2.  Acquisitions and Divestitures

2013 Divestitures.  On July 11, 2013, we sold our non-operated working interest in two offshore fields located in the Gulf of Mexico; the Green Canyon 60 field and the Green Canyon 19 field.  The effective date was October 1, 2011 and we retained the deep rights in both fields.  Due to the length of time from the effective date, we paid $4.3 million to sell the properties as revenues exceeded operating expenses and the purchase price for the period between the effective date and the close date.  In connection with the sale, we reversed $15.6 million of our asset retirement obligations (“ARO”). 

On September 26, 2013, we sold our working interests in the West Delta area block 29 with an effective date of January 1, 2013.  The property is located in the Gulf of Mexico.  Including adjustments for the effective date, the net proceeds were $16.5 million.   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 are made.  Replacement purchases are expected to be consummated within the replacement periods defined under the IRC.  The net proceeds are recorded on the Balance Sheet in Restricted cash and cash equivalents due to the restrictions on the use of the cash under IRC regulations for like-kind exchanges.  In connection with this sale, we reversed $3.9 million of ARO.  

2012 Acquisition.  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 in the Gulf of Mexico (the “Newfield Properties”).  The Newfield Properties consist of leases covering 78 offshore blocks on approximately 416,000 gross acres (268,000 net acres) (excluding overriding royalty interests).  Including adjustments from an effective date of July 1, 2012, the adjusted purchase price was $205.7 million and we assumed the future ARO associated with the Newfield Properties.  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 long-term debt in October 2012.  See Note 6 for information on long-term debt.  The purchase price was finalized during the second quarter of 2013 and no further adjustments are expected.  Adjustments to the purchase price of a net increase of $0.2 million were recorded in the nine months ended September 30, 2013.   

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

 

The acquisition was recorded at fair value, which was determined by applying the market and income approaches using Level 3 inputs.  The Level 3 inputs were: (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 were 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 could vary significantly from these estimates.  No goodwill was recorded for the Newfield Properties acquisition.

Revenues, 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 three months ended September 30, 2013, the Newfield Properties accounted for $31.9 million of revenues, $5.5 million of direct operating expenses, $14.7 million of depreciation, depletion, amortization and accretion (“DD&A”) and $4.1 million of income taxes, resulting in $7.6 million of net income.  For the nine months ended September 30, 2013, the Newfield Properties accounted for $94.2 million of revenues, $19.6 million of direct operating expenses, $41.1 million of DD&A and $11.7 million of income taxes, resulting in $21.8 million of net income.  The net income attributable to these properties does not reflect certain expenses, such as general and administrative (“G&A”) expense 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.  Expenses associated with acquisition activities and transition activities related to the acquisition of the Newfield Properties were less than $0.1 million for the three and nine months ended September 30, 2012.

Consistent with the computation of pro forma financial information presented in Item 8, Financial Statements and Supplementary Data, in the Annual Report on Form 10-K for the year end December 31, 2012, 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 for annual periods, W&T’s unaudited historical condensed consolidated financial statements for the interim periods, the Newfield Properties’ audited historical financial statement for 2011 and the Newfield Properties’ unaudited historical financial statements for the 2012 interim periods.

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; the realized sales prices for oil, natural gas liquids (“NGLs”) and natural gas may have been different; and the 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):

 

For the pro forma financial information, certain information was derived from financial records and certain information was estimated. 

 

The following table presents incremental items included in the pro forma information reported above for the Newfield Properties (in thousands):

 

 

	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.
	(b)	Incremental costs for insurance were estimated using the incremental costs to add the Newfield Properties to W&T’s insurance programs.  The direct operating expenses for the Newfield Properties described above exclude insurance costs.  Expenses were reduced for acquisition costs incurred.
	(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 was estimated by W&T management.
	(d)	The acquisition was assumed to be funded entirely with borrowed funds.  Interest expense was computed using assumed borrowings of $205.7 million, which equates to the cash paid including purchase price adjustments 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.
	(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.
	(f)	Income tax expense was computed using the 35% federal statutory rate.

2012 Divestiture.  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 with an effective date of April 1, 2012.  The transaction was structured as a like-kind exchange under the 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.