UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended:
June 30, 2013
 
or
 
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from:
____________ to _____________
Commission File Number 001-14039
CALLON PETROLEUM COMPANY
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction
of incorporation or organization)
64-0844345
(I.R.S. Employer
Identification No.)
 
 
200 North Canal Street
Natchez, Mississippi
(Address of principal executive offices)
 
 39120
(Zip Code)
601-442-1601
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x
 
No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x
 
No ¨

Indicate by check mark whether the registrant is a larger accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨
Accelerated filer x
 
 
Non-accelerated filer ¨
Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨
 
No x

As of August 5, 2013 there were outstanding 40,328,507 shares of the Registrant’s common stock, par value $0.01 per share.





Table of Contents
Part I. Financial Information
 
 
 
Item 1. Financial Statements (Unaudited)
 
 
 
Consolidated Balance Sheets  (Unaudited)
 
 
Consolidated Statements of Operations (Unaudited)
 
 
Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
 
 
Consolidated Statements of Cash Flows (Unaudited)
 
 
Notes to Consolidated Financial Statements (Unaudited)
 
 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
Item 3.  Quantitative and Qualitative Disclosures about Market Risk
 
 
Item 4.  Controls and Procedures
 
 
Part II.  Other Information
 
 
 
Item 1.  Legal Proceedings
 
 
Item 1A.  Risk Factors
 
 
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
 
Item 3.  Defaults Upon Senior Securities
 
 
Item 4.  Mine Safety Disclosures
 
 
Item 5.  Other Information
 
 
Item 6.  Exhibits
 
 


2

Table of Contents



Part I. Financial Information
Item I. Financial Statements
Callon Petroleum Company
Consolidated Balance Sheets
(in thousands, except per share data)
 
June 30, 2013
 
December 31, 2012
ASSETS
Unaudited
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
13,406

 
$
1,139

Accounts receivable
15,828

 
15,608

Fair market value of derivatives
1,647

 
1,674

Other current assets
904

 
1,502

Total current assets
31,785

 
19,923

Oil and natural gas properties, full-cost accounting method:
 
 
 
Evaluated properties
1,583,159

 
1,497,010

Less accumulated depreciation, depletion and amortization
(1,317,961
)
 
(1,296,265
)
Net oil and natural gas properties
265,198

 
200,745

Unevaluated properties excluded from amortization
55,182

 
68,776

Total oil and natural gas properties
320,380

 
269,521

 
 
 
 
Other property and equipment, net
9,926

 
10,058

Restricted investments
3,800

 
3,798

Investment in Medusa Spar LLC
7,946

 
8,568

Deferred tax asset
63,892

 
64,383

Other assets, net
3,474

 
1,922

Total assets
$
441,203

 
$
378,173

 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
40,637

 
$
36,016

Asset retirement obligations
6,223

 
2,336

Fair market value of derivatives
106

 
125

Total current liabilities
46,966

 
38,477

13% Senior Notes:
 
 
 
Principal outstanding
96,961

 
96,961

Deferred credit, net of accumulated amortization of $19,415 and $17,800, respectively
12,092

 
13,707

Total 13% Senior Notes
109,053

 
110,668

 
 
 
 
Senior secured revolving credit facility

 
10,000

Asset retirement obligations
7,175

 
10,965

Other long-term liabilities
1,474

 
2,092

Total liabilities
164,668

 
172,202

Stockholders' equity:
 
 
 
Preferred stock, series A cumulative, $0.01 par value and $50.00 liquidation preference, 2,500 shares authorized: 1,579 and 0 shares outstanding, respectively
16

 

Common stock, $0.01 par value, 60,000 shares authorized; 40,277 and 39,801 shares outstanding, respectively
404

 
398

Capital in excess of par value
399,380

 
328,116

Retained deficit
(123,265
)
 
(122,543
)
Total stockholders' equity
276,535

 
205,971

Total liabilities and stockholders' equity
$
441,203

 
$
378,173


The accompanying notes are an integral part of these consolidated financial statements.


3

Table of Contents

Callon Petroleum Company
Consolidated Statements of Operations
(Unaudited; in thousands, except per share data)

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2013
 
2012
 
2013
 
2012
Operating revenues:
 
 
 
 
 
 
 
 
Crude oil sales
 
$
19,061

 
$
22,073

 
$
38,601

 
$
47,822

Natural gas sales
 
3,699

 
3,287

 
6,700

 
6,833

Total operating revenues
 
22,760

 
25,360

 
45,301

 
54,655

 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
Lease operating expenses
 
5,384

 
5,246

 
11,142

 
13,484

Production taxes
 
687

 
575

 
1,226

 
1,122

Depreciation, depletion and amortization
 
10,654

 
11,844

 
21,696

 
24,033

General and administrative
 
4,545

 
4,374

 
8,284

 
9,405

Accretion expense
 
533

 
562

 
1,098

 
1,135

Total operating expenses
 
21,803

 
22,601

 
43,446

 
49,179

 
 
 
 
 
 
 
 
 
Income from operations
 
957

 
2,759

 
1,855

 
5,476

 
 
 
 
 
 
 
 
 
Other (income) expenses:
 
 
 
 
 
 
 
 
Interest expense
 
1,537

 
2,384

 
3,052

 
4,961

Gain on early extinguishment of debt
 

 
(1,366
)
 

 
(1,366
)
Gain on derivative contracts
 
(1,981
)
 
(3,505
)
 
(1,563
)
 
(3,575
)
Other income, net
 
(44
)
 
(157
)
 
(89
)
 
(461
)
Total other (income) expenses, net
 
(488
)
 
(2,644
)
 
1,400

 
(441
)
 
 
 
 
 
 
 
 
 
Income before income taxes
 
1,445

 
5,403

 
455

 
5,917

Income tax expense
 
663

 
1,610

 
494

 
1,754

Income (loss) before equity in earnings of Medusa Spar LLC
 
782

 
3,793

 
(39
)
 
4,163

Equity in (loss) earnings of Medusa Spar LLC
 
(24
)
 
6

 
(3
)
 
124

Net income (loss)
 
758

 
3,799

 
(42
)
 
4,287

Preferred stock dividends
 
(680
)
 

 
(680
)
 

Net income (loss) available to common shareholders
 
$
78

 
$
3,799

 
$
(722
)
 
$
4,287

 
 
 
 
 
 
 
 
 
Net income (loss) per common share:
 
 
 
 
 
 
 
 
Basic
 
$
0.00

 
$
0.10

 
$
(0.02
)
 
$
0.11

Diluted
 
$
0.00

 
$
0.09

 
$
(0.02
)
 
$
0.11

 
 
 
 
 
 
 
 
 
Shares used in computing net income (loss) per common share:
 
 
 
 
 
 
 
 
Basic
 
40,089

 
39,399

 
39,941

 
39,375

Diluted
 
40,323

 
40,155

 
39,941

 
40,204


The accompanying notes are an integral part of these consolidated financial statements.

4

Table of Contents

Callon Petroleum Company
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited; in thousands)

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2013
 
2012
 
2013
 
2012
Net income (loss)
 
$
758

 
$
3,799

 
$
(42
)
 
$
4,287

Other comprehensive (loss) income:
 
 
 
 
 
 
 
 
     Change in fair value of derivatives designated as hedges,
 

 
1,393

 

 
(77
)
     net of tax (See Note 5)
 
 
 
 
 
 
 
 
Comprehensive income (loss)
 
758

 
5,192

 
(42
)
 
4,210

Preferred stock dividends
 
(680
)
 

 
(680
)
 

Comprehensive income (loss) available to common shareholders
 
$
78

 
$
5,192

 
$
(722
)
 
$
4,210


The accompanying notes are an integral part of these consolidated financial statements.


5

Table of Contents

Callon Petroleum Company
Consolidated Statements of Cash Flows
(Unaudited; in thousands)

 
 
Six Months Ended June 30,
 
 
2013
 
2012
Cash flows from operating activities:
 
 
 
 
Net income (loss)
 
$
(42
)
 
$
4,287

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
 
Depreciation, depletion and amortization
 
22,405

 
24,676

Accretion expense
 
1,098

 
1,135

Amortization of non-cash debt related items
 
228

 
225

Amortization of deferred credit
 
(1,615
)
 
(1,538
)
Non-cash gain on early extinguishment of debt
 

 
(1,366
)
Equity in loss (earnings) of Medusa Spar LLC
 
3

 
(124
)
Deferred income tax expense
 
494

 
1,754

Unrealized loss (gain) on derivative contracts
 
(249
)
 
(3,897
)
Non-cash expense related to equity share-based awards
 
734

 
722

Change in the fair value of liability share-based awards
 
(852
)
 
989

Payments to settle asset retirement obligations
 
(615
)
 
(1,029
)
Changes in current assets and liabilities:
 
 
 
 
     Accounts receivable
 
789

 
(2,036
)
     Other current assets
 
598

 
63

     Current liabilities
 
(324
)
 
4,756

     Payments to settle vested liability share-based awards
 
(239
)
 
(199
)
     Change in natural gas balancing receivable
 
(118
)
 
(95
)
     Change in natural gas balancing payable
 
(62
)
 
(17
)
     Change in other long-term liabilities
 
(206
)
 

     Change in other assets, net
 
(1,790
)
 
(865
)
Cash provided by operating activities
 
$
20,237

 
$
27,441

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Capital expenditures
 
(58,385
)
 
(72,538
)
Acquisition
 
(11,000
)
 

Proceeds from sale of mineral interest and equipment
 
1,389

 
522

Distribution from Medusa Spar LLC
 
616

 
1,120

Cash used in investing activities
 
$
(67,380
)
 
$
(70,896
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Borrowings on senior secured revolving credit facility
 
31,000

 
10,000

Payments on senior secured revolving credit facility
 
(41,000
)
 

Redemption of 13% senior notes
 

 
(10,225
)
Issuance of preferred stock
 
70,090

 

Payment of preferred stock dividends
 
(680
)
 

Taxes paid related to exercise of employee stock options
 

 
(2
)
Cash provided by (used in) financing activities
 
$
59,410

 
$
(227
)
 
 
 
 
 
Net change in cash and cash equivalents
 
12,267

 
(43,682
)
Beginning of period cash and cash equivalents
 
1,139

 
43,795

End of period cash and cash equivalents
 
$
13,406

 
$
113


The accompanying notes are an integral part of these consolidated financial statements.

6

Table of Contents

Callon Petroleum Company
Notes to the Consolidated Financial Statements
(Unless otherwise indicated, amounts included in the footnotes to the financial statements are presented in thousands,
except for share, well, acreage and per-derivative instrument data.)

INDEX TO THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Description of Business and Basis of Presentation
Fair Value Measurements
Property Disclosures and Operating Leases
Income Taxes
Earnings Per Share
Asset Retirement Obligations
Borrowings
Equity Transactions
Derivative Instruments and Hedging Activities
 
 

Note 1 - Description of Business and Basis of Presentation

Description of business

Callon Petroleum Company is an independent crude oil and natural gas company, which since 1950 has been focused on building reserves and production both onshore and offshore through efficient operations and low finding and development costs. In 2009, we began to shift our operational focus from exploration in the Gulf of Mexico to building an onshore asset portfolio in order to provide a multi-year, low-risk drilling program in both crude oil and natural gas basins. To date, a significant portion of this onshore transition has been funded by reinvesting the cash flows from our Gulf of Mexico properties. In the fourth quarter of 2012, we monetized our interest in the deepwater Habanero field in order to accelerate development of our onshore properties.

The Company’s properties and operations are geographically concentrated onshore in Texas and Louisiana and the offshore waters of the Gulf of Mexico.

Basis of presentation

Unless otherwise indicated, all amounts included within the footnotes to the financial statements are presented in thousands, except for share, well, acreage and per-derivative instrument data.

The interim consolidated financial statements of the Company have been prepared in accordance with (1) accounting principles generally accepted in the United States (“US GAAP”), (2) the Securities and Exchange Commission’s instructions to Quarterly Report on Form 10-Q and (3) Rule 10-01 of Regulation S-X, and include the accounts of the Company, and its subsidiary, Callon Petroleum Operating Company (“CPOC”). CPOC also has subsidiaries, namely Callon Offshore Production, Inc., and Mississippi Marketing, Inc.

These interim consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The balance sheet at December 31, 2012 has been derived from the audited financial statements at that date.

Operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ended December 31, 2013.

In the opinion of management, the accompanying unaudited consolidated financial statements reflect all adjustments, including normal recurring adjustments and all intercompany account and transaction eliminations, necessary to present fairly the Company’s financial position, the results of its operations and its cash flows for the periods indicated. When necessary to ensure consistent presentation, certain prior year amounts may be reclassified. To the extent the amounts reclassified are material, we have either footnoted them within the Company’s disclosures or have noted the items within this footnote.

New accounting standard

In February 2013, the Financial Accounting Standards Board issued an Accounting Standards Update (ASU) that clarified the reclassification requirements from accumulated other comprehensive income to net income. This ASU requires disclosure of amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present either on the face of the financial statements or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount is reclassified in its entirety to net income in the same

7

 
Footnotes to the Financial Statements
Unless otherwise indicated, amounts included in the footnotes to the financial statements are presented in thousands, except for share, well, acreage and per-derivative instrument data.

reporting period. For amounts not reclassified in their entirety to net income, an entity is required to cross-reference to the related note on the face of the financial statements for additional information. Callon adopted this guidance effective January 1, 2013, which did not have a material impact on its financial statements.
 
Note 2 - Property Disclosures and Operating Leases

In April 2012, the Company took delivery of a drilling rig for a term of two years to support its horizontal drilling program in the Permian Basin, and on August 1, 2013, the Company contracted an additional drilling rig for a one year term. Lease cost recorded during the three and six months ended June 30, 2013 was $2,280 and $4,551, respectively. Lease payments will approximate $12,601 in 2013 (with $8,050 remaining at June 30, 2013) and $6,941 in 2014. The agreements include early termination provisions that would reduce the minimum rentals under the agreement, assuming the lessor is unable to re-charter the rig and staffing personnel to another lessee, to $5,055 in 2013 and $4,530 in 2014.

On June 1, 2013, the Company acquired approximately 2,468 gross (2,186 net) acres in Reagan County, Texas, which is located in the southern portion of the Midland Basin and which is prospective for both horizontal and vertical drilling. The acquisition also included seven gross vertical wells and 1,051 barrels of oil equivalent proved reserves. The purchase price of $11,000 was funded using a portion of the proceeds from the preferred stock offering (discussed in Note 9).

Note 3 - Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2013
 
2012
 
2013
 
2012
(a) Net income (loss) available to common shareholders
 
$
78

 
$
3,799

 
$
(722
)
 
$
4,287

 
 
 
 
 
 
 
 
 
(b) Weighted average shares outstanding
 
40,089

 
39,399

 
39,941

 
39,375

Dilutive impact of stock options
 

 
7

 

 
14

Dilutive impact of restricted stock
 
234

 
749

 

 
815

(c) Weighted average shares outstanding for diluted net income (loss) per share
 
40,323

 
40,155

 
39,941

 
40,204

 
 
 
 
 
 
 
 
 
Basic net income (loss) per share (a/b)
 
$
0.00

 
$
0.10

 
$
(0.02
)
 
$
0.11

Diluted net income (loss) per share (a/c)
 
$
0.00

 
$
0.09

 
$
(0.02
)
 
$
0.11

 
 
 
 
 
 
 
 
 
The following were excluded from the diluted EPS calculation because their effect would be anti-dilutive:
Stock options
 
52

 
67

 
52

 
52

Restricted stock
 
267

 
1,013

 
267

 
1,013


Note 4Borrowings

The Company’s borrowings consisted of the following at:
 
 
June 30, 2013
 
December 31, 2012
Principal components:
 
 
 
 
Credit Facility
 
$

 
$
10,000

13% Senior Notes due 2016, principal
 
96,961

 
96,961

Total principal outstanding
 
96,961

 
106,961

Non-cash components:
 
 

 
 

13% Senior Notes due 2016 unamortized deferred credit
 
12,092

 
13,707

Total carrying value of borrowings
 
$
109,053

 
$
120,668



8

 
Footnotes to the Financial Statements
Unless otherwise indicated, amounts included in the footnotes to the financial statements are presented in thousands, except for share, well, acreage and per-derivative instrument data.

Senior Secured Revolving Credit Facility (the “Credit Facility”)

As of June 30, 2013, the Company’s $200,000 Credit Facility had an associated borrowing base of $75,000 and a maturity of March 15, 2016. Regions Bank serves as the administrative agent for the Credit Facility, which also includes Citibank, NA, IberiaBank, Whitney Bank and OneWest Bank, FSB as participating lenders. Amounts borrowed under the Credit Facility may not exceed a borrowing base, which is generally reviewed on a semi-annual basis and is then eligible for re-determination. The Credit Facility is secured by mortgages covering the Company’s major producing fields.

On May 10, 2013, the Company entered into the second amendment to our Fourth Amended and Restated Credit Agreement that allows the Company to pay quarterly Senior Unsecured Debt and Preferred Equity dividends of $5.5 million per quarter, so long as the Company is not in default under the Credit Facility. The amendment became effective with the receipt of the cash proceeds from the preferred equity offering discussed in Note 9.

As of June 30, 2013, no balance was outstanding on the Credit Facility as a portion of the proceeds from the preferred stock offering was used to repay the balance then outstanding. The Credit Facility has an interest rate calculated as the London Interbank Offered Rate (“LIBOR”) plus a tiered rate ranging from 2.5% to 3.0%, which is determined by utilization of the facility. In addition, the Credit Facility carries a commitment fee of 0.5% per annum on the unused portion of the borrowing base, which is payable quarterly.

13% Senior Notes due 2016 (“Senior Notes”) and Deferred Credit

The Senior Notes’ 13% interest coupon is payable on the last day of each quarter. Certain of the Company’s subsidiaries guarantee the Company’s obligations under the unsecured Senior Notes. The subsidiary guarantors are 100% owned, all of the guarantees are full and unconditional and joint and several, the parent company has no independent assets or operations, and any subsidiaries of the parent company other than the subsidiary guarantors are minor. Upon issuing the Senior Notes in November 2009, the Company recorded as a deferred credit the $31,507 difference between the adjusted carrying amount of the Senior Notes that were exchanged and the principal of the Senior Notes. This deferred credit is being amortized as a reduction of interest expense over the life of the Senior Notes at an 8.5% effective interest rate. The following table summarizes the Company’s deferred credit balance:
Gross Carrying
 
Accumulated Amortization at
 
Carrying Value at
 
Amortization Recorded during Current Year as a Reduction of
 
Estimated Amortization to be Recorded during the Remainder of the
 Amount
 
6/30/2013
 
6/30/2013
 
Interest Expense
 
 Current Year
$31,507
 
$19,415
 
$12,092
 
$1,615
 
$1,684

Restrictive Covenants

The indentures governing our Senior Notes and the Company’s Credit Facility contain various covenants including restrictions on additional indebtedness and payment of cash dividends. In addition, Callon’s Credit Facility contains covenants for maintenance of certain financial ratios. The Company was in compliance with these covenants at June 30, 2013.

Note 5 - Derivative Instruments and Hedging Activities

Objectives and strategies for using derivative instruments

The Company is exposed to fluctuations in realized crude oil and natural gas prices for its production. Consequently, the Company believes it is prudent to manage the variability in cash flows on a portion of its crude oil and natural gas production. The Company primarily utilizes collars, put and call options and swap derivative financial instruments to manage fluctuations in cash flows resulting from changes in commodity prices. The Company does not use these instruments for speculative purposes.

Counterparty risk

The use of derivative transactions exposes the Company to the risk that a counterparty will be unable to meet its commitments. To manage this risk, the Company’s established counterparties for commodity derivative instruments include a large, well-known financial institution and a large, well-known oil and gas company. While the Company monitors counterparty creditworthiness on an ongoing basis, it cannot predict sudden changes in counterparties’ creditworthiness. In addition, even if such changes are not sudden, the Company may be limited in its ability to mitigate an increase in counterparty credit risk. Should one of these

9

 
Footnotes to the Financial Statements
Unless otherwise indicated, amounts included in the footnotes to the financial statements are presented in thousands, except for share, well, acreage and per-derivative instrument data.

counterparties not perform, the Company may not realize the benefit of some of its derivative instruments under lower commodity prices. Counterparty credit risk is considered when determining a derivative instruments’ fair value; See Note 6 for additional information.
     
The Company executes commodity derivative transactions under master agreements that have netting provisions that provide for offsetting payables against receivables. In general, if a party to a derivative transaction incurs an event of default, as defined in the applicable agreement, the other party will have the right to demand the posting of collateral, demand a cash payment transfer or terminate the arrangement.
Financial statement presentation and settlements
In the first quarter of 2013, the Company monetized the remaining portion (covering the period Feb13-Dec13) of its 2013 crude oil collar positions of 40 Bbls per month. The proceeds from this transaction, combined with the proceeds from the sale of the below listed put for 30 Bbls per month, were used to finance the uplift in the crude oil swap for the period Feb13-Dec13.

Listed in the table below are the outstanding crude oil and natural gas derivative contracts as of June 30, 2013:
Commodity
 
Instrument
 
Average Notional Volumes per Month
 
Quantity Type
 
Put/Call Price
 
Fixed-Price Swap
 
Period
 
Designation under ASC 815
Natural gas
 
Swap
 
91
 
MMbtu
 
n/a

 
$
3.52

 
Jul13 - Dec13
 
Not Designated
Natural gas
 
Put Option
 
91
 
MMbtu
 
$
3.00

 
n/a

 
Jul13 - Dec13
 
Not Designated
Crude oil
 
Swap
 
40
 
Bbls
 
n/a

 
$
101.30

 
Jul13 - Dec13
 
Not Designated
Natural gas
 
Call Option
 
38
 
MMbtu
 
$
4.75

 
n/a

 
Jan14 - Dec14
 
Not Designated
Crude oil
 
Swap
 
30
 
Bbls
 
n/a

 
$
93.35

 
Jan14 - Dec14
 
Not Designated
Crude oil
 
Put Option
 
30
 
Bbls
 
$
70.00

 
n/a

 
Jan14 - Dec14
 
Not Designated

Settlements of the Company’s derivative instruments are based on the difference between the contract price or prices specified in the derivative instrument and a New York Mercantile Exchange (“NYMEX”) price. The fair value of the Company’s derivative instruments, depending on the type of instruments, was determined by the use of present value methods or standard option valuation models with assumptions about commodity prices based on those observed in underlying markets. See Note 6 for additional information regarding fair value.

The following table reflects the fair values of the Company’s derivative instruments for the periods presented (none of which were designated as hedging instruments under ASC 815):
 
 
Balance Sheet Presentation
 
Asset Fair Value
 
Liability Fair Value
 
Net Derivative Fair Value
Commodity
 
Classification
 
Line Description
 
06/30/13
 
12/31/12
 
06/30/13
 
12/31/12
 
06/30/13
 
12/31/12
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Natural gas
 
Current
 
Fair market value of derivatives
 
$

 
$

 
$
(106
)
 
$
(125
)
 
$
(106
)
 
$
(125
)
Natural gas
 
Non-current
 
Other long-term liabilities
 

 

 
(38
)
 
(116
)
 
(38
)
 
(116
)
Crude oil
 
Current
 
Fair market value of derivatives
 
1,647

 
1,674

 



 
1,647


1,674

Crude oil
 
Non-current
 
Other long-term assets
 
428

 
250

 

 

 
428

 
250

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Totals
 
 
 
$
2,075

 
$
1,924

 
$
(144
)

$
(241
)
 
$
1,931

 
$
1,683


The Company’s derivative contracts are subject to netting arrangements and, being representative of the way in which the contracts settle, are presented in the balance sheet at their fair values on a net basis based on the underlying commodity being hedged. The following presents the impact of this presentation to the Company’s recognized assets and liabilities at June 30, 2013:
 
 
Presented without
 
 
 
As Presented with
 
 
Effects of Netting
 
Effects of Netting
 
Effects of Netting
Current assets: Fair value of hedging contracts
 
$
2,330

 
$
(683
)
 
$
1,647

Long-term assets: Fair value of hedging contracts
 
852

 
(424
)
 
428

Current liabilities: Fair value of hedging contracts
 
(789
)
 
683

 
(106
)
Long-term liabilities: Fair value of hedging contracts
 
(462
)
 
424

 
(38
)

10

 
Footnotes to the Financial Statements
Unless otherwise indicated, amounts included in the footnotes to the financial statements are presented in thousands, except for share, well, acreage and per-derivative instrument data.

Derivatives not designated as hedging instruments

As discussed in the Company’s Form 10-K for the year ended December 31, 2012, the Company elected not to designate as an accounting hedge under FASB ASC 815 any of its derivative contracts executed subsequent to December 31, 2011, nor does it expect to designate future derivative contracts. Any derivative contract not designated as an accounting hedge is carried at its fair value on the balance sheet with both realized and unrealized (mark-to-market) gains or losses on these derivatives recorded on the statement of operations as a component of the Company’s other income and expenses. For the periods indicated, the Company recorded the following related to its derivative instruments that were not designated as accounting hedges:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2013
 
2012
 
2013
 
2012
Natural gas derivatives
 
 
 
 
 
 
 
 
     Realized gain (loss), net
 
$
(156
)
 
$

 
$
(107
)
 
$

     Unrealized gain (loss), net
 
485

 
(331
)
 
97

 
(331
)
          Sub-total gain (loss), net
 
$
329

 
$
(331
)
 
$
(10
)
 
$
(331
)
 
 
 
 
 
 
 
 
 
Crude oil derivatives
 
 
 
 
 
 
 
 
     Realized gain, net
 
$
849

 
$

 
$
1,422

 
$

     Unrealized gain, net
 
803

 
3,836

 
151

 
3,906

          Sub-total gain, net
 
$
1,652

 
$
3,836

 
$
1,573

 
$
3,906

 
 
 
 
 
 
 
 
 
Total gain on derivative instruments, net
 
$
1,981

 
$
3,505

 
$
1,563

 
$
3,575


Derivatives designated as hedging instruments

As previously discussed, the Company elected to discontinue hedge accounting at the start of 2012, though certain of the Company’s crude oil derivative contracts designated as cash flow hedges were executed in prior periods and were in effect during 2012. Consequently, these designated contracts were recorded at fair market value with the effective portion of the changes in fair value recorded net of tax through other comprehensive income (loss) (“OCI”) in stockholders’ equity. The cash settlements on contracts for future production were recorded as an increase or decrease in crude oil revenues. Both changes in fair value and cash settlements of ineffective derivative contracts were recognized as derivative expense (income). All contracts previously designated as hedging instruments expired during 2012.

The tables below present the effect of the Company’s derivative financial instruments on the consolidated statements of operations as an increase (decrease) to crude oil revenues for the effective portion and as an increase (decrease) to other (income) expense for the ineffective portion and amounts excluded from effectiveness testing:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2013
 
2012
 
2013
 
2012
Amount of gain reclassified from OCI into income (effective portion)
 
$

 
$
512

 
$

 
$
512

Amount of gain recognized in income (ineffective portion and amount excluded from effectiveness testing)
 

 
92

 

 
322


Subsequent Event: Derivative contracts executed subsequent to June 30, 2013 include the following:
Commodity
 
Instrument
 
Average Notional Volumes per Month
 
Quantity Type
 
Put/Call Price
 
Fixed-Price Swap
 
Period
 
Designation under ASC 815
Crude oil
 
Swap
 
18
 
Bbls
 
n/a
 
$
102.08

 
Sep13 - Dec13
 
Not Designated
Crude oil
 
Swap
 
9
 
Bbls
 
n/a
 
$
94.58

 
Jan14 - Dec14
 
Not Designated



11

 
Footnotes to the Financial Statements
Unless otherwise indicated, amounts included in the footnotes to the financial statements are presented in thousands, except for share, well, acreage and per-derivative instrument data.

Note 6 - Fair Value Measurements

The fair value hierarchy outlined in the relevant accounting guidance gives the highest priority to Level 1 inputs, which consist of unadjusted quoted prices for identical instruments in active markets. Level 2 inputs consist of quoted prices for similar instruments. Level 3 valuations are derived from inputs that are significant and unobservable, and these valuations have the lowest priority.

Fair value of financial instruments

Cash, cash equivalents, short-term investments. The carrying amounts for these instruments approximate fair value due to the short-term nature or maturity of the instruments.
 
Debt. The Company’s debt is recorded at the carrying amount on its Consolidated Balance Sheet. The fair value of Callon’s fixed-rate debt, which is valued using Level 2 inputs, is based upon estimates provided by an independent investment banking firm. The carrying amount of floating-rate debt approximates fair value because the interest rates are variable and reflective of market rates.

The following table summarizes the respective carrying and fair values at: 
 
 
June 30, 2013
 
December 31, 2012
 
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
Credit Facility
 
$

 
$

 
$
10,000

 
$
10,000

13% Senior Notes due 2016 (1)
 
109,053

 
101,615

 
110,668

 
100,112

     Total
 
$
109,053

 
$
101,615

 
$
120,668

 
$
110,112


(1) Fair value is calculated only in relation to the $96,961 principal outstanding of the Senior Notes at each of the dates indicated above, respectively. The remaining $12,092 and $13,707, respectively, which the Company has recorded as a deferred credit, is excluded from the fair value calculation, and will be recognized in earnings as a reduction of interest expense over the remaining amortization period. See Note 4 for additional information.

Assets and liabilities measured at fair value on a recurring basis

Certain assets and liabilities are reported at fair value on a recurring basis (unless otherwise noted below) in the Company’s Consolidated Balance Sheet. The following methods and assumptions were used to estimate the fair values:

Commodity derivative instruments: Callon’s derivative policy allows for commodity derivative instruments to consist of natural gas and crude oil collars, basis swaps, puts, calls and similar commodity instrument structures. The fair value of these derivatives is derived using a valuation model that utilizes market-corroborated inputs that are observable over the term of the derivative contract, and the values are corroborated by quotes obtained from counterparties to the agreements. The Company’s fair value calculations, based on analysis of each contract, also incorporate an estimate of the counterparties’ default risk for derivative assets and an estimate of the Company’s default risk for derivative liabilities. The Company believes that the majority of the inputs used to calculate the commodity derivative instruments fall within Level 2 of the fair-value hierarchy based on the wide availability of quoted market prices for similar commodity derivative contracts. See Note 5 for additional information regarding the Company’s derivative instruments.


12

 
Footnotes to the Financial Statements
Unless otherwise indicated, amounts included in the footnotes to the financial statements are presented in thousands, except for share, well, acreage and per-derivative instrument data.

The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis for each hierarchy level:
As of June 30, 2013
 
Balance Sheet Presentation
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Derivative financial instruments - current
 
Fair market value of derivatives
 
$

 
$
1,647

 
$

 
$
1,647

Derivative financial instruments - non-current
 
Other long-term assets
 

 
428

 

 
428

     Sub-total assets
 
 
 

 
2,075

 

 
2,075

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Derivative financial instruments - current
 
Fair market value of derivatives
 
$

 
$
106

 
$

 
$
106

Derivative financial instruments - non-current
 
Other long-term liabilities
 

 
38

 

 
38

     Sub-total liabilities
 
Other long-term liabilities
 

 
144

 

 
144

 
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
$

 
$
1,931

 
$

 
$
1,931

 
 
 
 
 
 
 
 
 
 
 
As of 12/31/2012
 
Balance Sheet Presentation
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Derivative financial instruments - current
 
Fair market value of derivatives
 
$

 
$
1,674

 
$

 
$
1,674

Derivative financial instruments - non-current
 
Other long-term assets
 

 
250

 

 
250

     Sub-total assets
 
 
 

 
1,924

 

 
1,924

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Derivative financial instruments - current
 
Fair market value of derivatives
 
$

 
$
125

 
$

 
$
125

Derivative financial instruments - non-current
 
Other long-term liabilities
 

 
116

 

 
116

     Sub-total liabilities
 
 
 

 
241

 

 
241

 
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
$

 
$
1,683

 
$

 
$
1,683


Assets and liabilities measured at fair value on a nonrecurring basis

Certain assets and liabilities are reported at fair value on a nonrecurring basis in Callon’s Consolidated Balance Sheet. The following methods and assumptions were used to estimate the fair values:

Asset retirement obligations incurred in current period. Callon estimates the fair value of AROs based on discounted cash flow projections using numerous estimates, assumptions and judgments regarding such factors as (1) the existence of a legal obligation for an ARO, (2) amounts and timing of settlements, (3) the credit-adjusted risk-free rate to be used and (4) inflation rates. AROs incurred during the six months ended June 30, 2013, including upward revisions of $360, were Level 3 fair value measurements. See Note 8, Asset Retirement Obligations, which provides a summary of changes in the ARO liability.

Acquisition. In accordance with the acquisition method of accounting, the purchase price from the Company’s acquisition during the period has been allocated to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. In valuing the acquired assets and liabilities assumed, fair values were based on expected future cash flows based on estimated reserve quantities; costs to produce and develop reserves; and oil and gas forward prices. The fair value measurements were based on significant inputs not observable in the market and thus represent a level 3 measurement.

Note 7 - Income Taxes

The Company provides for income taxes at a statutory rate of 35% adjusted for permanent differences expected to be realized, which primarily relate to statutory depletion and non-deductible executive compensation expenses. The effective tax rate for the six months ended June 30, 2013 and 2012 was 109% and 30%, respectively. The 109% effective tax rate for the six months ended June 30, 2013 is primarily a result of the permanent differences previously noted, as well as certain discrete items occurring in the second quarter of 2013, including shortfalls associated with the Company’s restricted stock awards vesting during the period. We have no liability for uncertain tax positions or any accrued interest or penalties as of June 30, 2013.

13

 
Footnotes to the Financial Statements
Unless otherwise indicated, amounts included in the footnotes to the financial statements are presented in thousands, except for share, well, acreage and per-derivative instrument data.

Note 8 - Asset Retirement Obligations

The following table summarizes the Company’s asset retirement obligations activity for the six months ended June 30, 2013:
Asset retirement obligations at January 1, 2013
 
$
13,301

Accretion expense
 
1,098

Liabilities incurred
 
572

Liabilities settled
 
(397
)
Revisions to estimate
 
(1,176
)
Asset retirement obligations at end of period
 
13,398

Less: Current asset retirement obligations
 
6,223

Long-term asset retirement obligations at June 30, 2013
 
$
7,175

Certain of the Company’s operating agreements require that assets be restricted for future abandonment obligations. Amounts recorded on the Consolidated Balance Sheets as restricted investments were $3,800 at June 30, 2013. These investments include primarily U.S. Government securities, and are held in abandonment trusts dedicated to pay future abandonment costs for several of the Company’s crude oil and natural gas properties.

Note 9 - Equity Transactions

On May 30, 2013, the Company issued $75,000 of 10.0% Series A Cumulative Preferred Stock (the “Preferred Stock”) and received $70,000 net proceeds after deducting the underwriting commissions and offering expenses. The sale consisted of 1.6 million shares of Preferred Stock, par value $0.01 per share, public offering price of $47.50 per share and liquidation preference of $50.00 per share in an underwritten public offering. The Preferred Stock ranks senior to the Company’s common stock with respect to the payment of dividends and distribution of assets upon liquidation or dissolution. The Preferred Stock has no stated maturity and is not subject to mandatory redemption or any sinking fund. The Preferred Stock will remain outstanding indefinitely unless repurchased by the Company or converted into Callon common stock in connection with certain changes in control as defined in the Preferred Stock prospectus.

Holders of the Preferred Stock are entitled to receive, when, as and if declared by our Board of Directors (the “Board”), out of funds legally available for the payment of dividends, cumulative cash dividends at a rate of 10.0% per annum of the $50.00 liquidation preference per share (equivalent to $5.00 per annum per share). Dividends are payable quarterly in arrears on the last day of each March, June, September and December when, as and if declared by our Board. The first dividend date for the Preferred Stock was June 30, 2013, and these dividends were paid on June 28, 2013 (as June 30 fell on a weekend) in the amount of $0.43 per share or $680 for the stub period beginning with the issuance on May 30, 2013 through the dividend date on June 30, 2013.

Beginning on May 30, 2018, the Company may, solely at its option, redeem the Preferred Stock in whole at any time, or in part from time to time, for cash at a redemption price of $50.00 per share, plus accrued and unpaid dividends (whether or not declared) to the redemption date. The Company may redeem the Preferred Stock following certain changes of control as defined in the Preferred Stock prospectus, in whole or in part, within 120 days after the date on which the change of control has occurred, for cash at $50.00 per share, plus accrued and unpaid dividends (whether or not declared) to the redemption date. If the Company elects not to exercise this option, the holders of the Preferred Stock have the option to convert each share of Preferred Stock into a predefined number of Company common shares, subject to certain adjustments. As defined in a provision of the Preferred Stock prospectus, the common shares reserved for issuance vary based on the number of authorized common shares. Based on the Company’s 60 million currently authorized shares, 16.8 million shares are reserved for a potential conversion.

The number of reserved common shares increases to a maximum of 42.2 million at such time as the Company’s authorized common shares increase. Except as required by law, holders of the Preferred Stock will have no voting rights unless dividends fall into arrears for six or more quarterly periods (whether or not consecutive). In that event and until such dividends in arrears are paid in full, the holders will be entitled to elect two directors to the Board, which will increase in size by that same number of directors.



14

Table of Contents

Special Note Regarding Forward Looking Statements

All statements, other than historical fact or present financial information, may be deemed to be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements that address activities, outcomes and other matters that should or may occur in the future, including, without limitation, statements regarding the financial position, business strategy, production and reserve quantities, present value and growth and other plans and objectives for our future operations, are forward-looking statements. Although we believe the expectations expressed in such forward-looking statements are based on reasonable assumptions, such statements are not guarantees of future performance. We have no obligation and make no undertaking to publicly update or revise any forward-looking statements, except as may be required by law.
 
Forward-looking statements include the items identified in the preceding paragraph, information concerning possible or assumed future results of operations and other statements in this Form 10-K identified by words such as “anticipate,” “project,” “intend,” “estimate,” “expect,” “believe,” “predict,” “budget,” “projection,” “goal,” “plan,” “forecast,” “target” or similar expressions.

You should not place undue reliance on forward-looking statements. They are subject to known and unknown risks, uncertainties and other factors that may affect our operations, markets, products, services and prices and cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. In addition to any assumptions and other factors referred to specifically in connection with forward-looking statements, risks, uncertainties and factors that could cause our actual results to differ materially from those indicated in any forward-looking statement include, but are not limited to:

the timing and extent of changes in market conditions and prices for commodities (including regional basis differentials),
our ability to transport our production to the most favorable markets or at all,
the timing and extent of our success in discovering, developing, producing and estimating reserves,
our ability to respond to low natural gas prices,
our ability to fund our planned capital investments,
the impact of government regulation, including any increase in severance or similar taxes, legislation relating to hydraulic fracturing, the climate and over-the-counter derivatives,
the costs and availability of oilfield personnel services and drilling supplies, raw materials, and equipment and services,
our future property acquisition or divestiture activities, including the possible sale of our Medusa property,
the effects of weather,
increased competition,
the financial impact of accounting regulations and critical accounting policies,
the comparative cost of alternative fuels,
conditions in capital markets, changes in interest rates and the ability of our lenders to provide us with funds as agreed,
credit risk relating to the risk of loss as a result of non-performance by our counterparties, and
any other factors listed in the reports we have filed and may file with the Securities and Exchange Commission (“SEC”).

We caution you that the forward-looking statements contained in this Form 10-Q are subject to all of the risks and uncertainties, many of which are beyond our control, incident to the exploration for and development, production and sale of crude oil and natural gas. These risks include, but are not limited to, the risks described in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012 (the “2012 Annual Report on Form 10-K”), and all quarterly reports on Form 10-Q filed subsequently thereto (“Form 10-Qs”).

Should one or more of the risks or uncertainties described above or elsewhere in our 2012 Annual Report on Form 10-K occur, or should underlying assumptions prove incorrect, our actual results and plans could differ materially from those expressed in any forward-looking statements. We specifically disclaim all responsibility to publicly update any information contained in a forward-looking statement or any forward-looking statement in its entirety and therefore disclaim any resulting liability for potentially related damages.

All forward-looking statements attributable to us are expressly qualified in their entirety by this cautionary statement.

15

Table of Contents
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The following management’s discussion and analysis describes the principal factors affecting the Company’s results of operations, liquidity, capital resources and contractual cash obligations. This discussion should be read in conjunction with the accompanying unaudited consolidated financial statements and our 2012 Annual Report on Form 10-K, which include additional information about our business practices, significant accounting policies, risk factors, and the transactions that underlie our financial results. Our website address is www.callon.com.  All of our filings with the SEC are available free of charge through our website as soon as reasonably practicable after we file them with, or furnish them to, the SEC. Information on our website does not form part of this report on Form 10-Q.

We have been engaged in the exploration, development, acquisition and production of crude oil and natural gas properties since 1950. In 2009, we began to shift our operational focus from exploration in the Gulf of Mexico to building an onshore asset portfolio in order to provide a multi-year, low-risk drilling program in both crude oil and natural gas basins. To date, a significant portion of this onshore transition has been funded by reinvesting the cash flows from our Gulf of Mexico properties. In the fourth quarter of 2012, we monetized our interest in the deepwater Habanero field in order to accelerate development of our onshore properties. In furtherance of this strategy, in April 2013, we announced our intention to evaluate alternatives with respect to a potential sale of our interests in the Medusa field, our remaining deepwater asset.

Recent key accomplishments and development progress:

In May, we successfully completed a $75 million Preferred Stock offering, which provided us with $70 million of net proceeds to accelerate the development of our Permian acreage and to retire the balance on our Credit Facility, leaving $75 million of available borrowing capacity on the Credit Facility.

In June, we expanded our acreage position in the Permian Basin with the acquisition of 2,468 gross (2,186 net) acres in the southern portion of the Midland Basin for approximately $11 million. The properties acquired were producing approximately 145 net Boe per day at the time of acquisition.

During August, we increased our capital budget by 36% to $170 million with approximately 90% of our budgeted operating expenditures (including drilling, completion, and infrastructure) allocated to our Midland Basin operations in an effort to accelerate the development of our fields in the southern and central portions of the Basin. As a result of this budget increase, we expect to increase the total number of Permian wells planned to be drilled in 2013 to 31 gross wells, including 22 horizontal wells (completion of 17 gross wells) and nine vertical wells (completion of eight gross wells) .

On August 1, 2013, we accepted delivery of an additional horizontal drilling rig under a one-year contract to support our expanded drilling program.

To date in 2013, we continue to execute our horizontal drilling program (gross production data provided):

Two recent Wolfcamp B shale wells in the East Bloxom field produced at a peak (24-hour) rate of 1,258 Boe per day and an average peak 30-day rate of 634 Boe per day. Since commencing program development of this field in 2012, we have drilled seven wells with an average lateral length of 7,000 feet and completed four wells with demonstrated average peak initial (24-hour) rates of 1,031 Boe per day.

At our Taylor Draw field, we placed one well targeting the lower Wolfcamp B shale on production. The well produced at a 24-hour rate of 860 Boe per day. We also completed three additional wells in the upper Wolfcamp B zone that are in the process of flowing back. The average lateral length for these four drill wells and an additional well completed in the first quarter of 2013 is 4,700 feet.

Also during 2013, we continue to execute our vertical Wolfberry drilling program with positive initial results. In our Pecan Acres field, our first well to simultaneous complete multiple zones down to the Woodford shale produced at a gross peak initial (24-hour) production rate of 543 Boe per day.






16

Table of Contents
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Overview and Outlook

Production and highlights of our operations include:
 
 
Net Production (MBoe)
 
 
Three Months Ended June 30,
 
 
2013
 
2012
 
Change
 
% Change
Onshore - Permian Basin:
 
 
 
 
 
 
 
 
  Southern Portion
 
122

 
85

 
37

 
44
 %
  Central Portion
 
48

 
57

 
(9
)
 
(16
)%
    Total Permian
 
170

 
142

 
28

 
20
 %
 
 
 
 
 
 
 
 
 
Offshore - Deepwater Properties
 
 
 
 
 
 
 
 
  Medusa
 
73

 
90

 
(17
)
 
(19
)%
  Habanero
 

 
40

 
(40
)
 
(100
)%
    Total Deepwater
 
73

 
130

 
(57
)
 
(44
)%
 
 
 
 
 
 
 
 
 
Other:
 
 
 
 
 
 
 
 
  Haynesville Shale
 
7

 
17

 
(10
)
 
(59
)%
  Gulf of Mexico shelf
 
79

 
85

 
(6
)
 
(7
)%
    Total Other
 
86

 
102

 
(16
)
 
(16
)%
 
 
 
 
 
 
 
 
 
Total
 
329

 
374

 
(45
)
 
(12
)%

 
 
Net Production (MBoe)
 
 
Six Months Ended June 30,
 
 
2013
 
2012
 
Change
 
% Change
Onshore - Permian Basin:
 
 
 
 
 
 
 
 
  Southern Portion
 
216

 
162

 
54

 
33
 %
  Central Portion
 
98

 
94

 
4

 
4
 %
    Total Permian
 
314

 
256

 
58

 
23
 %
 
 
 
 
 
 
 
 
 
Offshore - Deepwater Properties
 
 
 
 
 
 
 
 
  Medusa
 
178

 
225

 
(47
)
 
(21
)%
  Habanero
 

 
81

 
(81
)
 
(100
)%
    Total Deepwater
 
178

 
306

 
(128
)
 
(42
)%
 
 
 
 
 
 
 
 
 
Other:
 
 
 
 
 
 
 
 
  Haynesville Shale
 
14

 
23

 
(9
)
 
(39
)%
  Gulf of Mexico shelf
 
152

 
181

 
(29
)
 
(16
)%
    Total Other
 
166

 
204

 
(38
)
 
(19
)%
 
 
 
 
 
 
 
 
 
Total
 
658

 
766

 
(108
)
 
(14
)%

The following table sets forth productive wells as of June 30, 2013:
 
 
Crude Oil Wells
 
Natural Gas Wells
 
 
Gross
 
Net
 
Gross
 
Net
Working interest
 
118

 
95.23

 
11

 
4.8

Royalty interest
 
3

 
0.10

 
2

 
0.08

   Total
 
121

 
95.33

 
13

 
4.88



17

Table of Contents
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Highlights of our onshore development program and offshore assets include:

Onshore – Permian Basin

We expect that our production and reserve growth initiatives will continue to focus primarily on the Permian Basin, in which we own approximately 40,275 gross (34,931 net) acres as of August 5, 2013. In order to advance our growth plans, we are directing a significant amount of our 2013 capital budget to horizontal drilling of the Wolfcamp shale formation in the Permian Basin, in addition to our ongoing vertical Wolfberry program. The following table summarizes the Company’s drilling progress in the Permian Basin for the six months ended June 30, 2013:

 
 
Drilled
 
Completed (a)
 
 
Gross
 
Net
 
Gross
 
Net
Southern portion:
 
 
 
 
 
 
 
 
   Horizontal wells
 
9

 
8.22

 
5

 
4.51

 
 
 
 
 
 
 
 
 
Central portion:
 
 
 
 
 
 
 
 
   Vertical wells
 
3

 
1.75

 
4

 
2.29

   Horizontal wells
 

 

 

 

     Total central portion
 
3

 
1.75

 
4

 
2.29

 
 
 
 
 
 
 
 
 
Northern portion:
 
 
 
 
 
 
 
 
   Vertical wells
 

 

 
1

 
0.75

   Horizontal wells
 

 

 
1

 
0.75

     Total northern portion
 

 

 
2

 
1.50

 
 
 
 
 
 
 
 
 
Total
 
12

 
9.97

 
11

 
8.30

(a)
Completions include wells drilled prior to the first half of 2013.

Southern portion: We currently own approximately 9,971 net acres in the southern portion of the Permian Basin. Our current production in the southern portion of the Midland Basin (Crockett, Reagan and Upton Counties in Texas) is derived from vertical drilling operations in the Wolfberry play and horizontal development of the Wolfcamp shale.

During the six months ended June 30, 2013, we drilled nine gross horizontal wells, with an average lateral length of over 6,600 feet, targeting either the Wolfcamp A or Wolfcamp B formations, and we fracture stimulated five gross horizontal wells targeting the Wolfcamp formation. As of June 30, 2013, we had five gross horizontal wells awaiting fracture stimulation.

During the second quarter of 2013, we acquired 2,468 gross (2,186 net) acres and seven gross vertical wells in southern Reagan County, Texas on which we intend to initiate drilling with two gross horizontal wells and two gross vertical wells planned for 2013.

Based on our initial results and the results of other industry participants, we are planning to increase our level of horizontal drilling activity in 2013 in this portion of the Basin, drilling a total of 11 horizontal wells and two vertical wells. Given this level of sustained activity, we are drilling these wells from pads, and intend to incorporate batch completions as the year progresses in an effort to maximize capital efficiency and reduce overall drill and completion time.

Central portion: We currently own approximately 3,343 net acres in the central portion of the Permian Basin. Our current production in the central portion of the Midland Basin (Ector, Glasscock, and Midland Counties in Texas) is primarily from the Wolfberry play, which has recently been modified in this area to include deeper target zones below the Atoka formation.

During the six months ended June 30, 2013, we drilled three gross vertical wells, recompleted one gross vertical well, and fracture stimulated three gross vertical wells. We currently have one gross vertical well awaiting fracture stimulation. In late 2012, we modified our Wolfberry drilling program in the Pecan Acres field to target deeper intervals below the Atoka formation. Given initial results from this initiative, our future vertical drilling plans in both Pecan Acres and Carpe Diem fields will incorporate these deeper zones as part of the completion design. Our remaining 2013 drilling plans include an additional three vertical wells, though we may modify these plans based on the drilling results achieved. In addition, there has been a significant increase in horizontal Wolfcamp shale drilling in the areas surrounding our acreage position in Ector and Midland Counties. Based on the

18

Table of Contents
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

results of other industry participants, our remaining 2013 drilling plans will include two horizontal Wolfcamp shale wells on our Carpe Diem acreage.

Northern portion: We currently own approximately 21,617 net acres in the northern portion of the Permian Basin, which includes the 14,653 net acres in Borden County, Texas and 6,964 net acres in Lynn County, Texas. During the six months ended June 30, 2013, we fracture stimulated one gross horizontal well targeting the Mississippian lime zone for evaluation. Due to difficulties in maintaining the drilling of the lateral in our target zone, the results from the well were inconclusive. We plan to drill a vertical well in Borden County to advance our evaluation of the acreage and provide additional information regarding the Mississippian interval.

Although the area has experienced a recent increase in drilling activity, the northern Midland Basin has had limited drilling activity compared with the southern Basin (where our current production is located), which significantly increases the risk associated with successful drilling activities in this area.

Offshore - Deepwater properties

Our net interest in the Medusa field, our remaining deepwater property, produced an average of 981 Boe per day during the six months ended June 30, 2013, approximately 88% being crude oil that receives pricing based on Mars crude. The Medusa platform was shut-in for 23 days during the second quarter of 2013 for planned construction activities on the West Delta 143 oil pipeline through which Medusa’s production is transported. Production from the platform was fully restored on June 27, 2013, and as of August 5, 2013 was producing approximately 1,100 Boe, net.

As previously announced in April 2013 and in furtherance of our strategy to accelerate development of our onshore properties, we retained an advisor to assist with the potential sale of the Medusa property.

Other – Shale Gas (Haynesville shale)

We own a 69% working interest in a 429 net acre unit in the Haynesville shale play in Bossier Parish, Louisiana. As of June 30, 2013, our Haynesville well was producing approximately 477 Mcf of natural gas per day. We currently have no drilling obligations related to this lease position.

Other – Gulf of Mexico shelf properties

During the six months ended June 30, 2013, these wells produced 152 MBoe, which accounted for 23% of our total production. We are in the process of plugging and abandoning our only remaining operated shelf property, Mobile Bay 908. Production from the East Cameron Block 257 field, which had been shut-in since November 2011, recommenced on May 9, 2013, and contributed an average of 232 Boe per day of production for the second quarter.

Liquidity and Capital Resources

Historically, our primary sources of funding have been cash flows from operations, borrowings from financial institutions, the sale of debt and equity securities and divestitures, such as the sale of our interest in the deepwater Habanero field.

Cash and cash equivalents of $13.4 million increased by $12.3 million at June 30, 2013 compared to $1.1 million at December 31, 2012. The increase is attributable to proceeds from the preferred stock offering previously discussed in Note 9 and summarized below. As of June 30, 2013, the Company’s liquidity position approximated $88.4 million inclusive of cash and cash equivalents and available borrowing capacity under our Credit facility.

On May 30, 2013, we issued $75.0 million of 10.0% Series A Cumulative Preferred Stock (the “Preferred Stock”) and received $70 million net proceeds after deducting the underwriting commissions and offering expenses. The first dividend date for the Preferred Stock was June 30, 2013, and these dividends were paid on July 1, 2013 in the amount of $0.7 million for the stub period beginning with the issuance on May 30, 2013 through the first dividend date.

As of June 30, 2013, our $200 million Credit Facility had an associated borrowing base of $75 million and a maturity of March 15, 2016. Amounts borrowed under the Credit Facility may not exceed a borrowing base, which is generally reviewed on a semi-annual basis and is then eligible for re-determination. The Credit Facility is secured by mortgages covering the Company’s major producing fields.


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

As of June 30, 2013, no balance was outstanding on the Credit Facility as a portion of the proceeds from the Preferred Stock offering was used to repay the balance then outstanding. The Credit Facility has an interest rate calculated as the London Interbank Offered Rate (“LIBOR”) plus a tiered rate ranging from 2.5% to 3.0%, which is based on utilization of the facility. In addition, the Credit Facility carries a commitment fee of 0.5% per annum on the unused portion of the borrowing base, which is payable quarterly.

On May 10, 2013, we entered into the second amendment to our Fourth Amended and Restated Credit Agreement dated as of June 20, 2012 to allow us to pay quarterly Senior Unsecured Debt and Preferred Equity Dividends (as defined in the Credit Facility) of $5.5 million per quarter, so long as we are not in default under the Credit Facility. The amendment became effective with the receipt of a minimum of $30.0 million of net cash proceeds from a preferred equity offering, which in turn was used to pay down the facility.

At June 30, 2013, we had approximately $97 million principal amount of 13% Senior Notes due 2016 outstanding with interest payable quarterly.

2013 capital expenditures

Our revised 2013 capital budget (excluding acquisitions) approximates $170 million and represents a 36% increase over the previous 2013 capital development budget estimate of $125 million. The increase relates to expenditures for additional development activities on our Midland Basin acreage. Approximately 90% of our budgeted operational expenditures (including drilling, completion and infrastructure) are allocated to our Midland Basin operations. Our budget includes further exploration and development of our Permian Basin properties with plans to complete approximately 31 gross wells including 22 horizontal wells and nine vertical wells. Components of the 2013 capital budget include (in millions):
Midland Basin
 
$
142

Gulf of Mexico
 
11

Total budgeted capital expenditures
 
$
153

 
 
 
Capitalized general and administrative costs
 
13

Capitalized interest and other
 
4

Total budgeted capitalized expenses
 
$
17

 
 
 
Total operational budget
 
170

 
 
 
Acquisition - Southern Midland Basin
 
11

Total capital expenditures
 
$
181

 
We believe that our cash on hand and the availability under our Credit Facility, combined with our expected operating cash flow based on current commodity prices and forecasted production, will be adequate to meet our forecasted capital expenditures, interest payments, and operating requirements for the remainder of 2013. Depending on economic conditions or the Company’s operational results, our capital budget may be adjusted up or down during the year.

The capital expenditures for the six months ended June 30, 2013 include the following (in millions):
Southern Midland Basin
 
$
43

Central Midland Basin
 
4

Northern Midland Basin
 
3

Total capital expenditures
 
$
50

 
 
 
Capitalized general and administrative costs
 
5

Capitalized interest and other
 
2

Total capitalized expenses
 
$
7

 
 
 
Total operational expenditures
 
57

 
 
 
Acquisition - Southern Midland Basin
 
11

Total capital expenditures
 
$
68



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Table of Contents
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Summary cash flow information is provided as follows:

Operating activities.  For the six months ended June 30, 2013, net cash provided by operating activities decreased $7.2 million to $20.2 million, from $27.4 million for the same period in 2012. The decrease relates primarily to a $9.4 million decrease in revenue stemming from a 12% decrease in equivalent production, which was partially offset by a 2% increase in price per equivalent unit produced and lower operating expenses, which were in line with our lower production. Realized prices and production volumes are discussed below within Results of Operations.

Investing activities.  For the six months ended June 30, 2013, net cash used in investing activities was $67.4 million as compared to $70.9 million for the same period in 2012. The $3.5 million decrease is primarily attributable to the $15 million acquisition of additional acreage in Borden County located in the northern portion of the Permian Basin during 2012 offset by the $11.0 million acreage acquisition highlighted above and discussed in Note 2.

Financing activities.  For the six months ended June 30, 2013, net cash provided by financing activities was $59.4 million compared to cash used in financing activities of $0.2 million during the same period of 2012. The $59.6 million increase relates primarily to the $70.1 million net proceeds from the previously discussed preferred stock offering reduced by cash used to repay amounts outstanding on our Credit Facility.



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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Results of Operations

The following table sets forth certain unaudited operating information with respect to the Company’s crude oil and natural gas operations for the periods indicated:
 
 
Three Months Ended June 30,
 
 
 
2013
 
2012
 
Change
 
% Change
 
Net production:
 
 
 
 
 
 
 
 
 
Crude oil (MBbls)
 
198

 
223

 
(25
)
 
(11
)%
*
Natural gas (MMcf)
 
787

 
902

 
(115
)
 
(13
)%
*
Total production (MBoe)
 
329

 
374

 
(45
)
 
(12
)%
 
Average daily production (MBoe)
 
3.6

 
4.1

 
(0.5
)
 
(12
)%
 
 
 
 
 
 
 
 
 
 
 
Average realized sales price (a):
 
 

 
 

 
 

 
 

 
Crude oil (Bbl)
 
$
96.27

 
$
98.78

 
$
(2.51
)
 
(3
)%
 
Natural gas (Mcf)
 
$
4.70

 
$
3.65

 
$
1.05

 
29
 %
 
Average realized sales price on an equivalent basis (Boe)
 
$
69.18

 
$
67.85

 
$
1.33

 
2
 %
 
 
 
 
 
 
 
 
 
 
 
Crude oil and natural gas revenues (in thousands):
 
 

 
 

 
 

 
 

 
Crude oil revenue
 
$
19,061

 
$
22,073

 
$
(3,012
)
 
(14
)%
 
Natural gas revenue
 
3,699

 
3,287

 
411

 
13
 %
 
Total
 
$
22,760

 
$
25,360

 
$
(2,600
)
 
(10
)%
 
 
 
 
 
 
 
 
 
 
 
Additional per Boe data:
 
 

 
 

 
 

 
 

 
Average realized sales price
 
$
69.18

 
$
67.85

 
$
1.33

 
2
 %
 
Lease operating expense
 
16.36

 
14.03

 
2.33

 
17
 %
 
Production taxes
 
2.09

 
1.54

 
0.55

 
36
 %
 
Operating margin
 
$
50.73

 
$
52.28

 
$
(1.55
)
 
(3
)%
 
 
 
 
 
 
 
 
 
 
 
Other expenses per Boe:
 
 

 
 

 
 

 
 

 
Depletion, depreciation and amortization
 
$
32.38

 
$
31.69

 
$
0.69

 
2
 %
 
General and administrative
 
13.81

 
11.70

 
2.11

 
18
 %
 
 
 
 
 
 
 
 
 
 
 
(a) Below is a reconciliation of the average NYMEX price to the average realized sales price:
 
 
 
 
 
 
 
 
 
 
 
Average NYMEX price per barrel ("Bbl") of crude oil
 
$
94.22

 
$
93.49