized sales prices for oil, NGLs and natural gas sales prices may have been different and costs of operating the properties may have been different. The following table presents a summary of our pro forma financial information (in thousands except earnings per share):

 

		(unaudited) Year  Ended December 31, 2010
Revenue		$	818,230
Net income			148,359
Basic and diluted earnings per common share			1.99

For the pro forma financial information, certain information was derived from financial records and certain information was estimated. The sources of information and significant assumptions are described below:

 

(a)

Revenues and direct operating expenses for the Total Properties and the Tahoe Properties were derived from the historical records of the sellers for the period of January 1, 2010 to the respective closing dates. Incremental revenues and operating expenses for 2010 were $112.4 million and $25.3 million, respectively.

 

(b)

DD&A was estimated using the full-cost method and determined as the incremental DD&A expense due to adding the Total Properties and the Tahoe Properties’ costs, reserves and production into our currently existing full cost pool in order to compute such amounts. ARO and related accretion were estimated by W&T management. Incremental DD&A was estimated at $39.6 million.

 

(c)

Incremental transaction expenses related to the acquisitions completed during 2010 were $0.5 million and were assumed to be funded from cash on hand. These were adjusted from 2010 results.

 

(d)

Reductions in interest income were computed related to cash paid for the acquisitions as cash on hand was sufficient to fund the acquisitions as of January 1, 2009. Average interest rates earned on short-term investments for the respective years were used in determining the adjustment. Decrease in interest income was estimated at $1.1 million.

 

(e)

An incremental income tax rate of 35% was used in the calculations for the estimated incremental earnings before taxes. Incremental income taxes were estimated at $16.4 million.

 

(f)

The 2010 period does not included any pro forma adjustments related to the 2011 acquisitions described above.

2012 Divestitures

On May 15, 2012, we sold our 40%, non-operated working interest in the South Timbalier 41 field located in the Gulf of Mexico for $30.5 million, net, with an effective date of April 1, 2012. The transaction was structured as a like-kind exchange under the Internal Revenue Service Code (“IRC”) Section 1031 and other applicable regulations, with funds held by a qualified intermediary until replacement purchases could be executed. Replacement purchases were consummated during 2012. In connection with this sale, we reversed $4.0 million of ARO.