W&T Offshore, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Significant Accounting Policies (Policies)

Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2015

W&T Offshore, Inc. and subsidiaries, referred to herein as “W&T,” “we,” “us,” “our,” or the “Company”, is an independent oil and natural gas producer focused primarily in the Gulf of Mexico. On October 15, 2015, a substantial amount of our interest in onshore acreage was sold, which is described in Note 2. The Company is active in the exploration, development and acquisition of oil and natural gas properties. Our interest in fields, leases, structures and equipment are primarily owned by the parent company, W&T Offshore, Inc. (on a stand-alone basis, the “Parent Company”) and our wholly-owned subsidiary, W & T Energy VI, LLC (“Energy VI”).

Basis of Presentation

Our consolidated financial statements include the accounts of W&T Offshore, Inc. and its majority-owned subsidiaries. All significant intercompany transactions and amounts have been eliminated for all years presented. Our consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) and the appropriate rules and regulations of the Securities and Exchange Commission (“SEC”).

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, the reported amounts of revenues and expenses during the reporting periods and the reported amounts of proved oil and natural gas reserves. Actual results could differ from those estimates.

Early Adoption of Accounting Standard Amendments

Accounting Standards Update No. 2015-03 (“ASU 2015-03”), Interest – Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs, was early adopted as of December 31, 2015 and applied on a retrospective basis. The amendment requires debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of liability, consistent with debt discounts or premiums. The guidance also clarified that debt issuance costs related to credit facilities could be reported as an asset regardless of the balance outstanding. The adoption of ASU 2015-03 resulted in $7.9 million of unamortized debt issuance costs reclassified from long-term assets to a reduction in long-term liabilities as of December 31, 2014. We elected to continue to report unamortized debt issuance costs related to our revolving bank credit facility as a long-term asset. The early adoption of ASU 2015-03 did not affect the statements of operations or the statements of cash flows. See Note 7 for additional information.

Accounting Standards Update No. 2015-17 (“ASU 2015-17”), Balance Sheet Classification of Deferred Taxes, was early adopted as of December 31, 2015 and applied on a retrospective basis. The amendment requires all deferred tax assets and liabilities to be classified as noncurrent. For the Balance Sheet as of December 31, 2014, $11.7 million of deferred tax assets was reclassified from Current assets to Deferred income taxes liability (noncurrent). The early adoption of ASU 2015-17 did not affect the statements of operations or the statements of cash flows. See Note 13 for additional information.

Reclassifications

Certain reclassifications have been made to prior periods’ financial statements to conform to the current presentation as follows: Within the Consolidated Statements of Cash Flows, adjustments were made for the changes in operating assets and liabilities associated with investing activities. The adjustments resulted in Net cash provided by operating activities and Net cash used in investing activities to be decreased by $37.5 million for 2014 and increased by $1.4 million for 2013. Similar adjustments were made in the Condensed Consolidating Statements of Cash flow totaling the same amounts for the respective years. The adjustments did not affect the Consolidated Balance Sheets or the Consolidated Statements of Operations.

Transactions Between Entities Under Common Control

Transactions between Entities under Common Control

The prior period financial information for 2014 presented in Note 20, Supplemental Guarantor Information, has been retrospectively adjusted due to transactions between entities under common control, as required under authoritative guidance.

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 and future rate of growth. The prices of these commodities began falling in the second half of 2014 and were significantly lower during 2015 compared to the last few years.

We have taken several steps during 2015 to mitigate the effects of these lower prices including: (i) significantly reducing 2015 capital spending from the previous year and budgeted further reductions in capital spending for 2016 (exclusive of acquisitions); (ii) suspending our drilling and completion activities at several locations; (iii) suspending the regular quarterly common stock dividend; (iv) implementing numerous cost reduction projects to reduce our operating costs; (v) entered into a second lien term loan (the “9.00% Term Loan”); (vi) entered into three Amendments to our Fifth Amended and Restated Credit Agreement (as amended, the “Credit Agreement”); and (vii) sold our interest in the Yellow Rose onshore field. See Notes 2 and Note 7 for additional information.

In February 2016, we announced that we had borrowed $340.0 million under the Credit Agreement for general corporate purposes. Also, in February and March 2016, we received demands from the Bureau of Ocean Energy Management (“BOEM”) ordering us to secure financial assurances totaling approximately $260.8 million, with amounts specified by certain designated leases. See Note 20 for additional information.

We have assessed our financial condition, the current capital markets and options given different scenarios of commodity prices and believe we will have adequate liquidity to fund our operations through December 31, 2016; however, we cannot predict how an extended period of low commodity prices or the impact of future bonding requirements will affect our operations and liquidity levels.

Cash Equivalents

We consider all highly liquid investments purchased with original or remaining maturities of three months or less at the date of purchase to be cash equivalents.

Revenue Recognition

We recognize oil and natural gas revenues based on the quantities of our production sold to purchasers under short-term contracts (less than 12 months) at market prices when delivery has occurred, title has transferred and collectability is reasonably assured. We use the sales method of accounting for oil and natural gas revenues from properties with joint ownership. Under this method, we record oil and natural gas revenues based upon physical deliveries to our customers, which can be different from our net revenue ownership interest in field production. These differences create imbalances that we recognize as a liability only when the estimated remaining recoverable reserves of a property will not be sufficient to enable the under-produced party to recoup its entitled share through production. We do not record receivables for those properties in which the Company has taken less than its ownership share of production. At December 31, 2015 and 2014, $6.9 million and $6.4 million, respectively, were included in current liabilities related to natural gas imbalances.

Concentration of Credit Risk

Our customers are primarily large integrated oil and natural gas companies and large financial institutions. Our production is sold utilizing month-to-month contracts that are based on bid prices. We also have receivables from joint interest owners on properties we operate and we may have the ability to withhold future revenue disbursements to recover amounts due us. We attempt to minimize our credit risk exposure to purchasers of our oil and natural gas, joint interest owners, derivative counterparties and other third-party entities through formal credit policies, monitoring procedures, and letters of credit or guaranties when considered necessary. We historically have not had any significant problems collecting our receivables, but with the decline in commodity prices, several oil and gas companies have filed for bankruptcy. We use the specific identification method of determining if an allowance for doubtful accounts is needed. As of December 31, 2015 and 2014, we recorded $2.5 million and $0.7 million, respectively, in the allowance for doubtful accounts. During 2015 and 2014, there was no usage of the amounts recorded for allowance for doubtful accounts.

The following identifies customers from whom we derived 10% or more of receipts from sales of crude oil, NGLs and natural gas.

	Year Ended December 31,
	2015			2014			2013
Customer
Shell Trading (US) Co.		50	%		47	%		48	%
J. P. Morgan		14	%	**			**

** less than 10%

We believe that the loss of any of the customers above would not result in a material adverse effect on our ability to market future oil and natural gas production as replacement customers could be obtained in a relatively short period of time on terms, conditions and pricing substantially similar to those currently existing.

Insurance Receivables

We recognize insurance receivables with respect to capital, repair and plugging and abandonment costs as a result of hurricane damage when we deem those to be probable of collection, which arises when our insurance underwriters’ adjuster reviews and approves such costs for payment by the underwriters. Claims that have been processed in this manner have customarily been paid on a timely basis. See Note 18 for information related to unpaid claims by certain underwriters.

Prepaid Expenses and Other

Prepaid expenses and other

Amounts recorded in Prepaid expenses and other on the Consolidated Balance Sheets are expected to be realized within one year. Items representing 5% or more of total current assets in either period presented are disclosed in the following table:

	Year Ended December 31,
	2015		2014
Derivative assets - current ⁽¹⁾	$	10,036	$	7,417
Prepaid insurance and surety bonds		7,475		13,130
Prepaid deposits related to royalties		5,943		9,681
Other ⁽²⁾		3,425		6,119
Prepaid expenses and other	$	26,879	$	36,347

(1)

Includes open and closed (and not yet collected) derivative commodity contracts recorded at fair value.

(2)

Individual items were less than 5% of total current assets for either period presented.

Properties and Equipment

We use the full-cost method of accounting for oil and natural gas properties and equipment. Under this method, all costs associated with the acquisition, exploration, development and abandonment of oil and natural gas properties are capitalized. Acquisition costs include costs incurred to purchase, lease or otherwise acquire properties. Exploration costs include costs of drilling exploratory wells and external geological and geophysical costs, which mainly consist of seismic costs. Development costs include the cost of drilling development wells and costs of completions, platforms, facilities and pipelines. Costs associated with production, certain geological and geophysical costs and general and administrative costs are expensed in the period incurred.

Oil and natural gas properties and equipment include costs of unproved properties. The cost of unproved properties related to significant acquisitions are excluded from the amortization base until it is determined that proved reserves can be assigned to such properties or until such time as the Company has made an evaluation that impairment has occurred. The costs of drilling exploratory dry holes are included in the amortization base immediately upon determination that such wells are non-commercial.

We capitalize interest on the amount of unproved properties that are excluded from the amortization base. Interest is capitalized only for the period that exploration and development activities are in progress. Capitalization of interest ceases when the property is moved into the amortization base. All capitalized interest is recorded within Oil and natural gas property and equipment on the Consolidated Balance Sheets.

Oil and natural gas properties included in the amortization base are amortized using the units-of-production method based on production and estimates of proved reserve quantities. In addition to costs associated with evaluated properties and capitalized asset retirement obligations (“ARO”), the amortization base includes estimated future development costs to be incurred in developing proved reserves as well as estimated plugging and abandonment costs, net of salvage value, related to developing proved reserves. Future development costs related to proved reserves are not recorded as liabilities on the balance sheet, but are part of the calculation of depletion expense.

Sales of proved and unproved oil and natural gas properties, whether or not being amortized currently, are accounted for as adjustments of capitalized costs with no gain or loss recognized unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and natural gas.

Furniture, fixtures and non-oil and natural gas property and equipment are depreciated using the straight-line method based on the estimated useful lives of the respective assets, generally ranging from five to seven years. Leasehold improvements are amortized over the shorter of their economic lives or the lease term. Repairs and maintenance costs are expensed in the period incurred.

Ceiling Test Write-Down

Under the full cost method of accounting, we are required to periodically perform a “ceiling test,” which determines a limit on the book value of our oil and natural gas properties. If the net capitalized cost of oil and natural gas properties (including capitalized ARO) net of related deferred income taxes exceeds the ceiling test limit, the excess is charged to expense on a pre-tax basis and separately disclosed. Any such write downs are not recoverable or reversible in future periods. The ceiling test limit is calculated as: (i) the present value of estimated future net revenues from proved reserves, less estimated future development costs, discounted at 10%; (ii) plus the cost of unproved oil and natural gas properties not being amortized; (iii) plus the lower of cost or estimated fair value of unproved oil and natural gas properties included in the amortization base; and (iv) less related income tax effects. Estimated future net revenues used in the ceiling test for each period are based on current prices for each product, defined by the SEC as the unweighted average of first-day-of-the-month commodity prices over the prior twelve months for that period. All prices are adjusted by field for quality, transportation fees, energy content and regional price differentials.

Due primarily to declines in the unweighted rolling 12-month average of first-day-of-the-month commodity prices for oil and natural gas, we recorded ceiling test write-downs in 2015 which are reported as a separate line in the Statements of Operations. The average price using the SEC required methodology at December 31, 2015 was $46.79 per barrel for West Texas Intermediate (“WTI”) crude oil and $2.59 per million British Thermal Unit (“MMBtu”) for Henry Hub natural gas. These prices are before adjustments for quality, transportation, fees, energy content and regional price differentials. The ceiling test write-downs of the carrying value of our oil and natural gas properties, which included $32.4 million in the fourth quarter of 2015, were $987.2 million for the full year of 2015. We did not record a ceiling test write-down during 2014 or 2013. If crude oil and natural gas prices remain or decrease from current levels, it is probable that a ceiling test write-down will be recorded in the first quarter of 2016 and possibly in subsequent quarters during 2016.

Asset Retirement Obligations

We are required to record a separate liability for the present value of our ARO, with an offsetting increase to the related oil and natural gas properties on our balance sheet. We have significant obligations to plug and abandon well bores, remove our platforms, pipelines, facilities and equipment and restore the land or seabed at the end of oil and natural gas production operations. These obligations are primarily associated with plugging and abandoning wells, removing pipelines, removing and disposing of offshore platforms and site cleanup. Estimating the future restoration and removal cost is difficult and requires us to make estimates and judgments because the removal obligations may be many years in the future and contracts and regulations often have vague descriptions of what constitutes removal. Asset removal technologies and costs are constantly changing, as are regulatory, political, environmental, safety and public relations considerations, which can substantially affect our estimates of these future costs from period to period. For additional information, refer to Note 5.

Oil and Natural Gas Reserve Information

We use the unweighted average of first-day-of-the-month commodity prices over the preceding 12-month period when estimating quantities of proved reserves. Similarly, the prices used to calculate the standardized measure of discounted future cash flows and prices used in the ceiling test for impairment are the 12-month average commodity prices. Proved undeveloped reserves may only be classified as such if a development plan has been adopted indicating that they are scheduled to be drilled within five years, with some limited exceptions allowed. Refer to Note 21 for additional information about our proved reserves.

Derivative Financial Instruments

Our market risk exposure relates primarily to commodity prices and interest rates. From time to time, we use various derivative instruments to manage our exposure to commodity price risk from sales of oil and natural gas and interest rate risk from floating interest rates on our credit facility. Our derivative instruments currently consist of commodity swap contracts for oil. We do not enter into derivative instruments for speculative trading purposes.

Derivative instruments are recorded on the balance sheet as an asset or a liability at fair value. Changes in a derivative’s fair value are required to be recognized currently in earnings unless specific hedge accounting and documentation criteria are met at the time the derivative contract is entered into. We have elected not to designate our commodity derivatives as hedging instruments, therefore, all changes in fair value are recognized in earnings.

Fair Value of Financial Instruments

We include fair value information in the notes to our consolidated financial statements when the fair value of our financial instruments is different from the book value or it is required by applicable guidance. We believe that the book value of our cash and cash equivalents, receivables, accounts payable and accrued liabilities materially approximates fair value due to the short-term nature and the terms of these instruments. We believe that the book value of our restricted deposits approximates fair value as deposits are in cash or short-term investments. We believe the carrying amount of debt under our revolving bank credit facility approximates fair value because the interest rates are variable and reflective of market rates.

Fair Value of Acquisitions

Acquisitions are recorded on the closing date of the transaction at their fair value, which is determined by applying the market and income approaches using Level 3 inputs. The Level 3 inputs are: (i) analysis of comparable transactions obtained from various third-parties, (ii) estimates of ultimate recoveries of reserves, and (iii) estimates of discounted cash flows based on estimated reserve quantities, reserve categories, timing of production, costs to produce and develop reserves, future prices, ARO and discount rates. The estimates and assumptions are determined by management and third-parties. The fair value is based on subjective estimates and assumptions, which are inherently imprecise, and the actual realized values can vary significantly from estimates that are made. No goodwill was recorded for the acquisitions completed in 2014 or 2013.

Income Taxes

We use the liability method of accounting for income taxes in accordance with the Income Taxes topic of the Codification. Under this method, deferred tax assets and liabilities are determined by applying tax rates in effect at the end of a reporting period to the cumulative temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. 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. We recognize uncertain tax positions in our financial statements when it is more likely than not that we will sustain the benefit taken or expected to be taken. When applicable, we recognize interest and penalties related to uncertain tax positions in income tax expense. See Early Adoption of Accounting Standard Amendments above and Note 13 for additional information.

Debt Issuance Costs

Debt issuance costs associated with our revolving bank credit facility are amortized using the straight-line method over the scheduled maturity of the debt. Debt issuance costs associated with all other debt are deferred and amortized over the scheduled maturity of the debt utilizing the effective interest method. As described above, unamortized debt issuance costs associated with our revolving bank credit facility is reported within Other Assets (noncurrent) and unamortized debt issuance costs associated with our other debt is reported as a reduction in Long-Term Debt, less current maturities in the Consolidated Balance Sheets. See Note 7 for additional information.

Premiums Received on Debt Issuance

Premiums Received and Discounts Provided on Debt Issuance

Premiums and discounts are recorded in Long-Term Debt, less current maturities in the Consolidated Balance Sheets and are amortized over the term of the related debt using the effective interest method.

Share-Based Compensation

Compensation cost for share-based payments to employees and non-employee directors is based on the fair value of the equity instrument on the date of grant and is recognized over the period during which the recipient is required to provide service in exchange for the award. The fair value for equity instruments subject to only time or to Company performance measures was determined using the closing price of the Company’s common stock at the date of grant. The fair value of equity instruments subject to market-based performance measurements was determined using a Monte Carlo simulation probabilistic model. We recognize share-based compensation expense on a straight line basis over the period during which the recipient is required to provide service in exchange for the award. Estimates are made for forfeitures during the vesting period, resulting in the recognition of compensation cost only for those awards that are estimated to vest and estimated forfeitures are adjusted to actual forfeitures when the equity instrument vests. See Note 11 for more information.

Earnings Per Share

Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and are included in the computation of earnings per share under the two-class method. For additional information, refer to Note 14.

Other Income, Net

Other (Income) Expense, Net

For 2015, the amount includes write-offs of debt issuance costs of $3.2 million related to reductions in the borrowing base of the revolving bank credit facility under the Credit Agreement. The write-offs of debt issuance costs is included as an adjustment to net income in determining Net cash provided by operating activities in the Consolidated Statements of Cash Flows as the write-offs were non-cash transactions. For 2013, the amount reported consisted primarily of $9.1 million of net proceeds received in conjunction with a payment for an option exercised by a counterparty. The net amount was included in Net cash flows from investing activities within the line, Net proceeds from sales of assets in the Consolidated Statements of Cash Flows.

Recent Accounting Developments

In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-15 (“ASU 2014-15”), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (Subtopic 205-40). The guidance addresses management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. We do not expect the revised guidance to materially affect our evaluation as to being a going concern, or have an effect on our financial statements or related disclosures.

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (“ASU 2014-09”), Summary and Amendments That Create Revenue from Contracts and Customers (Subtopic 606). ASU 2014-09 amends and replaces current revenue recognition requirements, including most industry-specific guidance. The revised guidance establishes a five step approach to be utilized in determining when, and if, revenue should be recognized. ASU 2014-09 is effective for annual and interim periods beginning after December 15, 2017. Upon application, an entity may elect one of two methods, either restatement of prior periods presented or recording a cumulative adjustment in the initial period of application. We have not determined the effect ASU 2014-09 will have on the recognition of our revenue, if any, nor have we determined the method we will utilize upon adoption, which would be in the first quarter of 2018.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02 (“ASU 2016-02”), Leases (Subtopic 842). Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current GAAP, the recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP, which requires only capital leases to be recognized on the balance sheet, ASU 2016-02 will require both types of leases to be recognized on the balance sheet. ASU 2016-02 also will require disclosures to help investors and other financial statement users to better understand the amount, timing and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements. ASU 2016-02 does not apply for leases for oil and gas properties, but does apply to equipment used to explore and develop oil and gas resources. Our current operating leases that will be impacted by ASU 2016-02 when it is effective are leases for office space in Houston and New Orleans, although ASU 2016-02 may impact the accounting for leases related to operations equipment depending on the term of the lease. We currently do not have any leases classified as financing leases. ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018 and is to be applied using the modified retrospective approach. We have not yet fully determined or quantified the effect ASU 2016-02 will have on our financial statements.